o license approval for one additional HMO subsidiary, for a total of 15 fully operational HMOs.
The number of new 401(k) case sales (employer groups), including third-party administration business generated through the Company's marketing and administration arrangement with New England, increased 973 or 19% in 2000 as compared to 811 in 1999 (828 in 1998). The 401(k) block of business under administration totaled 7,000 employer groups and 551,000 individual participants, compared to 6,400 employer groups and more than 500,000 individual participants in 1999, and 6,100 employer groups and 475,000 individual participants in 1998.
In order to remain competitive with respect to our morbidity results, an increased emphasis on our provider contracting is essential. Furthermore, the Company will enhance its focus on expense economies and synergies, to ensure competitive administrative costs on a per member per month basis. The successful consolidation of the benefit payment offices will remain an important operational issue from both a cost and quality perspective.
The Company will continue to enhance its One Health Plan managed care subsidiaries. In 2001, the total number of licensed One Health Plan HMOs is expected to be 18. These HMO's will continue to provide current customers with a comprehensive national managed care network. In 2000, the Company implemented an Internet based disease management program for members with diabetes, asthma, or coronary heart disease, which will continue in 2001, with expansion to include new conditions.
Customer demand for investment diversification continued to grow during 2000. New contributions to variable business represented 56% of the total premium equivalents in 2000 versus 64% in 1999. The Company continues to expand the investment products available through its in-house Maxim Series Fund, Inc., and Orchard Series Fund, and through partnership arrangements with external fund managers. Externally managed funds offered to participants in 2000 included AIM, American Century, Ariel, Fidelity, Founders, INVESCO, Janus, Loomis Sayles, Templeton and T. Rowe Price.
FASCorp administered records for approximately 1,875,000 participants in 2000 versus 1,595,000 in 1999. FASCorp's fee income was $63.8 million, $53.8 million, and $44.0 million for the years ending December 31, 2000, 1999 and 1998, respectively.
At December 31, 2000 and 1999, the Company had two bonds in default with a carrying value of $10.7 million.
The U.S. economy grew at a real rate of approximately 5% in 2000. The rate of growth, however, slowed noticeably in the second half of the year, and several factors suggest that the slowdown will be sustained. The Federal Reserve Board, after 18 months of restrictive policy, on January 3, 2001 and January 31, 2001, cut the Federal Funds rate by 50 basis points from 6.50% to 6.00% and from 6.00% to 5.50%, respectively. The rate cut was in response to data releases indicating that the economy was slowing more quickly than anticipated. The Federal Open Market Committee bias is currently towards easing the interest rates. The magnitude and timing of further rate cuts will be dependent on economic conditions.
The Company's investment portfolio is well positioned for a potential declining interest rate environment. The portfolio is diversified and is comprised of high quality, stable assets. Asset acquisitions in 2001 will target investment grade bonds appropriate for the expected economic and interest rate environment and liability requirements. It is the Company's philosophy and intent to maintain its proactive portfolio management policies in an ongoing effort to ensure the quality and performance of its investments.
Funds provided by premiums and fees, investment income and maturities of investment assets are reasonably predictable and normally exceed liquidity requirements for payment of claims, 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. Also, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities. The Company's capital resources represent funds available for long-term business commitments and primarily consist of retained earnings and proceeds from the issuance of commercial paper and equity securities. Capital resources provide protection for policyholders and financial strength to support the underwriting of insurance risks, and allow for continued business growth. The amount of capital resources that may be needed is determined by the Company's senior management and Board of Directors as well as by regulatory requirements. The allocation of resources to new long-term business commitments is designed to achieve an attractive return, tempered by considerations of risk and the need to support the Company's existing business.
The Financial Accounting Standards Board (FASB) has issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement of FASB Statement No. 125", which revises the standards for accounting for securitizations and other transfers of financial assets and collateral, and requires certain disclosures. Statement No. 140 will be effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. However, certain disclosure requirements under Statement No. 140 were effective December 15, 2000, and these requirements have been incorporated in the Company's financial statements (see Note 6 to the Consolidated Financial Statements). Management does not anticipate that the adoption of the New Statement will have a significant effect on the financial position or results of operations of the Company.
The Following are the Company's Consolidated Financial Statements for the Years Ended December 31, 2000, 1999, and 1998 and the Independent Auditors' Report thereon.
We have audited the accompanying consolidated balance sheets of GWL&A Financial Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholder's equity, and cash flows for each of the three years ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998 ================================================================================ (Amounts in Thousands, except Share Amounts)
On December 31, 2000, the Company and certain affiliated companies completed a corporate reorganization. Prior to December 31, 2000, the Company was an indirect wholly-owned subsidiary of The Great-West Life Assurance Company (GWL). Under the new structure, the Company and GWL each continue to be indirectly and directly, respectively, owned by Great-West Lifeco Inc., but GWL no longer holds an equity interest in the Company.
The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on its impaired loans. Management's judgement is based on past loss experience, current and projected economic conditions, and extensive situational analysis of each individual loan. The measurement of impaired loans is based on the fair value of the collateral.
Participating Fund Account - Participating life and annuity policy reserves are $4,557,599 and $4,297,823 at December 31, 2000 and 1999, respectively. Participating business approximates 28.6%, 31.0%, and 32.7% of the Company's ordinary life insurance in force and 85.2%, 94.0%, and 71.9% of ordinary life insurance premium income for the years ended December 31, 2000, 1999, and 1998, respectively.
Recognition of Premium and Fee Income and Benefits and Expenses - Life insurance premiums are recognized when due. Annuity premiums with life contingencies are recognized as received. Accident and health premiums are earned on a monthly pro rata basis. Revenues for annuity and other contracts without significant life contingencies consist of contract charges for the cost of insurance, contract administration, and surrender fees that have been assessed against the contract account balance during the period and are recognized when earned. Fee income is derived primarily from contracts for claim processing or other administrative services related to uninsured business and from assets under management. Fees from contracts for claim processing or other administrative services are recorded as the services are provided. Fees from assets under management, which consist of contract maintenance fees, administration fees and mortality and expense risk charges, are recognized when due. Benefits and expenses on policies with life contingencies are associated with earned premiums so as to result in recognition of profits over the life of the contracts. This association is accomplished by means of the provision for future policy benefit reserves. The average crediting rate on annuity products was approximately 6.2%, 6.2%, and 6.3% in 2000, 1999, and 1998.
Interest rate swap agreements are used to convert the interest rate on certain debt securities from a floating rate to a fixed rate or vice versa, to convert from a fixed rate to floating rate. Interest rate floors and caps are interest rate protection instruments that require the payment by a counterparty to the Company of an interest rate differential only if interest rates fall or rise to certain levels. The differential represents the difference between current interest rates and an agreed-upon rate, the strike rate, applied to a notional principal amount. Foreign currency exchange contracts are used to hedge the foreign exchange rate risk associated with bonds denominated in other than U.S. dollars. Written call options are used in conjunction with interest rate swap agreements to effectively convert convertible, fixed rate bonds to non-convertible variable rate bonds as part of the Company's overall asset-liability maturity program. Futures are used to hedge the interest rate risks of forecasted acquisitions of fixed rate fixed maturity investments. Equity swap transactions generally involve the exchange of variable market performance of a basket of securities for a fixed interest rate.
Although derivative financial instruments taken alone may expose the Company to varying degrees of market and credit risk in excess of amounts recognized in the financial statements, when used for hedging purposes, these instruments typically reduce overall market, foreign exchange, and interest rate risk. The Company controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures. As the Company generally enters into derivative transactions only with high quality institutions, no losses associated with non-performance on derivative financial instruments have occurred or are expected to occur.
Effective January 1, 2001, the Company adopted FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by FASB Statement No. 138. The Statements require that all derivative financial instruments be recognized in the financial statements as assets or liabilities and measured at fair value regardless of the purpose or intent for holding them. Gains or losses resulting from changes in the fair value of derivatives are accounted for depending on the intended use of the derivative and whether it qualifies for hedge accounting. Upon adoption, a transition adjustment of approximately $1,000 increased accumulated comprehensive income.
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - The Financial Accounting Standards Board (FASB) has issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A replacement of FASB Statement No. 125", which revises the standards for accounting for securitizations and other transfers of financial assets and collateral, and requires certain disclosures. Statement No. 140 will be effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. However, certain disclosure requirements under Statement No. 140 were effective December 15, 2000, and these requirements have been incorporated in the Company's financial statements (see Note 6). Management does not anticipate that the adoption of the new Statement will have a significant effect on the financial position or results of operations of the Company.
Assuming the Alta acquisition had been effective on January 1, 1998, pro forma 1998 revenues would have been $2,671,361 and pro forma 1998 net income would have been $191,552. The pro forma financial information is not necessarily indicative of either the results of operations that would have occurred had this agreement been effective on January 1, 1998, or of future operations.
In connection with this transaction, the GWL made a capital contribution of $3,200 to the Company.
At December 31, 2000 and 1999, due to GWL includes $17,743 and $10,647 due on demand and $25,338 and $25,338 of notes payable which bear interest and mature on October 1, 2006. These notes may be prepaid in whole or in part at any time without penalty; the issuer may not demand payment before the maturity date. The amounts due on demand to GWL bear interest at the public bond rate (7.0% and 6.7% at December 31, 2000 and 1999, respectively) while the note payable bears interest at 5.4%.
Proceeds from sales of securities available-for-sale were $1,460,672, $3,176,802, and $6,169,678 during 2000, 1999, and 1998, respectively. The realized gains on such sales totaled $5,845, $10,080, and $41,136 for 2000, 1999, and 1998, respectively. The realized losses totaled $20,562, $19,720, and $8,643 for 2000, 1999, and 1998, respectively. During the years 2000, 1999, and 1998, held-to-maturity securities with amortized cost of $8,571, $0, and $9,920 were sold due to credit deterioration with insignificant gains and losses.
The Company engages in hedging activities to manage interest rate, market and foreign exchange risk. The following table summarizes the 2000 financial hedge instruments:
The Company has established specific investment guidelines designed to emphasize a diversified and geographically dispersed portfolio of mortgages collateralized by commercial and industrial properties located in the United States. The Company's policy is to obtain collateral sufficient to provide loan-to-value ratios of not greater than 75% at the inception of the mortgages. At December 31, 2000, approximately 32% of the Company's mortgage loans were collateralized by real estate located in California.
1-Percentage 1-Percentage Point Point Increase Decrease ------------ -------------- Increase (decrease) on total of service and interest cost on components $ 1,189 $ (812) Increase (decrease) on post-retirement benefit 7,220 (5,517) obligation
The Company sponsors a defined contribution 401(k) retirement plan which provides eligible participants with the opportunity to defer up to 15% of base compensation. The Company matches 50% of the first 5% of participant pre-tax contributions. For employees hired after January 1, 1999, the Company matches 50% of the first 8% of participant pre-tax contributions. Company contributions for the years ended December 31, 2000, 1999, and 1998 totaled $6,130, $5,504, and $3,915, respectively.
2000 1999 1998 ----------- ----------- ----------- Federal tax rate 35.0 % 35.0 % 35.0 % Change in tax rate resulting from: Settlement of GWL tax exposures (5.9) Other, net (0.9) (0.3) (1.6) ----------- ----------- ----------- Total 34.1 % 28.8 % 33.4 % =========== =========== ===========
The Company's income tax provision was favorably impacted in 1999 by the release of contingent liabilities relating to taxes of the GWL's U.S. branch associated with blocks of business that were transferred from the Parent Corporation's U.S. branch to the Company from 1989 to 1993; the Company had agreed to the transfer of these tax liabilities as part of the transfer of this business. The release recorded in 1999 reflected the resolution of certain tax issues with the Internal Revenue Service (IRS), and totaled $17,150; however, $8,900 of the release was attributable to participating policyholders and therefore had no effect on the net income of the Company since that amount was credited to the provision for policyholders' share of earnings on participating business in the accompanying 1999 statement of income.
Effective September 30, 1998, the Company purchased all of its outstanding series of preferred stock, which were owned by GWL, for $121,800. At December 31, 2000 and 1999, the Company has 1,500 authorized shares each of Series A, Series B, Series C and Series D cumulative preferred stock; and 2,000,000 authorized shares of non-cumulative preferred stock.
Additional variable options granted in 1998 and 2000 totaling 380,000 and 120,000, respectively, become exercisable if certain sales or financial targets are attained. During 2000, 1999, and 1998 13,250, 11,250, and 30,000 of these options vested and accordingly, the Company recognized compensation expense of $151, $23, and $116, respectively. If exercisable, the exercise period expires ten years from the date of grant.
Summarized segment financial information for the year ended and as of December 31 was as follows: