The Company’s corporate office facility consists of a 752,000 square foot complex located in Greenwood Village, Colorado. The Company owns its corporate office facilities. The Company leases sales and claims processing offices throughout the United States. Management believes that the Company’s properties are suitable and adequate for its current and anticipated business operations.
The following is a summary of selected consolidated financial information for the Company. The selected consolidated financial information for the years ended December 31, 2006, 2005 and 2004, and at December 31, 2006 and 2005 has been derived in part from the Company’s audited consolidated financial statements included in Item 8, Financial Statements and Supplementary Data. Note 1 to the audited consolidated financial statements discusses the significant accounting policies of the Company. The selected consolidated financial information for the years ended December 31, 2004, 2003 and 2002 has been derived in part from the Company’s audited consolidated financial statements not included elsewhere herein. The following information should be read in conjunction with and is qualified in its entirety by the information contained in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and the consolidated financial statements appearing in Item 8. Certain previously reported amounts have been reclassified to conform to the presentation at and for the year ended December 31, 2006.
Self-funded health care premium equivalents generally represent paid claims under minimum premium and administrative services only contracts, which amounts approximate the additional premiums that could have been earned under such contracts if they had been written as traditional indemnity or health maintenance organization programs.
This Form 10-K contains forward-looking statements. Forward-looking statements are statements not based on historical information and that relate to future operations, strategies, financial results, or other developments. In particular, statements using verbs such as “expected,” “anticipate,” “believe,” or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements that represent the Company’s beliefs concerning future or projected levels of sales of its products, investment spreads or yields, or the earnings or profitability of the Company’s activities. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates, some of which may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation and others of which may relate to the Company specifically, such as credit, volatility and other risks associated with its investment portfolio and other factors. Readers should also consider other matters, including any risks and uncertainties, discussed in documents filed by the Company and certain of its subsidiaries with the Securities and Exchange Commission. This discussion should be read in conjunction with the Company’s consolidated financial statements included in Item 8.
Management’s discussion and analysis of financial condition and results of operations of the Company for the three years ended December 31, 2006 follows. This management discussion and analysis should be read in conjunction with the financial data contained in Item 6, Selected Financial Data, and in Item 8, Financial Statements and Supplementary Data.
During the year ended December 31, 2006, the Company completed three significant acquisitions to complement both its Great-West Healthcare and Financial Services segment operations.
The Company also acquired IHN, Inc. (“IHN”), a company that provides network provider access to health care and workers compensation payors such as third-party administrators, insurance carriers and employers for approximately 70,000 members. IHN also provides out of network repricing and negotiation services.
In the highly competitive healthcare marketplace, employers often regularly seek competitive bids to obtain better pricing as well as varied product choices to meet their employees’ differing needs. In many cases, it is more cost effective and efficient for an employer to contract with a carrier that offers multiple product lines and centralized administration. The Great-West Healthcare segment continues to focus on its consumer driven product portfolio in addition to improving programs that benefit members and deliver cost savings to employers.
The Company made significant progress in advancing Great-West Healthcare’s position in consumer-driven healthcare (“CDHC”). In offering an integrated suite of consumer-driven healthcare products, it continued to promote Great-West Healthcare Consumer AdvantageSM, a healthcare savings account plan and a healthcare reimbursement account. During 2006, the Company supported CDHC growth by providing an online employer readiness survey, a comprehensive HSA resources package and quarterly webinars covering in-depth topics such as HSA contribution strategies and HSA legislation.
During 2006, Great-West Healthcare continued to expand its specialty risk market segment. The specialty risk market segment provides services to third-party administrators, health insurance carriers and other specialized distribution channels. During September 2005, the Company completed the acquisition of Mediversal, Inc., a healthcare services company that administers claims for employers with self-funded group health and worker’s compensation plans. The November 2006 acquisition of IHN further supplemented the Company’s efforts to expand in these areas.
The Company’s Other segment Includes the activities of Great-West Life & Annuity Insurance Company of South Carolina (“GWSC”), an indirect wholly owned subsidiary, whose sole business is the assumption of a certain block of term life insurance retroceded by CLAC, corporate items not directly allocated to any other reportable business segment, and interest expense on long-term debt.
The critical accounting policies are those that the Company believes are important to the portrayal of its results of operations and financial condition and which require management to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. The Company believes that the most critical accounting policies include the reported amounts of policy reserves, allowances for credit losses on mortgage loans, deferred acquisition costs and value of business acquired, derivative instruments, valuation of privately placed fixed maturity investments, employee benefit plans, and taxes on income. Many of these policies, estimates and related judgments are common in the insurance and financial services industries.
Reinsurance - The Company enters into reinsurance transactions as both a provider and a purchaser of reinsurance. Policy reserves ceded to other insurance companies are carried as reinsurance receivables in the Company’s consolidated balance sheets. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations under these contracts could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions and activities of the reinsurers to minimize its exposure to significant losses from reinsurer defaults. In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and coinsurance contracts. The Company retains a maximum of $3.5 million of coverage per individual life.
See Notes 1 and 8 to the accompanying consolidated financial statements for a further discussion of policy reserves and reinsurance transactions.
Policy acquisition costs, which primarily consist of sales commissions, cost of policy issuance and underwriting and costs associated with the Company’s sales representatives related to the production of new business, have been deferred to the extent recoverable. VOBA represents the present value of future profits embedded in acquired insurance, annuity and investment-type business. The recoverability of DAC and VOBA is dependent upon the future profitability of the related business. The amount of future profit is primarily dependent on investment returns, mortality, morbidity, persistency, interest crediting rates and the expenses incurred to administer the business. DAC and VOBA associated with annuity products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits, which can be affected by such factors as investment yield, realized investment gains and losses and policyholder retention. DAC and VOBA associated with traditional life insurance are amortized over the premium-paying period of the related policies in proportion to premium revenues recognized.
Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the values of securities or commodities. The Company uses certain derivative instruments, such as futures, options and swaps, for purposes of hedging its risk exposure to changes in interest rates, market exchanges and foreign currency exchanges. The Company designates its derivative financial instruments as (i) fair value hedges, (ii) cash flow hedges, (iii) foreign currency hedges and (iv) derivatives not qualifying for hedge accounting.
Cash flow hedges - The effective portion of the changes in the fair value of a derivative instrument that is designated as a cash flow hedge is recorded in accumulated other comprehensive income on the consolidated balance sheet and reclassified to earnings when the cash flow of the hedged item impacts earnings. The ineffective portion of the changes in the fair value of cash flow hedges is recorded as an adjustment to net investment income.
See Notes 1 and 5 to the accompanying consolidated financial statements for a further discussion of the Company’s derivative instruments.
To determine fair value for fixed maturity investments not actively traded, the Company utilizes discounted cash flows calculated at current market rates on investments of similar quality and term.
The Company sponsors pension and other retirement plans in various forms covering employees who meet specific eligibility requirements. Expenses and liabilities reported in connection with these plans require an extensive use of estimates and assumptions. The estimates and assumptions include the expected interest rate used to determine the expected return on plan assets, the rate of future employee compensation increases and compensation levels and
The estimates and assumptions utilized by the Company may differ materially from actual results obtained due to changes in market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the various plan’s participants.
The Company’s effective tax rate is based upon expected income and statutory income tax rates and available tax planning opportunities. In the determination of the Company’s effective income tax rate, management considers judgments regarding its business plans, planning opportunities and expectations about their future outcomes. Certain changes or future events, such as changes in tax legislation and the commencement or completion of tax audits, could have an impact on management’s estimates and the Company’s effective tax rate.
The amount of income taxes paid by the Company is subject to ongoing audits in the various jurisdictions in which it carries on business. The Internal Revenue Service (the “IRS”) has completed audits of the Company’s income tax returns through 1996. IRS audits of the Company’s income tax returns for the years 1997 through 2004 are in various stages of completion. Although the results of these audits are not final, based upon available information, management believes provisions for potential audit assessments are adequate.
The Company’s consolidated net income decreased by $35 million, or 9.4%, to $337 million during the year ended December 31, 2006 when compared to 2005. The decrease in net income is primarily due to net realized gains on investments of $0.4 million during 2006 compared to $42.3 million during 2005, excluding the participating policyholders’ share. In the Great-West Healthcare segment, a deterioration in the aggregate and individual stop loss claims experience also contributed to the decrease in net income. These are partially offset by higher fee income and improved investment margins in both the Great-West Healthcare and Financial Services segments.
Fee income increased by $79 million, or 8.2%, to $1,044 million for the year ended December 31, 2006 when compared to 2005. This increase is primarily the result of increased administrative fees on higher membership and increased pharmacy benefit management revenue in the Great-West Healthcare segment and new institutional partner relationships and improved United States equity markets in the Financial Services segment.
an increase of $19 million on the assets received in the MetLife acquisition;
an increase of $11 million on invested assets associated with the reinsurance agreement between CLAC and GWSC and
The Company incurred net realized losses on investments in the amount of $12 million during the year ended December 31, 2006 compared with net realized gains on investments in the amount of $39 million during 2005. The losses in 2006 are primarily due to interest rate related realized losses on repurchase agreement financing transactions and short duration fixed maturity investments and losses on the sale of exchange-traded bond funds and derivative instruments. The gains during 2005 include a one-time gain in the amount of $45 million on an equity investment sale.
Policyholder benefit expenses include amounts paid or credited to policyholders, changes in policy liabilities, claims, surrenders and annuity and maturity payments. Total policyholder benefits increased by $275 million, or 15.4%, to $2,068 million, during the year ended December 31, 2006 when compared to 2005. The increase in benefits and expenses is primarily related to the aforementioned Allianz reinsurance agreement termination which resulted in ceded benefits of $0 and $207 million in 2006 and 2005, respectively, and higher aggregate and individual stop loss claims experience in the Great-West Healthcare segment.
an increase of $26 million of general and administrative expenses and commissions associated with the 2006 activity from the GWSC reinsurance agreement with CLAC;
an increase in the Financial Services Individual Markets area commissions of $12 million, or 40.1%, primarily due to increased BOLI sales and
Deposits to separate accounts increased by $334 million, or 15.7%, to $2,459 million, during the year ended December 31, 2006 when compared to 2005. The increase is due primarily to an increase in business owned life insurance and individual annuity sales in the Individual Markets area of the Financial Services segment.
Self-funded premium equivalents have remained relatively constant, increasing by $26 million, or 0.6%, to $4,638 million during the year ended December 31, 2006 when compared to 2005.
During the year ended December 31, 2005, premium income increased by $554 million, or 82.6%, to $1,225 million when compared to 2004. The increase in revenues during 2005 was in part due to the February 2004 CLAC recapture of certain group life and health business from the Company associated with the original indemnity reinsurance agreement, as discussed in Note 3 to the accompanying consolidated financial statements. Under the terms of this reinsurance agreement, the Great-West Healthcare segment recorded an income statement impact in the amount of $256 million of negative premium income and an offsetting change in reserves associated with these recaptured policies. Also in the Great-West Healthcare segment, premiums ceded to Allianz decreased by $141 million during 2005 when compared to 2004 as a result of the lower contractual cession percentages on the contract. GWSC also entered into a reinsurance agreement with CLAC on December 31, 2005, pursuant to which it assumed a certain specific in-force block of term life insurance. Under the terms of this reinsurance agreement, the Company recorded premiums of $167 million.
Net investment income increased by $41 million, or 3.9%, to $1,090 million during the year ended December 31, 2005 when compared to 2004. The increase was primarily the result of higher interest earned rates due to less amortization of premiums on fixed maturity investments in 2005 and more invested assets, which more than offset the impact of the change in the embedded derivative on the CLAC funds withheld that decreased investment income by $24 million during the year ended December 31, 2005 when compared to 2004.
Income tax expense increased by $11 million, or 7.3%, during the year ended December 31, 2005 when compared to 2004. This increase was primarily due to the 12.0% increase in the Company’s pretax income partially offset by a decrease in its 2005 effective tax rate, from 31.5% to 30.3% during the years ended December 31, 2004 and 2005, respectively.
Deposits to Separate Accounts, Deposits To and Withdrawals From Investment-Type Contracts, and Self-Funded Premium Equivalents
Deposits to investment-type contracts and deposits to the separate accounts increased by $594 million, or 22.0%, during the year ended December 31, 2005 when compared to 2004. The increase was due to an increase in transfers by participants from unaffiliated retail investment options to the Company’s general account investment options.
Self-funded premium equivalents decreased by $94 million, or 2.0%, during the year ended December 31, 2005 when compared to 2004. This decrease was primarily due to decreased membership in the Great-West Healthcare segment.
The Great-West Healthcare segment’s net income decreased by $35 million, or 19.9%, to $141 million during the year ended December 31, 2006 from $176 million in 2005. The decrease is the result of a deterioration in the aggregate stop loss claims experience in all market segments, excluding Specialty Markets, and individual stop loss claims experience in all market segments. These results were partially offset by increased investment gains, administrative fees on higher membership and pharmacy benefit management revenue.
Fee income increased by $40 million, or 6.0%, during the year ended December 31, 2006 when compared to 2005 due to increased membership in the Specialty Markets segment and improved pharmacy benefits management revenue.
Net investment income increased by $13 million, or 19.1%, to $81 million during the year ended December 31, 2006 when compared to 2005. The increase was the result of higher interest earned rates and increased investment income on surplus assets.
Net realized gains on investments decreased by $20 million to $0 during the year ended December 31, 2006 when compared to 2005. The decrease is primarily due to a one-time gain in the amount of $16 million on an equity investment sale during 2005.
Excluding the $207 million of benefits and expenses associated with the Allianz reinsurance cession in 2005, benefits and expenses increased by $131 million, or 19.7%, for the year ended December 31, 2006 when compared to 2005. The increase is due primarily to higher aggregate stop loss claims in all market segments, excluding Specialty Markets, and higher individual stop loss claims in all market segments.
Premium and fee income increased by $431 million, or 47.4%, to $1,340 million during the year ended December 31, 2005 when compared to 2004. The increase was attributable to the inclusion of negative premium in the amount of $207 million in 2004 as a result of the February 2004 recapture discussed previously, comprised of $256 million of negative premiums offset by $49 million of normal CLAC reinsurance activity recorded before the recapture. In addition, premiums ceded to Allianz decreased by $141 million during 2005 when compared to 2004 as a result of lower contractual cession percentages on the contract. The remaining increase was the result of higher renewal pricing partially offset by the decline in full service membership. These results also include higher pharmacy benefit management fee revenue due to greater utilization combined with favorable contract amendments resulting from the conversion of the Company’s pharmacy business to Express Scripts, Inc.
Net investment income increased by $17 million, or 33.3%, to $68 million during the year ended December 31, 2005 when compared to 2004. The increase was the result of higher interest earned rates primarily due to less amortization of premiums on fixed maturity investments in 2005 and increased investment income on surplus assets.
During 2006, the specialty markets segment, which focuses on third-party administrators, insurance carriers and other specialized distribution channels, was expanded. The acquisition of Mediversal, Inc., a healthcare services company that administers claims for employers with self-funded group health and workers’ compensation plans, was completed in September 2005.
During 2006, IHN, Inc. was acquired to strengthen the Company’s network in Indiana. The continued expansion of additional third-party administrator and network relationships is a focus for 2007 as well as the implementation of new product offerings such as pharmacy benefit management through our third-party administrator channels.
Efforts to enhance brand awareness also continue as the theme of the Company’s targeted advertising campaign, “New Ideas From the Frontier of Health Care”, communicates the strategy for delivering innovative, affordable benefits plans to businesses. The Company will continue to promote its strengths in self-funding, creative solutions, and medical management expertise.
The following is a summary of the Financial Services segment participant accounts at December 31, 2006 and 2005.
increased net investment income. These increases were partially offset by a decrease in net realized gains (losses) on investments.
Deposits to separate accounts increased by $334 million, or 15.7%, to $2,459 million, during the year ended December 31, 2006 when compared to 2005. The increase is due primarily to a $239 million increase in the Individual Markets area due to improved sales of BOLI and individual annuity business.
Deposits to investment-type contracts decreased by $118 million, or 10.2%, to $1,041 million, during the year ended December 31, 2006 when compared to 2005. This decrease is primarily attributable to the purchase in 2005 of $363 million of the Company’s guaranteed interest annuity contracts by the Maxim Series Fund, Inc. as compared to the purchase of $68 million during 2006. This decrease was partially offset by a $132 million increase in BOLI sales during the year ended December 31, 2006 when compared to 2005.
Retirement participant accounts, including third-party administration and institutional accounts, at December 31, 2006 of 3,855 thousand increased by 19.7% from 3,221 thousand at December 31, 2005, primarily as the result of MetLife and U.S. Bank 401(k) acquisitions and new institutional record keeping clients.
Account values invested in the general account fixed investment options have increased by 25.6% at December 31, 2006 compared to 2005 primarily due to the MetLife acquisition.
Premium income decreased by $29 million, or 7.1%, to $380 million during the year ended December 31, 2005 when compared to 2004. This decrease is primarily due to a $30 million decrease in individual life premiums acquired under the CLAC reinsurance agreement resulting from the discontinuation of new CLAC sales in 2003.
Net investment income increased by $14 million, or 1.4%, to $1,007 million during the year ended December 31, 2005 from $993 million in 2004. This increase is primarily due to an increase in the average earned rate on investments from 5.37% in 2004 to 5.82% in 2005 primarily due to less amortization of premiums on fixed maturity investments in 2005 and more invested assets. This increase was partially offset by a $17 million increase in the loss resulting from the change in the market value of the embedded derivative on the CLAC funds withheld reinsurance agreement in during the year ended December 31, 2005 compared to 2004.
Deposits to investment-type contracts and deposits to the separate accounts increased by $594 million, or 22.0%, during the year ended December 31, 2005 when compared to 2004. The
Withdrawals from investment-type contracts increased by $134 million, or 10.7%, during the year ended December 31, 2005, when compared to 2004. This increase is primarily attributable to increased transfers from general account investment options to separate account investment and unaffiliated retail investment options and from increased policy maturities.
Account values invested in the general account fixed investment options have increased by 8.7% at December 31, 2005 compared to 2004 primarily due the guaranteed interest annuity contract transfers into the general account.
The past year has been a year of significant growth in the Retirement Services area. In the institutional marketplace, the Company was able to form new partnerships to provide administrative and record-keeping services to Federated Investors, Inc. and Franklin Templeton. Also in 2006, the Company completed the acquisition of two important blocks of 401(k) business from MetLife and U.S. Bank. Through a combination of sales and these acquisitions, the number of participants serviced by the Company reached a total of 3,414 thousand, placing the Company firmly in the top four record-keepers in the United States according to Spectrem Group.
Also, in late 2005 and throughout 2006, Advised Asset Group, LLC (“AAG”), the Company’s registered investment advisory subsidiary, expanded Reality Investing, a program that extends AAG’s participant level advice tool into a suite of investment advisory services. Reality Investing provides access to a range of advice services including professional account management at the participant level. In 2007, the Company will introduce these advisory services to existing and new customers within Retirement Services.
The following is a summary of certain financial data of the Company’s Other segment.
policyholder benefits decreased by 25% and 31%, respectively. The decrease in both is attributable to $167 million of premiums and an increase in reserves resulting from the initial recording of this reinsurance at December 31, 2005, compared to $125 million and $115 million of premiums and policyholder benefits, respectively, resulting from normal reinsurance activity in 2006. Net investment income and operating expenses include $12 million and $26 million, respectively, of GWSC reinsurance activity in 2006 compared to $0 in 2005. The remaining activity in the Other segment is comprised of an increase in interest expense of $14 million due to the issuance of a $333 million surplus note in May of 2006 and minor fluctuations within the corporate area of the Company’s business.
The following tables summarize the fair values and gross unrealized losses on fixed maturity investments, where the estimated fair value has declined and remained below amortized cost by 20% or more at December 31, 2006 and 2005:
For the year ended December 31, 2006, the unrealized losses are generally related to asset- backed securities with small business loan collateral. For the year ended December 31, 2005, the unrealized losses are generally related to the automobile and technology industries. The Company considers these investments to be only temporarily impaired.
During the years ended December 31, 2006 and 2005, the Company recorded other-than-temporary impairments in the fair value of its fixed maturity investments in the amounts of $6.2 million and $12.9 million, respectively. The write-downs during the year ended December 31, 2006 and 2005 generally related to asset-backed securities with manufactured housing collateral and corporate debt securities in the automobile industry. At December 31, 2006, the fair value of all fixed maturity investments in the automobile industries was less than 0.4% of total fixed maturities.
See Note 5 to the accompanying consolidated financial statements for a further discussion of fixed maturity investments.
The average balance of impaired loans decreased to $11.8 million during the year ended December 31, 2006 compared to $14.0 million during the year ended December 31, 2005. In 2005 there was one property acquired through foreclosure with a carrying value in the amount of $4.3 million. This property was subsequently sold in 2006. There were no properties acquired through foreclosure in 2006. The low levels of problematic mortgage loans relative to the Company’s overall financial position are due to its active loan management program.
See Note 5 to the accompanying consolidated financial statements for a further discussion of mortgage loans.
Other investments consist primarily of policy loans, equity investments, and short-term investments. The Company anticipates limited participation in the equity markets during the year ended December 31, 2007.
See Note 5 to the accompanying consolidated financial statements for a further discussion of equity investments.
The Company uses certain derivatives, such as futures, options and swaps, for purposes of hedging interest rate, market and foreign currency exchange risks. These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, when used for hedging, these instruments typically reduce risk. The Company controls the credit risk of its financial contracts through established credit approvals, limits and monitoring procedures. The Company has also developed controls within its operations to ensure that only derivative transactions authorized by the Board of Directors are executed. Notes 1 and 5 to the consolidated financial statements contain a discussion of the Company’s derivative activities.
Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio and utilizing cash flows from operations. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash that totaled $1,090 million and $1,128 million as of December 31, 2006 and 2005, respectively. In addition, at December 31, 2006 and 2005, 98.2% and 97.4%, respectively, of the bond portfolio carried an investment grade rating, thereby providing significant liquidity to the Company's overall investment portfolio.
benefits and expenses. However, since the timing of available funds cannot always be matched precisely to commitments, imbalances may arise when demands for funds exceed those on hand. In addition, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities. The sources of the funds that may be required in such situations include the issuance of commercial paper or other debt instruments. Management believes that the liquidity profile of its assets is sufficient to satisfy the liquidity requirements of reasonably foreseeable scenarios.
The Company’s financial strength provides the capacity and flexibility to enable it to raise funds in the capital markets through the issuance of commercial paper. The Company continues to be well capitalized, with sufficient borrowing capacity to meet the anticipated needs of its business. The Company had $95.0 million and $95.1 million of commercial paper outstanding at December 31, 2006 and 2005, respectively. The commercial paper has been given a rating of A-1+ by Standard & Poor’s Ratings Services and a rating of P-1 by Moody’s Investors Service, each being the highest rating available.
The Company also has available a corporate credit facility agreement in the amount of $50 million for general corporate purposes. The Company had no borrowings under the credit facility at either December 31, 2006 or 2005.
The Company makes commitments to lend funds for mortgage loan investments in the normal course of its business. The amounts of mortgage loan commitments at December 31, 2006 and 2005 were $36 million and $50 million, respectively. There are no other obligations or liabilities arising from such arrangements that are reasonably likely to become material.
as additional purchase consideration and will result in an adjustment to the purchase price allocation in the period in which the contingency is resolved.
The table above does not include obligations under the Company’s life or health insurance contracts, as the timing of cash requirements is largely dependent on the occurrence and timing of future events. As discussed previously, the Company follows strict asset/liability management practices designed to provide funds for the payment of its insurance obligations.
From time to time, the Company enters into agreements or contracts, including capital leases, to purchase goods or services in the normal course of its business. However, these agreements and contracts are not material to the Company’s results of operations or financial position.
In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R replaces Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and supersedes Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB No. 25”). SFAS No. 123R requires a company to use the fair value method to recognize the cost of its stock-based employee compensation and to provide certain other additional disclosures. Previously, the Company elected only to disclose the proforma impact of recording the fair value of stock options under the provisions of SFAS No. 123 in the notes to its consolidated financial statements. The Company adopted the provisions of SFAS No. 123R on January 1, 2006. The adoption of SFAS No. 123R did not have a material effect on the Company’s consolidated balance sheets or the results of its operations. See Note 19 to the accompanying consolidated financial statements for a further discussion of share-based compensation.
any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation under Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” to be carried at fair value in its entirety, with changes in fair value recognized in earnings. In addition, SFAS No. 155 requires that beneficial interests in securitized financial assets be analyzed to determine whether they are freestanding derivatives or contain an embedded derivative. SFAS No. 155 is applicable to new or modified financial instruments in fiscal years beginning after September 15, 2006, however it may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis. The Company adopted SFAS No. 155 on January 1, 2007. The adoption of SFAS No. 155 did not have a material effect on the Company’s consolidated financial position or the results of its operations.
In June 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with FASB Statement No. 109 “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 also provides expanded information about the extent to which a company measures assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 is applicable whenever other authoritative pronouncements require or permit assets or liabilities to be measured at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company will adopt the provisions of SFAS No.
157 for its fiscal year beginning January 1, 2008. The Company is evaluating the impact that the adoption of SFAS No. 157 will have on its consolidated financial position, the results of its operations and the disclosure requirements applicable to its fair value measurements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (“SFAS No.159”). SFAS No. 159 permits an entity to measure financial instruments and certain other items at estimated fair value. Most of the provisions of SFAS No. 159 are elective; however, the amendment to FASB No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, applies to all entities that own trading and available-for-sale securities. The fair value option created by SFAS No. 159 permits an entity to measure eligible items at fair value as of specified election dates. The fair value option (a) may generally be applied instrument by instrument, (b) is irrevocable unless a new election date occurs, and (c) must be applied to the entire instrument and not to only a portion of the instrument. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company will adopt the provisions of SFAS No. 159 for its fiscal year beginning January 1, 2008. The Company is evaluating the impact that the adoption of SFAS No. 159 will have on its consolidated financial position and the results of its operations.
We have audited the accompanying consolidated balance sheets of Great-West Life & Annuity Insurance Company and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholder’s equity, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Organization - Great-West Life & Annuity Insurance Company and its subsidiaries (collectively, the “Company”) is a direct wholly-owned subsidiary of GWL&A Financial Inc. (“GWL&A Financial”), a holding company formed in 1998. GWL&A Financial is an indirect wholly-owned subsidiary of Great-West Lifeco Inc. (“Lifeco”). The Company offers a wide range of life insurance, health insurance and retirement and investment products to individuals, businesses and other private and public organizations throughout the United States. The Company is an insurance company domiciled in the State of Colorado, and is subject to regulation by the Colorado Division of Insurance.
Basis of presentation - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are required to account for policy reserves, allowances for credit losses on mortgage loans, deferred acquisition costs and value of business acquired, goodwill and other intangible assets, derivative instruments, valuation of privately placed fixed maturity investments, employee benefits plans and taxes on income. Actual results could differ from those estimates.
Mortgage loans on real estate are carried at their unpaid balances adjusted for any unamortized premiums or discounts and any uncollectible accounts. Interest income is accrued on the unpaid principal balance. Discounts and premiums are amortized to net investment income using the scientific interest method. Accrual of interest is discontinued on any impaired loans where collection of interest is doubtful.
The Company may employ a trading strategy that involves the sale of securities with a simultaneous agreement to repurchase similar securities at a future date at an agreed-upon price. Proceeds of the sale are reinvested in other securities and may enhance the current yield and total return. The difference between the sales price and the future repurchase price is recorded as an adjustment to interest income. During the period between the sale and repurchase, the Company will not be entitled to receive interest and principal payments on the securities sold. Losses may arise from changes in the value of the securities or if the counterparty enters bankruptcy proceedings or becomes insolvent. In such cases, the Company’s right to repurchase the security may be restricted. Amounts owed to brokers under these arrangements are included in repurchase agreements in the accompanying consolidated balance sheets. The liability is collateralized by securities with approximately the same fair value.
The Company receives collateral for lending securities that are held as part of its investment portfolio. The Company requires collateral in an amount greater than or equal to 102% of the market value of domestic securities loaned and 105% of foreign securities loaned. Such collateral is used to replace the securities loaned in event of default by the borrower. The Company’s securities lending transactions are accounted for as collateralized borrowings. Collateral is defined as government securities, letters of credit and/or cash collateral. The borrower can return and the Company can request the loaned securities at any time. The Company maintains ownership of the securities at all times and is entitled to receive from the borrower any payments for interest or dividends received on such securities during the loan term.
Deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”) - DAC, which primarily consists of sales commissions and costs associated with the Company’s sales representatives related to the production of new business or through the acquisition of insurance or annuity contracts through indemnity reinsurance transactions, have been deferred to the extent recoverable. VOBA represents the estimated fair value of insurance or annuity contracts acquired either directly through the acquisition of another insurance company or through the acquisition of insurance or annuity contracts through assumption reinsurance transactions. The recoverability of such costs is dependent upon the future profitability of the related business. DAC and VOBA associated with the annuity products and flexible premium universal life insurance products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits. DAC and VOBA associated with traditional life insurance are amortized over the premium-paying period of the related policies in proportion to premium revenues recognized. See Note 9 for additional information regarding deferred acquisition costs and the value of businesses acquired.
Goodwill and other intangible assets - Goodwill is the excess of cost over the fair value of assets acquired and liabilities assumed in connection with an acquisition. The Company tests goodwill for impairment annually or more frequently if events or circumstances indicate that there may be justification for conducting an interim test. If the carrying value of goodwill exceeds its fair value, the excess is recognized as an impairment and recorded as a charge against net income in the period in which the impairment is identified. There were no impairments of goodwill recognized during the years ended December 31, 2006, 2005 or 2004.
Other intangible assets represent the estimated fair value of the portion of the purchase price that was allocated to the value of customer relationships, preferred provider networks and healthcare provider networks in various acquisitions. These intangible assets have been assigned values using various methodologies, including present value of projected future cash flows, analysis of similar transactions that have occurred or could be expected to occur in the market, and replacement or reproduction cost. The initial valuations of these intangible assets were supported by an independent valuation study that was commissioned by the Company and executed by qualified valuation experts. Other identified intangible assets with finite lives are amortized over their estimated useful lives, which initially ranged from 4 to 14 years (weighted average 13 years), primarily based on the cash flows generated by these assets.
Separate accounts - Separate account assets and related liabilities are carried at fair value in the accompanying consolidated balance sheets. The Company’s separate accounts invest in
Income taxes - Income taxes are recorded using the asset and liability method in which deferred tax assets and liabilities are recorded for expected future tax consequences of events have been recognized in either the Company’s financial statements or tax returns. In estimating future tax consequences, all expected future events, other than the enactments or changes in the tax laws or rules, are considered. Although realization is not assured, management believes it is more likely than not that the deferred tax asset will be realized.
Stock options - Lifeco maintains the Great-West Lifeco Inc. Stock Option Plan (the “Lifeco plan”) that provides for the granting of options on its common shares to certain of its officers and employees and those of its subsidiaries, including the Company. On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R “Share-Based Payment” (“SFAS No. 123R”) which requires it to use the fair value method to recognize the cost of share-based employee compensation. Previously, the Company elected only to disclose the proforma impact of recording the fair value of stock options under the provisions of SFAS No. 123 in the notes to its consolidated financial statements. (See Notes 3 and 19).
On October 2, 2006, the Company purchased several parts of the full service-bundled, small and midsized 401(k) as well as some defined benefit plan business from Metropolitan Life Insurance Company and its affiliates (“MetLife”). The assets acquired and liabilities assumed and the results of operations have been included in the Company’s consolidated financial statements since that date. The acquisition included the associated dedicated distribution group, including wholesalers, relationship managers and sales associates. As a result of the acquisition, the Company added approximately 300,000 participants in the 401(k) full service segment and increased its distribution capacity.
The purchase included a 100% coinsurance agreement reinsuring the acquired general account business and a 100% modified-coinsurance agreement reinsuring the acquired separate account business. The Company will replace the acquired MetLife policies with its policies over a three year period. As these policies are replaced, they will no longer be subject to the reinsurance agreements. Under the coinsurance agreement, the Company acquired all of the insurance liabilities associated with these contracts and received from MetLife cash to support these
liabilities, net of the purchase price. Under the modified-coinsurance agreement, MetLife retains the approximate $2.3 billion of separate account assets and liabilities but cedes to the Company all of the net profits and losses and related net cash flows. In addition, the Company acquired the rights to provide administrative services and recordkeeping functions for approximately $3.4 billion of participant account values.
The value of the identifiable intangible assets reflects the estimated fair value of customer relationships for the recordkeeping business acquired and amounted to $6,337 as a result of this acquisition. This intangible will be amortized in relation to the expected economic benefits of the agreement. If actual experience with customer relationships differs from expectations, the amortization will be adjusted to reflect actual experience. The customer relationship intangible asset has an expected weighted average amortization period of 14 years.
On November 30, 2006, the Company purchased all outstanding shares of IHN, Inc. (“IHN”). The results of IHN’s operations have been included in the Company’s consolidated financial statements since that date. IHN provides network provider access to health care and workers compensation payors such as third-party administrators, insurance carriers and employers for approximately 70,000 members. Additional consideration may be paid in 2008 if certain earnings targets are met. Any contingent consideration paid or accrued in future years will be recorded as an adjustment to the purchase price allocation in the period in which the contingency is resolved.
The purchase price has been allocated to the assets acquired and liabilities assumed using management’s best estimate of their fair values as of the acquisition date. The following table presents an allocation of the purchase price to assets acquired and liabilities assumed at December 31, 2006. The Company is in the process of obtaining third-party valuations of the intangible assets; thus, the allocation of the purchase price is subject to refinement. This process is expected to be completed before December 31, 2007.
The value of the identifiable intangible assets reflects the estimated fair value of customer relationships acquired of $19,790 and the estimated fair value of the preferred provider agreement of $14,490. These intangibles will be amortized in relation to the expected economic benefits of the agreement. If actual experience with differs from expectations, the amortization will be adjusted to reflect actual experience. The intangibles have an expected weighted average amortization period of 14 years.
In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position No. 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts” (“SOP 05-1”). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in FASB Statement of Financial Accounting Standards No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses From the Sale of Investments.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The Company adopted SOP 05-1 on January 1, 2007. The adoption of SOP 05-1 did not have a material effect on the Company’s consolidated financial position or the results of its operations.
adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). For fiscal years ending after December 15, 2006, SFAS No. 158 requires a company to recognize in its balance sheet an asset for a defined benefit postretirement plan’s overfunded status or a liability for a plan’s underfunded status and recognize changes in the funded status of a defined benefit postretirement plan in the other comprehensive income section of stockholder’s equity in the year in which the changes occur, and provide additional disclosures. The Company adopted the recognition and disclosure provisions of SFAS No. 158 as of December 31, 2006. The adoption of SFAS No. 158 decreased accumulated other comprehensive income (loss) by $6,734. The adoption of SFAS No. 158 did not affect the results of operations for the year ended December 31, 2006, and will not affect the Company’s results of operations in future periods. For fiscal years ended after December 15, 2008, SFAS No. 158 requires a company to measure a defined benefit postretirement plan’s assets and obligations that determine its funded status as of the end of its fiscal year. The Company is evaluating the impact that the adoption of the measurement date provision of SFAS No. 158 will have on its consolidated financial position and results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 also provides expanded information about the extent to which a company measures assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 is applicable whenever other authoritative pronouncements require or permit assets or liabilities to be measured at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company will adopt the provisions of SFAS No. 157 for its fiscal year beginning January 1, 2008. The Company is evaluating the impact that the adoption of SFAS No. 157 will have on its consolidated financial position, the results of its operations and the disclosure requirements applicable to its fair value measurements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (“SFAS No.159”). SFAS No. 159 permits an entity to measure financial instruments and certain other items at estimated fair value. Most of the provisions of SFAS No. 159 are elective; however, the amendment to FASB No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, applies to all entities that own trading and available-for-sale securities. The fair value option created by SFAS No. 159 permits an entity to measure eligible items at fair value as of specified election dates. The fair value option (a) may generally be applied instrument by instrument, (b) is irrevocable unless a new election date occurs, and (c) must be applied to the entire instrument and not to only a portion of the instrument. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007.
The Company will adopt the provisions of SFAS No. 159 for its fiscal year beginning January 1, 2008. The Company is evaluating the impact that the adoption of SFAS No. 159 will have on its consolidated financial position and the results of its operations.
The following table summarizes amounts due from parent and affiliates at December 31, 2006 and 2005.
A note payable to GWL&A Financial was issued as a surplus note on November 15, 2004, with a face amount of $195,000 and carrying amounts of $194,184 and $194,174 at December 31, 2006 and 2005, respectively. The surplus note bears interest at the rate of 6.675% per annum, payable in arrears on each May 14 and November 14. The note matures on November 14, 2034.
The note payable to The Great-West Life Assurance Company was paid during September 2006. The note bore interest at the rate of 5.4% per annum.
Interest expense attributable to these related party debt obligations was $28,848, $14,396 and $15,189 for the years ended December 31, 2006, 2005 and 2004, respectively.
The following table summarizes the transfer of funds withheld assets by CLAC to the Company during the years ended December 31, 2006 and 2005.
As a result of these asset transfers, the reinsured 80% of the life, health and annuity business is 65% coinsurance and 15% coinsurance with funds withheld at December 31, 2006.
The reinsurance receivable relates to the amount due to the Company for reserves ceded by coinsurance with funds withheld. The Company’s return on this reinsurance receivable is the interest and other investment returns earned, as defined by the agreement, on a segregated pool of investments of CLAC’s United States branch. Pursuant to an interpretation of SFAS No. 133, as amended, the Company has identified an embedded derivative for its exposure to interest rate and credit risk on the segregated pool of investments. As this embedded derivative does not qualify for hedge accounting treatment, it was marked to market resulting in the Company’s net income decreasing by $1,486, $8,454, and $5,282, net of policyholder related amounts and deferred taxes, during the years ended December 31, 2006, 2005, and 2004, respectively.
The Company recorded, at fair value, the following at December 31, 2005 as a result of this transaction.
Included within reinsurance receivable in the consolidated balance sheets are $231,842 and $166,688 of funds withheld assets as of December 31, 2006 and 2005, respectively. CLAC pays the Company interest on the funds withheld balance at a rate of 4.55% per annum.
The following table summarizes fixed maturity investments and equity securities available-for-sale at December 31, 2005.
See Note 6 for additional information on policies regarding estimated fair value of fixed maturity and equity investments.
The following table summarizes information regarding the sales of fixed maturity investments for the years ended December 31, 2006, 2005 and 2004.
maturity investments. These transactions are entered into pursuant to master agreements that provide for a single net payment to be made by one party to the agreement at each due date.
Hedge ineffectiveness in the amount of $89 was recorded as a decrease to net investment income during the year ended December 31, 2006, while $567 was recorded as an increase to net investment income during the year ended December 31, 2005 and $3,534 was recorded as a decrease to net investment income during the year ended December 31, 2004.
Derivatives not designated as hedging instruments - The Company attempts to match the timing of when interest rates are committed on insurance products with other new investments. However, timing differences may occur and can expose the Company to fluctuating interest rates. To offset this risk, the Company uses U.S. Treasury futures contracts. The Company also utilizes U.S. Treasury futures as a method of adjusting the duration of the overall portfolio.
The Company occasionally purchases a financial instrument that contains a derivative instrument that is “embedded” in the financial instrument. Upon purchasing the instrument, the Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e. the host contract) and whether a separate instrument with the same terms as the embedded instrument could meet the definition of a derivative instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract and carried at its fair value.
The following tables summarize derivative financial instruments at December 31, 2006 and 2005.
Mortgage loans - The following table summarizes information with respect to impaired mortgage loans at December 31, 2006 and 2005.
The following table summarizes activity in the allowance for mortgage loan credit losses for the years 2006, 2005 and 2004.
At December 31, 2006 and 2005, the Company had $345,192 and $374,295, respectively, invested in limited partnerships and limited liability corporations. The Company makes commitments to fund partnership interests in the normal course of its business. The amounts of unfunded commitments at December 31, 2006 and 2005 were $27,441 and $33,648, respectively.
The Company participates in a securities lending program whereby securities, which are included in invested assets in the accompanying consolidated balance sheets, are loaned to third parties. The Company requires a minimum of 102% of the fair value of the loaned securities to be separately maintained as collateral for the loans. Securities with a cost or amortized cost in the amounts of $365,219 and $138,530 and estimated fair values in the amounts of $365,341 and
The Company’s security investments fluctuate in value based upon interest rates in financial markets and other economic factors. These fluctuations, caused by market interest rate changes, have little bearing on whether or not the investment will be ultimately recoverable. The Company has the ability and intent to hold the securities with unrealized losses until a recovery of fair value; therefore, the Company considers these declines in value as temporary.
The following tables summarize unrealized investment losses by class of investment at December 31, 2006 and 2005. The Company considers these investments to be only temporarily impaired.
Fixed maturity investments - At December 31, 2006 and 2005, there were 980 and 1,134 securities, respectively, that had been in a loss position for less than twelve months with carrying values in the amounts of $3,706,657 and $5,188,408, respectively, and unrealized losses in the amounts of $38,919 and $97,622, respectively. At December 31, 2006 and 2005, less than 1% and less than 2%, respectively, of these securities were rated non-investment grade. At December 31, 2006 and 2005, there were 1,456 and 641 securities, respectively, that had been in a continuous loss position for twelve months or longer with carrying values in the amounts of $5,707,123 and $2,139,212, respectively, and unrealized losses in the amounts of $175,705 and $83,762, respectively. The unrealized losses on these securities are primarily attributable to changes in market interest rates and changes in credit spreads since the securities were acquired. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2006.
U.S. Government direct obligations and U.S. agencies, obligations of U.S. states and their subdivisions and foreign governments - The unrealized losses on the Company’s investments in U.S. Government direct obligations and U.S. agencies, obligations of U.S. States and their subdivisions, and foreign governments as of December 31, 2006 and 2005 were caused by market interest rate increases since the securities were acquired. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investments. All of these investments are rated “A” and above. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2006.
In the automobile related industry, one security has been in a loss position for less than twelve months with an unrealized loss of in the amount of $11. Seven securities have been in a loss position for twelve months or longer with unrealized losses in the amount of $3,435. There were three automobile industry securities upon which $1,299 of impairment write-downs were recognized during the year ended December 31, 2006. Based on the Company’s analysis of the liquidity of the issuers in these investments, the Company considers the remaining principal to be fully recoverable under the contractual terms of the investments.
The Company has investments in Canadian bank debt securities of which one security has been in a loss position for less than twelve months with an unrealized loss in the amount of $14. Three securities have been in a loss position for twelve months or longer with unrealized losses in the amount of $3,857. None of these unrealized losses in these industries were related to a decrease in credit quality.
Mortgage-backed and asset-backed securities - At December 31, 2006 and 2005, there were 51 and 102 securities, respectively, that had been in a loss position for less than twelve months with carrying values in the amounts of $724,267 and $1,590,209, respectively, and unrealized losses in the amounts of $7,782 and $26,855, respectively. At December 31, 2006 and 2005, there were 139 and 67 securities, respectively, that had been in a continuous loss position for twelve months or longer with carrying values in the amounts of $2,091,923 and $714,946, respectively, and unrealized losses in the amounts of $62,867and $26,469, respectively. None of these losses were related to a decrease in credit quality. The losses on these securities are primarily attributable to changes in market interest rates and changes in credit spreads since the securities were acquired. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2006.
The estimated fair values of financial instruments have been determined using available information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data in order to develop estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts of the Company’s financial instruments.
The estimated fair values of fixed maturity, short-term, and equity investments that are publicly traded are obtained from an independent pricing service. To determine the fair values of fixed maturity and equity investments that are not actively traded, the Company utilizes discounted cash flows calculated at current market rates on investments of similar quality and term. The fair values of cost method investments are not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect.
The estimated fair values and carrying amounts of reinsurance receivables at December 31, 2006 and 2005 include a reduction of $53,048 and $34,063, respectively, representing the estimated fair value of the embedded derivative associated with the Company’s reinsurance receivable under its coinsurance with funds withheld agreement with the United States branch of CLAC (See Note 4). Valuation of the derivative is based upon the estimated fair value of the segregated pool of assets from which the Company derives its return on the reinsurance receivable.
The estimated fair values of policyholders’ funds are the same as the carrying amounts since the Company can change the interest crediting rates with 30 days notice.
The estimated fair values of the notes payable to GWL&A Financial and GWL are based upon discounted cash flows at current market rates on high quality investments.
Included in other assets at December 31, 2006 and 2005 are derivative financial instruments in the amounts of $2,127 and $4,695, respectively. Included in other liabilities at December 31, 2006 and 2005 are derivative financial instruments in the amounts of $7,757 and $12,789, respectively. The estimated fair values of over-the-counter derivatives, primarily consisting of interest rate swaps, which are held for other than trading purposes, are the estimated amounts the Company would receive or pay to terminate the agreements at each year-end, taking into consideration current interest rates and other relevant factors.
The Company maintains an allowance for credit losses at a level that, in management’s opinion, is sufficient to absorb credit losses on amounts receivable related to uninsured accident and health insurance plan claims and premiums in course of collection. Management’s judgment is based upon past loss experiences and current and projected economic conditions.
The following table summarizes activity in the allowances for amounts receivable related to uninsured accident and health insurance plan claims paid on behalf of customers for the years 2006, 2005 and 2004.
The Great-West Healthcare segment of the Company entered into a reinsurance agreement, effective January 1, 2003, with an unrelated third-party to cede 90% in 2003, 75% in 2004 and 40% in 2005 of direct written group health stop-loss and excess loss activity. This agreement was terminated on December 31, 2005.
The following tables summarize life insurance in-force and life and accident/health premiums at, and for the year ended, December 31, 2004.
The following table summarizes activity in deferred acquisition costs and value of business acquired for the years ended December 31, 2006, 2005 and 2004.
The balances of and changes in goodwill by segment for the years ended December 31, are as follows.
The following table summarizes other intangible assets as of December 31.
The estimated future amortization of other intangible assets using current assumptions, which are subject to change, for the years ended December 31, 2007 through December 31, 2011 is as follows.
The Company has a commercial paper program that is partially supported by a $50,000 corporate credit facility (See Note 21).
The following table presents the composition of other comprehensive income (loss) for the year ended December 31, 2006.
The following table presents the composition of other comprehensive income (loss) for the year ended December 31, 2005.
The following table summarizes the components of general insurance expenses for the years ended December 31, 2006, 2005 and 2004.
On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158. SFAS No. 158 required the Company to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations for the defined benefit plan or the accumulated post-retirement benefit obligation for the post- retirement medical plan) of its pension plan and post-retirement medical plan in the December 31, 2006 statement of financial position, with a corresponding adjustment to accumulated other comprehensive income, net of tax. The adjustment to accumulated other comprehensive income at adoption represents the net unrecognized actuarial losses, unrecognized prior service costs, and unrecognized transition obligation remaining from the initial adoption of Statement of Financial Accounting Standards No. 87, Employer’s Accounting for Pensions (“SFAS No. 87”) all of which were previously netted against the plan’s funded status in the Company’s statement of financial position pursuant to the provisions of SFAS No. 87. These amounts will be subsequently recognized as net periodic pension cost pursuant to the Company’s historical
The incremental effects of adopting the provisions of SFAS No. 158 on the Company’s statement of financial position at December 31, 2006 are presented in the following table. The adoption of SFAS No. 158 had no effect on the Company’s consolidated statement of income for the year ended December 31, 2006, or for any prior period presented, and it will not effect the Company’s operating results in future periods. Prior to adopting the recognition provisions of SFAS No. 158 at December 31, 2006, the Company recognized an additional minimum pension liability pursuant to the provisions of SFAS No. 87. The effect of recognizing the additional minimum liability is included in table below in the column labeled “Prior to Adopting SFAS No. 158.”
Defined benefit pension and post-retirement medical plans - The Company has a noncontributory defined benefit pension plan covering substantially all of its employees that were hired before January 1, 1999. Pension benefits are based principally on an employee’s years of service and compensation levels near retirement. The Company’s policy for funding the defined benefit pension plans is to make annual contributions, which equal or exceed regulatory requirements.
The Company sponsors an unfunded post-retirement medical plan (the “medical plan”) that provides health benefits to retired employees who are not Medicare eligible. The medical plan is contributory and contains other cost sharing features, which may be adjusted annually for the expected general inflation rate. The Company’s policy is to fund the cost of the medical plan benefits in amounts determined at the discretion of management.
During December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. Under the Act, which takes effect on January 1, 2006, employers who sponsor postretirement plans that provide for a prescription drug benefit under Medicare Part D may be entitled to a subsidy payment. In conjunction with the effect of this legislation, the Company amended its post-retirement medical plan, whereby it eliminated the provision of medical benefits for retired employees once they become Medicare eligible. The adoption of the amendment resulted in a reduction of the Company’s estimated post-retirement medical plan benefit obligation in the amount of $34,965 on January 1, 2006. On January 1, 2005, the United States employees of CLAC became participants in the Company’s post-retirement medical benefit plan.
The following table provides a reconciliation of the changes in the benefit obligations, fair value of plan assets, and the funded status for the Company’s defined benefit pension and post-retirement medical plans as of the years ended December 31, 2006 and 2005.
The accumulated benefit obligation for the defined benefit pension plan was $279,828 and $255,992 at December 31, 2006 and 2005, respectively.
The following table presents how the Company’s pension plan assets are invested at December 31, 2006 and 2005.
The following table presents the Company’s target allocation for invested plan assets at December 31, 2007.
The investment objective of the defined benefit pension plan is to provide an attractive risk-adjusted return that will ensure the payment of benefits while protecting against the risk of substantial investment losses. Correlations among the asset classes are used to identify an asset mix that the Company believes will provide the most attractive returns. Long-term return forecasts for each asset class using historical data and other qualitative considerations to adjust for projected economic forecasts are used to set the expected rate of return for the entire portfolio.
The expected benefit payments for the Company’s supplemental executive retirement plans for the years indicated are as follows:
Other employee benefit plans - The Company sponsors a defined contribution 401(k) retirement plan, which provides eligible participants with the opportunity to defer up to 50% of base compensation. The Company matches 50% of the first 5% of participant pre-tax contributions for employees hired before January 1, 1999. For all other employees, the Company matches 50% of the first 8% of participant pre-tax contributions. Company contributions for the years ended December 31, 2006, 2005 and 2004 were $8,825, $8,153 and $7,522, respectively.
The Company has a deferred compensation plan for select sales personnel with the opportunity to participate in an unfunded deferred compensation program. Under this program, participants
program no longer accepted participant deferrals. Participant balances, which are included in other liabilities in the accompanying consolidated balance sheets, are $5,658 and $6,055 at December 31, 2006 and 2005, respectively. The participant deferrals earned interest at the average rate of 4.50% during both years ended December 31, 2006 and 2005. The interest rate is based on an annual rate determined by the Company. The interest expense related to this plan was $269, $282 and $291 for the years ended December 31, 2006, 2005 and 2004, respectively.
The following table presents a reconciliation between the statutory federal income tax rate and the Company’s effective federal income tax rate for the years ended December 31, 2006, 2005 and 2004.
Amounts presented for investment assets above include $4,329 and $(3,709) related to the unrealized (gains) losses on the Company’s fixed maturity and equity investments, which are classified as available-for-sale at December 31, 2006 and 2005, respectively.
The Company’s operations are not materially dependent on one or a few customers, brokers or agents. The following tables summarize segment financial information for the year ended and as of December 31, 2006.
The following tables summarize segment financial information for the year ended and as of December 31, 2005.
Lifeco, of which the Company is an indirect wholly-owned subsidiary, has a stock option plan (the “Lifeco plan”) that provides for the granting of options on its common shares to certain of its officers and employees and those of its subsidiaries, including the Company. Options are granted with exercise prices not less than the market price of the shares on the date of the grant. Termination of employment prior to the vesting of the options results in the forfeiture of the unvested options. The Lifeco plan provides for the granting of options with varying terms and vesting requirements. Generally, options under the Lifeco plan vest and become exercisable twenty percent per year commencing on the first anniversary of the grant and expire ten years from the date of grant. As of December 31, 2006 there were 3,118,288 underlying options available for award to employees under the Lifeco plan.
The following table presents other information regarding options under the Lifeco plan during the year ended December 31, 2006.
The intrinsic value of options exercised is calculated as the difference between the market price of Lifeco common shares on the date of exercise and the exercise price of the option multiplied by the number of options exercised.
On February 1, 2007, Lifeco announced that it had entered into agreements with Marsh & McLennan Companies, Inc. whereby GWL&A Financial will acquire the asset management business of Putnam Investment Trust (“Putnam”). The transaction is expected to close in the second quarter of 2007.
In connection with the Putnam transaction, the Company plans to terminate the CLAC indemnity reinsurance agreement discussed in Note 4. This termination is expected to occur in the second quarter of 2007 and will result in a reduction of invested assets, cash and reinsurance receivables as well as policy benefit liabilities of approximately $1,948 million.