The Company’s corporate office facility is comprised of an 882,000 square foot complex located in Greenwood Village, Colorado. The Company owns its corporate office facilities. At December 31, 2013, the Company leased approximately 188,000 square feet of the complex to CIGNA for a lease period expiring on March 31, 2018. The Company also leases sales and administrative offices throughout the United States. Management believes that the Company’s properties are suitable and adequate for its current and anticipated business operations.
Management’s discussion and analysis of financial condition and results of operations of the Company for the three years ended December 31, 2013 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.”
The Company recorded the following on January 1, 2013 in its condensed consolidated statement of income in connection with the termination of the reinsurance agreement (in millions):
During 2013, the financial markets continued to strengthen. As a result, the S&P 500 index ended 2013 up by 30% as compared to 2012 and 2012 was up by 13% when compared to 2011. The average of the S&P 500 index during the year ended December 31, 2013 was up by 19% when compared to the average for the year ended December 31, 2012 and the average was up by 9% for the year ended December 31, 2012 when compared to the average for the year ended December 31, 2011.
Also as a result of improvements in overall economic conditions in 2013, interest rates began to rise. As a result, the 10-year U.S. Treasury rate ended 2013 up by 126 basis points as compared to 2012 while 2012 was down 11 basis points when compared to 2011. The average of the 10-year U.S. Treasury rate during the year ended December 31, 2013 was up by 52 basis points when compared to the average for the year ended December 31, 2012 and the average was down by 94 basis points for the year ended December 31, 2012 when compared to the average for the year ended December 31, 2011.
Unrealized gains on fixed maturity investments fluctuate with changes in the prevailing interest rates. When interest rates rise, market values of fixed maturity investments generally fall. Net unrealized investment gains (losses) recognized in earnings changed by $36 million from a gain of $11 million in 2012 to a loss of $25 million in 2013. The Company has also recorded an increase in
· Valuation of investments and derivatives in the absence of quoted market values;
The Company establishes liabilities for amounts payable under insurance policies and annuity contracts. Generally, amounts are payable over an extended period of time and related liabilities are calculated as the present value of future expected benefits to be paid, reduced by the present value of future expected premiums. Such liabilities are established based upon methods and underlying assumptions in accordance with GAAP and applicable actuarial standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, policy lapse, renewal, retirement, investment returns, inflation, expenses and other contingent events as appropriate to the respective product type. These assumptions are established at the time the policy is issued and are intended to estimate the experience for the period the policy benefits are payable. Utilizing these assumptions, liabilities are established on a block of business basis. If experience is less favorable than the
The Company incurs significant costs in connection with acquiring new and renewal insurance business. DAC varies with and relates to costs that consist primarily of commissions and agency and policy issue expenses. DAC is amortized over the expected lives of the related contracts based upon the level and timing of either gross profits or gross premiums, depending upon the type of contract as discussed below. The recovery of DAC is dependent upon the future profitability of the related business.
Quarterly, the Company updates the estimated present values of gross profits. Periodically but at least semi-annually, the actual gross profits are compared to the estimated gross profits. When the actual gross profits change from previous estimates, the cumulative DAC amortization is re-estimated and adjusted by the cumulative charge or credit to current period earnings. When actual gross profits exceed those previously estimated, the DAC amortization will increase, resulting in a current period charge to earnings. The opposite result occurs when the actual gross profits are below those previously estimated. These adjustments are made when the Company revises its estimates for such factors as investment yield, realized investment gains and losses and policyholder retention.
The Company has three reportable segments: Individual Markets, Retirement Services and Other. The Individual Markets segment distributes life insurance, annuity and retirement products (including IRAs) to both individuals and businesses through various distribution channels. Life insurance products in-force include participating and non-participating term life, whole life, universal life and variable universal life. The Retirement Services segment provides various retirement plan products and investment options as well as comprehensive administrative and record-keeping services for financial institutions and employers, which include educational, advisory, enrollment and communication services to employer-sponsored defined contribution plans and associated defined benefit plans. Defined contribution plans provide for benefits based upon the value of contributions to, and investment returns on, an individual’s account. The Company’s Other reporting segment is substantially comprised of activity under the assumption of reinsurance between GWSC and CLAC (“the GWSC operating segment”), corporate items not directly allocated to the other operating segments and interest expense on long-term debt.
The Company’s consolidated net income decreased by $109 million, or 46%, to $129 million for the year ended December 31, 2013 when compared to 2012. The decrease in earnings is primarily due to realized investment losses in 2013, primarily driven by forward settling TBA security transactions, compared to realized investment gains in 2012. There was also a decrease in net investment income primarily due to unrealized losses from derivatives in 2013 compared to unrealized gains in 2012 and lower yields. Additionally, there was an increase in operating expenses. These amounts are partially offset by higher fee income due to increased average asset levels driven by higher average equity market levels.
Fee income increased by $83 million, or 15%, to $619 million for the year ended December 31, 2013 when compared to 2012. The increase is primarily related to improved variable fee income due to increased average asset levels driven by higher average equity market levels. The equity market performance is evidenced by a 19% increase in the average S&P 500 index during the year ended December 31, 2013 as compared to December 31, 2012.
Other revenue increased by $7 million for the year ended December 31, 2013 when compared to 2012 as a result of the termination of the reinsurance agreement with CLAC.
Total benefits and expenses increased by $86 million, or 5%, to $1,979 million for the year ended December 31, 2013 when compared to 2012. The increase in benefits and expenses is attributable to the $43 million increase in the Company’s Individual Markets segment primarily driven by benefits expense incurred in conjunction with the termination of the reinsurance agreement with CLAC partially offset by a decrease in policyholder benefits due to the change in the mix of sales mentioned in premiums and improved persistency in 2013 as compared to 2012. The Retirement Services segment had an increase of $37 million primarily driven by higher asset-based commissions and incentive compensation due to higher sales. The Other segment had an increase of $6 million primarily due to lower persistency on a block of 10-year term policies.
Income tax expense decreased by $76 million, or 56%, to $59 million for the year ended December 31, 2013 when compared to 2012 primarily due to a decrease in net income before tax. Additionally, there was a decrease in the effective tax rate due to an $11 million adjustment to taxes included in the 2012 expense related to the 2008 tax year IRS examination.
Premium income decreased by $101 million, or 19%, to $422 million for the year ended December 31, 2012 when compared to 2011. This decrease is primarily related to the $82 million decrease in the Company’s Individual Markets segment which is driven by an $88 million decline in sales of the SPWL product marketed through banks. In 2011, the Company began replacing the SPWL product with a SPUL product, which recorded deposits due to sales of $451 million for the year ended December 31, 2012, as compared to $196 million for the year ended December 31, 2011. Additionally, there is a $21 million decrease in the Other segment primarily due to run-off in the closed block of business.
Income tax expense increased by $41 million, or 44%, to $135 million for the year ended December 31, 2012 when compared to 2011 primarily due to an increase in net income before tax. Additionally, there was an increase in the effective tax rate from 32% to 36% primarily due to an $11 million adjustment to prior year income taxes included in the 2012 expense related to the 2008 tax year IRS examination.
Fee income increased by $19 million, or 25%, to $94 million for the year ended December 31, 2013 when compared to 2012. The increase is primarily related to fees earned on the SPUL product and certain executive benefits products. Additionally, the increase is driven by fees on the executive benefits and IRA products reflecting higher variable policy balances and an overall increase in the size of the block of business.
Net investment income decreased by $42 million, or 6%, to $688 million for the year ended December 31, 2013 when compared to 2012. The decrease is due to a $32 million change in derivatives due to unrealized losses in 2013 as compared to unrealized gains in 2012. Additionally, there was a $7 million decrease in investment income earned on bonds, mortgages and policy loans as a result of lower yields partially offset by higher invested assets balances.
Income tax expense decreased by $17 million, or 33%, to $34 million during the year ended December 31, 2013 when compared to 2012, primarily due to the decrease in net income before income taxes.
Net income for the Individual Markets segment increased by $4 million, or 4%, to $104 million for the year ended December 31, 2012 when compared to 2011. The increase in earnings is primarily due to increases in net investment income and realized investment gains (losses), net. Partially offsetting these increases are an increase in mortality losses in the closed blocks and higher operating expenses.
Total benefits and expenses decreased by $27 million, or 3%, to $1,020 million for the year ended December 31, 2012 when compared to 2011. The benefit and expense improvement is attributable to a $55 million, or 6%, decrease in policyholder benefits which primarily reflects the change in the mix of sales mentioned in premiums above offset by higher mortality losses. Partially offsetting this decrease is a $28 million increase in operating expenses primarily related to an increase in the amortization of deferred acquisition expenses as a result of actual gross profits exceeding those previously estimated gross profits.
increased average asset levels driven by higher average equity market levels. The equity market performance is evidenced by a 19% increase in the average S&P 500 index during the year ended December 31, 2013 as compared to 2012.
Total benefits and expenses increased by $37 million, or 5%, to $734 million for the year ended December 31, 2013 when compared to 2012. The increase in benefits and expense is primarily attributable to a $45 million, or 9%, increase in operating expenses driven by higher asset-based commission and incentive compensation expense reflecting sales growth and improved performance of the U.S. equities market. The higher operating expenses are also due to an increase in other general operating expense due to segment growth in 2013 as well as a guaranty fund assessment incurred by the Company in 2013. Offsetting the increase in operating expenses is an $8 million, or 4%, decline in policyholder benefits primarily driven by a decrease in interest paid to policyholders due to lower credited rates in 2013 as compared to 2012 and lower annuity payments.
The following is a summary of certain financial data of the Retirement Services segment:
Net income for the Retirement Services segment increased by $48 million, or 43%, to $160 million for the year ended December 31, 2012 when compared to 2011. The increase is due to higher net realized gains on investments of $58 million and higher fee income of $39 million when compared to the prior year. Partially offsetting these increases was higher operating expenses of $58 million when compared to the prior year primarily due to growth in the segment from sales.
Income tax expense increased by $27 million, or 53%, to $78 million during the year ended December 31, 2012 when compared to 2011. The increase is primarily due to the increase in net income before income taxes.
Net loss for the Company’s Other segment decreased by $15 million from a loss of $26 million to a loss of $11 million during the year ended December 31, 2013 when compared to 2012. The decrease in net loss is due to the $15 million change in income tax expense (benefit) from an expense of $6 million in 2012 to a benefit in 2013 of $9 million. The change in income tax expense (benefit) is primarily the
Net loss for the Company’s Other segment increased by $16 million from a loss of $10 million to a loss of $26 million during the year ended December 31, 2012 when compared to 2011. The loss is primarily due to a $21 million decrease in premiums as a result of run-off in the closed block of business, along with an $8 million increase in policyholder benefits resulting from an unfavorable change in lapse rate experience. Partially offsetting the decrease is a $24 million decline in operating expenses resulting from lower commission expense attributable to a decrease in premium income, lower consulting expenses on strategic initiatives and lower guarantee fund assessments. Additionally, the Company had increased tax expense of $12 million. The increase in income taxes is the result of an $11 million adjustment to prior year taxes included in the 2012 expense related to the 2008 tax year IRS examination.
The Company’s primary investment objective is to acquire assets with duration and cash flow characteristics reflective of its liabilities, while meeting industry, size, issuer and geographic diversification standards. Formal liquidity and credit quality parameters have also been established.
A summary of the Company’s general account investment assets and the assets as a percentage of total general account investments follows:
The distribution of the Company’s fixed maturity portfolio by the Company’s internal credit rating is summarized as follows:
The following table contains the sector distribution of the Company’s corporate fixed maturity investment portfolio, calculated as a percentage of fixed maturities:
Each fixed maturity investment is categorized in a hierarchy based on the observability of inputs into the valuation methodology with Level 3 being the least observable. Management uses some judgment in determining the observability of valuation inputs. Level 3 assets at December 31, 2013 were $260 million, or 1%, of total net assets and liabilities carried at fair value compared to Level 3 assets of $267 million, or 1%, at December 31, 2012. The decrease in Level 3 assets is primarily due to principal reductions.
The Company’s mortgage loans on real estate are comprised exclusively of domestic commercial collateralized real estate loans. The mortgage loan portfolio is diversified with regard to geographical markets and commercial real estate property types within the United States. The Company originates, directly or through correspondents, real estate mortgages with the intent to hold to maturity. The Company’s portfolio includes loans which are fully amortizing, amortizing with a balloon balance at maturity, interest only to maturity and interest only for a number of years followed by an amortizing period. During the years ended December 31, 2013 and 2012, the Company originated 45 and 36 new loans with aggregate principal balances of $562 million and $525 million, respectively.
(pass-throughs). These transactions enhance the return on the Company’s investment portfolio and provide a more liquid and cost effective method of achieving these goals than purchasing or selling individual agency mortgage-backed pools. The Company controls the credit risk of its over-the-counter derivative contracts through credit approvals, limits, monitoring procedures and in most cases, requiring collateral. Risk of loss is generally limited to the portion of the fair value of derivative instruments that exceeds the value of the collateral held and not to the notional or contractual amounts of the derivatives.
The principal sources of the Company’s liquidity are premiums and contract deposits, fees, investment income and investment maturities and sales. Funds provided from these sources are reasonably predictable and normally exceed liquidity requirements for payment of policy benefits, payments to policy and contract holders in connection with surrenders and withdrawals and general 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. A primary liquidity concern regarding cash flows from operations is the risk of early policyholder and contract holder withdrawals. A primary liquidity concern regarding investment activity is the risk of defaults and market volatility. 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 participates in a securities lending program in which the Company lends securities that are held as part of its general account investment portfolio to third parties for the purpose of enhancing the total return on its investment portfolio. The Company generally requires initial collateral in an amount greater than or equal to 102% of the fair value of domestic securities loaned and 105% of foreign securities loaned. The Company received securities with a fair value of $9,424 and zero as collateral at December 31, 2013 and 2012, respectively, which have not been recorded on the consolidated balance sheets.
GWL&A Financial obtained two letters of credit for the benefit of the Company as collateral under a reinsurance agreement for policy liabilities and capital support. The first letter of credit is for $1,173 million and renews annually until it expires on December 31, 2027. The second letter of credit is for $70 million and renews annually for an indefinite period of time.
The following table summarizes the Company’s major contractual obligations at December 31, 2013:
(3) Policyholders’ funds - Policyholders’ funds consist primarily of future policy benefits associated with policyholder deposits, participating policy dividends left on deposit and provisions for experience rating refunds. Because the timing of the payment of some of these obligations is unknown and beyond the
(11) Operating leases - The Company is obligated to make payments under various non-cancelable operating leases, primarily for office space. Contractual provisions exist that could increase the lease obligations presented, including operating expense escalation clauses. Management does not consider the impact of any such clauses to be material to the Company’s operating lease obligations. The Company’s total future operating lease obligation will be reduced by minimum reimbursement of $10,905 due in the future under non-cancelable agreements.
We have audited the accompanying consolidated balance sheets of Great-West Life & Annuity Insurance Company and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income (loss), stockholder’s equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.
date basis. Net unrealized gains and losses related to participating contract policies that cannot be distributed are recorded as undistributed earnings on participating business.
2. Mortgage loans on real estate consist of domestic commercial collateralized loans and are carried at their unpaid principal balances adjusted for any unamortized premiums or discounts, origination fees and mortgage provision allowances. Interest income is accrued on the unpaid principal balance for all loans, except for loans on non-accrual status. Premiums, discounts and origination fees are amortized to net investment income using the scientific interest method. Prepayment penalty fees are recognized in other realized investment gains upon receipt.
· Non-performing - generally indicates there is a potential for loss due to the deterioration of financial/monetary default indicators or potential foreclosure. Due to the potential for loss, these loans are evaluated for impairment.
3. Limited partnership and other corporation interests are accounted for using either the cost or equity method of accounting. The Company uses the cost method on investments where it has a minor equity interest and no significant influence over the entity’s operations. The Company uses the equity method when it has a partnership interest that is considered more than minor, although the Company has no significant influence over the entity’s operations. Also included in limited partnership interests are limited partnerships established for the purpose of investing in low-income housing that qualify for federal and state tax credits. These interests are carried at amortized cost as determined using the effective yield method.
management does not intend to sell the fixed maturity investment and it is not more likely than not the Company will be required to sell the fixed maturity investment before recovery of its amortized cost basis, is based upon management’s case-by-case evaluation of the underlying reasons for the decline in fair value of each individual security. Management considers a wide range of factors, as described below, regarding the security issuer and uses its best judgment in evaluating the cause of the decline in its estimated fair value and in assessing the prospects for near-term recovery.
· The extent to which estimated fair value is below cost;
· The length of time for which the estimated fair value has been below cost;
· Whether dividends have been reduced or eliminated or scheduled interest payments have not been made.
· Level 1 inputs utilize observable, quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Financial assets and liabilities utilizing Level 1 inputs include certain money market funds.
· Derivative instruments - trading activity, swap curves, credit spreads, currency volatility, net present value of cash flows and news sources.
Purchased software costs, as well as certain internal and external costs incurred to develop internal use computer software during the application development stage, are capitalized and amortized using the straight-line method over the software’s estimated useful life, ranging from five to seven years. Capitalized internal use software development costs, net of accumulated amortization, in the amounts of $50,134 and $48,280, are included in other assets at December 31, 2013 and 2012, respectively. The Company capitalized $14,640, $17,593 and $16,676 of internal use software development costs during the years ended December 31, 2013, 2012 and 2011, respectively.
The Company incurs costs in connection with the acquisition of new and renewal insurance business. Costs that vary directly with and relate to the successful production of new business are deferred as DAC. These costs consist primarily of commissions, costs associated with the Company’s sales representatives and policy issuance and underwriting expenses related to the production of successfully acquired new business or the
acquisition of insurance or annuity contracts. A success factor is derived from actual contracts issued by the Company from requests for proposals or applications received. 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.
Goodwill is the excess of cost over the fair value of assets acquired and liabilities assumed in connection with an acquisition. It is considered an indefinite lived asset and therefore is not amortized. 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.
Other intangible assets represent the estimated fair value of the portion of the purchase price that was allocated to the value of customer relationships 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 commissioned by the Company. 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 account assets and related liabilities are carried at fair value in the accompanying consolidated balance sheets. The Company issues variable annuity contracts and variable universal life contracts through separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contract holder and therefore are not included in the Company’s consolidated statements of income.
Life insurance and annuity future benefits with life contingencies in the amounts of $14,296,153 and $13,808,516 at December 31, 2013 and 2012, respectively, are computed on the basis of assumed investment yield, mortality, morbidity and expenses, including a margin for adverse deviation. These future policy benefits are calculated as the present value of future benefits (including dividends) and expenses less the present value of future net premiums. The assumptions used in calculating the future policy benefits generally vary by plan, year of issue and policy duration. Additionally, these future policy benefits are established for claims that have been incurred but not reported based on factors derived from past experience.
The accompanying statements of cash flows for the years ended December 31, 2012 and 2011 have been restated to reflect the following corrections of misstatements identified subsequent to the issuance of the December 31, 2012 audited financial statements:
· During the fourth quarter of 2013, the Company recorded a cumulative out-of-period adjustment in connection with certain derivative instruments not qualifying for hedge accounting due to ineffectiveness. These derivative instruments were deemed to have a financing element at inception which should be classified as a financing activity instead of an operating activity within the statement of cash flows. As a result, net cash provided by operating activities was overstated by $68,824 and net cash provided by financing activities was understated by the same amount for the year ended December 31, 2012. The Company believes the effects of this error are immaterial to the prior period.
The following table summarizes the effect of the adjustments the Company made to its financial statements:
In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-11 Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU No. 2011-11”). ASU No. 2011-11 provides for entities to disclose information about financial instruments and derivative instruments that are either offset in the balance sheet (presented on a net basis), or subject to an enforceable master netting arrangement or similar arrangement. ASU No. 2011-11 was effective for fiscal years and interim periods within those years beginning on or after January 1, 2013. The Company adopted the provisions of ASU No. 2011-11 for its fiscal year beginning January 1, 2013. The adoption did not have an impact on the Company’s consolidated financial statements; see additional disclosures required for balance sheet offsetting in Note 7. ASU No. 2011-11 was subsequently amended by ASU No. 2013-01.
In January 2014, the FASB issued ASU No. 2014-01 Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. ASU No. 2014-01 permits reporting entities to make an accounting election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those pre-existing investments. The Company uses the effective yield method for its investments in qualified affordable housing projects. ASU 2014-01 is effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. The Company is currently evaluating the impact of this guidance on its financial statements.
(5) Reinsurance recoveries have been restated from $6,426 for the year ended December 31, 2011. The Company believes the effects of this error are immaterial to the prior period.
(1) 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 $194,418 and 194,390 at December 31, 2013 and 2012, 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.
(2) A note payable to GWL&A Financial was issued as a surplus note on May 19, 2006, with a face amount and carrying amount of $333,400. The surplus note bears interest initially at the rate of 7.203% per annum, payable in arrears on each May 16 and November 16 until May 16, 2016. After May 16, 2016, the surplus note bears an
Interest expense attributable to these related party debt obligations was $37,059 for the years ended December 31, 2013 and 2012, and $37,163 for the year ended December 31, 2011. Included in other liabilities on the consolidated balance sheets at December 31, 2013 and 2012 is $4,701 of interest payable attributable to these related party debt obligations.
The Company’s separate accounts invest in shares of Great-West Funds, Inc. and Putnam Funds, which are affiliates of the Company and shares of other non-affiliated mutual funds and government and corporate bonds. The Company’s separate accounts include mutual funds or other investment options that purchase guaranteed interest annuity contracts issued by the Company. During the years ended December 31, 2013, 2012 and 2011, these purchases totaled $198,107, $131,593 and $112,117, respectively. As the general account investment contracts are also included in the separate account balances in the accompanying consolidated balance sheets, the Company has reduced the separate account assets and liabilities by $333,074 and $289,730 at December 31, 2013 and 2012, respectively, to eliminate these amounts in its consolidated balance sheets at those dates.
reflected in liabilities in undistributed earnings on participating business in the Company’s condensed consolidated balance sheets.
The Company recorded, at fair value, the following on January 1, 2013, in its condensed consolidated balance sheet in connection with the termination of the reinsurance agreement:
The Company recorded the following on January 1, 2013, in its condensed consolidated statement of income in connection with the termination of the reinsurance agreement:
In 2013, the Company performed its regular review of the investment portfolios. As a result of that review, on December 1, 2013, the Company transferred $3,862 of cash and two mortgages with a market value of $28,959 to CLAC in exchange for four fixed maturity investments with a market value of $32,821. As a result of the transaction, the Company recognized realized investment loss of $1,041.
The following tables summarize fixed maturity investments classified as available-for-sale and the non-credit-related component of OTTI in AOCI:
(1) Indicates the amount of any OTTI (gain) loss included in AOCI that is included in gross unrealized gains and losses. OTTI (gain) loss included in AOCI, as presented above, includes both the initial recognition of non-credit losses and the effects of subsequent increases and decreases in estimated fair value for those fixed maturity securities that had previous non-credit impairment. The non-credit loss component of OTTI (gain) loss was in an unrealized gain position due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.
(2) Includes perpetual debt investments with amortized cost of $226,069 and estimated fair value of $153,100.
Included in net investment income are unrealized gains (losses) of ($9,447), ($634) and $12,935 on held-for-trading fixed maturity investments still held at December 31, 2013, 2012 and 2011, respectively.
The average recorded investment of impaired mortgage loans was zero, $1,034 and $5,822 for the years ended December 31, 2013, 2012 and 2011, respectively.
The recorded investment of the mortgage loan portfolio categorized as performing was $3,137,145 and $2,884,648 as of December 31, 2013 and 2012, respectively.
Limited partnership and other corporation interests - At December 31, 2013 and 2012, the Company had $79,236 and $124,814, respectively, invested in limited partnership and other corporation interests. Included in limited partnership interests are investments in low-income housing partnerships that qualify for federal and state tax credits and ownership interests in pooled investment funds.
The Company has determined each investment in low-income housing limited partnerships (“LIHLP”) to be considered a VIE. Although the Company is involved with the VIE, it determined that consolidation was not required because it has no power to direct the activities that most significantly impact the entities’ economic performance.
Special deposits and securities lending - The Company had securities on deposit with government authorities as required by certain insurance laws with fair values of $14,072 and $15,791 at December 31, 2013 and 2012, respectively.
The Company participates in a securities lending program whereby securities are loaned to third parties. Securities with a cost or amortized cost of $28,178 and $138,654 and estimated fair values of $27,166 and $138,297 were on loan under the program at December 31, 2013 and 2012, respectively. The Company received restricted cash of $18,534 and $142,022 and securities with a fair value of $9,424 and zero as collateral at December 31, 2013 and 2012, respectively.
This increase was across most asset classes and was due to higher interest rates resulting in generally lower valuations of these fixed maturity securities. The number of securities with unrealized losses in the less than twelve months category increased from 85 at December 31, 2012 to 458 at December 31, 2013. The securities continue to be rated investment grade.
greater than twelve months. Non-investment grade corporate securities account for $12,095 of unrealized losses and OTTI greater than twelve months and $10,276 of the losses are on perpetual debt investments issued by banks in the United Kingdom, which have bank ratings of BBB+ or higher. The Company determined the majority of the unrealized losses on perpetual securities were due to widening credit spreads and low London Interbank Offered Rate (“LIBOR”) based coupon rates on the securities, which are not expected to compromise the issuers’ ability to service the investments. Management does not have the intent to sell these assets; therefore, an OTTI was not recognized in earnings.
(1) All of the $4,429 in credit related OTTI is bifurcated credit loss recognized on two asset-backed fixed maturities.
The OTTI on fixed maturity securities where the loss portion is bifurcated and the credit related component is recognized in realized investment gains (losses) is summarized as follows:
At December 31, 2013 and 2012, the Company had pledged $143,710 and $54,400, respectively, of unrestricted cash collateral to counterparties in the normal course of business.
rate maturity investments. These derivatives are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities.
Interest rate swap agreements are used to convert the interest rate on certain debt securities from a fixed rate to a floating rate to manage the interest rate risk of the change in the fair value of certain fixed rate maturity investments. Interest rate futures are used to manage the interest rate risk of the change in the fair value of certain fixed rate maturity investments.
The derivative instruments mentioned above are economic hedges and used to manage risk. These transactions are used to offset changes in liabilities including those in variable annuity products, hedge the economic effect of a large increase in interest rates, manage the potential variability in future interest payments due to a change in credited interest rates and the related change in cash flows due to increased surrenders and manage interest rate risks of forecasted acquisitions of fixed rate maturity investments and forecasted liability pricing.
The Company uses forward settling TBA securities to gain exposure to the investment risk and return of agency mortgage-backed securities (pass-throughs). These transactions enhance the return on the Company’s investment portfolio and provide a more liquid and cost effective method of achieving these goals than purchasing or selling individual agency mortgage-backed pools. As the Company does not regularly accept delivery of such securities, they are accounted for as derivatives but hedge accounting is not elected. These transactions are disclosed as Other forward contracts.
Notional amounts are used to express the extent of the Company’s involvement in derivative transactions and represent a standard measurement of the volume of its derivative activity. Notional amounts represent those amounts used to calculate contractual flows to be exchanged and are not paid or received.
The Company had 46 and 75 swap transactions with an average notional amount of $3,175 and $8,685 during the years ended December 31, 2013 and 2012, respectively. During the years ended December 31, 2013 and 2012, the Company had 17 and 23 cross-currency swap transactions with an average notional amount of $13,881 and $12,710, respectively. The Company had 695 and 931 futures transactions with an average number of contracts per transaction of 9 and 11 during the years ended December 31, 2013 and 2012, respectively. The Company had 52 and 46 swaption transactions with an average notional amount of $5,040 and $5,528 during the years ended December 31, 2013 and 2012, respectively. The Company had 986 forward settling TBA security transactions with an average notional amount of $47,566 during the year ended December 31, 2013.
Significant changes in the derivative notional amount during the year ended December 31, 2013 were primarily due to the following:
The Company recognized total derivative gains (losses) in net investment income of ($44,929), $12,567 and ($15,428) for the years ended December 31, 2013, 2012 and 2011, respectively. The Company recognized net investment gains (losses) on closed derivative positions of ($65,019), ($10,221) and ($38,794) for the years
ended December 31, 2013, 2012 and 2011, respectively. The preceding amounts are shown net of any gains (losses) on the hedged assets in a fair value hedge that has been recorded in net investment income.
The following tables present the effect of derivative instruments in the consolidated statement of income reported by cash flow hedges, fair value hedges and economic hedges:
(1) Hedge ineffectiveness of zero, zero and ($2,128) was recognized during the years ended December 31, 2013, 2012 and 2011, respectively.
(2) The estimated fair value of derivative instrument assets is reported in other assets in the consolidated balance sheets and includes income and expense accruals.
The amortized cost of short-term investments, collateral under securities lending agreements and payable under securities lending agreements is a reasonable estimate of fair value due to their short-term nature and high credit quality of the issuers.
Included in other assets and other liabilities are derivative financial instruments. The estimated fair values of OTC derivatives, primarily consisting of cross-currency swaps, interest rate swaps and interest rate swaptions, are the estimated amounts the Company would receive or pay to terminate the agreements at the end of each reporting period, taking into consideration current interest rates and other relevant factors.
Separate account assets and liabilities primarily include investments in mutual fund, fixed maturity and short-term securities. Mutual funds are recorded at net asset value, which approximates fair value, on a daily basis. The fixed maturity and short-term investments are valued in the same manner, and using the same pricing sources and inputs as the fixed maturity and short-term investments of the Company.
At December 31, 2013, after adjusting the ABX Index spread assumption by the liquidity premium, the overall discount rate ranged from 327 to 647 basis points. The constant default rate assumption ranged from 2.0 to 12.9.
At December 31, 2012, after adjusting the ABX Index spread assumption by the liquidity premium, the overall discount rate ranged from 384 to 918 basis points. The constant default rate assumption ranged from 1.2 to 7.9.
The following tables summarize the carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on a recurring basis:
Policy loans are funds provided to policy holders in return for a claim on the policy. The funds provided are limited to the cash surrender value of the underlying policy. The nature of policy loans is to have a negligible default risk as the loans are fully collateralized by the value of the policy. Policy loans do not have a stated maturity and the balances and accrued interest are repaid either by the policyholder or with proceeds from the policy. Due to the collateralized nature of policy loans and unpredictable timing of repayments, the Company believes the fair value of policy loans approximates carrying value. The estimated fair value was classified as Level 2.
The carrying amount of policyholders’ funds approximates the fair value since the Company can change the interest credited rates with 30 days notice. The estimated fair value was classified as Level 2.
The following table summarizes total premium income for the year ended December 31, 2011:
Reinsurance recoveries for life and other policy benefits were $34,716, $46,492 and $36,876 for the years ended December 31, 2013, 2012, and 2011, respectively.
(1) The January 1, 2013 DAC balance has been restated. During 2013, management reviewed its practices related to the accounting for certain fees paid by customers at the onset of an insurance contract and the related acquisition costs incurred by the Company on the sale of the insurance contract in the Company’s executive benefits market. Management concluded that the fees paid by the customers should be deferred as unearned revenue liability and the acquisition costs should be deferred as DAC in the consolidated balance sheet. The Company has previously accounted for the fees paid by customers as a reduction of the DAC in the consolidated balance sheet. The misstatement was corrected by an opening adjustment to DAC on January 1, 2013. The Company believes the effects of this error are immaterial to the prior period.
The estimated future amortization of VOBA for the years ended December 31, 2014 through December 31, 2018 is approximately $3,900 per annum.
Amortization expense for other intangible assets included in general insurance expenses was $3,094, $3,606 and $3,787 for the years ended December 31, 2013, 2012 and 2011, respectively. Except for goodwill, the Company has no intangible assets with indefinite lives. The Company did not incur costs to renew or extend the term of acquired intangible assets during the year ended December 31, 2013.
The estimated future amortization of other intangible assets using current assumptions, which are subject to change, for the years ended December 31, 2014 through December 31, 2018 is approximately $2,400 per annum.
The following table provides information regarding the Company’s commercial paper program:
The maximum amount of dividends that can be paid to stockholders by insurance companies domiciled in the State of Colorado, without prior approval of the Insurance Commissioner, is subject to restrictions relating to statutory capital and surplus and statutory net gain from operations. As filed with the Colorado Division of Insurance, the statutory capital and surplus and net gain from operations at and for the year ended December 31, 2013 were $1,200,609 and $218,016, respectively. Based on the as filed amounts, the Company may pay up to $218,016 of dividends during the year ended December 31, 2014 without the prior approval of the Colorado Insurance Commissioner. Prior to any payments of dividends, the Company seeks approval from the Colorado Insurance Commissioner.
The following tables present the composition of other comprehensive income (loss):
(1) These accumulated other comprehensive income components are included in the computation of net periodic (benefit) cost of employee benefit plans (see Note 16 for additional details).
The Company also provides Supplemental Executive Retirement Plans to certain key executives. These plans provide key executives with certain benefits upon retirement, disability or death based upon total compensation. The Company has purchased individual life insurance policies with respect to each employee covered by this plan. The Company is the owner and beneficiary of the insurance contracts.
Net periodic (benefit) cost of the Defined Benefit Pension, Post-Retirement Medical and Supplemental Executive Retirement plans included in general insurance expenses in the accompanying consolidated statements of income includes the following components:
The following tables present information about the Defined Benefit Retirement Plan’s assets measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value:
Included in the unrecognized tax benefits of $21,154 at December 31, 2013 was $3,262 of tax benefits that, if recognized, would impact the annual effective tax rate. The Company anticipates additional increases in its unrecognized tax benefits of $3,000 to $4,000 in the next twelve months, primarily due to changes in the composition of the consolidated group.
The Company files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal income tax examinations by tax authorities for years 2009 and prior. Tax years 2010, 2011 and 2012 are open to federal examination by the I.R.S. The Company does not expect significant increases or decreases to unrecognized tax benefits relating to federal, state or local audits.
Amounts presented for investment assets above include $(209,434) and $(410,044) related to the net unrealized losses (gains) on the Company’s investments, which are classified as available-for-sale at December 31, 2013 and 2012, respectively.
Included in due from parent and affiliates at December 31, 2013 and 2012 is $65,186 and $4,353, respectively, of income taxes receivable from Lifeco U.S. related to the consolidated income tax return filed by the Company and certain subsidiaries. Included in the consolidated balance sheets at December 31, 2013 and 2012 is $7,736 and $12,585, respectively, of income taxes receivable in other assets primarily related to the separate state income tax returns filed by certain subsidiaries.
The Retirement Services reporting and operating segment provides various retirement plan products and investment options as well as comprehensive administrative and record-keeping services for financial institutions and employers, which include educational, advisory, enrollment and communication services for employer-sponsored defined contribution plans and associated defined benefit plans.
The Company’s Other reporting segment is substantially comprised of activity under the assumption of reinsurance between GWSC and CLAC (“the GWSC operating segment”), corporate items not directly allocated to the other operating segments and interest expense on long-term debt.
The accounting principles used to determine segment results are the same as those used in the consolidated financial statements. The Company evaluates performance of its reportable segments based on their profitability from operations after income taxes. Inter-segment transactions and balances have been eliminated in consolidation. The Company’s operations are not materially dependent on one or a few customers, brokers or agents.
Performance share units are settled in cash and are recorded as liabilities until payout is made. Unlike share-settled awards, which have a fixed grant-date fair value, the fair value of unsettled or unvested liabilities awards is remeasured at the end of each reporting period based on the change in fair value of one share of Lifeco common stock. The liability and corresponding expense are adjusted accordingly until the award is settled.
During the year ended December 31, 2013, Lifeco granted 591,400 stock options to employees of the Company. These stock options vest over five-year periods ending in March 2018. Compensation expense of $2,697 will be recognized in the Company’s financial statements over the vesting period of these stock options using the accelerated method of recognition.