Filed Pursuant to Rule 424(b)(3)
File Number 333-69786
SUPPLEMENT DATED OCTOBER 14, 2005 TO
PROSPECTUS DATED APRIL 29, 2005 FOR
MODIFIED GUARANTEED ANNUITY CONTRACTS
ISSUED BY
GE LIFE AND ANNUITY ASSURANCE COMPANY
This supplement updates certain information contained in your prospectus.
Please read it and keep it with your prospectus for future reference.
The Company
The second paragraph of "The Company" provision is deleted and replaced with
the following:
Capital Brokerage Corporation serves as principal underwriter for the contracts
and is a broker/dealer registered with the SEC. GNA Corporation directly owns
the stock of Capital Brokerage Corporation. Genworth Financial, Inc. directly
owns GNA Corporation. General Electric Company owns approximately 27% of
Class A common stock shares of Genworth Financial, Inc. as of September 27,
2005. GE Asset Management Incorporated, the investment adviser to GE
Investments Funds, Inc., is also indirectly owned by General Electric Company
and, therefore, the Company, Capital Brokerage Corporation and GE Asset
management Incorporated are affiliated companies.
GE Life and Annuity Assurance Company
The entire "GE Life and Annuity Assurance Company" provision of your prospectus
is hereby deleted in their entirety and replaced with the following:
GE Life and Annuity Assurance Company
Overview
GE Life and Annuity Assurance Company (the "Company", "we", "us", or "our"
unless context otherwise requires) is a stock life insurance company operating
under a charter granted by the Commonwealth of Virginia on March 21, 1871 as
The Life Insurance Company of Virginia. General Electric Capital Corporation
("GE Capital"), an affiliate of the General Electric Company ("GE"), acquired
us from Aon Corporation on April 1, 1996. GE Capital subsequently contributed
us to its wholly owned subsidiary, GE Financial Assurance Holdings, Inc.,
("GEFAHI") and ultimately the majority of the outstanding common stock to
General Electric Capital Assurance Company ("GECA"). As part of an internal
reorganization of GEFAHI's insurance subsidiaries, the Harvest Life Insurance
Company ("Harvest") merged into us on January 1, 1999. At this time we were
renamed GE Life and Annuity Assurance Company. Harvest's former parent, Federal
Home Life Insurance Company ("Federal"), received our common stock in exchange
for its interest in Harvest.
On May 24, 2004, GEFAHI transferred substantially all of its assets to Genworth
Financial, Inc. ("Genworth"), including all of the outstanding capital stock of
GNA Corporation ("GNA"), our indirect parent and 800 shares of our common stock
that GEFAHI had held directly. As a result, we became an indirect, wholly-owned
subsidiary of Genworth. On May 25, 2004, Genworth's Class A common stock began
trading on The New York Stock Exchange. As of December 31, 2004, approximately
30% of Genworth's common stock was owned by public shareholders and GEFAHI
owned approximately 70% of Genworth's common stock.
On May 31, 2004, (1) Genworth contributed to GNA and GNA in turn contributed to
GECA 800 shares of our common stock and (2) Federal paid a dividend to GECA
consisting of 2,378 shares of our common stock. As a result of the foregoing
contribution and dividend, we became a direct, wholly-owned subsidiary of GECA
while remaining an indirect, wholly-owned subsidiary of Genworth.
GE, as a beneficial owner of Genworth, has stated that, subject to market
conditions, it expects to reduce its ownership in Genworth in an orderly manner
over the next two years as Genworth transitions to full independence.
On March 31, 2005 and September 27, 2005, GE completed respective secondary
offerings of Genworth's common stock. As of September 30, 2005, approximately
73% of Genworth's common stock was owned by public shareholders and
approximately 27% of Genworth's common stock was beneficially owned by GE.
We principally offer annuity contracts, guaranteed investment contracts
("GICs"), funding agreements, Medicare supplement insurance and life insurance
policies. We do business in the District of Columbia and all states, except New
York. Our principal offices are located at 6610 West Broad Street, Richmond,
Virginia 23230.
We are one of a number of subsidiaries of Genworth, a company that, through its
subsidiaries, provides consumers financial security solutions by selling a wide
variety of insurance, investment and retirement products, primarily in North
America. Our product offerings are divided along two segments of consumer
needs: (1) Retirement Income and Investments and (2) Protection.
. Retirement Income and Investments. We offer deferred annuities (variable
and fixed) and variable life insurance to a broad range of individual
consumers who want to accumulate tax-deferred assets for retirement,
desire a tax-efficient source of income and seek to protect against
outliving their assets. We also offer GICs and funding agreements as
investment products to qualified buyers.
. Protection. Our Protection segment includes universal life insurance,
interest-sensitive whole life insurance and Medicare supplement insurance.
Life insurance products provide protection against financial hardship
after the death of an insured by providing cash payment to the
beneficiaries of the policyholder. Medicare supplement insurance provides
coverage for Medicare-qualified expenses that are not covered by Medicare
because of applicable deductibles or maximum limits.
We also have a Corporate and Other segment, which consists primarily of net
realized investment gains, unallocated corporate income, expenses and income
taxes.
Market Environment and Opportunities
We believe we are well positioned to benefit from a number of significant
demographic, governmental and market trends, including the following:
. Aging U.S. population with growing retirement income needs. According to
the U.S. Social Security Administration in a report issued in 2004, from
1945 to 2003, U.S. life expectancy at birth increased from 62.9 years to
74.4 years for men and from 68.4 years to 79.5 years for women,
respectively, and life expectancy is expected to increase further. In
addition, increasing numbers of baby boomers are approaching retirement
age. Based on the 2000 census, the U.S. Census Bureau projects that the
percentage of the U.S. population aged 55 or older will increase from
approximately 22% (65 million) in 2004 to more than 29% (97 million) in
2020. These increases in life expectancy and the average age of the U.S.
population heighten the risk that individuals will outlive their
retirement savings. In addition, approximately $4.2 trillion of invested
financial assets are held by people within 10 years of retirement and
approximately $2.4 trillion of invested financial assets are held by
individuals who are under age 70 and consider themselves retired, in each
case according to a survey conducted by SRI Consulting Business
Intelligence in 2004. We believe these trends will lead to growing demand
for products, such as our income annuities and other investment products
that help consumers accumulate assets and provide reliable retirement
income.
. Growing lifestyle protection gap. The aging U.S. population and a number
of other factors are creating a significant lifestyle protection gap for a
growing number of individuals. This gap is the result of individuals not
having sufficient resources, including insurance coverage, to ensure that
their future assets and income will be adequate to support their desired
lifestyle. Other factors contributing to this gap include declining
individual savings rates, rising healthcare and nursing care costs, and a
shifting of the burden for funding protection needs from governments and
employers to individuals. For example, many companies have reduced
employer-paid benefits in recent years, and the Social Security
Administration projected in 2004 that the annual costs of Social Security
will exceed the program's tax revenue under current law in 2018, creating
the potential for both long-term benefit reductions from these traditional
sources and the need for individuals to identify alternative sources for
these benefits.
Competitive Strengths
We believe the following competitive strengths will enable us to capitalize on
opportunities in our targeted markets:
. Product innovation. We have a tradition of developing innovative
insurance products to serve the needs of our customers. We introduced the
Income Distribution Series of guaranteed income annuity product and riders
that provide the contractholder with a guaranteed minimum income stream
and an opportunity to participate in market appreciation. We are selective
in the products we offer and strive to maintain appropriate return and
risk thresholds when we expand the scope of our product offerings. We
believe our reputation for innovation and our variety of products enable
us to sustain strong relationships with our distributors. They also
position us to benefit from the current trend among distributors to reduce
the number of insurers with whom they
maintain relationships, while at the same time providing distributors
continued access to a variety of products.
. Extensive, multi-channel distribution network. We have extensive
distribution reach and offer consumers access to our products through a
broad network of financial intermediaries, independent producers and
dedicated sales specialists. In addition, we maintain strong relationships
with leading distributors by providing a high level of specialized and
differentiated distribution support, such as product training, advanced
marketing and sales solutions and technology solutions that support the
distributors' sales efforts.
. Technology-enhanced, scalable, low-cost operating platform. We have
pursued an aggressive approach to cost-management and continuous process
improvement. We employ an extensive array of cost management disciplines,
forming dedicated teams to identify opportunities for cost reductions and
the continuous improvement of business processes. This has enabled us to
reduce our recurring operating expenses and provide funds for new growth
and technology investments. We also have developed sophisticated
technology tools that enhance performance by automating key processes and
reducing response times and process variations. These tools also make it
easier for our customers and distributors to do business with us. Through
an outsourcing provider that is 40% owned by GE, we also have a
substantial team of professionals in India who provide us with a variety
of support services.
. Disciplined risk management with strong compliance practices. Risk
management and regulatory compliance are critical parts of our business,
and we believe we are recognized in the insurance industry for our
excellence in these areas. We employ comprehensive risk management
processes in virtually every aspect of our operations, including product
development, underwriting, investment management, asset-liability
management and technology development programs. We have an experienced
group of professionals dedicated exclusively to our risk management
processes. We believe our disciplined risk management processes have
enabled us to avoid a number of the pricing and product design pitfalls
that have affected other participants in the insurance industry. For
example, we have not offered a traditional guaranteed minimum income
benefit with our variable annuities as offered by many of our competitors
because we concluded the exposures inherent in these benefits exceed our
permissible risk tolerance. We take a similar disciplined approach to
legal and regulatory compliance. Throughout our company we instill a
strong commitment to integrity in business dealings and compliance with
applicable laws and regulations.
. Strong balance sheet and high-quality investment portfolio. As part of
Genworth, we believe our ratings and capital strength provide us with a
significant competitive advantage. We have a diversified, high-quality
investment portfolio with $8,850.6 million of invested assets, as of
December 31, 2004. Approximately 91.2% of our fixed maturities had ratings
equivalent to investment-grade, and less than 1.0% of our total investment
portfolio consisted of equity securities, as of December 31, 2004. We also
actively manage the relationship between our investment assets and our
insurance liabilities. Our prudent approach to managing our balance sheet
reflects our commitment to maintaining financial strength.
Growth Strategies
Our objective is to increase operating earnings and enhance returns on equity.
We intend to pursue this objective by focusing on the following strategies:
. Capitalize on attractive growth trends in our key markets. We have
positioned our product portfolio and distribution relationships to
capitalize on the attractive growth prospects in our key markets:
Retirement income, where we believe growth will be driven by a
variety of favorable demographic trends and the approximately $4.2
trillion of invested financial assets in the U.S. that are held by
people within 10 years of retirement and approximately $2.4 trillion
of invested assets that are held by individuals who are under age 70
and consider themselves retired, in each case according to a survey
conducted by SRI Consulting Business Intelligence in 2004. Our Income
Distribution Series of products are designed to enable the growing
retired population to convert their accumulated assets into reliable
income that they cannot outlive.
Funding-Agreement Backed Notes ("FA -BNs") in both unregistered and
registered platforms, where the total FA-BN market has grown from
$20.3 billion in 2000 issuance to $37.6 billion in 2004 issuance
according to Standard and Poor's Rating Services ("S&P"). The latest
development has been issuing these through an SEC registered
platform, the first of which was launched in late 2003. Genworth's
Retirement Income and Investments segment began issuing in the
unregistered market in 2001 and has placed $5.8 billion through 2004,
$685.0 million of which was issued through the Company. We expect to
introduce our registered platform late in 2005 targeting
institutional investors. In 2006, we will explore introducing a
retail notes platform whereby retail investors can purchase amounts
in denominations of $1,000. The demand for strong credit ratings and
diversity of issuer base should support growth for us in this market
space.
. Further strengthen and extend our distribution channels. We intend to
further strengthen and extend our distribution channels by continuing to
differentiate ourselves in areas where we believe we have distinct
competitive advantages. These areas include:
Product innovations, as evidenced by new product introductions, such
as the introduction of our Income Distribution Series of product and
riders that provide guaranteed income for life with potential for
market upside while mitigating some of the risks associated with
income guarantees via patent pending product design features. We have
also continued to add new design features to our income product and
riders to more closely match the needs of specific populations such
as liquidity and payment options.
Collaborative approach to key distributors, which includes our
tailored approach to our sales intermediaries addressing their unique
service needs and benefiting our distributors and deepening our
relationships with them. We have also added extensively to our
wholesaling network with approximately 180 internal and external
wholesalers focused on educating distributors on the rapidly emerging
need for guaranteed income as of December 31, 2004.
. Enhance returns on capital and increase margins. We believe we will be
able to enhance our returns on capital and increase our margins through
the following means:
Adding new business layers at targeted returns and optimizing mix. We
have introduced revised pricing and new products, which we believe
will increase our expected returns. We have exited or placed in
run-off certain product lines in blocks of business with low returns,
including, for example, our older GICs. As these blocks decrease, we
expect to release capital over time to deploy to higher-return
products and/or businesses.
Investment income enhancements. The yield on our investment portfolio
is affected by the practice, prior to Genworth's separation from GE,
of realizing investment gains through the sale of appreciated
securities and other assets during a period of historically low
interest rates. This strategy had been pursued to offset impairments
in our investment portfolio, fund consolidations and restructurings
in our business and provide current income. Subsequent to Genworth's
separation from GE, our investment strategy is to optimize investment
income without relying on realized investment gains. Although the
interest-rate environment since Genworth's separation from GE in
mid-2004 has been challenging, we expect over time that the yield on
our investment portfolio will stabilize, with the potential for yield
increases in a rising interest rate environment. We also will seek to
improve our investment yield by continuously evaluating our asset
class mix, pursuing additional investment classes and accepting
additional credit risk when we believe that it is prudent to do so.
Ongoing operating cost reductions and efficiencies. We continually
focus on reducing our cost base while maintaining strong service
levels for our customers. We expect to accomplish this goal through a
wide range of cost management disciplines, including, reducing
supplier costs, leveraging process improvement efforts, forming
focused teams to identify opportunities for cost reductions and
investing in new technology, particularly for web-based, digital
end-to-end processes.
Retirement Income and Investments
Overview
Through our Retirement Income and Investments segment, we offer fixed and
variable deferred annuities and income annuities. We offer these products to a
broad range of consumers who want to accumulate tax-deferred assets for
retirement, desire a reliable source of income during their retirement, and/or
seek to protect against outliving their assets during retirement. According to
VARDS, we were the largest provider of variable income annuities in the U.S.
for the year ended December 31, 2004, based upon total premiums and deposits.
According to LIMRA International, sales of individual annuities were $220
billion and $219 billion in 2002 and 2003, the last years for which industry
data regarding aggregate sales of individual annuities is available. We believe
aggregate sales of individual annuities in 2004 remained nearly constant from
2003 and 2002 levels for two reasons. First, the low interest rates that
persisted throughout 2003 and 2004 resulted in low crediting rates and limited
market demand for certain annuities. Second,
continued volatility in the equity markets caused potential purchasers to
refrain from purchasing products, such as variable annuities and variable life
insurance, that have returns linked to the performance of the equity markets.
We believe that higher interest rates and greater stability in equity markets
will result in increased demand for annuities and other investment products
that help consumers accumulate assets and provide reliable retirement income.
We offer variable and fixed deferred annuities, in which assets accumulate
until the contract is surrendered, the contractholder dies or the
contractholder begins receiving benefits under an annuity payout option. We
also offer variable income annuities. We believe our variable annuity offerings
continue to appeal to contractholders who wish to participate in returns linked
to equity and bond markets. We also offer variable life insurance through our
Retirement Income and Investments segment because this product provides
investment features that are similar to our variable annuity products.
In addition to our annuity and variable life insurance products, we offer a
number of specialty products, including GICs and funding agreements. We sell
GICs to ERISA-qualified plans, such as pension and 401(k) plans, and we sell
funding agreements to money market funds that are not ERISA qualified and to
other institutional investors.
We develop our annuity products through a rigorous pricing and product
development process designed to achieve targeted returns based upon each
product's risk profile and our expected rate of investment returns. We compete
for sales of annuities through competitive pricing policies and innovative
product design. For example, in 2004, we introduced the Income Distribution
Series of guaranteed income annuity product and riders that provide a
guaranteed minimum income stream with an opportunity for the contractholder to
participate in market appreciation but reduce some of the risks to insurers
that generally accompany traditional products with guaranteed minimum income
benefits.
We offer our annuities and other investment products primarily through
financial institutions and specialized brokers, as well as independent
accountants and independent advisers associated with Genworth's captive broker
dealer. We provide extensive training and support to our distributors through a
wholesaling sales force that specializes in retirement income needs.
The following table sets forth selected financial information regarding the
products we offer through our Retirement Income and Investments segment as of
the dates and for the periods indicated:
As of for the Years Ended
December 31,
--------------------------------
(Dollar amounts in millions) 2004 2003 2002
- -------------------------------------------------------------------------------------------------------
Fee-Based Products
- -------------------------------------------------------------------------------------------------------
Variable annuities
Account value, net of reinsurance, beginning of period $ 10,455.1 $ 8,891.9 $10,058.8
Deposits 766.9 1,822.6 1,595.2
Market Performance 70.3 1,254.9 (1,136.3)
Surrenders, benefits and product charges (35.4) (1,514.3) (1,625.8)
Reinsurance transfer/1/ (10,253.0) -- --
---------- --------- ---------
Account value, net of reinsurance, end of period $ 1,003.9 $10,455.1 $ 8,891.9
Variable life
Account value, net of reinsurance, beginning of period $ 313.2 $ 255.9 $ 283.5
Deposits 38.9 45.3 47.5
Market Performance 41.4 42.4 (31.5)
Surrenders, benefits and product charges (49.5) (30.4) (43.6)
---------- --------- ---------
Account value, net of reinsurance, end of period $ 344.0 $ 313.2 $ 255.9
Total fee-based products account value, end of period $ 1,347.9 $10,768.3 $ 9,147.8
Spread-Based Institutional Products
- -------------------------------------------------------------------------------------------------------
GICs and funding agreements
Account value, net of reinsurance, beginning of period $ 4,051.8 $ 5,263.3 $ 5,960.1
Deposits 460.1 869.2 1,239.7
Interest credited 144.5 177.8 230.2
Surrenders, benefits and product charges (989.1) (2,258.5) (2,166.7)
---------- --------- ---------
Account value, net of reinsurance, end of period $ 3,667.3 $ 4,051.8 $ 5,263.3
Spread-Based Retail Products
- -------------------------------------------------------------------------------------------------------
Fixed annuities
Account value, net of reinsurance, beginning of period $ 939.3 $ 1,026.6 $ 1,118.2
Deposits 8.9 5.7 59.3
Interest credited 39.0 42.2 46.7
Surrenders, benefits and product charges (133.8) (135.2) (197.6)
---------- --------- ---------
Account value, net of reinsurance, end of period $ 853.4 $ 939.3 $ 1,026.6
Single Premium Income Annuities
Account value, net of reinsurance, beginning of period $ 78.6 $ 83.9 $ 89.5
Deposits 10.3 8.2 5.7
Interest credited 5.7 3.8 8.1
Surrenders, benefits and product charges (15.8) (17.3) (19.4)
---------- --------- ---------
Account value, net of reinsurance, end of period $ 78.8 $ 78.6 $ 83.9
Structured Settlements
Account value, net of reinsurance, beginning of period $ 181.3 $ 184.2 $ 184.8
Deposits -- -- --
Interest credited -- 13.1 13.2
Surrenders, benefits and product charges 0.2 (16.0) (13.8)
Reinsurance transfer/1/ (181.5) -- --
---------- --------- ---------
Account value, net of reinsurance, end of period $ -- $ 181.3 $ 184.2
Total spread-based retail products, net of reinsurance, end of period $ 932.2 $ 1,199.2 $ 1,294.7
- -------------------------------------------------------------------------------------------------------
/1/ We ceded to Union Fidelity Life Insurance Company ("UFLIC"), effective as
of January 1, 2004, all of our in-force structured settlement contracts and
substantially all of our in-force variable annuity contracts.
Products
Variable annuities
We offer variable annuities that allow the contractholder to make payments into
a guaranteed interest-rate account and separate accounts that invest in
available underlying mutual funds, with allocations determined by the
contractholder. A deferred variable annuity has an accumulation period and a
payout period. Our variable annuity products allow the contractholder to
allocate all or a portion of his account value to separate accounts that invest
in investment accounts that are distinct from our general account. Assets
allocated to each separate account track the performance of available
underlying mutual funds. There is no guaranteed minimum rate of return in these
subaccounts which invest in these underlying mutual funds, and the
contractholder bears the entire risk associated with the performance of these
subaccounts. Some of our variable annuities also permit the contractholder to
allocate a portion of his account value to our general account, in which case
we credit interest at specified rates, subject to certain guaranteed minimums,
which are comparable to the minimum rates in effect for our fixed annuities.
Our variable annuity contracts permit the contractholder to withdraw all or
part of the premiums paid, plus the amount credited to his account, subject to
surrender charges, if any. The cash surrender value of a variable annuity
contract depends upon the value of the assets that have been allocated to the
contract, how long those assets have been in the contract and the investment
performance of the mutual funds to which the contractholder has allocated
assets.
Variable annuities provide us with fee-based revenue in the form of expense
charges and, in some cases, mortality charges. These fees equal a percentage of
the contractholder's assets in the separate account and typically range from
1.2% to 1.7% per annum. We also receive fees charged on assets allocated to our
separate account to cover administrative costs.
We also offer variable annuities with fixed account options and with bonus
features. Variable annuities with fixed account options enable the
contractholder to allocate a portion of his account value to the fixed account,
which pays a fixed interest crediting rate. New deposits to the fixed account
within the variable annuity are limited to 25% of the total deposit. The
portion of the account value allocated to the fixed account option represents
general account liability for us and functions similarly to a traditional fixed
annuity, whereas for the portion allocated to the separate account, the
contractholder bears the investment risk. Our variable annuities with bonus
features entitle the contractholder to an additional increase to his account
value upon making a deposit. However, variable annuities with bonus features
are subject to different surrender charge schedules and expense charges than
variable annuities without the bonus feature.
Our variable annuity contracts provide for a guaranteed minimum death benefit,
or GMDB, which provides a minimum account value to be paid upon the annuitant's
death. Our contractholders also have the option to purchase, at an additional
charge, a GMDB rider that provides for an enhanced death benefit. Assuming
every annuitant died on December 31, 2004, as of that date, contracts with GMDB
features not covered by reinsurance had an account value of $992.7 million and
a related death benefit exposure of $0.9 million net amount at risk. In May
2003, we raised prices of, and reduced certain benefits under, our newly issued
GMDBs. We continue to evaluate our pricing and hedging of GMDB
features and intend to change prices if appropriate. In addition, in July 2004,
we introduced a variable annuity product with a guaranteed minimum withdrawal
benefit, or GMWB. This product provides a guaranteed annual withdrawal of a
fixed portion of the initial deposit over a fixed period of time but requires a
balanced asset allocation of the customer's separate account deposit.
We continually review potential new variable annuity products and pursue only
those where we believe we can achieve targeted returns in light of the risks
involved. Unlike several of our competitors, we have not offered variable
annuity products with traditional guaranteed minimum income benefits, or GMIBs,
or with guaranteed minimum accumulation benefits, or GMABs. Traditional GMIB
products guarantee a specified minimum appreciation rate for a defined period
of time, after which annuity payments commence. GMAB products guarantee a
customer's account value will be no less than the original investment at the
end of a specified accumulation period, plus a specified interest rate.
Although we do not offer traditional GMIBs or GMABs, we have been able to
capitalize on the demand for products with guarantees with our GE Retirement
Answer(R), or GERA/(TM)/. GERA/(TM) /is a variable deferred annuity that has a
minimum 10-year scheduled deposit period for customers who desire guaranteed
minimum income streams at the end of an accumulation period. The income stream
may exceed the guaranteed minimum based upon the performance of the mutual fund
underlying the separate account. As of December 31, 2004, our sales as measured
by collected scheduled periodic deposits and future scheduled periodic deposits
for this product totaled $1.2 billion since its inception in April 2002. Based
on key product design features, some of which have patents pending which have
been assigned to Genworth, we believe GERA/(TM) /allows us to provide our
customers a guaranteed income annuity product that mitigates a number of the
risks that accompany traditional guaranteed minimum income benefits offered by
many of our competitors.
GERA/(TM) /is a component of our Income Distribution Series of variable annuity
product and riders. The Income Distribution Series also includes the GE
Guaranteed Income Advantage, or GIA, and the GE Principal Protection Advantage,
or PPA. The GIA is a rider to several of our variable annuity products that
provides retirement benefits similar to the GERA/(TM) /but requires
contractholders to allocate assets among a group of available investment
options. Whereas the GERA/(TM) /and the GIA require a minimum ten-year
accumulation period, the PPA is designed for purchasers nearing retirement and
requires only a three-year accumulation period before annuitization.
Variable life insurance
We offer variable life insurance products that provide insurance coverage
through a policy that gives the policyholder flexibility in investment choices
and, in some products, in premium payments and coverage amounts. Our variable
life products allow the policyholder to allocate all or a portion of his
premiums to separate accounts that invest in investment accounts that are
distinct from our general account. Assets allocated to each separate account
track the performance of available underlying mutual funds. There is no
guaranteed minimum rate of return in these subaccounts, which invest in these
underlying mutual funds, and the policyholder bears the entire investment risk
associated with the performance of the subaccounts. Some of our variable life
insurance products also permit the policyholder to allocate all or a portion of
his account value to our general account, in which case we credit interest at
specified rates, subject to certain guaranteed minimums, which are comparable
to the minimum rates in effect for our fixed annuities.
Similar to our variable annuity products, we collect specified mortality and
expense charges and fees charged on assets allocated to the separate account to
cover administrative services and costs. We also collect cost of insurance
charges on our variable life insurance products to compensate us for the
mortality risk of the guaranteed death benefit, particularly in the early years
of the policy when the death benefit is significantly higher than the value of
the policyholder's account.
Guaranteed investment contracts and funding agreements
We offer GICs and funding agreements, which are deposit-type products that pay
a guaranteed return to the contractholder on specified dates. GICs are
purchased by ERISA qualified plans, including pension and 401(k) plans. Funding
agreements are purchased by institutional accredited investors for various
kinds of funds and accounts that are not ERISA qualified. Purchasers of funding
agreements include money market funds, bank common trust funds and other
corporate and trust accounts and private investors in the U.S. and other
countries.
Substantially all our GICs allow for the payment of benefits at contract value
to ERISA plans prior to contract maturity in the event of death, disability,
retirement or change in investment election. We carefully underwrite these
risks before issuing a GIC to a plan and historically have been able to
effectively manage our exposure to these benefit payments. Our GICs typically
credit interest at a fixed interest rate and have a fixed maturity generally
ranging from two to six years.
Our funding agreements generally credit interest on deposits at a floating rate
tied to an external market index. To hedge our exposure to fluctuations in
interest rates, we invest the proceeds backing floating-rate funding agreements
in floating-rate assets. Some of our funding agreements are purchased by money
market funds, bank common trust funds and other short-term investors. These
funding agreements typically are renewed annually, and generally contain "put"
provisions, through which the contractholder has an option to terminate the
funding agreement for any reason after giving notice within the contract's
specified notice period, which is generally 90 days. As of December 31, 2004,
we had an aggregate of $1,108.0 million of floating-rate funding agreements
outstanding, compared to $1,186.9 million as of December 31, 2003. Of the
$1,108.0 million aggregate amount outstanding as of December 31, 2004, $458.0
million had put option features, none of which were less than 90 days. GE
Capital has guaranteed certain obligations under floating-rate funding
agreements with a final maturity on or before June 30, 2005. This guarantee
covers our obligations to contractholders and requires us to reimburse GE
Capital for any payments made to contractholders under the guarantee. As of
December 31, 2004, GE Capital's guarantee covered $858.0 million of outstanding
floating-rate funding agreements.
We also issue funding agreements to trust accounts to back medium-term notes
purchased by investors. These contracts typically are issued for terms of one
to seven years. As of December 31, 2004 and 2003, we had an aggregate of $435.0
million of these funding agreements. These funding agreements did not permit
early termination.
Fixed annuities
We have a closed block of single premium deferred annuities ("SPDAs"). In
addition, we offer two fixed annuity products in the form of modified
guaranteed annuity contracts. These contracts provide for a
single premium to be allocated to a guaranteed term option for one or more
guaranteed terms ranging from 1 to 10 years in duration. During the
accumulation period, the portion of the single premium payment allocated to any
guaranteed term will earn a pre-declared guaranteed rate of interest for that
term. However, if the contractholder surrenders or annuitizes the contract,
withdraws or transfers any portion of assets prior to the end of the guaranteed
term, we will apply a market value adjustment to the proceeds and we may assess
a surrender charge. The market value adjustment may result in a positive,
negative or zero change in value depending on interest rates in effect at the
time the market value adjustment is applied. For example, if interest rates are
rising, generally the contractholder will bear the risk that the market value
adjustment will be negative, causing a reduction in the amount available for
surrender. However, if interest rates are falling, generally, the
contractholder will receive a positive market value adjustment, providing an
increase in value when surrendering the contract. If there is no change in
interest rates at the time of the market value adjustment, generally, the
market value adjustment will have no impact on contract value. Approximately
$178.3 million, or 20.9% of the total account value of our fixed annuities as
of December 31, 2004, were subject to surrender charges.
At least once each month, we set an interest crediting rate for newly issued
fixed SPDAs and additional deposits. We maintain the initial crediting rate for
a minimum period of one year or the guarantee period, whichever is longer.
Thereafter, we may adjust the crediting rate no more frequently than once per
year for any given deposit. Our modified guaranteed annuity contracts have a
minimum guaranteed crediting rate of 3.0%.
Our earnings from fixed annuities are based upon the spread between the
crediting rate on our fixed annuity contracts and the returns we earn on our
investment of premiums in our general account.
Income annuities
We offer variable income annuities, which provide for an accumulation period,
followed by a guaranteed minimum income stream for the life of the annuitant,
with the possibility of additional income depending upon underlying investment
account performance.
We anticipate higher sales of income annuities with the demographic shift
toward more people reaching retirement age and focusing on their need for
dependable retirement income.
Structured settlements
Structured settlement contracts provide an alternative to a lump sum
settlement, generally in a personal injury lawsuit or worker's compensation
claim, and typically are purchased by property and casualty insurance companies
for the benefit of an injured claimant. The structured settlements provide
scheduled payments over a fixed period or, in the case of a life-contingent
structured settlement, for the life of the claimant with a guaranteed minimum
period of payments. Structured settlement contracts also may provide for
irregularly scheduled payments to coincide with anticipated medical or other
claimant needs. These settlements offer tax-advantaged, long-range financial
security to the injured party and facilitate claim settlement for the property
and casualty insurance carrier. Structured settlement contracts are long-term
in nature, guarantee a fixed benefit stream and generally do not permit
surrender or borrowing against the amounts outstanding under the contract.
In the second quarter 2004, we entered into reinsurance transactions in which
we ceded, effective January 1, 2004, all of our inforce structured settlements
business to UFLIC.
Underwriting and pricing
We generally do not underwrite individual lives in our annuity products.
Instead, we price our products based upon our expected investment returns and
our expectations for mortality, longevity and persistency for the group of our
contractholders as a whole, taking into account mortality improvements in the
general population and our historical experience. We price deferred annuities
by analyzing longevity and persistency risk, volatility of expected earnings on
our assets under management, and the expected time to retirement. We price our
GICs using customized pricing models that estimate both expected cash flows and
likely variance from those expectations caused by reallocations of assets by
plan participants.
Underwriting for our variable life insurance policies involves a determination
of the type and amount of risk that we are willing to accept. Our underwriters
evaluate each policy application on the basis of the information provided by
the applicant and others. We follow detailed and uniform underwriting practices
and procedures designed to properly assess and quantify risks before issuing
coverage to qualified applicants. The long-term profitability of our products
is affected by the degree to which future experience deviates from these
assumptions.
Competition
We face significant competition in all our Retirement Income and Investments
businesses. Many other companies actively compete for sales in our markets,
including other major insurers, banks, other financial institutions, mutual
fund and money asset management firms and specialty providers. In many of our
product lines, we face competition from competitors that have greater market
share or breadth of distribution, offer a broader range of products, services
or features, assume a greater level of risk, have lower profitability
expectations or have higher claims paying ratings than we do. Many competitors
offer similar products and use similar distribution channels. The substantial
expansion of banks' and insurance companies' distribution capacities and
expansion of product features in recent years has intensified pressure on
margins and production levels and has increased the level of competition in
many of our business lines.
We believe competition in our Retirement Income and Investments businesses is
based on several factors, including product features, customer service, brand
reputation, penetration of key distribution channels, breadth of product
offering, product innovations and price.
Protection
Overview
Through our Protection segment, we offer life insurance which includes
universal life insurance and interest-sensitive whole life insurance and
accident and health insurance which includes Medicare supplement insurance.
Products
Life Insurance
Our life insurance products provide protection for the entire life of the
insured and allow for cash value accumulation. These products include
interest-sensitive whole life ("ISWL") and universal life insurance ("UL"). Our
life insurance policies provide a death benefit payable upon death of the
insured. Owners of life insurance pay premiums that are applied to their
account value, net of any expense charges. We deduct cost of insurance charges,
which vary by age, gender, plan, and class of insurance from the account value.
We determine our cost of insurance each year in advance, which is subject to a
maximum stated in each policy. The owner may access their account value through
policy loans, partial withdrawals, or full surrender of the policy. Some
withdrawals and surrenders are subject to surrender charges. Our premiums and
deposits collected on life insurance in-force for the years ended December 31,
2004, 2003, and 2002 were $143.7 million, $164.5 million, and $163.1 million,
respectively.
We credit the policyholder account value for ISWL and UL policies with interest
at an interest rate we determine in advance and generally guarantee for a
policy year at a time. Policies have a minimum credited interest rate, which
varies by policy and ranges from 4.0% to 6.0%. ISWL and UL differ in two major
ways. ISWL requires the contractholder to pay a fixed premium we determine each
year, while UL allows a contractholder to determine the amount of premium to be
paid, subject to certain minimum and maximum values. Also, the ISWL death
benefit is fixed at issue, while the contractholder may decrease and (subject
to evidence of good health) increase the death benefit on a UL policy.
Our UL policies provide policyholders with lifetime death benefit coverage, the
ability to accumulate assets on a flexible, tax-deferred basis, and the option
to access the cash value of the policy through a policy loan, partial
withdrawal or full surrender. Our UL products allow policyholders to adjust the
timing and amount of premium payments. We credit premiums paid, less certain
expenses, to the policyholder's account and from that account deduct regular
expense charges and certain risk charges, known as cost of insurance, which
generally increase from year to year as the insured ages. Our UL policies
accumulate cash value that we pay to the insured when the policy lapses or is
surrendered. Most of our UL policies also include provisions for surrender
charges for early termination and partial withdrawals. As of December 31, 2004,
60.8% of our in-force block of universal life insurance was subject to
surrender charges. We also sell joint, second-to-die policies that are
typically used for estate planning purposes. These policies insure two lives
rather than one, with the policy proceeds paid after the death of both insured
individuals.
Accident and Health Insurance
The primary product in this line is Medicare supplement insurance. Our Medicare
supplement insurance provides coverage for Medicare-qualified expenses that are
not covered by Medicare because of applicable deductible or maximum limits.
These products are sold to individuals through dedicated sales specialists.
Competition
We face significant competition in all our Protection segment operations. Our
competitors include other large and highly rated insurance carriers. Some of
these competitors have greater resources than we do, and many of them offer
similar products and use similar distribution channels.
Corporate and Other
We also have a Corporate and Other segment, which consists primarily of net
realized investment gains and unallocated corporate income, expenses and income
taxes.
Distribution
We distribute our products through an extensive and diversified distribution
network that is balanced between independent sales intermediaries, including
financial intermediaries and independent producers, and dedicated sales
specialists. We believe this access to a variety of distribution channels
enables us to respond effectively to changing consumer needs and distribution
trends. We compete with other financial institutions to attract and retain
commercial relationships in each of these channels, and our success in
competing for sales through these sales intermediaries depends upon factors
such as the amount of sales commissions and fees we pay, the breadth of our
product offerings, the strength of our brand, our perceived stability and our
financial strength ratings, the marketing and services we provide to them and
the strength of the relationships we maintain with individuals at those firms.
We have strategically positioned our multi-channel distribution network to
capture a broad share of the distributor and consumer markets and to
accommodate different consumer preferences in how to purchase insurance and
financial services products.
Retirement Income and Investments and Protection segments
Our Retirement Income and Investments and Protection segments both distribute
their products through the following channels:
. financial intermediaries, including banks, securities brokerage firms, and
independent broker/dealers;
. independent producers, including brokerage general agencies, or BGAs,
affluent market producer groups and specialized brokers; and
. dedicated sales specialists, including affiliated networks of both
accountants and personal financial advisers.
The following table sets forth our annualized first-year premiums and deposits
for the products in our Retirement Income and Investments and Protection
segments, categorized by each of our distribution channels.
Annualized First- Year Ended December 31, 2004 Year Ended December 31, 2003
Year Premiums ----------------------------------------------- -----------------------------------------------
and Deposits/1/ Dedicated Dedicated
(Dollar amounts Financial Independent Sales Financial Independent Sales
in millions) Intermediaries Producers Specialists Total Intermediaries Producers Specialists Total
- - -----------------------------------------------------------------------------------------------
Retirement Income
and Investments $932.3 $170.6 $43.9 $1,146.8 $1,663.1 $565.2 $92.6 $2,320.9
Protection -- 0.1 10.6 10.7 -- 0.3 8.8 9.1
- -----------------------------------------------------------------------------------------------------------------
/1/ Annualized first-year premiums and deposits reflect the amount of business
we generated during a specified period. We consider annualized first-year
premiums and deposits to be a measure of our operating performance because
they represent a measure of new sales of insurance policies and additional
investments by our customers during a specified period, rather than a
measure of our revenues or profitability during that period.
Financial intermediaries
We have selling agreements with various financial intermediaries in the U.S.,
including banks, securities brokerage firms and independent broker/dealers. We
use financial intermediaries to distribute a significant portion of our
deferred and income annuities and other investment products. They also
distribute a small portion of our life insurance policies to their individual
clients. We have wholesalers who are our employees and who work to develop
sales relationships with new financial intermediaries and to expand sales with
existing financial intermediaries. Approximately 11.9% of our variable annuity
product sales in 2004 were through one national bank. However, we do not
believe that the loss of such business would have a long-term adverse effect on
our business and operations due to our competitive position in the marketplace
and the availability of business from other distributors.
Independent producers
Brokerage general agencies. We distribute most of our products, including life
insurance and annuities through independent BGAs located throughout the U.S.
BGAs market our products, and those of other insurance companies, through a
network of independent brokers who sell our products.
Affluent market producer groups. Through strong relationships with several
industry-leading affluent market producer groups, we have access to producers
who sell our products. These groups target high-net-worth individuals, which we
define to include households with at least $1 million of liquid assets. We
distribute annuity products through these groups.
Specialized brokers. We distribute certain products through brokers that
specialize in a particular insurance or investment product and deliver
customized service and support to their clients. We distribute GICs and funding
agreements through a group of approximately 35 specialized brokers and
investment managers as of December 31, 2004.
Dedicated sales specialists. We have dedicated sales specialists who sell our
Medicare supplement insurance product and other products of our affiliated
insurers on a select basis.
Marketing
As part of Genworth, we promote and differentiate our products and services
through a variety of offerings, technology services, specialized support for
our distributors and innovative marketing programs tailored to particular
consumer groups.
In 2002, we introduced GERA/TM /which became the foundation for our Income
Distribution Series. Our Income and Distribution Series product and riders
provide contractholders a lifetime income payout after an accumulation period
of defined duration. These product and riders provide the opportunity for the
contractholder to participate in the equity upside of the underlying accounts
over the life of the annuitant while product design features, some of which
have patents pending, mitigate risk to us. Marketing of these products is
supported by internal and external wholesalers who help distributors understand
each product's and rider's features. In addition, we also hold "Income Summits"
throughout the country, educating distributors on the need for guaranteed
income during one's retirement years as part of a sound overall financial plan.
We believe education of our distributors and potential contractholders is key
to our success in marketing these products as they move from accumulation of
assets to the "spend-down" or distribution of assets.
Since the completion of the Genworth Initial Public Offering ("IPO"), Genworth
has customized its marketing approach to promote its new brand to key
constituencies, including sales intermediaries, employees, investors and
consumers. These programs include advertising on television shows and in trade
and business periodicals that are likely to reach those demographic groups. We
also seek to build recognition of the Genworth brand and maintain strong
relationships with leading distributors by providing a high level of
specialized and differentiated distribution support, such as product training,
advanced marketing and sales solutions, financial product design for affluent
customers and technology solutions that support the distributors' sales efforts
and by pursuing joint business improvement efforts. In addition, we sponsor
various advisory councils with independent sales intermediaries and dedicated
sales specialists to gather their feedback on industry trends, new product
suggestions and ways to enhance our relationships.
In order to further meet the needs of our sales intermediaries, we also market
the Genworth brand and our products to key consumer groups through targeted
marketing programs. For example, Genworth sponsors the Genworth Center for
Financial Learning, which provides a website to promote financial literacy. We
believe the website contributes to the recognition of our products and services
and generates loyalty among independent sales intermediaries and consumers.
Our branding strategy is to establish the new Genworth brand expeditiously
while we continue to use the GE brand name and logo with customers. We have
begun to transition some of our marketing and distribution activities to
replace the GE brand name and monogram with our Genworth brand and logo. At the
same time, we continue to use the GE brand name and monogram in marketing and
distribution activities that we will replace with the Genworth brand in the
future. Pursuant to a transitional trademark license agreement, GE granted us
the right to use the "GE" mark and the "GE" monogram for up to five years
following the Genworth IPO in connection with our products and services.
Risk Management
Overview
Risk management is a critical part of our business and we have adopted rigorous
risk management processes in virtually every aspect of our operations,
including product development, underwriting, investment management,
asset-liability management and technology development projects. The primary
objective of these risk management processes is to reduce the variations we
experience from our expected results. We have an experienced group of
professionals, including actuaries, statisticians and other specialists,
dedicated exclusively to our risk management process. We believe we have
benefited from the sophisticated risk management techniques that GE applies
throughout its businesses, and we have emphasized our adherence to those
techniques as a competitive advantage in marketing and managing our products.
New product introductions
Our risk management process begins with the development and introduction of new
products and services. We have established a rigorous product development
process that specifies a series of required analyses, reviews and approvals for
any new product. This process includes a review of the market opportunity and
competitive landscape for each proposed product, major pricing assumptions and
methodologies, return expectations, reinsurance strategies, underwriting
criteria and business risks and potential mitigating factors. Before we
introduce a new product in the market, we establish a monitoring program with
specific performance targets and leading indicators, which we monitor
frequently to identify any deviations from expected performance so that we can
take prompt corrective action when necessary. Significant product introductions
require approval by our senior management team. We use a similarly rigorous
process to introduce variations to existing products and to introduce existing
products through new distribution channels.
Product performance reviews
We have Risk Committees at the Retirement Income and Investments and Protection
segment levels. We also utilize Genworth's Risk Committee which includes the
following executives of Genworth: President and Chief Executive Officer, Chief
Risk Officer, Chief Financial Officer, Chief Investment Officer, Chief Actuary,
and the Presidents of our operating segments. This risk committee process
requires reviews of each of the products in all operating segments on a regular
cycle, typically approximately twice per year. These reviews include an
analysis of the major drivers of profitability, underwriting performance,
variations from expected results, regulatory and competitive environment and
other factors affecting product performance. In addition, we initiate special
reviews when a product's performance fails to meet any of the indicators we
established during that product's introductory review process. If a product
does not meet our performance criteria, we consider adjustments in pricing,
design and marketing or ultimately discontinuing sales of that product. We
review our underwriting, pricing and risk selection strategies on a regular
basis to ensure that our products remain progressive, competitive and
consistent with our marketing and profitability objectives. We are also subject
to periodic external audits by our reinsurers, which provide us with valuable
insights into other innovative risk management practices.
Asset-liability management
We maintain segmented investment portfolios for the majority of our product
lines. This enables us to perform an ongoing analysis of the interest rate
risks associated with each major product line, in addition to the interest rate
risk for our overall enterprise. We analyze the behavior of our liability cash
flows across a wide variety of future interest rate scenarios, reflecting
policy features and expected policyholder behavior. We also analyze the
behavior of our asset portfolios across the same scenarios. We believe this
analysis shows the sensitivity of both our assets and liabilities to large and
small changes in interest rates and enables us to manage our assets and
liabilities more effectively.
Portfolio diversification
We use limits to ensure a spread of risk in our business. We have strict
limitations on credit risk to avoid concentration in our investment portfolio.
Our product portfolios have considerable diversification due to the variety of
products we have sold over a number of years. We also manage unique product
exposures in our business segments.
Actuarial databases and information systems
Our extensive actuarial databases and innovative information systems technology
are important tools in our risk management programs. We also have substantial
experience in offering individual life insurance products, and we have
developed a large database of claims experience, particularly in preferred risk
classes, which provides significant predictive experience for mortality.
Compliance
We take a disciplined approach to legal and regulatory compliance practices and
throughout our company instill a strong commitment to integrity in business
dealings and compliance with applicable laws and regulations. We have
professionals dedicated to legal and regulatory compliance matters.
Related Party Transactions
We, and various other Genworth insurance company affiliates, all direct and or
indirect subsidiaries of GE Capital are parties to an amended and restated
services and shared expenses agreement under which each company agrees to
provide and each company agrees to receive certain general services. These
services include, but are not limited to, data processing, communications,
marketing, public relations, advertising, investment management, human
resources, accounting, actuarial, legal, administration of agent and agency
matters, purchasing, underwriting and claims. Under the terms of the agreement
settlements are to be made quarterly.
We are a party to an Amended and Restated Master Outsourcing Agreement and
Project Specific Agreements with GE Capital International Services and a Master
Outsourcing Agreement and Project Specific Agreements with GE Capital
International Services -- Americas, Inc. pursuant to which we receive various
administrative, systems and other services.
We have an Administrative Services Agreement with GE Capital Life Assurance
Company of New York ("GECLA") whereby we provide services to GECLA with respect
to GECLA's variable annuity products.
We are a party to an Amended and Restated Investment Management and Services
Agreement with GE Asset Management Incorporated ("GEAM") pursuant to which the
Company receives investment-related services.
Additional information regarding related parties is included in note 8 to the
financial statements included in our Annual Report on Form 10-K for the year
ended December 31, 2004 (the "Annual Report").
Operations and Technology
Service and support
We benefit from Genworth's dedicated team of service and support personnel
(including the operations through an arrangement with an outsourcing provider
in India that is 40% owned by GE) who assist our sales intermediaries and
customers with their service needs. We use advanced and, in some cases,
proprietary, patent-pending technology to provide customer service and support,
and we operate service centers that leverage technology, integrated processes,
and Six Sigma process management techniques.
In our Retirement Income and Investments and Protection segments, we interact
directly and cost-effectively with our independent sales intermediaries and
dedicated sales specialists through secure websites that have enabled them to
transact business with us electronically, obtain information about our
products, submit applications, check application and account status and view
commission information. We also provide our independent sales intermediaries
and dedicated sales specialists with account information to disseminate to
their customers through the use of industry-standard XML communications.
Operating centers
We have centralized our operations and have established scalable, low-cost
operating centers in Virginia. We expect to realize additional efficiencies
from further facility rationalization, which includes centralizing additional
U.S. operations and consolidating mailrooms and print centers. In addition,
through an arrangement with an outsourcing provider that is 40% owned by GE, we
have a substantial team of professionals in India who provide a variety of
services to us, including customer service, transaction processing, and
functional support including finance, investment research, actuarial, risk and
marketing resources to our insurance operations. Most of the personnel in India
have college degrees, and many have graduate degrees.
Technology capabilities and process improvement
We rely on Genworth's proprietary processes for project approvals, execution,
risk management and benefit verification as part of our approach to technology
investment. Genworth holds, or has applied for, more than 120 patents.
Genworth's technology team is experienced in large-scale project delivery,
including many insurance administration system consolidations and the
development of Internet-based servicing capabilities. Genworth continually
manages technology costs by standardizing its technology infrastructure,
consolidating application systems, reducing servers and storage devices and
managing
project execution risks. Genworth also works with associates from GE's Global
Research Center to develop new technologies that help deliver competitive
advantages to our company. Genworth also may work in the future on new projects
with the GE Global Research Center, other research organizations or academic
institutions.
Reserves
We calculate and maintain reserves for estimated future benefit payments to our
policyholders and contractholders in accordance with U.S. GAAP and industry
accounting practices. We release these reserves as those future obligations are
extinguished. The reserves we establish reflect estimates and actuarial
assumptions with regard to our future experience. These estimates and actuarial
assumptions involve the exercise of significant judgment. Our future financial
results depend significantly upon the extent to which our actual future
experience is consistent with the assumptions we have used in pricing our
products and determining our reserves. Many factors can affect future
experience, including economic and social conditions, inflation, healthcare
costs, changes in doctrines of legal liability and damage awards in litigation.
Therefore, we cannot determine with complete precision the ultimate amounts we
will pay for actual future benefits or the timing of those payments.
Retirement Income and Investments
For our investment contracts, including annuities, GICs, and funding
agreements, contractholder liabilities are equal to the accumulated contract
account values, which generally consist of an accumulation of deposit payments,
less withdrawals, plus investment earnings and interest credited to the
account, less expense, mortality, and profit charges, if applicable. We also
maintain a separate reserve for any expected future payments in excess of the
account value due to the potential death of the contractholder. For variable
life insurance policies, policyholder liabilities are generally based on
policyholder account values, to include premiums collected, interest credited,
deduction of policy charges and market performance.
Protection
We establish reserves for life insurance policies based upon generally
recognized actuarial methods. We use mortality tables in general use in the
U.S., modified where appropriate, to reflect relevant historical experience and
our underwriting practices. Persistency, expense and interest rate assumptions
are based upon relevant experience and expectations for future development. We
establish reserves at amounts which, including the receipt of assumed
additional premiums and interest assumed to be earned on the assets underlying
the reserves, we expect to be sufficient to satisfy our policy obligations. The
liability for policy benefits for universal life insurance policies and
interest-sensitive whole life policies is equal to the balance that accrues to
the benefit of policyholders, including credited interest, plus any amount
needed to provide for additional benefits. We also establish reserves for
amounts that we have deducted from the policyholder's balance to compensate us
for services to be performed in future periods.
Our liability for unpaid health insurance claims is an estimate of the ultimate
net cost of both reported and unreported losses not yet settled. Our liability
is based upon an evaluation of historical claim
run-out patterns and includes a provision for adverse claim development.
Reserves for incurred but not reported claims in our health insurance business
are based upon historic incidence rates.
Reinsurance
We follow the industry practice of reinsuring portions of our insurance risks
with reinsurance companies. We use reinsurance both to diversify our risks and
to manage loss exposures and capital effectively. The use of reinsurance
permits us to write policies in amounts larger than the risk we are willing to
retain, and also to write a larger volume of new business.
We cede insurance primarily on a treaty basis, under which risks are ceded to a
reinsurer on specific blocks of business where the underlying risks meet
certain predetermined criteria. To a lesser extent, we cede insurance risks on
a facultative basis, under which the reinsurer's prior approval is required on
each risk reinsured. Use of reinsurance does not discharge us, as the insurer,
from liability on the insurance ceded. We, as the insurer, are required to pay
the full amount of our insurance obligations even in circumstances where we are
entitled or able to receive payments from our reinsurer. The principal
reinsurers to which we cede risks have A.M. Best financial strength ratings
ranging from "A+" to "A-." Historically, we have not had significant
concentrations of reinsurance risk with any one reinsurer. However, prior to
the completion of the Genworth IPO, we entered into reinsurance transactions
with UFLIC, which resulted in a significant concentration of reinsurance risk
with UFLIC.
The following table sets forth our exposure to our top five reinsurers, along
with the reinsurance recoverable as of December 31, 2004, and the A.M. Best
ratings of those reinsurers as of that date:
Reinsurance
(Dollar amounts in millions) Recoverable A.M. Best Rating
----------------------------------------------------------------
UFLIC/1/ $2,596.3 A-
Max Re Ltd 43.5 A-
Employers Reinsurance Corporation 5.9 A
Swiss Re Life & Health America Inc. 4.3 A+
RGA Reinsurance Co. 2.9 A+
----------------------------------------------------------------
/1/ See note 5 to the financial statements included in Item 8 of our Annual
Report.
Financial Strength Ratings
Ratings with respect to financial strength are an important factor in
establishing the competitive position of insurance companies. Ratings are
important to maintaining public confidence in us and our ability to market our
products.
Rating organizations review the financial performance and condition of most
insurers and provide opinions regarding financial strength, operating
performance and ability to meet obligations to policyholders or
contractholders, but these ratings are not designed to be, and do not serve as,
measures of protection or valuation offered to our policyholders or
contractholders.
We are rated by A.M. Best, S&P, Moody's and Fitch as follows:
A.M. Best Rating S&P Rating Moody's Rating Fitch Rating
- ----------------------------------------------------------------------------------------------
Financial strength rating A+ (Superior) AA- (Very Strong) Aa3 (Excellent) AA- (Very Strong)
Short-term rating Not rated A-1+ P-1 Not rated
- ----------------------------------------------------------------------------------------------
A.M. Best states that its "A+" (Superior) rating is assigned to those companies
that have, in its opinion, a superior ability to meet their ongoing obligations
to policyholders. The "A+" (Superior) rating is the second-highest of fifteen
ratings assigned by A.M. Best, which range from "A++" to "F".
S&P states that an insurer rated "AA" (Very Strong) has very strong financial
security characteristics that outweigh any vulnerabilities, and is highly
likely to have the ability to meet financial commitments. The "AA" range is the
second-highest of the four ratings ranges that meet these criteria, and also is
the second-highest of nine financial strength rating ranges assigned by S&P,
which range from "AAA" to "R." A plus (+) or minus (-) shows relative standing
in a rating category. Accordingly, the "AA-" rating is the fourth-highest of
S&P's 20 ratings categories. The short-term "A-1" rating is the highest rating
and shows the capacity to meet financial commitments is strong. Within this
category, the designation of a plus sign (+) indicates capacity to meet its
financial commitments is extremely strong.
Moody's states that insurance companies rated "Aa" (Excellent) offer excellent
financial security. Moody's states that companies in this group constitute what
are generally known as high-grade companies. The "Aa" range is the
second-highest of nine financial strength rating ranges assigned by Moody's,
which range from "Aaa" to "C." Numeric modifiers are used to refer to the
ranking within the group, with 1 being the highest and 3 being the lowest.
Accordingly, the "Aa3" rating is the fourth-highest of Moody's 21 ratings
categories. Short-term rating "P1" is the highest rating and shows superior
ability for repayment of short-term debt obligations.
Fitch states that "AA" (Very Strong) rated insurance companies are viewed as
possessing very strong capacity to meet policyholder and contract obligations.
Risk factors are modest, and the impact of any adverse business and economic
factors is expected to be very small. The "AA" rating category is the
second-highest of eight financial strength rating categories, which range from
"AAA" to "D." The symbol (+) or (-) may be appended to a rating to indicate the
relative position of a credit within a rating category. These suffixes are not
added to ratings in the "AAA" category or to ratings below the "CCC" category.
Accordingly, the "AA-" rating is the fourth-highest of Fitch's 24 ratings
categories.
A.M. Best, S&P, Moody's and Fitch review their ratings periodically and we
cannot assure you that we will maintain our current ratings in the future.
Other agencies may also rate our company on a solicited or an unsolicited basis.
Investments
As of December 31, 2004, we had total cash and invested assets of $8,877.0
million and an additional $8,636.7 million held in our separate accounts, for
which we do not bear investment risk. We manage our assets to meet
diversification, credit quality, yield and liquidity requirements of our policy
and contract liabilities by investing primarily in fixed maturities, including
government, municipal and corporate bonds, mortgage-backed and other
asset-backed securities and mortgage loans on commercial real estate. We also
invest in short-term securities and other investments, including a small
position in equity securities. In all cases, our investments are required to
comply with restrictions imposed by applicable laws and insurance regulatory
authorities.
Our primary investment objective is to meet our obligations to policyholders
and contractholders while increasing value to our stockholders by investing in
a diversified portfolio of high-quality, income
producing securities and other assets. Our investment strategy seeks to
optimize investment income without relying on realized investment gains. Our
investment strategy focuses primarily on:
. minimizing interest rate risk through rigorous management of asset
durations relative to policyholder and contractholder obligations;
. selecting assets based on fundamental, research-driven strategies;
. emphasizing fixed-interest, low-volatility assets;
. maintaining sufficient liquidity to meet unexpected financial obligations;
. continuously evaluating our asset class mix and pursuing additional
investment classes; and
. rigorous, continuous monitoring of asset quality.
We are exposed to two primary sources of investment risk:
. credit risk, relating to the uncertainty associated with the continued
ability of a given issuer to make timely payments of principal and
interest; and
. interest rate risk, relating to the market price and cash flow variability
associated with changes in market interest rates.
We manage credit risk by analyzing issuers, transaction structures and real
estate properties. We use sophisticated analytic techniques to monitor credit
risk. For example, we continually measure the probability of credit default and
estimated loss in the event of such a default, which may provide us with early
notification of worsening credits. If an issuer downgrade causes our holdings
of that issuer to exceed our risk thresholds, we automatically undertake a
detailed review of the issuer's credit. We also manage credit risk through
industry and issuer diversification and asset allocation practices. For
commercial real estate loans, we manage credit risk through geographic,
property type and product type diversification and asset allocation. We
routinely review different issuers and sectors and conduct more formal
quarterly portfolio reviews with our Investment Committee.
We mitigate interest rate risk through rigorous management of the relationship
between the duration of our assets and the duration of our liabilities, seeking
to minimize risk of loss in both rising and falling interest rate environments.
For further information on our management of interest rate risk, see "--
Quantitative and Qualitative Disclosures About Market Risk."
The following table sets forth our cash, cash equivalents and invested assets
as of the dates indicated:
December 31,
--------------------------------
2004 2003
--------------- ----------------
Carrying % of Carrying % of
(Dollar amounts in millions) Value Total Value Total
- ----------------------------------------------------------------------------------
Fixed-maturities, available-for-sale
Public $4,706.7 53.0% $ 7,357.5 64.9%
Private 2,294.5 25.8% 2,283.2 20.2%
Mortgage loans 1,207.7 13.6% 1,262.3 11.1%
Other investments 466.5 5.3% 162.1 1.4%
Policy loans 148.4 1.7% 138.5 1.2%
Equity securities, available for sale 26.8 0.3% 26.0 0.2%
Cash, cash equivalents and short-term investments 26.4 0.3% 112.0 1.0%
-------- ------ --------- ------
Total cash and invested assets $8,877.0 100.0% $11,341.6 100.0%
- ----------------------------------------------------------------------------------
Investment results
The annualized yield on general account cash and invested assets, excluding net
realized investment gains was 4.2%, 4.6% and 5.2% for the years ended
December 31, 2004, 2003 and 2002, respectively. The decline in investment
yields is primarily attributable to purchases of assets in an interest rate
environment where current market yields are lower than the existing portfolio
yields.
The following table sets forth information about our investment income,
excluding realized gains and losses, for the components of our investment
portfolio for the periods indicated:
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------- ------------- ------------
(Dollar amounts in millions) Yield Amount Yield Amount Yield Amount
- --------------------------------------------------------------------------------------------
Fixed maturities -- taxable 4.5% $360.8 4.5% $467.1 5.1% $528.7
Fixed maturities -- non-taxable 7.7% 0.1 7.8% 0.1 8.0% 0.1
Mortgage loans 6.3% 77.1 7.2% 81.8 7.6% 73.2
Equity securities 0.4% 0.1 (0.3)% (0.1) 1.2% 0.8
Other investments (4.0)% (16.8) (9.0)% (10.4) 1.0% 0.6
Policy loans 5.2% 7.5 8.3% 10.8 5.4% 6.3
------ ------ ------
Gross investment income before expenses and fees 4.3% 428.8 4.7% 549.3 5.3% 609.7
Expenses and fees (7.8) (11.3) (9.5)
------ ------ ------
Net investment income 4.2% $421.0 4.6% $538.0 5.2% $600.2
- --------------------------------------------------------------------------------------------
Yields are based on average carrying values except for fixed maturities, equity
securities and securities lending activity. Yields for fixed maturities and
equity securities are based on amortized cost and cost, respectively. Yields
for securities lending activity, which is included in other investments, are
calculated net of the corresponding securities lending liability.
Fixed maturities
Fixed maturities, including tax-exempt bonds, consist principally of publicly
traded and privately placed debt securities, and represented 78.9% and 85.0% of
total cash and invested assets as of December 31, 2004 and 2003, respectively.
Based upon estimated fair value, public fixed maturities represented 67.2% and
76.3% of total fixed maturities as of December 31, 2004 and 2003, respectively.
Private fixed maturities represented 32.8% and 23.7% of total fixed maturities
as of December 31, 2004 and 2003, respectively. We invest in privately placed
fixed maturities in an attempt to enhance the overall value of the portfolio,
increase diversification and obtain higher yields than can ordinarily be
obtained with comparable public market securities. Generally, private
placements provide us with protective covenants, call protection features and,
where applicable, a higher level of collateral. However, our private placements
are not freely transferable because of restrictions imposed by federal and
state securities laws, the terms of the securities, and illiquid trading
markets.
The Securities Valuation Office of the National Association of Insurance
Commissioners ("NAIC") evaluates bond investments of U.S. insurers for
regulatory reporting purposes and assigns securities to one of six investment
categories called "NAIC designations." The NAIC designations parallel the
credit ratings of the Nationally Recognized Statistical Rating Organizations
for marketable bonds. NAIC
designations 1 and 2 include bonds considered investment grade (rated "Baa3" or
higher by Moody's, or rated "BBB-" or higher by S&P) by such rating
organizations. NAIC designations 3 through 6 include bonds considered below
investment grade (rated "Ba1" or lower by Moody's, or rated "BB+" or lower
by S&P).
The following tables present our public, private and aggregate fixed maturities
by NAIC and/or equivalent ratings of the Nationally Recognized Statistical
Rating Organizations, as well as the percentage, based upon estimated fair
value, that each designation comprises. Our non-U.S. fixed maturities generally
are not rated by the NAIC and are shown based upon their equivalent rating of
the Nationally Recognized Statistical Rating Organizations. Similarly, certain
privately placed fixed maturities that are not rated by the Nationally
Recognized Statistical Rating Organizations are shown based upon their NAIC
designation. Certain securities, primarily non-U.S. securities, are not rated
by the NAIC or the Nationally Recognized Statistical Rating Organizations and
are so designated.
December 31,
---------------------------------------------------------------
Public Fixed Maturities 2004 2003
- ------------------------------------ ------------------------------- -------------------------------
NAIC Rating Agency
Rating Equivalent Designation
- ------ -----------------------------
Amortized Estimated Fair % of Amortized Estimated Fair % of
(Dollar amounts in millions) Cost Value Total Cost Value Total
- ----------------------------------------------------------------------------------------------------
1 Aaa/Aa/A $3,008.1 $3,046.6 64.7% $4,524.6 $4,595.1 62.5%
2 Baa 1,210.5 1,258.8 26.7% 2,086.4 2,175.3 29.6%
3 Ba 287.9 305.2 6.5% 371.1 392.0 5.3%
4 B 78.6 77.8 1.7% 141.5 138.1 1.9%
5 Caa and lower 16.3 13.5 0.3% 32.1 28.9 0.4%
6 In or near default 4.1 4.8 0.1% 24.5 27.1 0.3%
Not rated -- -- -- 1.0 1.0 --
-------- -------- ------ -------- -------- ------
Total public fixed maturities $4,605.5 $4,706.7 100.0% $7,181.2 $7,357.5 100.0%
- ----------------------------------------------------------------------------------------------------
December 31,
---------------------------------------------------------------
Private Fixed Maturities 2004 2003
- ------------------------------------- ------------------------------- -------------------------------
NAIC Rating Agency
Rating Equivalent Designation
- ------ ------------------------------
Amortized Estimated Fair % of Amortized Estimated Fair % of
(Dollar amounts in millions) Cost Value Total Cost Value Total
- -----------------------------------------------------------------------------------------------------
1 Aaa/Aa/A $ 973.9 $ 978.4 42.6% $1,194.4 $1,210.6 53.0%
2 Baa 1,068.5 1,102.9 48.1% 865.4 884.1 38.7%
3 Ba 120.3 125.7 5.5% 89.4 89.6 3.9%
4 B 57.0 57.7 2.5% 20.2 20.1 0.9%
5 Caa and lower 14.4 13.4 0.6% 69.4 62.9 2.8%
6 In or near default 3.0 3.0 0.1% 16.1 15.9 0.7%
Not rated 13.2 13.4 0.6% -- -- --
-------- -------- ------ -------- -------- ------
Total private fixed maturities $2,250.3 $2,294.5 100.0% $2,254.9 $2,283.2 100.0%
- -----------------------------------------------------------------------------------------------------
December 31,
---------------------------------------------------------------
Total Fixed Maturities 2004 2003
- ----------------------------- ------------------------------- -------------------------------
NAIC Rating Agency
Rating Equivalent Designation
- ------ ----------------------
Amortized Estimated Fair % of Amortized Estimated Fair % of
(Dollar amounts in millions) Cost Value Total Cost Value Total
- ---------------------------------------------------------------------------------------------
1 Aaa/Aa/A $3,982.0 $4,025.0 57.5% $5,719.0 $5,805.7 60.2%
2 Baa 2,279.0 2,361.7 33.7% 2,951.8 3,059.4 31.7%
3 Ba 408.2 430.9 6.2% 460.5 481.6 5.0%
4 B 135.6 135.5 1.9% 161.7 158.2 1.6%
5 Caa and lower 30.7 26.9 0.4% 101.5 91.8 1.0%
6 In or near default 7.1 7.8 0.1% 40.6 43.0 0.5%
Not rated 13.2 13.4 0.2% 1.0 1.0 --
-------- -------- ------ -------- -------- ------
Total fixed maturities $6,855.8 $7,001.2 100.0% $9,436.1 $9,640.7 100.0%
- ---------------------------------------------------------------------------------------------
The following table sets forth the amortized cost and estimated fair value of
fixed maturities by contractual maturity dates (excluding scheduled sinking
funds) as of the date indicated:
December 31, 2004
-----------------------------
Estimated Fair
(Dollar amounts in millions) Amortized Cost Value
--------------------------------------------------------------------
Due in one year or less $ 411.5 $ 413.7
Due after one year through five years 1,886.2 1,938.3
Due after five years through ten years 1,603.9 1,662.9
Due after ten years 967.0 987.0
-------- --------
Subtotal 4,868.6 5,001.9
Mortgage-backed and asset-backed 1,987.2 1,999.3
-------- --------
Total fixed maturities $6,855.8 $7,001.2
--------------------------------------------------------------------
We diversify our fixed maturities by security sector. The following table sets
forth the estimated fair value of our fixed maturities by sector as well as the
percentage of the total fixed maturities holdings that each security sector
comprised as of the dates indicated:
December 31,
-------------------------------------------
2004 2003
--------------------- ---------------------
Estimated Fair % of Estimated Fair % of
(Dollar amounts in millions) Value Total Value Total
------------------------------------------------------------------------
U.S. government and agencies $ 52.4 0.7% $ 18.0 0.2%
State and municipal 0.7 -- % 0.9 -- %
Government-Non U.S. 105.4 1.5% 72.6 0.8%
U.S. corporate 4,040.6 57.7% 5,583.3 57.9%
Corporate-Non-U.S. 802.8 11.5% 893.5 9.3%
Mortgage-backed 1,319.7 18.9% 1,843.2 19.1%
Asset-backed 679.6 9.7% 1,229.2 12.7%
-------- ------ -------- ------
Total fixed maturities $7,001.2 100.0% $9,640.7 100.0%
------------------------------------------------------------------------
The following table sets forth the major industry types that comprise our
corporate bond holdings, based primarily on industry codes established by
Lehman Brothers, as well as the percentage of the total corporate bond holdings
that each industry comprised as of the dates indicated:
December 31,
-------------------------------------------
2004 2003
--------------------- ---------------------
Estimated Fair % of Estimated Fair % of
(Dollar amounts in millions) Value Total Value Total
-------------------------------------------------------------------------
Finance and insurance $1,712.6 35.4% $2,402.1 37.1%
Utilities and energy 834.5 17.2% 1,125.5 17.4%
Consumer -- non cyclical 587.1 12.1% 808.5 12.5%
Capital goods 367.7 7.6% 468.9 7.2%
Consumer -- cyclical 363.6 7.5% 460.1 7.1%
Industrial 288.7 6.0% 387.1 6.0%
Technology and communications 222.7 4.6% 355.9 5.5%
Transportation 92.1 1.9% 143.3 2.2%
Other 374.4 7.7% 325.4 5.0%
-------- ------ -------- ------
Total $4,843.4 100.0% $6,476.8 100.0%
-------------------------------------------------------------------------
We diversify our corporate bond holdings by industry and issuer. The portfolio
does not have significant exposure to any single issuer. As of December 31,
2004, our combined corporate bond holdings in the ten issuers to which we had
the greatest exposure was $682.0 million which was approximately 7.7% of our
total cash and invested assets as of December 31, 2004. The exposure to the
largest single issuer of corporate bonds held as of December 31, 2004 was
$100.2 million, which was less than 1.1% of our total cash and invested assets
as of that date.
Mortgage-backed securities
The following table sets forth the types of mortgage backed securities we held
as of the dates indicated:
December 31,
-------------------------------------------
2004 2003
--------------------- ---------------------
Estimated Fair % of Estimated Fair % of
(Dollar amounts in millions) Value Total Value Total
- ---------------------------------------------------------------------------------
Commercial mortgage-backed securities $ 863.6 65.4% $1,248.0 67.7%
Collateralized mortgage obligations 243.0 18.4% 359.2 19.5%
Sequential pay class bonds 131.5 10.0% 157.8 8.5%
Planned amortization class bonds 16.8 1.3% 38.4 2.1%
Pass-through securities 23.7 1.8% 39.8 2.2%
Other 41.1 3.1% -- --
-------- ------ -------- ------
Total $1,319.7 100.0% $1,843.2 100.0%
- ---------------------------------------------------------------------------------
We purchase mortgage-backed securities to diversify our portfolio risk
characteristics from primarily corporate credit risk to a mix of credit risk
and cash flow risk. The principal risks inherent in holding mortgage-backed
securities are prepayment and extension risks, which will affect the timing of
when cash flow will be received. The majority of the mortgage-backed securities
in our investment portfolio have relatively low cash flow variability. Our
active monitoring and analysis of this portfolio, focus on stable types of
securities and limits on our holdings of more volatile types of securities
reduces the effects of interest rate fluctuations on this portfolio.
Commercial mortgage-backed securities, or CMBS, which represent our largest
class of mortgage-backed securities, are securities backed by a diversified
pool of first mortgage loans on commercial properties ranging in size, property
type and geographic location. The primary risk associated with CMBS is default
risk. Prepayment risk on CMBS is generally low because of prepayment
restrictions contained in the underlying collateral.
The majority of our collateralized mortgage obligations, or CMOs, are
guaranteed or otherwise supported by the Federal National Mortgage Association,
Federal Home Loan Mortgage Corporation or Government National Mortgage
Association. CMOs separate mortgage pools into different maturity classes
called tranches. This separation generally provides for greater cash flow
stability than other mortgage-backed securities.
Sequential pay class bonds receive principal payments in a prescribed sequence
without a pre-determined prepayment schedule. Planned amortization class bonds
are bonds structured to provide more certain cash flows to the investor and
therefore are subject to less prepayment and extension risk than other
mortgage-backed securities.
Pass-through securities are the most liquid assets in the mortgage-backed
sector. Pass-through securities distribute, on pro rata basis to their holders,
the monthly cash flows of principal and interest, both scheduled and
prepayments, generated by the underlying mortgages.
Asset-backed securities
The following table sets forth the types of asset-backed securities we held as
of the dates indicated:
December 31,
-------------------------------------------
2004 2003
--------------------- ---------------------
Estimated Fair % of Estimated Fair % of
(Dollar amounts in millions) Value Total Value Total
------------------------------------------------------------------------
Credit card receivables $214.7 31.6% $ 322.9 26.3%
Home equity loans 117.1 17.2% 282.5 23.0%
Automobile receivables 130.5 19.2% 505.0 41.1%
Other 217.3 32.0% 118.8 9.6%
------ ------ -------- ------
Total $679.6 100.0% $1,229.2 100.0%
------------------------------------------------------------------------
We purchase asset-backed securities both to diversify the overall risks of our
fixed maturities portfolio and to provide attractive returns. Our asset-backed
securities are diversified by type of asset, issuer and servicer. As of
December 31, 2004, approximately $407.7 million, or 60.0%, of the total amount
of our asset-backed securities were rated "Aaa/AAA" by Moody's or S&P.
The principal risks in holding asset-backed securities are structural, credit
and capital market risks. Structural risks include the security's priority in
the issuer's capital structure, the adequacy of and ability to realize proceeds
from the collateral and the potential for prepayments. Credit risks include
consumer or corporate credits such as credit card holders, equipment lessees,
and corporate obligors. Capital market risks include the general level of
interest rates and the liquidity for these securities in the marketplace.
Mortgage loans
Our mortgage loans are collateralized by commercial properties, including
multifamily residential buildings. The carrying value of mortgage loans is
stated at original cost net of prepayments and amortization.
We diversify our commercial mortgage loans by both property type and geographic
region. The following table sets forth the distribution across property type
and geographic region for commercial mortgage loans as of the dates indicated:
December 31,
---------------------------------------------------
2004 2003
Property Type ------------------------- -------------------------
(Dollar amounts in millions) Carrying Value % of Total Carrying Value % of Total
- --------------------------------------------------------------------------------
Office $ 356.1 29.5% $ 410.0 32.5%
Industrial 386.2 32.0% 421.7 33.4%
Retail 335.9 27.8% 301.5 23.9%
Apartments 105.6 8.7% 97.3 7.7%
Mixed use/other 23.9 2.0% 31.8 2.5%
-------- ------ -------- ------
Total $1,207.7 100.0% $1,262.3 100.0%
- --------------------------------------------------------------------------------
December 31,
---------------------------------------------------
2004 2003
Geographic Region ------------------------- -------------------------
(Dollar amounts in millions) Carrying Value % of Total Carrying Value % of Total
- --------------------------------------------------------------------------------
Pacific $ 332.8 27.6% $ 376.4 29.8%
South Atlantic 255.3 21.1% 252.1 20.0%
Middle Atlantic 129.3 10.7% 163.7 13.0%
East North Central 215.1 17.8% 218.8 17.3%
Mountain 101.4 8.4% 105.2 8.4%
West South Central 65.8 5.4% 50.8 4.0%
West North Central 52.0 4.3% 48.1 3.8%
East South Central 15.4 1.3% 16.4 1.3%
New England 40.6 3.4% 30.8 2.4%
-------- ------ -------- ------
Total $1,207.7 100.0% $1,262.3 100.0%
- --------------------------------------------------------------------------------
The following table sets forth the distribution of our commercial mortgage
loans by loan size as of the dates indicated:
December 31,
-------------------------------------------------------------
2004 2003
------------------------------ ------------------------------
Number of Principal Number of Principal
(Dollar amounts in millions) Loans Balance % of Total Loans Balance % of Total
- ---------------------------------------------------------------------------------------------------
Under $5 million 287 $ 585.8 48.1% 316 $ 642.8 50.6%
$5 million but less than $10 million 40 268.8 22.1% 44 284.9 22.4%
$10 million but less than $20 million 11 157.6 13.0% 13 180.1 14.2%
$20 million but less than $30 million 2 45.1 3.7% 2 47.0 3.7%
More than $30 million 4 159.4 13.1% 3 116.4 9.1%
--- -------- ------ --- -------- ------
Total 344 $1,216.7 100.0% 378 $1,271.2 100.0%
- ---------------------------------------------------------------------------------------------------
The following table sets forth the scheduled maturities for our commercial
mortgage loans as of the date indicated:
December 31, 2004
-------------------------
(Dollar amounts in millions) Carrying Value % of Total
----------------------------------------------------------
Due in 1 year or less $ 24.5 2.0%
Due after 1 year through 2 years 10.2 0.9%
Due after 2 year through 3 years 11.3 0.9%
Due after 3 year through 4 years 92.0 7.6%
Due after 4 year through 5 years 66.2 5.5%
Due after 5 years 1,003.5 83.1%
-------- ------
Total $1,207.7 100.0%
----------------------------------------------------------
We monitor our mortgage loans on a continual basis. These reviews include an
analysis of the property, its financial statements, the relevant market and
tenant creditworthiness. Through this monitoring process, we review loans that
are restructured, delinquent or under foreclosure and identify those that
management considers to be potentially delinquent.
The following table sets forth the changes in allowance for losses on mortgage
loans as of the dates indicated:
As of or for the years ended December 31,
------------------------------------------
(Dollar amounts in millions) 2004 2003
-------------------------------------------------------------------------------------
Balance, beginning of period $10.4 $ 8.9
Additions 1.0 1.5
Deductions for writedowns and dispositions (1.0) --
----- -----
Balance, end of period $10.4 $10.4
-------------------------------------------------------------------------------------
Equity securities
Our equity securities, which are classified as available-for-sale, primarily
consist of retained interests in our securitization transactions, as well as
mutual funds and investments in publicly-traded preferred and common stocks of
U.S. and non-U.S. companies.
Other investments
The following table sets forth the carrying values of our other investments as
of the dates indicated:
December 31,
---------------------------------------------------
2004 2003
------------------------- -------------------------
(Dollar amounts in millions) Carrying Value % of Total Carrying Value % of Total
- --------------------------------------------------------------------------------
Securities lending $406.9 87.2% $102.7 63.4%
Limited partnerships 53.0 11.4% 53.9 33.2%
Other investments 6.6 1.4% 5.5 3.4%
------ ------ ------ ------
Total $466.5 100.0% $162.1 100.0%
- --------------------------------------------------------------------------------
We participate in a securities lending program whereby blocks of securities
included in our portfolio are loaned primarily to major brokerage firms. We
require a minimum of 102% of the fair value of the loaned securities to be
separately maintained as collateral for the loans. The limited partnerships
primarily represent interests in pooled investment funds that make private
equity investments in U.S. and
non-U.S. companies. Real estate consists of ownership of real property,
primarily commercial property. Other investments are primarily swaps, amounts
on deposit with foreign governments, options and strategic equity investments.
Derivative financial instruments
Our policy allows for the use of derivative financial instruments, such as
interest rate and currency swaps, currency forwards and option-based financial
instruments, as part of our risk management strategy. We may use these
derivatives to mitigate certain risks, including interest rate risk, currency
risk and equity risk, by:
. reducing the risk between the timing of the receipt of cash and its
investment in the market;
. matching the currency of invested assets with the liabilities they support;
. converting the asset duration to match the duration of the liabilities;
. reducing our exposure to fluctuations in equity market indices that
underlie some of our products; and
. protecting against the early termination of an asset or liability.
As a matter of policy, we have not and will not engage in derivative
market-making, speculative derivative trading or other speculative derivatives
activities.
The following table sets forth our positions in derivative financial
instruments as of the dates indicated:
December 31,
---------------------------------------------------
2004 2003
------------------------- -------------------------
(Dollar amounts in millions) Notional Value % of Total Notional Value % of Total
- --------------------------------------------------------------------------------
Interest rate swaps $105.0 95.6% $186.8 97.1%
Equity index options 4.8 4.4% -- --
Swaptions -- -- 5.6 2.9%
------ ------ ------ ------
Total $109.8 100.0% $192.4 100.0%
- --------------------------------------------------------------------------------
Regulation
Our businesses are subject to extensive regulation and supervision.
General
Our insurance operations are subject to a wide variety of laws and regulations.
State insurance laws regulate most aspects of our business, and we are
regulated by the insurance departments of the states in which we are domiciled
and licensed to transact business. We and our insurance products also are
affected by U.S. federal, state and local tax laws. Insurance products that
constitute "securities," such as variable annuities and variable life insurance
policies, also are subject to U.S. federal and state securities laws and
regulations. The Securities and Exchange Commission, or SEC, the National
Association of Securities Dealers, or NASD, as well as the insurance
departments of the states in which we are licensed, regulate and supervise
these products.
The purpose of the laws and regulations affecting our insurance and securities
businesses is primarily to protect our customers. Many of the laws and
regulations to which we are subject are regularly re-examined, and existing or
future laws and regulations may become more restrictive or otherwise adversely
affect our operations.
In addition, insurance and securities regulatory authorities (including state
law enforcement agencies and attorneys general) increasingly make inquiries
regarding compliance by us with insurance, securities and other laws and
regulations regarding the conduct of our insurance business and insurance
products which are also regulated as securities products. We cooperate with
such inquiries and take corrective action when warranted.
Some of our customers and independent sales intermediaries also operate in
regulated environments. Changes in the regulations that affect their operations
also may affect our business relationships with them and their ability to
purchase or to distribute our products.
Insurance Regulation
We are licensed and regulated in all jurisdictions in which we conduct
insurance business. The extent of this regulation varies, but most
jurisdictions have laws and regulations governing the financial condition of
insurers, including standards of solvency, types and concentration of
investments, establishment and maintenance of reserves, credit for reinsurance
and requirements of capital adequacy, and the business conduct of insurers,
including marketing and sales practices and claims handling. In addition,
statutes and regulations usually require the licensing of insurers and their
agents, the approval of policy forms and related materials and the approval of
rates for certain lines of insurance.
The types of insurance laws and regulations applicable to us are described
below.
Insurance holding company regulation
All jurisdictions in which we conduct insurance business have enacted
legislation that requires each insurance company in a holding company system,
except captive insurance companies, to register with the insurance regulatory
authority of its jurisdiction of domicile and to furnish that regulatory
authority financial and other information concerning the operations of, and the
interrelationships and transactions among, companies within its holding company
system that may materially affect the operations, management or financial
condition of the insurers within that system. These laws and regulations also
regulate transactions between insurance companies and their parents and
affiliates. Generally, these laws and regulations require that all transactions
within a holding company system between an insurer and its affiliates be fair
and reasonable and that the insurer's statutory surplus following any
transaction with an affiliate be both reasonable in relation to its outstanding
liabilities and adequate to its financial needs. Statutory surplus is the
excess of admitted assets over the sum of statutory liabilities and capital.
For certain types of agreements and transactions between an insurer and its
affiliates, these laws and regulations require prior notification to, and
non-disapproval or approval by, the insurance regulatory authority of the
insurer's jurisdiction of domicile.
Policy forms
Our policy forms are subject to regulation in every jurisdiction in which we
are licensed to transact insurance business. In most jurisdictions, policy
forms must be filed prior to, or concurrent with, their use. In some
jurisdictions, forms may also need to be approved or declared effective by the
appropriate regulator prior to use.
Market conduct regulation
The laws and regulations of jurisdictions include numerous provisions governing
the marketplace activities of insurers, including provisions governing the form
and content of disclosure to consumers, product illustrations, advertising,
product replacement, sales and underwriting practices, complaint handling and
claims handling. Regulatory authorities generally enforce these provisions
through periodic market conduct examinations.
Statutory examinations
As part of their regulatory oversight process, insurance departments conduct
periodic detailed examinations of the books, records, accounts and business
practices of insurers which conduct business in their jurisdictions. These
examinations generally are conducted in cooperation with the insurance
departments of two or three other states or jurisdictions, representing each of
the NAIC zones, under guidelines promulgated by the NAIC. In the three-year
period ended December 31, 2004, we have not received any material adverse
findings resulting from any insurance department examinations.
Guaranty associations and similar arrangements
Most of the jurisdictions in which we are licensed to transact business require
life insurers doing business within the jurisdiction to participate in guaranty
associations, which are organized to pay contractual benefits owed pursuant to
insurance policies of insurers who become impaired or insolvent. These
associations levy assessments, up to prescribed limits, on all member insurers
in a particular jurisdiction on the basis of the proportionate share of the
premiums written by member insurers in the lines of business in which the
impaired, insolvent or failed insurer is engaged. Some jurisdictions permit
member insurers to recover assessments paid through full or partial premium tax
offsets.
Aggregate assessments levied against us totaled $0.5 million, $(0.6) million
and $(0.1) million for the years ended December 31, 2004, 2003 and 2002,
respectively. Although the amount and timing of future assessments are not
predictable, we have established liabilities for guaranty fund assessments that
we consider adequate for assessments with respect to insurers that currently
are subject to insolvency proceedings.
Policy and contract reserve sufficiency analysis
Under the laws and regulations of the Commonwealth of Virginia, we are required
to conduct annual analyses of the sufficiency of our life and health insurance
and annuity statutory reserves. In addition, other jurisdictions in which we
are licensed may have certain reserve requirements that differ from
those of our domiciliary jurisdiction. In each case, a qualified actuary must
submit an opinion that states that the aggregate statutory reserves, when
considered in light of the assets held with respect to such reserves, make good
and sufficient provision for the associated contractual obligations and related
expenses of the insurer. If such an opinion cannot be provided, the affected
insurer must set up additional reserves by moving funds from surplus. We submit
these opinions annually to applicable insurance regulatory authorities.
Surplus and capital requirements
Insurance regulators have the discretionary authority, in connection with the
ongoing licensing of our Company, to limit or prohibit the ability of an
insurer to issue new policies if, in the regulators' judgment, the insurer is
not maintaining a minimum amount of surplus or is in hazardous financial
condition. Insurance regulators may also limit the ability of an insurer to
issue new life insurance policies and annuity contracts above an amount based
upon the face amount and premiums of policies of a similar type issued in the
prior year. We do not believe that the current or anticipated levels of our
statutory surplus present a material risk that any such regulator would limit
the amount of new policies that we may issue.
Risk-based capital
The NAIC has established risk-based capital standards for our Company as well
as a model act with the intention that these standards be applied at the state
level. The model act provides that life insurance companies must submit an
annual risk-based capital report to state regulators reporting their risk-based
capital based upon four categories of risk: asset risk, insurance risk,
interest rate risk and business risk. For each category, the capital
requirement is determined by applying factors to various asset, premium and
reserve items, with the factor being higher for those items with greater
underlying risk and lower for less risky items. The formula is intended to be
used by insurance regulators as an early warning tool to identify possible
weakly capitalized companies for purposes of initiating further regulatory
action.
If an insurer's risk-based capital falls below specified levels, the insurer
would be subject to different degrees of regulatory action depending upon the
level. These actions range from requiring the insurer to propose actions to
correct the capital deficiency to placing the insurer under regulatory control.
As of December 31, 2004, our risk-based capital exceeded the level of
risk-based capital that would require us to take or become subject to any
corrective action.
Statutory accounting principles
Statutory accounting principles, or SAP, is a basis of accounting developed by
insurance regulators to monitor and regulate the solvency of insurance
companies. In developing SAP, insurance regulators were primarily concerned
with assuring an insurer's ability to pay all its current and future
obligations to policyholders. As a result, statutory accounting focuses on
conservatively valuing the assets and liabilities of insurers, generally in
accordance with standards specified by the insurer's domiciliary jurisdiction.
Uniform statutory accounting practices are established by the NAIC and
generally adopted by regulators in the various jurisdictions in which we
conduct business. These accounting principles and related regulations
determine, among other things, the amounts we may pay as dividends.
U.S. GAAP is designed to measure a business on a going-concern basis. It gives
consideration to matching of revenue and expenses and, as a result, certain
expenses are capitalized when incurred and then amortized over the life of the
associated policies. The valuation of assets and liabilities under U.S. GAAP is
based in part upon best estimate assumptions made by the insurer. Stockholders'
equity represents both amounts currently available and amounts expected to
emerge over the life of the business. As a result, the values for assets,
liabilities and equity reflected in financial statements prepared in accordance
with U.S. GAAP may be different from those reflected in financial statements
prepared under SAP.
Regulation of investments
We are subject to laws and regulations that require diversification of our
investment portfolio and limit the amount of our investments in certain asset
categories, such as below investment grade fixed maturities, equity real
estate, other equity investments and derivatives. Failure to comply with these
laws and regulations would cause investments exceeding regulatory limitations
to be treated as non-admitted assets for purposes of measuring surplus, and, in
some instances, would require divestiture of such noncomplying investments. We
believe our investments comply with these laws and regulations.
Federal regulation
Our variable life insurance and variable annuity products generally are
"securities" within the meaning of federal securities laws and regulations. As
a result, most of our variable annuity products and all of our variable life
insurance products are registered under the Securities Act of 1933 and are
subject to regulation by the SEC. These products are sold by broker/dealers of
member firms of the NASD, and the NASD, along with the SEC, regulates the sales
and marketing activities with respect to these products. Federal and state
securities regulation similar to that discussed below under "Other Laws and
Regulations -- Securities regulation" affect investment advice and sales and
related activities with respect to these products. In addition, although the
federal government does not comprehensively regulate the business of insurance,
federal legislation and administrative policies in several other areas,
including taxation, financial services regulation and pension and welfare
benefits regulation, can also significantly affect the insurance industry.
Federal initiatives
Although the federal government generally does not directly regulate the
insurance business, federal initiatives often and increasingly have an impact
on the business in a variety of ways. From time to time, federal measures are
proposed which may significantly affect the insurance business, including
limitations on antitrust immunity, tax incentives for lifetime annuity payouts,
simplification bills affecting tax-advantaged or tax-exempt savings and
retirement vehicles, and proposals to modify or make permanent the estate tax
repeal enacted in 2001. In addition, various forms of direct federal regulation
of insurance have been proposed in recent years. These proposals have included
"The Federal Insurance Consumer Protection Act of 2003" and "The State
Modernization and Regulatory Transparency Act." The Federal Insurance Consumer
Protection Act of 2003 would have established comprehensive and exclusive
federal regulation over all "interstate insurers," including all life insurers
selling in more than one state. This proposed legislation was not enacted. The
State Modernization and Regulatory Transparency Act would maintain state-based
regulation of insurance but would change the way that states regulate certain
aspects of the business of insurance including rates, agent and company
licensing, and market conduct examinations. This proposed legislation remains
pending. We cannot predict whether this or other proposals will be adopted, or
what impact, if any, such proposals or, if adopted, such laws may have on our
business, financial condition or results of operation.
Changes in tax laws
Changes in tax laws could make some of our products less attractive to
consumers. For example, the gradual repeal of the federal estate tax, begun in
2001, is continuing to be phased in through 2010. The repeal and continuing
uncertainty created by the repeal of the federal estate tax has resulted in
reduced sales, and could continue to adversely affect sales and surrenders, of
some of our estate planning products, including survivorship/second-to-die life
insurance policies. In May 2003, U.S. President George W. Bush signed into law
the Jobs and Growth Tax Relief Reconciliation Act of 2003, which lowered the
federal income tax rate on capital gains and certain ordinary dividends. This
reduction may provide an incentive for certain of our customers and potential
customers to shift assets into mutual funds and away from our products,
including annuities, that are designed to defer taxes payable on investment
returns.
Other Laws and Regulations
Securities regulation
Certain of our policies and contracts offered are subject to various levels of
regulation under the federal securities laws regulated by the SEC. Some of our
variable annuity contracts and all of our variable life insurance policy
separate accounts are registered under the Investment Company Act of 1940. Some
of our variable annuity contracts and all of our variable life policies are
registered under the Securities Act of 1933.
These laws and regulations are primarily intended to protect investors in the
securities markets and generally grant supervisory agencies broad
administrative powers, including the power to limit or restrict the conduct of
business for failure to comply with such laws and regulations. In such event,
the possible sanctions that may be imposed include suspension of individual
employees, limitations on the activities in which an investment adviser or
broker/dealer may engage, suspension or revocation of an investment adviser or
broker/dealer registration, censure or fines. We may also be subject to similar
laws and regulations in the states in which we offer the products described
above or conduct other securities-related activities.
We also serve as the depositor for variable annuity contracts and other debt
securities that rely on certain exemptions from registration under the
Investment Company Act of 1940 and the Securities Act of 1933. Nevertheless,
certain provisions of the Investment Company Act of 1940 and the Securities Act
of 1933 may apply to these products issued under certain circumstances.
The Investment Company Act of 1940, the Investment Advisers Act of 1940 and the
Securities Act of 1933, including the rules and regulations promulgated
thereunder, are subject to change, which may affect us and any products we
issue.
Environmental considerations
As an owner and operator of real property, we are subject to extensive U.S.
federal and state environmental laws and regulations. Potential environmental
liabilities and costs in connection with any required remediation of such
properties also is an inherent risk in property ownership and operation. In
addition, we hold equity interests in companies and have made loans secured by
properties that could potentially be subject to environmental liabilities. We
routinely have environmental assessments performed with respect to real estate
being acquired for investment and real property to be acquired through
foreclosure. We cannot provide assurance that unexpected environmental
liabilities will not arise. However, based upon information currently available
to us, we believe that any costs associated with compliance with environmental
laws and regulations or any remediation of such properties will not have a
material adverse effect on our business, financial condition or results of
operations.
ERISA considerations
We provide certain products and services to certain employee benefit plans that
are subject to ERISA or the Internal Revenue Code. As such, our activities are
subject to the restrictions imposed by ERISA and the Internal Revenue Code,
including the requirement under ERISA that fiduciaries must perform their
duties solely in the interests of ERISA plan participants and beneficiaries and
the requirement under ERISA and the Internal Revenue Code that fiduciaries may
not cause a covered plan to engage in certain prohibited transactions with
persons who have certain relationships with respect to such plans. The
applicable provisions of ERISA and the Internal Revenue Code are subject to
enforcement by the U.S. Department of Labor, the IRS and the Pension Benefit
Guaranty Corporation.
USA Patriot Act
The USA Patriot Act of 2001, or the Patriot Act, enacted in response to the
terrorist attacks on September 11, 2001, contains anti-money laundering and
financial transparency laws and mandates the implementation of various new
regulations applicable to broker/dealers and other financial services companies
including insurance companies. The Patriot Act seeks to promote cooperation
among financial institutions, regulators and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering.
Anti-money laundering laws outside of the U.S. contain similar provisions. The
increased obligations of financial institutions to identify their customers,
watch for and report suspicious transactions, respond to requests for
information by regulatory authorities and law enforcement agencies, and share
information with other financial institutions, require the implementation and
maintenance of internal practices, procedures and controls. We believe that we
have implemented, and that we maintain, appropriate internal practices,
procedures and controls to enable us to comply with the provisions of the
Patriot Act.
Privacy of consumer information
U.S. federal and state laws and regulations require financial institutions,
including insurance companies, to protect the security and confidentiality of
consumer financial information and to notify consumers about their policies and
practices relating to their collection and disclosure of consumer information
and their policies relating to protecting the security and confidentiality of
that information. Similarly, federal and state laws and regulations also govern
the disclosure and security of consumer
health information. In particular, regulations promulgated by the U.S.
Department of Health and Human Services regulate the disclosure and use of
protected health information by health insurers and others, the physical and
procedural safeguards employed to protect the security of that information and
the electronic transmission of such information. Congress and state
legislatures are expected to consider additional legislation relating to
privacy and other aspects of consumer information.
Selected Financial Data
The "Selected Financial Data" provision of your prospectus is hereby deleted in
its entirety and replaced with the following:
The following table sets forth selected financial information. The selected
financial information as of December 31, 2004 and 2003, and for the years ended
December 31, 2004, 2003 and 2002 has been derived from our financial
statements, which have been audited by KPMG LLP and are included in our Annual
Report. You should read this information in conjunction with the information
under " -- Management's Discussion and Analysis of Financial Condition and
Results of Operations," our financial statements, the related notes and the
accompanying independent registered public accounting firm's report (which
refers to a change in accounting for certain nontraditional long-duration
contracts and for separate accounts in 2004 and goodwill and other intangible
assets in 2002), which are included elsewhere in our Annual Report.
We entered into several significant reinsurance transactions with UFLIC, an
indirect, wholly-owned subsidiary of GE. As part of these transactions,
effective as of January 1, 2004, we ceded to UFLIC policy obligations under our
structured settlement contracts, which had reserves of $0.3 billion, and our
variable annuity contracts which had general account reserves of $2.5 billion
and separate account reserves of $7.6 billion, each as of December 31, 2003.
These contracts represent substantially all of our contracts that were in
force, excluding the GERATM product that was not reinsured, as of December 31,
2003 for these products. In the aggregate, these blocks of business did not
meet our target return thresholds, and although we remain liable under these
contracts and policies as the ceding insurer, the reinsurance transactions have
the effect of transferring the financial results of the reinsured blocks to
UFLIC.
Years Ended December 31,
---------------------------------------------------
(Dollar amounts in millions) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------
Statement of Earnings Information
- ------------------------------------------------------------------------------------------------------------
Revenues $ 699.9 $ 940.8 $ 1,045.4 $ 1,134.4 $ 1,153.4
Income before cumulative effect of change in accounting
principle 198.7 19.7 115.8 129.6 163.1
As of December 31,
---------------------------------------------------
(Dollar amounts in millions) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------
Statement of Financial Position Information
- ------------------------------------------------------------------------------------------------------------
Total investments $ 8,850.6 $11,329.2 $11,591.0 $11,779.1 $10,655.4
Separate account assets 8,636.7 8,034.9 7,182.8 8,994.3 10,393.2
Reinsurance recoverable 2,753.8 160.7 174.4 151.1 90.6
All other assets 591.5 1,337.8 1,399.9 1,538.2 1,473.3
--------- --------- --------- --------- ---------
Total assets $20,832.6 $20,862.6 $20,348.1 $22,462.7 $22,612.5
Policyholder liabilities $ 9,929.9 $10,431.6 $11,220.0 $11,255.7 $10,238.7
Separate account liabilities 8,636.7 8,034.9 7,182.8 8,994.3 10,393.2
All other liabilities 676.0 574.1 241.1 630.5 505.9
--------- --------- --------- --------- ---------
Total liabilities $19,242.6 $19,040.6 $18,643.9 $20,880.5 $21,137.8
Accumulated nonowner changes in stockholder's interest $ 75.3 $ 88.1 $ (9.7) $ (25.5) $ (18.7)
Total stockholder's interest $ 1,590.0 $ 1,822.0 $ 1,704.2 $ 1,582.2 $ 1,474.7
U.S. Statutory Information/1/
Statutory capital and surplus $ 817.2 $ 562.4 $ 550.7 $ 584.4 $ 592.9
Asset valuation reserve 86.8 62.9 82.0 127.8 129.6
- ------------------------------------------------------------------------------------------------------------
/1/ We derived the U.S Statutory Information from our Annual Statements that
were filed with the Commonwealth of Virginia, Bureau of Insurance and
prepared in accordance with statutory accounting practices prescribed or
permitted by the Commonwealth of Virginia, Bureau of Insurance. These
statutory accounting practices vary in certain material respects from U.S.
GAAP.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The "Management's Discussion and Analysis of Financial Condition and Results of
Operations" provision of your prospectus is hereby deleted in its entirety and
replaced with the following:
Risk Factors
Our business is subject to a number of important risks, including the following:
Interest rate fluctuations could adversely affect our business and
profitability.
Our insurance and investment products are sensitive to interest rate
fluctuations and expose us to the risk that falling interest rates will reduce
our "spread," or the difference between the returns we earn on the investments
that support our obligations under these products and the amounts that we must
pay policyholders and contractholders. Because we may reduce the interest rates
we credit on most of these products only at limited, pre-established intervals,
and because some of them have guaranteed minimum crediting rates, declines in
interest rates may adversely affect the profitability of those products. For
example, interest rates declined to unusually low levels in 2002 and 2003.
Although interest rates increased in 2004, they remain at low levels and limit
our returns on our spread-based investment products.
During periods of increasing market interest rates, we may offer higher
crediting rates on interest-sensitive products, such as universal life
insurance and fixed annuities, and we may increase crediting rates on in-force
products to keep these products competitive. In addition, rapidly rising
interest rates may cause increased policy surrenders, withdrawals from annuity
contracts and requests for policy loans, as policyholders and contractholders
shift assets into higher yielding investments. Increases in crediting rates, as
well as surrenders and withdrawals, could have an adverse effect on our
financial condition and results of operations.
Interest rate fluctuations also could have an adverse effect on the results of
our investment portfolio. During periods of declining market interest rates,
the interest we receive on variable interest rate investments decreases. In
addition, during those periods, we are forced to reinvest the cash we receive
as interest or return of principal on our investments in lower-yielding
high-grade instruments or in lower-credit instruments to maintain comparable
returns. Issuers of fixed-income securities also may decide to prepay their
obligations in order to borrow at lower market rates, which exacerbates the
risk that we may have to invest the cash proceeds of these securities in
lower-yielding or lower-credit instruments. Declining interest rates from 2002
to 2004 contributed to a decrease in our weighted average investment yield from
5.2% for the year ended December 31, 2002 to 4.6% and 4.2% for the years ended
December 31, 2003 and 2004, respectively.
Downturns and volatility in equity markets could adversely affect our business
and profitability.
Significant downturns and volatility in equity markets could have an adverse
effect on our financial condition and results of operations in two principal
ways. First, market downturns and volatility may discourage purchases of
separate account products, such as variable annuities and variable life
insurance, that have returns linked to the performance of the equity markets
and may cause some existing customers to withdraw cash values or reduce
investments in those products.
Second, downturns and volatility in equity markets can have an adverse effect
on the value of assets in our separate accounts, which, in turn, affects our
revenues and returns from our fee-based products. Because these products and
services depend on fees related primarily to the value of assets under
management, a decline in the equity markets could reduce our revenues by
reducing the value of the investment assets we manage. In addition, some of our
variable annuity products contain guaranteed minimum death benefits and
guaranteed minimum income payments tied to the investment performance of the
assets held within the variable annuity. A significant market decline could
result in declines in account values which could increase our payments under
guaranteed minimum death benefits and certain income payments in connection
with variable annuities, which could have an adverse effect on our financial
condition and results of operations.
Defaults in our fixed-income securities portfolio may reduce our earnings.
Issuers of the fixed-income securities that we own may default on principal and
interest payments. As a result of the economic downturn and recent corporate
malfeasance, the number of companies defaulting on their debt obligations has
increased dramatically in recent years. An economic downturn, further events of
corporate malfeasance or a variety of other factors could cause declines in the
value of our fixed maturities portfolio and cause our net earnings to decline.
A downgrade or a potential downgrade in our financial strength or credit
ratings could result in a loss of business and adversely affect our financial
condition and results of operations.
Financial strength ratings, which various ratings organizations publish as
measures of an insurance company's ability to meet contractholder and
policyholder obligations, are important to maintaining public confidence in our
products, the ability to market our products and our competitive position. We
currently have financial strength ratings of "AA-" (Very Strong) from S&P and
Fitch and "Aa3" (Excellent) from Moody's. The "AA-" rating is the
fourth-highest of S&P's 20 ratings categories. The "Aa3" rating is the
fourth-highest of Moody's 21 ratings categories. The "AA-" rating is the
fourth-highest of Fitch's 24 ratings categories.
A downgrade in our financial strength ratings, or the announced potential for a
downgrade, could have a significant adverse effect on our financial condition
and results of operations in many ways, including:
. reducing new sales of insurance products, annuities and other investment
products;
. adversely affecting our relationships with independent sales
intermediaries and our dedicated sales specialists;
. materially increasing the number or amount of policy surrenders and
withdrawals by contractholders and policyholders;
. requiring us to reduce prices for many of our products and services to
remain competitive; and
. adversely affecting our ability to obtain reinsurance or obtain reasonable
pricing on reinsurance.
In addition to our financial strength ratings, ratings agencies also publish
our credit ratings. The credit ratings have an impact on the interest rates we
pay on the money we borrow. Therefore, a downgrade in our credit ratings could
increase our cost of borrowing and have an adverse effect on our financial
condition and results of operations.
Our ratings are not evaluations directed to the protection of policyholders and
contractholders.
Our ratings described under " -- Financial Strength Ratings" reflect each
rating agency's current opinion of our financial strength, operating
performance and ability to meet obligations to policyholders and
contractholders. These factors are of concern to policyholders,
contractholders, agents, sales intermediaries and lenders. Ratings are not
evaluations directed to the protection of investors in our securities. In
addition, the standards used by rating agencies in determining financial
strength are different from capital requirements set by state insurance
regulators. We may need to take actions in response to changing standards set
by any of the ratings agencies, as well as statutory capital requirements,
which could cause our business and operations to suffer.
If our reserves for future policy benefits and claims are inadequate, we may be
required to increase our reserve liabilities, which could adversely affect our
results of operations and financial condition.
We calculate and maintain reserves for estimated future benefit payments to our
policyholders and contractholders in accordance with U.S. GAAP and industry
accounting practices. We release these reserves as those future obligations are
extinguished. The reserves we establish reflect estimates and actuarial
assumptions with regard to our future experience. These estimates and actuarial
assumptions
involve the exercise of significant judgment. Our future financial results
depend significantly upon the extent to which our actual future experience is
consistent with the assumptions we have used in pricing our products and
determining our reserves. Many factors can affect future experience, including
economic and social conditions, inflation, healthcare costs, changes in
doctrines of legal liability and damage awards in litigation. Therefore, we
cannot determine with complete precision the ultimate amounts we will pay for
actual future benefits or the timing of those payments.
We continually monitor our reserves. If we conclude that our reserves are
insufficient to cover actual or expected policy and contract benefits and
claims payments, we would be required to increase our reserves and incur income
statement charges for the period in which we make the determination, which
could adversely affect our results of operations and financial condition.
Some of our investments are relatively illiquid.
Our investments in privately placed fixed maturities, mortgage loans, policy
loans and limited partnership interests are relatively illiquid. These asset
classes represented 41.7% of the carrying value of our total cash and invested
assets as of December 31, 2004. If we require significant amounts of cash on
short notice in excess of our normal cash requirements, we may have difficulty
selling these investments in a timely manner, be forced to sell them for less
than we otherwise would have been able to realize, or both. If an unexpected
number of contractholders exercise their right to early termination and we are
unable to access other liquidity sources, we may have to liquidate assets
quickly. Our inability to quickly dispose of illiquid investments could have an
adverse effect on our financial condition and results of operations.
Intense competition could negatively affect our ability to maintain or increase
our market share and profitability.
Our businesses are subject to intense competition. We believe the principal
competitive factors in the sale of our products are product features, price,
commission structure, marketing and distribution arrangements, brand,
reputation, financial strength ratings and service.
Many other companies actively compete for sales in our Retirement Income and
Investments and Protection markets, including other major insurers, banks,
other financial institutions, mutual fund and money asset management firms and
specialty providers.
In many of our product lines, we face competition from competitors that have
greater market share or breadth of distribution, offer a broader range of
products, services or features, assume a greater level of risk, have lower
profitability expectations or have higher financial strength ratings than we
do. Many competitors offer similar products and use similar distribution
channels. The substantial expansion of banks' and insurance companies'
distribution capacities and expansion of product features in recent years have
intensified pressure on margins and production levels and have increased the
level of competition in many of our business lines.
We may be unable to attract and retain independent sales intermediaries and
dedicated sales specialists.
We distribute our products through financial intermediaries, independent
producers and dedicated sales specialists. We compete with other financial
institutions to attract and retain commercial relationships in each of these
channels, and our success in competing for sales through these sales
intermediaries depends upon factors such as the amount of sales commissions and
fees we pay, the breadth of our product offerings, the strength of our brand,
our perceived stability and our financial strength ratings, the marketing and
services we provide to them and the strength of the relationships we maintain
with individuals at those firms. From time to time, due to competitive forces,
we have experienced unusually high attrition in particular sales channels for
specific products. An inability to recruit productive independent sales
intermediaries and dedicated sales specialists, or our inability to retain
strong relationships with the individual agents at our independent sales
intermediaries, could have an adverse effect on our financial condition and
results of operations.
If the counterparties to our reinsurance arrangements or to the derivative
instruments we use to hedge our business risks default or fail to perform, we
may be exposed to risks we had sought to mitigate, which could adversely affect
our financial condition and results of operations.
We use reinsurance and derivative instruments to mitigate our risks in various
circumstances. Reinsurance does not relieve us of our direct liability to our
policyholders, even when the reinsurer is liable to us. Accordingly, we bear
credit risk with respect to our reinsurers. We cannot assure you that our
reinsurers will pay the reinsurance recoverable owed to us now or in the future
or that they will pay these recoverables on a timely basis. A reinsurer's
insolvency, inability or unwillingness to make payments under the terms of its
reinsurance agreement with us could have an adverse effect on our financial
condition and results of operations.
Prior to the completion of Genworth's IPO, we ceded to UFLIC effective as of
January 1, 2004, policy obligations under our structured settlement contracts,
which had reserves of $0.3 billion, and our variable annuity contracts which
had general account reserves of $2.5 billion and separate account reserves of
$7.6 billion, in each case as of December 31, 2003. These contracts represent
substantially all of our contracts, excluding the GERATM product that was not
reinsured, that were in force as of December 31, 2003 for these products. UFLIC
has established trust accounts for our benefit to secure its obligations under
the reinsurance arrangements, and GE Capital has agreed to maintain UFLIC's
risk-based capital above a specified minimum level. If UFLIC becomes insolvent
notwithstanding this agreement, and the amounts in the trust accounts are
insufficient to pay UFLIC's obligations to us, our financial condition and
results of operations could be materially adversely affected.
In addition, we use derivative instruments to hedge various business risks. We
may enter into a variety of derivative instruments, including options,
forwards, interest rate and currency swaps and options to enter into interest
rate and currency swaps with a number of counterparties. If our counterparties
fail or refuse to honor their obligations under the derivative instruments, our
hedges of the related risk will be ineffective. Such failure could have an
adverse effect on our financial condition and results of operations.
We are heavily regulated, and changes in regulation may reduce our
profitability and limit our growth.
As an insurance company, we are subject to a wide variety of laws and
regulations. State insurance laws regulate most aspects of our insurance
business, and we are regulated by the insurance departments of the states in
which we are domiciled and licensed.
State laws grant insurance regulatory authorities broad administrative powers
with respect to, among other things:
. licensing companies and agents to transact business;
. calculating the value of assets to determine compliance with statutory
requirements;
. mandating certain insurance benefits;
. regulating certain premium rates;
. reviewing and approving policy forms;
. regulating unfair trade and claims practices, including through the
imposition of restrictions on marketing and sales practices, distribution
arrangements and payment of inducements;
. establishing statutory capital and reserve requirements and solvency
standards;
. fixing maximum interest rates on insurance policy loans and minimum rates
for guaranteed crediting rates on life insurance policies and annuity
contracts;
. approving changes in control of insurance companies; and
. regulating the types, amounts and valuation of investments.
State insurance regulators and the NAIC regularly reexamine existing laws and
regulations applicable to insurance companies and their products. Changes in
these laws and regulations, or in interpretations thereof, are often made for
the benefit of the consumer at the expense of the insurer and thus could have
an adverse effect on our financial condition and results of operations.
In December 2004, the NAIC approved amendments to the NAIC's model Producer
Licensing Act. The amendments contain new disclosure requirements for producers
regarding compensation arrangements. If adopted, the NAIC amendments would
require producers to disclose to customers, in certain circumstances,
information concerning compensation arrangements. The NAIC also directed its
Executive Task Force on Broker Activities to give further consideration to the
development of additional requirements for recognition of a fiduciary
responsibility on the part of producers, disclosure of all quotes received by a
broker and disclosures relating to reinsurance arrangements between insurers
and reinsurance companies affiliated with a producer. We cannot predict the
effect that the NAIC's recent compensation disclosure amendments or anticipated
future activities in this area, at the NAIC or state level, will have on
influencing future legal actions, changes to business practices or regulatory
requirements applicable to us.
Currently, the U.S. federal government does not regulate directly the business
of insurance. However, federal legislation and administrative policies in
several areas can significantly and adversely affect insurance companies. These
areas include financial services regulation, securities regulation, pension
regulation, privacy, tort reform legislation and taxation. In addition, various
forms of direct federal regulation of insurance have been proposed. These
proposals include "The State Modernization and Regulatory Transparency Act,"
which would maintain state-based regulation of insurance but would affect state
regulation of certain aspects of the business of insurance including rates,
agent and company licensing, and market conduct examinations. We cannot predict
whether this or other proposals will be adopted, or what impact, if any, such
proposals or, if enacted, such laws may have on our business, financial
condition or results of operation.
Many of our customers and independent sales intermediaries also operate in
regulated environments. Changes in the regulations that affect their operations
also may affect our business relationships with them and their ability to
purchase or to distribute our products. Accordingly, these changes could have
an adverse effect on our financial condition and results of operation.
Compliance with applicable laws and regulations is time consuming and
personnel-intensive, and changes in these laws and regulations may increase
materially our direct and indirect compliance and other expenses of doing
business, thus having an adverse effect on our financial condition and results
of operations.
Legal and regulatory investigations and actions are increasingly common in the
insurance business and may result in financial losses and harm our reputation.
We face a significant risk of litigation and regulatory investigations and
actions in the ordinary course of operating our businesses, including the risk
of class action lawsuits. Our pending legal and regulatory actions include
proceedings specific to us and others generally applicable to business
practices in the industries in which we operate. We are or may become subject
to class actions and individual suits alleging, among other things, issues
relating to sales or underwriting practices, payment of contingent or other
sales commissions, claims payments and procedures, product design, disclosure,
administration, additional premium charges for premiums paid on a periodic
basis, denial or delay of benefits and breaches of fiduciary or other duties to
customers. Plaintiffs in class action and other lawsuits against us may seek
very large or indeterminate amounts, including punitive and treble damages,
which may remain unknown for substantial periods of time. We are also subject
to various regulatory inquiries, such as information requests, subpoenas and
books and record examinations, from state, federal and international regulators
and other authorities. A substantial legal liability or a significant
regulatory action against us could have an adverse effect on our business,
financial condition and results of operations. Moreover, even if we ultimately
prevail in the litigation, regulatory action or investigation, we could suffer
significant reputational harm, which could have an adverse effect on our
business, financial condition and results of operations.
Recently, the insurance industry has become the focus of increased scrutiny by
regulatory and law enforcement authorities concerning certain practices within
the insurance industry. In this regard, in May 2005, we received a subpoena
from the Northeast Regional Office of the SEC, requiring the production of
documents related to "certain loss mitigation insurance products," such as
finite risk reinsurance. We are cooperating fully with the SEC with respect to
its subpoena. In June 2005, GE received a subpoena from the United States
Attorney's Office for the Southern District of New York, also on the same
general subject. In the subpoena, GE is defined as including, among other
things, its subsidiaries and affiliates. We are cooperating with GE in
connection with GE's response to the subpoena.
This industry scrutiny also includes the commencement of investigations and
other proceedings by the New York State Attorney General and other governmental
authorities relating to allegations of improper conduct in connection with the
payment of, and the failure to disclose, contingent commissions by insurance
companies to insurance brokers and agents, the solicitation and provision of
fictitious or inflated quotes, the use of inducements to brokers or companies
in the sale of insurance products and the use of captive reinsurance
arrangements. We have not received a subpoena or inquiry from the State of New
York with respect to these matters. However, as part of industry-wide inquiries
in this regard, we have received inquiries and informational requests with
respect to some of these matters from other federal and state regulatory
authorities. We have responded to these inquiries and informational requests
and will continue to cooperate with these regulatory authorities.
Recent industry-wide inquiries also include those regarding market timing and
late trading in variable annuity contracts, variable annuity sales
practices/exchanges and electronic communication document retention practices.
In this regard, we responded in late 2003 to a New York State Attorney General
subpoena regarding market timing and late trading in variable products and
mutual funds. We have not received any further inquiries from the New York
State Attorney General regarding these matters, although we received inquiries
and informational requests regarding these matters from other federal and state
regulatory authorities. We have responded to these inquiries, follow-up
inquiries and informational requests and will continue to cooperate with these
regulatory authorities.
We cannot assure you that the current investigations and proceedings will not
have a material adverse effect on our business, financial condition or results
of operations. It is also possible that related investigations and proceedings
may be commenced in the future, and we could become subject to further
investigations and have lawsuits filed or enforcement actions initiated against
us. In addition, increased regulatory scrutiny and any resulting investigations
or proceedings could result in new legal precedents and industry-wide
regulations or practices that could adversely affect our business, financial
condition and results of operation.
We have significant operations in India that could be adversely affected by
changes in the political or economic stability of India or government policies
in India or the U.S.
Through an arrangement with an outsourcing provider that is 40% owned by GE, we
have a substantial team of professionals in India who provide a variety of
services to us, including customer service, transaction processing, and
functional support including finance, investment research, actuarial, risk and
marketing. The development of an operations center in India has been
facilitated partly by the liberalization policies pursued by the Indian
government over the past decade. The current government of India, formed in
October 1999, has announced policies and taken initiatives that support the
continued economic liberalization policies that have been pursued by previous
governments. However, we cannot assure you that these liberalization policies
will continue in the future. The rate of economic liberalization could change,
and specific laws and policies affecting our business could change as well. A
significant change in India's economic liberalization and deregulation policies
could adversely affect business and economic conditions in India generally and
our business in particular.
The political or regulatory climate in the U.S. or elsewhere also could change
so that it would not be practical or legal for us to use international
operations centers, such as call centers. For example, changes in privacy
regulations, or more stringent interpretation or enforcement of these
regulations,
could require us to curtail our use of low-cost operations in India to service
our businesses, which could reduce the cost benefits we currently realize from
using these operations.
Our computer systems may fail or their security may be compromised, which could
damage our business and adversely affect our financial condition and results of
operation.
Our business is highly dependent upon the uninterrupted operation of our
computer systems. We rely on these systems throughout our business for a
variety of functions, including processing claims and applications, providing
information to customers and distributors, performing actuarial analyses and
maintaining financial records. Despite the implementation of security measures,
our computer systems may be vulnerable to physical or electronic intrusions,
computer viruses or other attacks, programming errors and similar disruptive
problems. The failure of these systems for any reason could cause significant
interruptions to our operations, which could result in a material adverse
effect on our business, financial condition or results of operation.
We retain confidential information in our computer systems, and we rely on
sophisticated commercial technologies to maintain the security of those
systems. Anyone who is able to circumvent our security measures and penetrate
our computer systems could access, view, misappropriate, alter, or delete any
information in the systems, including personally identifiable customer
information and proprietary business information. In addition, an increasing
number of states and foreign countries require that customers be notified if a
security breach results in the disclosure of personally identifiable customer
information. Any compromise of the security of our computer systems that
results in inappropriate disclosure of personally identifiable customer
information could damage our reputation in the marketplace, deter people from
purchasing our products, subject us to significant civil and criminal liability
and require us to incur significant technical, legal and other expenses.
The occurrence of natural or man-made disasters could adversely affect our
financial condition and results of operation.
We are exposed to various risks arising out of natural disasters, including
earthquakes, hurricanes, floods and tornadoes, or manmade disasters, including
acts of terrorism and military actions. For example, a natural or man-made
disaster could lead to unexpected changes in persistency rates as policyholders
and contractholders who are affected by the disaster may be unable to meet
their contractual obligations, such as payment of premiums on our insurance
policies and deposits into our investment products. The continued threat of
terrorism and ongoing military actions may cause significant volatility in
global financial markets, and a natural or man-made disaster could trigger an
economic downturn in the areas directly or indirectly affected by the disaster.
These consequences could, among other things, result in a decline in business
and increased claims from those areas. Disasters also could disrupt public and
private infrastructure, including communications and financial services, which
could disrupt our normal business operations.
A natural or man-made disaster also could disrupt the operations of our
counterparties or result in increased prices for the products and services they
provide to us. For example, a natural or man-made disaster could lead to
increased reinsurance prices and potentially cause us to retain more risk than
we otherwise would retain if we were able to obtain reinsurance at lower
prices. In addition, a disaster could adversely affect the value of the assets
in our investment portfolio if it affects companies' ability
to pay principal or interest on their securities. See "-- We may face losses if
there are significant deviations from our assumptions regarding the future
persistency of our insurance policies and annuity contracts".
We may face losses if mortality rates differ significantly from our pricing
expectations.
We set prices for our insurance and some annuity products based upon expected
claims and payment patterns, using assumptions for, among other things,
mortality rates, or likelihood of death, of our policyholders and
contractholders. The long-term profitability of these products depends upon how
our actual experience compares with our pricing assumptions. For example, if
mortality rates are lower than our pricing assumptions, we could be required to
make greater payments under annuity contracts than we had projected.
Conversely, if mortality rates are higher than our pricing assumptions, we
could be required to make greater payments under our life insurance policies
and annuity contracts with guaranteed minimum death benefits than we had
projected.
We may be required to accelerate the amortization of deferred acquisition costs
and the present value of future profits, which would increase our expenses and
reduce profitability.
Deferred acquisition costs, or DAC, represent costs which vary with and are
primarily related to the sale and issuance of our insurance policies and
investment contracts that are deferred and amortized over the estimated life of
the related insurance policies and investment contracts. These costs include
commissions in excess of ultimate renewal commissions, solicitation and
printing costs, sales material and some support costs, such as underwriting and
contract and policy issuance expenses. Under U.S. GAAP, DAC is subsequently
amortized to income, over the lives of the underlying contracts, in relation to
the anticipated recognition of premiums or gross profits. In addition, when we
acquire a block of insurance policies or investment contracts, we assign a
portion of the purchase price to the right to receive future net cash flows
from existing insurance and investment contracts and policies. This intangible
asset, called the present value of future profits, or PVFP, represents the
actuarially estimated present value of future cash flows from the acquired
policies. We amortize the value of this intangible asset in a manner similar to
the amortization of DAC.
Our amortization of DAC and PVFP generally depends upon anticipated profits
from investments, surrender and other policy and contract charges, mortality,
morbidity and maintenance expense margins. Unfavorable experience with regard
to expected expenses, investment returns, mortality, morbidity, withdrawals or
lapses may cause us to increase the amortization of DAC or PVFP, or both, or to
record a charge to increase benefit reserves.
We regularly review DAC and PVFP to determine if they are recoverable from
future income. If these costs are not recoverable, they are charged to expenses
in the financial period in which we make this determination. For example, if we
determine that we are unable to recover DAC from profits over the life of a
block of insurance policies or annuity contracts, or if withdrawals or
surrender charges associated with early withdrawals do not fully offset the
unamortized acquisition costs related to those policies or annuities, we would
be required to recognize the additional DAC amortization as a current-period
expense.
We may be required to recognize impairment in the value of our goodwill, which
would increase our expenses and reduce our profitability.
Goodwill represents the excess of the amount we paid to acquire our
subsidiaries and other businesses over the fair value of their net assets at
the date of the acquisition. Under U.S. GAAP, we test the carrying value of
goodwill for impairment at least annually at the "reporting unit" level, which
is either an operating segment or a business one level below the operating
segment. Goodwill is impaired if the fair value of the reporting unit as a
whole is less than the fair value of the identifiable assets and liabilities of
the reporting unit, plus the carrying value of goodwill, at the date of the
test. For example, goodwill may become impaired if the fair value of a
reporting unit as a whole were to decline by an amount greater than the decline
in the value of its individual identifiable assets and liabilities. This may
occur for various reasons, including changes in actual or expected earnings or
cash flows of a reporting unit, generation of earnings by a reporting unit at a
lower rate of return than similar businesses or declines in market prices for
publicly traded businesses similar to our reporting units. If any portion of
our goodwill becomes impaired, we would be required to recognize the amount of
the impairment as a current-period expense.
Medical advances, such as genetic research and diagnostic imaging, and related
legislation could adversely affect the financial performance of our life
insurance and annuities businesses.
Genetic research includes procedures focused on identifying key genes that
render an individual predisposed to specific diseases, such as particular types
of cancer and other diseases. Other medical advances, such as diagnostic
imaging technologies, also may be used to detect the early onset of diseases
such as cancer and cardiovascular disease. We believe that if individuals learn
through medical advances that they are predisposed to particular conditions
that may reduce life longevity, they will be more likely to purchase our life
policies or not to permit existing polices to lapse. In contrast, if
individuals learn that they lack the genetic predisposition to develop the
conditions that reduce longevity, they will be less likely to purchase our life
insurance products but more likely to purchase certain annuity products. In
addition, such individuals that are existing policyholders will be more likely
to permit their policies to lapse.
If we were to gain access to the same genetic or medical information as our
prospective policyholders and contractholders, then we would be able to take
this information into account in pricing our life insurance policies and
annuity contracts. However, there are a number of regulatory proposals that
would make genetic and other medical information confidential and unavailable
to insurance companies. The U.S. Senate has approved a bill that would prohibit
group health plans, health insurers and employers from making enrollment
decisions or adjusting premiums on the basis of genetic testing information.
This legislation is now pending before a committee at the House of
Representatives. Legislators in certain states also have introduced similar
legislation. If these regulatory proposals were enacted, prospective
policyholders and contractholders would only disclose this information if they
chose to do so voluntarily. These factors could lead us to reduce sales of
products affected by these regulatory proposals and could result in a
deterioration of the risk profile of our portfolio, which could lead to
payments to our policyholders and contractholders that are higher than we
anticipated.
Medical advances also could lead to new forms of preventative care.
Preventative care could extend the life and improve the overall health of
individuals. If this were to occur, the duration of payments under certain of
our annuity products likely would increase, thereby reducing net earnings in
that business.
We may face losses if there are significant deviations from our assumptions
regarding the future persistency of our insurance policies and annuity
contracts.
The prices and expected future profitability of our insurance and deferred
annuity products are based in part upon expected patterns of premiums, expenses
and benefits, using a number of assumptions, including those related to
persistency, which is the probability that a policy or contract will remain
in-force from one period to the next. The effect of persistency on
profitability varies for different products. For most of our life insurance and
deferred annuity products, actual persistency that is lower than our
persistency assumptions could have an adverse impact on profitability,
especially in the early years of a policy or contract primarily because we
would be required to accelerate the amortization of expenses we deferred in
connection with the acquisition of the policy or contract. For our life
insurance policies, increased persistency that is the result of the sale of
policies to third parties that continue to make premium payments on policies
that would otherwise have lapsed, also known as life settlements, could have an
adverse impact on profitability because of the higher claims rate associated
with settled policies. For the years ended December 31, 2004, 2003 and 2002,
persistency in fixed annuity businesses has been slightly higher than assumed,
while persistency in our variable annuity and certain health insurance products
has been slightly lower than we had assumed.
Because our assumptions regarding persistency experience are inherently
uncertain, reserves for future policy benefits and claims may prove to be
inadequate if actual persistency experience is different from those
assumptions. Although some of our products permit us to increase premiums
during the life of the policy or contract, we cannot guarantee that these
increases would be sufficient to maintain profitability. Moreover, many of our
products do not permit us to increase premiums or limit those increases during
the life of the policy or contract. Significant deviations in experience from
pricing expectations regarding persistency could have an adverse effect on the
profitability of our products.
Changes in tax laws could make some of our products less attractive to
consumers.
Changes in tax laws could make some of our products less attractive to
consumers. For example, in May 2003, U.S. President George W. Bush signed into
law the Jobs and Growth Tax Relief Reconciliation Act of 2003, which reduced
the federal income tax that investors are required to pay on long-term capital
gains and on some dividends paid on stock. This reduction may provide an
incentive for some of our customers and potential customers to shift assets
into mutual funds and away from products, including annuities, designed to
defer taxes payable on investment returns. Because the income taxes payable on
long-term capital gains and some dividends paid on stock have been reduced,
investors may decide that the tax-deferral benefits of annuity contracts are
less advantageous than the potential after-tax income benefits of mutual funds
or other investment products that provide dividends and long-term capital
gains. A shift away from annuity contracts and other tax-deferred products
would reduce our income from sales of these products, as well as the assets
upon which we earn investment income.
We cannot predict whether any other legislation will be enacted, what the
specific terms of any such legislation will be or how, if at all, this
legislation or any other legislation could have an adverse effect on our
financial condition and results of operations.
Changes in U.S. federal and state securities laws may affect our operations and
our profitability.
U.S. federal and state securities laws apply to investment products that are
also "securities," including variable annuities and variable life insurance
policies. As a result, the policies and contracts we offer are subject to
regulation under these federal and state securities laws. Our separate accounts
are registered as investment companies under the Investment Company Act of
1940. Some variable annuity contracts and variable life insurance policies
issued by us are registered under the Securities Act of 1933.
Securities laws and regulations are primarily intended to ensure the integrity
of the financial markets and to protect investors in the securities markets or
investment advisory or brokerage clients. These laws and regulations generally
grant supervisory agencies broad administrative powers, including the power to
limit or restrict the conduct of business for failure to comply with those laws
and regulations. Changes to these laws or regulations that restrict the conduct
of our business could have an adverse effect on our financial condition and
results of operations.
Risks Relating to Our Separation from GE
Our separation from GE could adversely affect our business and profitability
due to GE's strong brand and reputation.
As an indirect subsidiary of GE, our businesses have marketed many of their
products using the "GE" brand name and logo, and we believe the association
with GE has provided many benefits, including:
. a world-class brand associated with trust, integrity and longevity;
. perception of high-quality products and services;
. preferred status among our customers, independent sales intermediaries and
employees;
. strong capital base and financial strength; and
. established relationships with U.S. federal and state regulators.
Our separation from GE following Genworth's corporate reorganization and the
IPO could adversely affect our ability to attract and retain highly qualified
independent sales intermediaries and dedicated sales specialists for our
products. In addition, because of our separation from GE, some of our existing
policyholders, contractholders and other customers may choose to stop doing
business with us, and this could increase our rate of surrenders and
withdrawals in our policies and contracts. In addition, other potential
policyholders and contractholders may decide not to purchase our products
because of our separation from GE.
We cannot accurately predict the effect that our separation from GE will have
on our sales intermediaries, customers or employees. The risks relating to our
separation from GE could materialize at various times in the future, including:
. GE's reduction in its ownership in Genworth's common stock to below 50%;
and
. when we cease using the GE name and logo in our sales and marketing
materials, particularly when we deliver notices to our distributors and
customers that our name will change.
We only have the right to use the GE brand name and logo for a limited period
of time. If we fail to establish in a timely manner a new, independently
recognized brand name with a strong reputation, our revenue and profitability
could decline.
Since the completion of Genworth's IPO, we may use the GE brand name and logo
in marketing our products and services for only a limited period of time.
Pursuant to a transitional trademark license agreement, GE granted us the right
to use the "GE" mark and the "GE" monogram for up to five years after
Genworth's IPO in connection with our products and services. GE also granted us
the right to use "GE," "General Electric" and "GE Capital" in the corporate
names of Genworth subsidiaries until the earlier of twelve months after the
date on which GE owns less than 20% of Genworth's outstanding common stock and
May 24, 2009. When our right to use the GE brand name and logo expires, we may
not be able to maintain or enjoy comparable name recognition or status under
our new brand. In addition, insurance regulators in jurisdictions where we do
business could require us to accelerate the transition to our independent
brand. If we are unable to successfully manage the transition of our business
to our new brand, our reputation among our independent sales intermediaries,
customers and employees could be adversely affected.
The terms of our arrangements with GE may be more favorable than we would be
able to obtain from an unaffiliated third party. We may be unable to replace
the services GE provides us in a timely manner or on comparable terms.
Genworth and GE entered into a transition services agreement and other
agreements in connection with the IPO. Pursuant to these arrangements, GE and
its affiliates agreed to provide us with a variety of services, including
investment management, treasury, payroll and other financial services, human
resources and employee benefit services, legal services, information systems
and network services, and procurement and sourcing support.
Genworth negotiated these arrangements with GE in the context of a
parent-subsidiary relationship. Although GE is contractually obligated to
provide us with services during the terms of these arrangements, we cannot
assure you that these services will be sustained at the same level after the
expiration of those arrangements, or that we will be able to replace these
services in a timely manner or on comparable terms. Other agreements with GE
also govern the relationship between us and GE and provide for the allocation
of employee benefit, tax and other liabilities and obligations attributable or
related to periods or events prior to Genworth's IPO. They also contain terms
and provisions that may be more favorable than terms and provisions we might
have obtained in arm's-length negotiations with unaffiliated third parties.
When GE ceases to provide services pursuant to those arrangements, our costs of
procuring those services from third parties may increase.
If GE engages in the same type of business we conduct, our ability to
successfully operate and expand our business may be hampered.
Genworth's certificate of incorporation provides that, subject to any
contractual provision to the contrary, GE will have no obligation to refrain
from:
. engaging in the same or similar business activities or lines of business
as us; or
. doing business with, or in competition with, any of our clients, customers
or vendors.
GE is a diversified technology and services company with significant financial
services businesses, including consumer finance, asset management and insurance
activities. GE is engaged in the marketing of supplemental life insurance,
including accidental death and dismemberment coverage and in the marketing and
underwriting of dental and vision insurance, medical stop-loss insurance and
primary property and casualty insurance. Because of GE's significant financial
resources, GE could have a significant competitive advantage over us should it
decide to engage in businesses that compete with any of the businesses we
conduct.
GE has generally agreed not to use the "GE" mark or the "GE" monogram or the
name "General Electric" until May 24, 2009 in connection with the marketing or
underwriting on a primary basis of life insurance and annuities anywhere in the
world. GE's agreement to restrict the use of its brand will terminate earlier
upon the occurrence of certain events, including termination of our
transitional trademark license agreement with GE and our discontinuation of the
use of the "GE" mark or the "GE" monogram.
Conflicts of interest may arise between Genworth and GE that could be resolved
in a manner unfavorable to us.
Questions relating to conflicts of interest may arise between Genworth and GE
in a number of areas relating to our past and ongoing relationships. Five of
Genworth's directors were designated to Genworth's board of directors by GE.
One of these directors is both an officer and director of GE, and the other
four of these directors are also officers of GE. These directors and a number
of our parent's officers own substantial amounts of GE stock and options to
purchase GE stock, and all of them participate in GE pension plans. Ownership
interests of Genworth's directors or officers in GE shares, or service as a
director or officer of both Genworth and GE, could give rise to potential
conflicts of interest when a director or officer is faced with a decision that
could have different implications for the two companies. These potential
conflicts could arise, for example, over matters such as the desirability of an
acquisition opportunity, employee retention or recruiting, or our dividend
policy.
The corporate opportunity policy set forth in Genworth's certificate of
incorporation addresses potential conflicts of interest between Genworth, on
the one hand, and GE and its officers and directors who are directors of
Genworth, on the other hand. Although these provisions are designed to resolve
conflicts between Genworth and GE fairly, we cannot assure you that any
conflicts will be so resolved.
Cautionary Note Regarding Forward-Looking Statements
This report contains certain "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Forward-looking
statements may be identified by words such as "expects," "intends,"
"anticipates," "plans," "believes," "seeks," "estimates," "will," or words of
similar meaning and include, but are not limited to, statements regarding the
outlook for our future business and financial performance. Forward-looking
statements are based on management's current expectations and assumptions,
which are subject to inherent uncertainties, risks and changes in circumstances
that are difficult to predict. Actual outcomes and results may differ
materially due to global political, economic, business, competitive, market,
regulatory and other factors, including the following:
. Risks relating to our businesses, including interest rate fluctuations,
downturns and volatility in equity markets, defaults in portfolio
securities, downgrades in our financial strength and credit
ratings, insufficiency of reserves, legal constraints on dividend
distributions, illiquidity of investments, competition, inability to
attract or retain independent sales intermediaries and dedicated sales
specialists, defaults by counterparties, foreign exchange rate
fluctuations, regulatory restrictions on our operations and changes in
applicable laws and regulations, legal or regulatory actions or
investigations, political or economic instability, the failure of any
compromise of the security of our computer systems and the occurrence of
natural or man-made disasters;
. Risks relating to our Retirement Income and Investments and Protection
segments, including unexpected changes in mortality, morbidity and
unemployment rates, accelerated amortization of deferred acquisition costs
and present value of future profits, goodwill impairments, medical
advances such as genetic mapping research, unexpected changes in
persistency rates, increases in statutory reserve requirements and changes
in tax and securities laws;
. Risks relating to our separation from GE, including the loss of benefits
associated with GE's brand and reputation, our need to establish our new
Genworth brand identity quickly and effectively, the possibility that we
will not be able to replace services previously provided by GE on terms
that are at least as favorable, potential conflicts of interest with GE
and GE's engaging in the same type of business as we do in the future.
We undertake no obligation to publicly update or review any forward-looking
statement, whether as a result of new information, future developments or
otherwise.
Overview
Our business
We are one of a number of subsidiaries of Genworth, a company that, through its
subsidiaries, provides consumers financial security solutions by selling a wide
variety of insurance, investment and retirement products, primarily in North
America. Our product offerings are divided along two segments of consumer
needs: (1) Retirement Income and Investments and (2) Protection.
. Retirement Income and Investments. We offer deferred annuities (variable
and fixed) and variable life insurance to a broad range of individual
consumers who want to accumulate tax-deferred assets for retirement,
desire a tax-efficient source of income and seek to protect against
outliving their assets. We also offer GICs and funding agreements as
investment products to qualified buyers.
. Protection. Our Protection segment includes universal life insurance,
interest-sensitive whole life insurance and Medicare supplement insurance.
Life insurance products provide protection against financial hardship
after the death of an insured by providing cash payment to the
beneficiaries of the policyholder. Medicare supplement insurance provides
coverage for Medicare-qualified expenses that are not covered by Medicare
because of applicable deductibles or maximum limits.
We also have a Corporate and Other segment, which consists primarily of net
realized investment gains, unallocated corporate income, expenses and income
taxes.
Revenues and expenses
Our revenues consist primarily of the following:
. Retirement Income and Investments. The revenues in our Retirement Income
and Investments segment consist primarily of:
. net investment income allocated to this segment; and
. policy fees and other income, including surrender charges and
mortality and expense charges.
. Protection. The revenues in our Protection segment consist primarily of:
. net premiums earned on individual life and Medicare supplement
insurance policies; and
. net investment income allocated to this segment's lines of business;
and
. policy fees and other income, including fees for mortality and
surrender charges primarily from universal life insurance policies,
and other administrative charges.
. Corporate and Other. The revenues in our Corporate and Other segment
consist primarily of:
. unallocated net investment income; and
. net realized investment gains.
We allocate net investment income from our Corporate and Other segment to our
Retirement Income and Investments and Protection segments using an approach
based principally upon the investment portfolio established to support each of
those segments' products and targeted capital levels.
All net realized investment gains are reflected in the Corporate and Other
segment and are not reflected in the results of any of our other segments.
Our expenses consist primarily of the following:
. benefits provided to policyholders and contractholders and changes in
reserves;
. interest credited on general account balances;
. underwriting, acquisition and insurance expenses, including commissions,
marketing expenses, policy and contract servicing costs, overhead and
other general expenses that are not capitalized (shown net of deferrals);
. amortization of deferred policy acquisition costs and other intangible
assets;
. income taxes.
We allocate corporate expenses to each of our operating segments based on the
amount of capital allocated to that segment.
Business trends and conditions
In recent years, our business has been, and we expect will continue to be,
influenced by a number of industry-wide and product-specific trends and
conditions.
Market and economic environment
Aging U.S. population with growing retirement income needs. According to the
U.S. Social Security Administration in a report issued in 2004, from 1945 to
2003, U.S. life expectancy at birth increased from 62.9 years to 74.4 years for
men and from 68.4 years to 79.5 years for women, respectively, and life
expectancy is expected to increase further. In addition, increasing numbers of
baby boomers are approaching retirement age. Based on the 2000 census, the U.S.
Census Bureau projects that the percentage of the U.S. population aged 55 or
older will increase from approximately 22% (65 million) in 2004 to more than
29% (97 million) in 2020. These increases in life expectancy and the average
age of the U.S. population heighten the risk that individuals will outlive
their retirement savings. In addition, approximately $4.2 trillion of invested
financial assets are held by people within 10 years of retirement and
approximately $2.4 trillion of invested financial assets are held by
individuals who are under age 70 and consider themselves retired, in each case
according to a survey conducted by SRI Consulting Business Intelligence in
2004. We believe these trends will lead to growing demand for retirement income
and investment products, such as our annuities and other investment products
that help consumers accumulate assets and provide reliable retirement income.
General conditions and trends affecting our businesses
Interest rate fluctuations. Fluctuations in market interest rates may have a
significant effect on our sales of insurance and investment products and our
margins on these products. Interest rates are highly sensitive to many factors,
including governmental monetary policies, domestic and international economic
and political conditions and other factors beyond our control. In our
Retirement Income and Investments and Protection segments, low market interest
rates may reduce the spreads between the amounts we credit to policyholders and
contractholders and the yield we earn on the investments that support these
obligations. In response to the unusually low interest rates that have
prevailed during the last several years, we have reduced crediting rates on
in-force contracts where permitted to do so. These actions have helped mitigate
the adverse impact of low interest rates on our spreads and profitability on
these products. A gradual increase in interest rates generally would have a
favorable effect on the profitability of these products. However, rapidly
rising interest rates also could result in reduced persistency in our
spread-based retail products as contractholders shift assets into higher
yielding investments.
Volatile equity markets. Equity market volatility may discourage purchases of
separate account products, such as variable annuities and variable life
insurance, that have returns linked to the performance of the equity markets
and may cause some existing customers to withdraw cash values or reduce
investments in those products. Equity market volatility also affects the value
of the assets in our separate accounts, which, in turn, affects our earnings
from fee-based products. After several years of declines, equity markets
increased in 2003 and 2004, and we expect that increases or relative stability
in equity markets could have a favorable impact on our sales of variable
products and our earnings from those products. The potential impact of volatile
equity markets on our results has been significantly reduced as a result of our
reinsurance arrangements with UFLIC, pursuant to which we reinsured, effective
as of January 1, 2004, substantially all of our in-force blocks of variable
annuities and structured settlement business. We retain variable annuities sold
after January 1, 2004 for our own account, subject to third-party reinsurance
transactions in the ordinary course of business, and
therefore we bear the risk of any adverse impact of future equity market
fluctuations on those annuities.
Credit default risk. As a result of the economic downturn in 2000 through 2002
and some high-profile corporate bankruptcies and scandals, the number of
companies defaulting on their debt obligations increased dramatically in 2001
and 2002. These defaults and other declines in the value of some of our
investments resulted in impairment charges. Credit defaults have decreased in
recent years as the economy has improved. Charges associated with impairments
of investments were $0.9 million, $26.4 million, and $77.4 million for the
years ended December 31, 2004, 2003 and 2002, respectively. A weakening in the
economic recovery could lead to increased credit defaults.
Investment portfolio. The yield on our investment portfolio is affected by the
practice, prior to Genworth's separation from GE, of realizing investment gains
through the sale of appreciated securities and other assets during a period of
historically low interest rates. This strategy had been pursued to offset
impairments and losses in our investment portfolio, fund consolidations and
restructurings in our business and provide current income. Our gross realized
gains were $80.2 million and $181.1 million for the years ended December 31,
2003 and 2002, respectively. This strategy has had an adverse impact on the
yield on our investment portfolio and our net investment income as we typically
sold higher-yielding securities and reinvested the proceeds in lower-yielding
securities during periods of declining or low interest rates. The impact is
most significant in the Retirement Income and Investments segment, which has a
higher percentage of our fixed maturities allocated to it than to our other
segments.
Since Genworth's separation from GE, our investment strategy has been to
optimize investment income without relying on realized investment gains. As a
result, our gross realized gains decreased to $10.7 million for the year ended
December 31, 2004. We also are currently experiencing a challenging
interest-rate environment in which the yields that we can achieve on new
investments are lower than the aggregate yield on our existing portfolio. This
environment has resulted in a decline in our overall investment yield, from
5.2% for the year ended December 31, 2002 to 4.6% and 4.2% for the years ended
December 31, 2003 and 2004, respectively. We seek to mitigate this decline in
investment yields by continuously evaluating our asset class mix, pursuing
additional investment classes and accepting additional credit risk when we
believe that it is prudent to do so. A continued increase in prevailing
interest rates also will mitigate this decline, whereas a decrease in interest
rates could lead to further declines.
Critical accounting policies
The accounting policies discussed in this section are those that we consider to
be particularly critical to an understanding of our financial statements
because their application places the most significant demands on our ability to
judge the effect of inherently uncertain matters on our financial results. For
all of these policies, we caution that future events rarely develop exactly as
forecast, and our management's best estimates may require adjustment.
Insurance liabilities and reserves. We calculate and maintain reserves for the
estimated future payment of claims to our policyholders and contractholders
based on actuarial assumptions and in accordance with industry practice and
U.S. GAAP. Many factors can affect these reserves, including economic and
social conditions, inflation, healthcare costs, changes in doctrines of legal
liability and damage awards in litigation. Therefore, the reserves we establish
are necessarily based on extensive estimates, assumptions and our analysis of
historical experience. Our results depend significantly upon the extent to
which our actual claims experience is consistent with the assumptions we used
in determining our reserves and pricing our products. Our reserve assumptions
and estimates require significant judgment and, therefore, are inherently
uncertain. We cannot determine with precision that the ultimate amounts that we
will pay for actual claims or the timing of those payments will be consistent
with our reserve assumptions.
Insurance reserves differ for long- and short-duration insurance policies and
annuity contracts. Measurement of long-duration insurance reserves is based on
approved actuarial methods, but necessarily includes assumptions about
expenses, mortality, morbidity, lapse rates and future yield on related
investments. Short-duration contracts are accounted for based on actuarial
estimates of the amount of loss inherent in that period's claims, including
losses incurred for which claims have not been reported. Short-duration
contract loss estimates rely on actuarial observations of ultimate loss
experience for similar historical events.
Deferred acquisition costs. Deferred acquisition costs ("DAC") represents costs
which vary with and are primarily related to the sale and issuance of our
insurance policies and investment contracts that are deferred and amortized
over the estimated life of the related insurance policies and investment
contracts. These costs include commissions in excess of ultimate renewal
commissions, solicitation and printing costs, sales material and some support
costs, such as underwriting and contract and policy issuance expenses. DAC is
subsequently amortized to income over the lives of the underlying policies and
contracts, in relation to the anticipated recognition of premiums or gross
profits.
The amortization of DAC for traditional long-duration insurance products is
determined as a level proportion of premium based on commonly accepted
actuarial methods and reasonable assumptions established when the contract or
policy is issued about mortality, morbidity, lapse rates, expenses, and future
yield on related investments. Amortization for annuity contracts without
significant mortality risk and investment and universal life products is based
on estimated gross profits and is adjusted as those estimates are revised. The
DAC amortization methodology for our variable products (variable annuities and
variable universal life insurance) includes a long-term equity market average
appreciation assumption of 8.5%. When actual returns vary from the expected
8.5%, we assume a reversion to this mean over a 3- to 7-year period, subject to
the imposition of ceilings and floors. The assumed returns over this reversion
period are limited to the 85th percentile of historical market performance.
We regularly review all of these assumptions and periodically test DAC for
recoverability. For deposit products, if the current present value of estimated
future gross profits is less than the unamortized DAC for a line of business, a
charge to income is recorded for additional DAC amortization. For other
products, if the benefit reserves plus anticipated future premiums and interest
earnings for a line of business are less than the current estimate of future
benefits and expenses (including any unamortized DAC), a charge to income is
recorded for additional DAC amortization or for increased benefit reserves.
Unfavorable experience with regard to expected expenses, investment returns,
mortality, morbidity, withdrawals or lapses, may cause us to increase the
amortization of DAC or to record a charge to increase benefit reserves. In
recent years, the portion of estimated product margins required to
amortize DAC has increased in most lines of our business, with the most
significant impact on investment products, primarily as the result of lower
investment returns.
Present value of future profits. In conjunction with the acquisition of a block
of life insurance policies or investment contracts, a portion of the purchase
price is assigned to the right to receive future gross profits arising from
existing insurance and investment contracts. This intangible asset, called PVFP
represents the actuarially estimated present value of future cash flows from
the acquired policies. PVFP is amortized, net of accreted interest, in a manner
similar to the amortization of DAC. We regularly review our assumptions and
periodically test PVFP for recoverability in a manner similar to our treatment
of DAC.
Goodwill impairment. Goodwill resulting from acquisitions is tested for
impairment at least annually using a fair value approach, which requires the
use of estimates and judgment. To the extent the carrying amount of goodwill
exceeds its fair value, an impairment charge to income would be recorded.
Valuation of investment securities. We obtain values for actively traded
securities from external pricing services. For infrequently traded securities,
we obtain quotes from brokers or we estimate values using internally developed
pricing models. These models are based upon common valuation techniques and
require us to make assumptions regarding credit quality, liquidity and other
factors that affect estimated values.
Impairment of investment securities. We regularly review investment securities
for impairment in accordance with our impairment policy, which includes both
quantitative and qualitative criteria. Our quantitative criteria include length
of time and amount that each security position is in an unrealized loss
position, and for fixed maturities, whether the issuer is in compliance with
terms and covenants of the security. Our qualitative criteria include the
financial strength and specific prospects for the issuer as well as our intent
to hold the security until recovery. We actively perform comprehensive market
research, monitor market conditions and segment our investments by credit risk
in order to minimize impairment risks.
Operating Results
The following table sets forth our results of operations.
Years Ended December 31,
-------------------------
(Dollar amounts in millions) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------
Revenues:
- ------------------------------------------------------------------------------------------------------------
Net investment income $ 421.0 $538.0 $ 600.2
Net realized investment gains 5.7 3.9 55.3
Premiums 96.8 104.0 105.3
Cost of insurance 142.2 153.1 125.8
Variable product fees 9.4 106.3 113.9
Other income 24.8 35.5 44.9
------- ------ --------
Total revenues 699.9 940.8 1,045.4
Benefits and Expenses:
- ------------------------------------------------------------------------------------------------------------
Interest credited 291.2 410.6 462.1
Benefits and other changes in policy reserves 182.8 245.7 178.2
Underwriting, acquisition and insurance expenses, net of deferrals 63.2 149.0 99.3
Amortization of deferred acquisition costs and intangibles 107.3 118.9 147.1
------- ------ --------
Total benefits and expenses 644.5 924.2 886.7
Income before income taxes and cumulative effect of change in accounting principle 55.4 16.6 158.7
Provision (benefit) for income taxes (143.3) (3.1) 42.9
------- ------ --------
Income before cumulative effect of change in accounting principle $ 198.7 $ 19.7 $ 115.8
Cumulative effect of change in accounting principle, net of tax of $0.4 million 0.7 -- --
------- ------ --------
Net income $ 199.4 $ 19.7 $ 115.8
- ------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Overview. Net income in 2004 was $199.4 million, a $179.7 million increase from
2003. The increase is primarily due to a tax benefit increase of $140.2 million
resulting primarily from reinsurance transactions entered into in 2004, in
which we ceded to UFLIC, an affiliate, substantially all of our in-force blocks
of variable annuities and structured settlements. The reinsurance transactions
with UFLIC were completed and accounted for at book value and will be reported
on our tax returns at fair value as determined for tax purposes, giving rise to
a net reduction in current and deferred income tax liabilities and resulting in
a net tax benefit for the year ended December 31, 2004. Also contributing to
the increase was a $50.0 million litigation reserve in 2003 and an increase in
investment income of $62.7 million in our Corporate and Other segment
associated with an increase in invested assets not allocated to the operating
segments. These amounts were partially offset by a goodwill impairment charge
of $59.8 million in 2004 resulting from the reinsurance transactions with UFLIC.
Net investment income. Net investment income decreased $117.0 million, or
21.7%, to $421.0 million in 2004 from $538.0 million in 2003. The decrease was
primarily a result of a $2,554.9 million, or 21.7%, decline in average invested
assets. The decline in average invested assets was due primarily to the
reinsurance transactions with UFLIC. Also contributing to the decrease in
average invested assets was a decline in outstanding institutional stable value
liabilities.
Net realized investment gains. Net realized investment gains consist of gross
realized investment gains and gross realized investment (losses), including
charges related to impairments. Net realized
investment gains increased $1.8 million to $5.7 million in 2004 from $3.9
million in 2003. For 2004, gross realized gains and (losses) were $10.7 million
and $(5.0) million, respectively. Realized losses for 2004 included $0.9
million of impairments that were primarily attributable to fixed-maturity and
equity securities. For 2003, gross realized gains and (losses) were $80.2
million and $(76.3) million, respectively. Realized losses for 2003 included
$26.4 million of impairments, primarily attributable to fixed-maturity and
equity securities.
Premiums. Premiums decreased $7.2 million, or 6.9% to $96.8 million in 2004
from $104.0 million in 2003. The decrease was primarily due to our Medicare
supplement product. Medicare supplement premiums were down $8.3 million in 2004
driven by a reduction in due premiums offset by growth in new business and
in-force premium rate actions.
Cost of Insurance. Cost of insurance decreased $10.9 million, or 7.1% to $142.2
million in 2004 from $153.1 million in 2003. The decrease was due primarily to
a decline of universal life policies in-force.
Variable product fees. Variable product fees decreased $96.9 million to $9.4
million in 2004 from $106.3 million in 2003. The decrease in variable product
fees was primarily due to the reinsurance transactions with UFLIC in which we
ceded, effective January 1, 2004, the majority of our in-force variable
annuities.
Other income. Other income decreased $10.7 million, or 30.1%, to $24.8 million
in 2004 from $35.5 million in 2003. The decrease was due primarily to lower
surrender fees attributable to the reinsurance transactions with UFLIC.
Interest credited. Interest credited represents interest credited on behalf of
policyholder and contractholder general account balances. Interest credited
decreased $119.4 million, or 29.1%, to $291.2 million for 2004 from $410.6
million for 2003. This decrease was primarily the result of an $84.5 million
decrease attributable to the reinsurance transactions with UFLIC and a $33.2
million decrease attributable to institutional stable value products. This
decrease was due to a combination of a decrease in liabilities and reduced
crediting rates on book with the maturity of higher cost liabilities and the
addition of new business with lower crediting rates.
Benefits and other changes in policy reserves. Benefits and other changes in
policy reserves decreased $62.9 million, or 25.6%, to $182.8 million in 2004
from $245.7 million in 2003. The decrease was primarily a result of a $46.7
million decrease attributable to the reinsurance transactions with UFLIC and a
$16.0 million reserve strengthening in 2003 related to whole life products.
Underwriting, Acquisition and Insurance Expenses, net of deferrals.
Underwriting, acquisition and insurance expenses, net of deferrals, decreased
$85.8 million, or 57.6%, to $63.2 million in 2004 from $149.0 million in the
prior year. This decrease was primarily the result of a $50.0 million reserve
accrual in 2003 associated with a class action lawsuit settlement agreed to in
principle and a $30.5 million decrease attributable to the reinsurance
transactions with UFLIC.
Amortization of deferred acquisition costs and intangibles. Amortization of
deferred acquisition costs and intangibles decreased $11.6 million, or 9.8%, to
$107.3 million in 2004 from $118.9 million in 2003. The decrease is primarily
the result of a $74.0 million decrease attributable to the reinsurance
transactions with UFLIC, which was partially offset by a $59.8 million goodwill
impairment charge, also as a result of the reinsurance transactions with UFLIC.
Provision (benefit) for income taxes. Benefit for income taxes increased $140.2
million to a benefit of $(143.3) million for the year ended December 31, 2004
from a benefit of $(3.1) million for the year ended December 31, 2003. The
increase in tax benefit was primarily attributable to the tax benefit
associated with the reinsurance transactions with UFLIC. The reinsurance
transactions with UFLIC were completed and accounted for at book value. These
transactions will be reported on our tax returns at fair value as determined
for tax purposes, giving rise to a net reduction in current and deferred income
tax liabilities and resulting in a net tax benefit for the year ended
December 31, 2004.
Cumulative effect of change in accounting principle. On January 1, 2004, we
adopted AICPA Statement of Position 03-1, Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts. The cumulative effect of change in accounting principle related to
adopting SOP 03-1 was $0.7 million, net of taxes, for the change in reserves,
less additional amortization of deferred acquisition costs, on variable annuity
contracts with guaranteed minimum death benefits.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Overview. Net earnings in 2003 were $19.7 million, a $96.1 million, or 83.0%,
decrease from 2002. The decrease is partially due to a reserve accrual of $50.0
million ($33.0 million after tax) associated with a settlement agreement in
principle that we reached on October 8, 2003, in connection with a putative
class action lawsuit. Additionally, the timing of the equity market changes in
2003 as compared to 2002 adversely impacted our product fee revenues. Lower
interest rates during the year have resulted in lower investment yields on our
fixed maturity portfolio, partially offset by reduced interest crediting rates
on certain of our contracts and policies.
Net investment income. Net investment income decreased $62.2 million, or 10.4%,
to $538.0 million in 2003 from $600.2 million in the prior year. These
decreases are primarily a result of a decrease in weighted average investment
yields to 4.6% in 2003 from 5.2% in 2002 due to the overall declining interest
rate environment.
Net realized investment gains. Net realized investment gains consist of gross
realized investment gains and gross realized investment (losses), including
charges related to impairments. Net realized investment gains decreased $51.4
million to $3.9 million in 2003 from $55.3 million in 2002. For 2003, gross
realized gains and (losses) were $80.2 million and $(76.3) million,
respectively. Realized losses for 2003 included $26.4 million of impairments
that were primarily attributable to fixed-maturity and equity securities. For
2002, gross realized gains and (losses) were $181.1 million and $(125.8)
million, respectively. Included in these gains were $17.6 million related to a
securitization transaction conducted by our indirect parent. Realized losses
for 2002 included $77.4 million of impairments, primarily attributable to
fixed-maturity and equity securities that included $29.5 million of impairments
on securities issued by WorldCom Inc. and its affiliates.
Premiums. Premiums remained relatively constant decreasing approximately 1.2%
to $104.0 million in 2003 from $105.3 million in 2002.
Cost of Insurance. Cost of insurance increased $27.3 million, or 21.7% to
$153.1 million in 2003 from $125.8 million in 2002. The increase was primarily
due to premium refunds received from a terminated reinsurance treaty.
Variable product fees. Variable product fees decreased $7.6 million, or 6.7%,
to $106.3 million in 2003 from $113.9 million in 2002. The decrease in variable
product fees primarily resulted from a decrease in the daily average separate
account values.
Other income. Other income decreased $9.4 million, or 20.9%, to $35.5 million
in 2003 from $44.9 million in 2002. The decrease was partly attributable to
lower surrender fee income on variable annuity products.
Interest credited. Interest credited represents interest credited on behalf of
policyholder and contractholder general account balances. Interest credited
decreased $51.5 million, or 11.1%, to $410.6 million for 2003 from $462.1
million for 2002. This decrease was primarily attributable to the decline in
GICs and funding agreements product liabilities and crediting rates, offset in
part by an increase in interest credited resulting from more variable annuity
policyholders selecting the fixed account option on their contracts, on which
we credit interest. The decrease in interest credited was also the result of a
reduction in our weighted average crediting rates to 4.0% for 2003 from 4.3%
for 2002.
Our weighted average crediting rates for interest-sensitive life products
decreased to 5.2% in 2003 from 5.8% for the prior year. Changes in our base
crediting rates are implemented in response to changes in market conditions,
the prevailing interest rate environment, contractual provisions, and other
factors. We monitor market conditions closely and reset interest crediting
rates as deemed appropriate in accordance with the terms of the underlying
contracts. During the year, the crediting rates on a number of fixed annuity
blocks were reduced to their guaranteed minimum crediting rates.
Benefits and other changes in policy reserves. Benefits and other changes in
policy reserves consist primarily of reserve activity related to current claims
and future policy benefits on long-duration life and health insurance products
as well as claims cost incurred during the year under these contracts. In
addition, the bonus feature of our bonus variable annuity product is initially
accounted for as a benefit. These costs increased $67.5 million, or 37.9%, to
$245.7 million in 2003 from $178.2 million in 2002. The increase was primarily
a result of increased death benefits on universal and whole life policies and
higher sales of our bonus variable annuity products.
Underwriting, Acquisition, and Insurance Expenses, net of deferrals.
Underwriting, acquisition, and insurance expenses, net of deferrals, increased
$49.7 million, or 50.0%, to $149.0 million in 2003 from $99.3 million in the
prior year. This increase was primarily the result of a reserve accrual of
$50.0 million associated with a settlement agreement in principle that we
reached on October 8, 2003, in connection with a putative class action lawsuit.
Amortization of deferred acquisition costs and intangibles. Amortization of
deferred acquisition costs and intangibles decreased $28.2 million, or 19.2%,
to $118.9 million in 2003 from $147.1 million in 2002. The decrease is
primarily the result of the impact of higher amortization in 2002 due to lower
equity valuation of assets in our variable annuity separate accounts.
Provision (benefit) for income taxes. Provision (benefit) for income taxes
decreased $46.0 million to $(3.1) million in 2003 from $42.9 million in 2002.
The Company's effective tax rate of (18.7%) in 2003 was 45.7 percentage points
lower than the effective tax rate of 27.0% in 2002. This decrease is primarily
attributable to the higher dividends received deduction benefits recorded in
2002 over lower pre-tax income. In 2002, the additional recorded benefits were
related to a change in estimate of the 2001 dividends received deduction.
Capital Resources and Liquidity
The "Capital Resources and Liquidity" provision of your prospectus is now
called the "Capital Resources" provision. Further, this section is hereby
deleted in its entirety and replaced with the following:
Capital Resources
Consolidated Balance Sheet
Total Investments. Total investments decreased $2,478.6 million, or 21.9%, to
$8,850.6 million at December 31, 2004 from $11,329.2 million at December 31,
2003. The decrease was primarily a result of the transfer of invested assets
associated with the reinsurance transactions with UFLIC and lower invested
assets due to a decline in outstanding institutional stable value liabilities,
which was partially offset by an increase in invested assets in our Corporate
and Other segment. The change in investments due to the reinsurance
transactions with UFLIC, institutional stable value liabilities and corporate
segment was $(2,782.5) million, $(354.4) million and $635.5 million,
respectively. The increase in investments in our corporate segment was due
primarily to an increase in the securities lending program.
Investment securities comprise mainly investment grade debt securities. Fixed
maturities and equity securities were $7,028.0 million, including gross
unrealized gains and losses of $192.6 million and $(41.2) million, respectively
at December 31, 2004 ($9,666.7 million, including gross unrealized gains and
losses of $278.7 million and $(71.1) million, respectively, as of December 31,
2003). Market value for these purposes is defined by relevant accounting
standards and should not be viewed as a forecast of future gains or losses.
Separate Account Assets and Liabilities. Separate account assets and
liabilities represent funds held for the exclusive benefit of variable annuity
and variable life contract holders. As of December 31, 2004, we held $8,636.7
million of separate account assets. The increase of $601.8 million, or 7.5%,
from $8,034.9 million at December 31, 2003 was related primarily to the
favorable market performance of the underlying securities, which was partially
offset by death, surrender and other benefits outpacing new deposits.
Future Annuity and Contract Benefits. Future annuity and contract benefits
decreased $636.6 million, to $9,604.6 million at December 31, 2004 from
$10,241.2 million at December 31, 2003. The decrease is primarily attributable
to a decline in the institutional stable value product liability, which
resulted from maturities outpacing sales. Also contributing to the decline in
future annuity and contract benefits was
the recapture of previously assumed structured settlement liabilities resulting
from the reinsurance transactions with UFLIC.
Statement of Changes in Stockholder's Interest
Stockholder's interest decreased $232.0 million to $1,590.0 million at
December 31, 2004 from $1,822.0 million at December 31, 2003. The decrease was
primarily attributable to dividends paid in the amount of $419.1 million and a
decline in net unrealized gains on invested securities of $15.7 million, which
was partially offset by current year net income of $199.4 million.
Impairment of Investment Securities
We regularly review each investment security for impairment in accordance with
our impairment policy, which includes both quantitative and qualitative
criteria. Quantitative criteria include length of time and amount that each
security position is in an unrealized loss position and for fixed maturity
securities, whether the issuer is in compliance with terms and covenants of the
security. Our qualitative criteria include the financial strength and specific
prospects for the issuer as well as our intent to hold the security until
recovery. Our impairment reviews involve our finance, risk and management teams
as well as the portfolio management and research capabilities of GEAM as well
as other third party asset managers, as appropriate. Our qualitative review
attempts to identify those issuers with a greater than 50% chance of default in
the coming twelve months. These securities are characterized as "at-risk" of
impairment. As of December 31, 2004, securities "at risk" of impairment had
aggregate unrealized losses of approximately $10.0 million.
For fixed maturity securities, we recognize an impairment charge to earnings in
the period in which we determine that we do not expect to either collect or
recover principal and interest in accordance with the contractual terms of the
instruments or based on underlying collateral values and considering events
such as payment default, bankruptcy or disclosure of fraud. For equity
securities, we recognize an impairment charge in the period in which we
determine that the security will not recover to book value within a reasonable
period. We determine what constitutes a reasonable period on a
security-by-security basis based upon consideration of all the evidence
available to us, including the magnitude of an unrealized loss and its
duration. In any event, this period does not exceed 18 months for common equity
securities. We measure impairment charges based on the difference between the
book value of the security and its fair value. Fair value is based on quoted
market price, except for certain infrequently traded securities where we
estimate values using internally developed pricing models. These models are
based upon common valuation techniques and require us to make assumptions
regarding credit quality, liquidity and other factors that affect estimated
values.
During 2004, 2003 and 2002, we recognized impairment losses of $0.9 million,
$26.4 million and $77.4 million, respectively. We generally intend to hold
securities in unrealized loss positions until they recover. However, from time
to time, we sell securities in the normal course of managing our portfolio to
meet diversification, credit quality, yield and liquidity requirements.
The following table presents the gross unrealized losses and estimated fair
values of our investment securities, aggregated by investment type and length
of time that individual investment securities have been in a continuous
unrealized loss position, at December 31, 2004:
Less than 12 Months
Amortized Unrealized % Below # of
(Dollar amounts in millions) Cost or Cost Fair Value Losses Cost Securities
- -------------------------------------------------------------------------------------------
Description of Securities
- -------------------------------------------------------------------------------------------
Fixed maturities:
U.S. government and agency $ 7.2 $ 7.2 $ -- -- 4
Non-U.S. government. 2.9 2.9 -- -- 3
U.S. corporate 505.2 494.5 (10.7) 2.1% 104
Non-U.S. corporate. 131.2 129.0 (2.2) 1.7% 30
Asset Backed 222.8 221.6 (1.2) 0.5% 38
Mortgage Backed 477.2 470.9 (6.3) 1.3% 76
-------- -------- ------ ----- ---
Total temporarily impaired securities $1,346.5 $1,326.1 $(20.4) 1.5% 255
% Underwater -- Fixed maturities
(less than) 20% Underwater $1,344.7 $1,324.8 $(19.9) 1.5% 253
20-50% Underwater 1.8 1.3 (0.5) 27.8% 2
(greater than) 50% Underwater -- -- -- -- --
-------- -------- ------ ----- ---
Total fixed maturities $1,346.5 $1,326.1 $(20.4) 1.5% 255
Investment Grade. $1,220.4 $1,203.8 $(16.6) 1.4% 223
Below Investment Grade 106.5 103.0 (3.5) 3.3% 26
Not rated 19.6 19.3 (0.3) 1.5% 6
-------- -------- ------ ----- ---
Total $1,346.5 $1,326.1 $(20.4) 1.5% 255
- -------------------------------------------------------------------------------------------
12 Months or More
Amortized Unrealized % Below # of
(Dollar amounts in millions) Cost or Cost Fair Value Losses Cost Securities
- -------------------------------------------------------------------------------------------
Description of Securities
- -------------------------------------------------------------------------------------------
Fixed maturities:
U.S. corporate $285.6 $267.0 $(18.6) 6.5% 29
State and municipal 0.3 0.3 -- -- 1
Non-U.S. corporate. 18.0 17.3 (0.7) 3.9% 4
Asset Backed 1.6 1.6 -- -- 1
Mortgage Backed 57.6 56.1 (1.5) 2.6% 20
------ ------ ------ ----- --
Total temporarily impaired securities $363.1 $342.3 $(20.8) 5.7% 55
% Underwater -- Fixed maturities
(less than) 20% Underwater $338.2 $323.5 $(14.7) 4.3% 51
20-50% Underwater 24.9 18.8 (6.1) 24.5% 4
(greater than) 50% Underwater -- -- -- -- --
------ ------ ------ ----- --
Total fixed maturities $363.1 $342.3 $(20.8) 5.7% 55
Investment Grade. $220.0 $208.2 $(11.8) 5.4% 40
Below Investment Grade 143.1 134.1 (9.0) 6.3% 15
Not rated equities -- -- -- -- --
------ ------ ------ ----- --
Total $363.1 $342.3 $(20.8) 5.7% 55
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The investment securities at December 31, 2004 in an unrealized loss position
for less than twelve months, account for $20.4 million or 49.5% of the total
unrealized losses. Of the securities in this category, there was no security
with an unrealized loss in excess of $5.0 million.
The investment securities in an unrealized loss position for twelve months or
more account for $20.8 million or 50.5% of the total unrealized losses as of
December 31, 2004. There are 35 fixed maturity securities in three industry
groups that account for $14.0 million or 67.3% of the unrealized losses in this
category.
Twenty-two of these 35 securities are in the finance and insurance sector.
Within this sector, no single issuer has unrealized losses in excess of $5.0
million. The unrealized losses of the securities are due to a higher interest
rate environment for the quarter ended December 31, 2004.
Six of these 35 securities are in the transportation sector and are related to
the airline industry. For those airline securities, which we have previously
impaired, we expect to recover our carrying amount based upon underlying
aircraft collateral values.
The remaining 7 of these 35 securities are in the consumer non-cyclical sector.
There is one issuer, comprising of one security, which represents $7.0 million.
No other single issuer of fixed maturities in this sector has an unrealized
loss in excess of $5.0 million.
Liquidity
The principal liquidity requirements for our insurance operations are our
contractual obligations to contract holders and annuitants. Contractual
obligations include payments of claims under outstanding insurance policies and
annuities, contract withdrawals and surrender benefits. The primary sources for
meeting these contractual obligations are investment activities and cash
generated from operating activities. We maintain a committed credit line with
an indirect parent, GNA, of $500 million to provide liquidity to meet normal
variation in cash requirements.
For the years ended December 31, 2004, 2003 and 2002 cash flows from operating
activities were $447.7 million, $527.6 million and $375.3 million,
respectively, and cash flows from financing activities were $(767.1) million,
$(959.2) million and $(659.5) million, respectively. These amounts include net
cash from financing activities relating to investment contract issuances and
redemptions of $(731.6) million, $(937.8) million and $(617.5) million for the
years ended December 31, 2004, 2003 and 2002, respectively.
As an insurance business, cash flows from operating and financing activities,
as premiums and deposits collected from our insurance and investment products
net of redemptions and benefits paid, are invested if positive and investments
are redeemed if negative. Net cash from investing activities was $333.4
million, $444.0 million and $284.2 million for the year ended December 31,
2004, 2003 and 2002, respectively. The decrease in cash from investing
activities for the year ended December 31, 2004 was primarily the result of a
decrease of cash used in financing activities.
As of December 31, 2004, we had approximately $1,108.0 million of renewable
floating rate funding agreements, which are deposit-type products that
generally credit interest on deposits at a floating rate tied to an external
market index. Purchasers of renewable funding agreements include money market
funds, bank common trust funds and other short-term investors. Some of our
funding agreements contain "put" provisions, through which the contractholder
has an option to terminate the funding agreement for any reason after giving
notice within the contract's specified notice period, which is
generally 90 days. Of the $1,108.0 million aggregate amount outstanding as of
December 31, 2004, $458.0 million had put option features, none of which were
less than 90 days. GE Capital has guaranteed certain obligations under
floating-rate funding agreements with a final maturity on or before June 30,
2005. This guarantee covers our obligations to contractholders and requires us
to reimburse GE Capital for any payments made to contractholders under the
guarantee. As of December 31, 2004, GE Capital's guarantee covered $858.0
million of outstanding floating-rate funding agreements.
The nature and quality of the various types of investments purchased by a life
insurance company must comply with the statutes and regulations imposed by the
various jurisdictions in which those entities are incorporated. Following is a
breakdown of the credit quality of our fixed maturity portfolio at December 31,
2004.
-----------------------------------------------------------------------------
BBB/Baa or above 91.2%
BB/Ba and below 8.6%
Not Rated 0.2%
------
Total portfolio 100.0%
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Certain of our products contain provisions for charges for surrender of, or
withdrawals from, the policy. At December 31, 2004 and December 31, 2003,
approximately 66.6% and 67.2%, respectively, of our annuity contracts were
subject to surrender charges or contained non-surrender provisions.
As of December 31, 2004, we had approximately $2,109.7 million of GICs.
Substantially all of these contracts allow for the payment of benefits at
contract value to ERISA plans prior to contract maturity in the event of death,
disability, retirement or change in investment election. We carefully
underwrite these risks before issuing a GIC to a plan and historically have
been able to effectively manage our exposure to these benefit payments. Our
GICs typically credit interest at a fixed interest rate and have a
fixed-maturity generally ranging from two to six years. Contracts provide for
early termination by the contractholder but subject to an adjustment to the
contract value for changes in the level of interest rates from the time the GIC
was issued plus an early withdrawal penalty.
Insurance companies are restricted by states as to the aggregate amount of
dividends they may pay to their parent in any consecutive twelve-month period
without regulatory approval. Dividends in excess of the prescribed limits or
the earned surplus are deemed extraordinary and require formal state insurance
department approval. We are able to pay $67.2 million in dividends in 2005
without obtaining regulatory approval.
Off-balance Sheet Transactions
We have used off-balance sheet securitization transactions to mitigate and
diversify our asset risk position and to adjust the asset class mix in our
portfolio by reinvesting securitization proceeds in accordance with our
approved investment guidelines. We have not used securitization transactions to
provide us with additional liquidity and we do not anticipate using
securitization transactions for that purpose in the future. The transactions
involved securitizations of some of our receivables and investments that were
secured by commercial mortgage loans, fixed maturities or other receivables,
consisting primarily of policy loans. Total securitized assets remaining as of
December 31, 2004 and 2003, were $297.9 million and $349.8 million respectively.
There were no securitization transactions in 2004 and 2003. Securitization
transactions resulted in net gains, before taxes, of approximately $5.8 million
for the year ended December 31, 2002.
We have arranged for the assets that we have transferred in securitization
transactions to be serviced by us directly, or pursuant to arrangements with
GEAM and with General Motors Acceptance Corporation. Servicing activities
include ongoing review, credit monitoring, reporting and collection activities.
Support. Financial support is provided under credit support agreements, in
which Genworth provides limited recourse for a maximum of $119 million of
credit losses in such entities. We do not provide any such recourse. Assets
with credit support are funded by demand notes that are further enhanced with
support provided by GE Capital.
Under FIN 46, Consolidation of Variable Interest Entities, new consolidation
criteria is applied to certain SPE's, which are defined as "Variable Interest
Entities". Additional information about entities that fall within the scope of
FIN 46 is included in our Annual Report.
Quantitative and Qualitative Disclosures About Market Risk and Interest Rate
Management
The "Quantitative and Qualitative Disclosures About Market Risk" provision of
your prospectus is hereby deleted in its entirety and replaced with the
following:
Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of the loss of fair value resulting from adverse
changes in market rates and prices, such as interest rates, foreign currency
exchange rates and equity prices. Market risk is directly influenced by the
volatility and liquidity in the markets in which the related underlying
financial instruments are traded. The following is a discussion of our market
risk exposures and our risk management practices.
We enter into market-sensitive instruments primarily for purposes other than
trading. The carrying value of our investment portfolio as of December 31, 2004
and 2003, was $8,850.6 million and $11,329.2 million, respectively, of which
79.1% and 85.1%, respectively, was invested in fixed maturities. The primary
market risk to our investment portfolio is interest rate risk associated with
investments in fixed maturities. We mitigate the market risk associated with
our fixed maturities portfolio by closely matching the duration of our fixed
maturities with the duration of the liabilities that those securities are
intended to support.
We are exposed to equity risk on our holdings of common stocks and other
equities. We manage equity price risk through industry and issuer
diversification and asset allocation techniques.
We use derivative financial instruments, such as interest rate and currency
swaps, currency forwards and option-based financial instruments, as part of our
risk management strategy. We use these derivatives to mitigate certain risks,
including interest rate risk, currency risk and equity risk, by:
. reducing the risk between the timing of the receipt of cash and its
investment in the market;
. converting the asset duration to match the duration of the liabilities;
. reducing our exposure to fluctuations in equity market indices that
underlie some of our products; and
. protecting against the early termination of an asset or liability.
As a matter of policy, we have not and will not engage in derivative
market-making, speculative derivative trading or other speculative derivatives
activities.
Sensitivity analysis
Sensitivity analysis measures the impact of hypothetical changes in interest
rates, foreign exchange rates and other market rates or prices on the
profitability of market-sensitive financial instruments.
The following discussion about the potential effects of changes in interest
rates and equity market prices is based on so-called "shock-tests," which model
the effects of interest rate and equity market price shifts on our financial
condition and results of operations. Although we believe shock tests provide
the most meaningful analysis permitted by the rules and regulations of the
Securities and Exchange Commission, they are constrained by several factors,
including the necessity to conduct the analysis based on a single point in time
and by their inability to include the extraordinarily complex market reactions
that normally would arise from the market shifts modeled. Although the
following results of shock tests for changes in interest rates and equity
market prices may have some limited use as benchmarks, they should not be
viewed as forecasts. These forward-looking disclosures also are selective in
nature and address only the potential impacts on our financial instruments.
They do not include a variety of other potential factors that could affect our
business as a result of these changes in interest rates and equity market
prices.
One means of assessing exposure of our fixed maturities portfolio to interest
rate changes is a duration-based analysis that measures the potential changes
in market value resulting from a hypothetical change in interest rates of 100
basis points across all maturities. This is sometimes referred to as a parallel
shift in the yield curve. Under this model, with all other factors constant and
assuming no offsetting change in the value of our liabilities, we estimated
that such an increase in interest rates would cause the market value of our
fixed income securities portfolio to decline by approximately $232.0 million,
based on our securities positions as of December 31, 2004.
One means of assessing exposure to changes in equity market prices is to
estimate the potential changes in market values on our equity investments
resulting from a hypothetical broad-based decline in equity market prices of
10%. Under this model, with all other factors constant, we estimated that such
a decline in equity market prices would cause the market value of our equity
investments to decline by approximately $2.4 million, based on our equity
positions as of December 31, 2004. In addition, fluctuations in equity market
prices affect our revenues and returns from our separate account products,
which depend upon fees that are related primarily to the value of assets under
management.
Counterparty credit risk
We manage counterparty credit risk on an individual counterparty basis, which
means that gains and losses are netted for each counterparty to determine the
amount at risk. When a counterparty exceeds credit exposure limits (see table
below) in terms of amounts owed to us, typically as the result of changes in
market conditions, no additional transactions are executed until the exposure
with that counterparty is reduced to an amount that is within the established
limit. All swaps are executed under master swap agreements containing mutual
credit downgrade provisions that provide the ability to require assignment or
termination in the event either party is downgraded below Moody's "A3" or
S&P's "A-."
Swaps, purchased options and forwards with contractual maturities longer than
one year are conducted within the credit policy constraints provided in the
table below. Our policy permits us to enter into derivative transactions with
counterparties rated "A3" by Moody's and "A-" by S&P if the agreements
governing such transactions require both parties to provide collateral in
certain circumstances. Our policy further requires foreign exchange forwards
with contractual maturities shorter than one year to be executed with
counterparties having a credit rating by Moody's of "A-1" and by S&P of "P-1"
and the credit limit for these transactions is $150 million per counterparty.
Counterparty credit criteria
Credit Rating
----------------
Standard
Moody's & Poor's
-----------------------------------------------------------------------------
Term of transaction
Up to five years Aa3 AA-
Greater than five years Aaa AAA
Credit exposure limit without collateral/1/
Up to $50 million Aa3 AA-
Up to $75 million Aaa AAA
Credit exposure limit with collateral/1/
Up to $5 million A3 A-
Up to $50 million Aa3 AA-
Up to $100 million Aaa AAA
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/1/ Credit exposure limits noted in this table are set by GE Capital and apply
in the aggregate to all companies that are consolidated into GE Capital.
The following table sets forth an analysis of our counterparty credit risk
exposures net of collateral held as of the dates indicated:
December 31,
--------------------
Moody's Rating 2004 2003 2002
- -------------------------------------------------------------------------------
Aaa 85.8% 86.5% 66.2%
Aa 14.2% 13.5% 33.8%
------ ------ ------
100.0% 100.0% 100.0%
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