Comparability of financial information is affected by acquisitions and other transactions in the periods presented. For acquisitions and other transactions completed in the last three years see “Acquisitions.”
Our income before cumulative effect of change in accounting principle was $1,315 million in 2001 reflecting a 5.8% or $72 million increase compared to $1,243 million in 2000. The 2001 results were impacted by several factors, including a weak U.S. economy and the planned run-off of the block of business acquired in the Toho Transfer following the significant surrender activity experienced in this block during 2000. In addition, we incurred approximately $25 million in losses related to the events of September 11th.
Net investment income. Net investment income decreased $32 million, or 0.8%, to $4,169 million for the year ended December 31, 2002 from $4,201 million for the year ended December 31, 2001. The decrease was primarily attributable to a decrease in our combined weighted average investment yields, which include investments in the United States and Japan, to 5.41% for the year ended December 31, 2002 from 6.05% for the year ended December 31, 2001, mostly offset by higher levels of average invested assets ($78.6 billion for the year ended December 31, 2002 vs. $69.3 billion for the year ended December 31, 2001).
Our weighted average crediting rates for annuities decreased to 4.71% in 2002 from 5.51% in 2001. Changes in our base crediting rates are implemented in response to changes in market conditions, the prevailing interest rate environment, contractual provisions and other factors. We monitor market conditions closely and reset interest crediting rates as deemed appropriate in accordance with the terms of the underlying contracts. During the year, the crediting rates on a number of our fixed annuity blocks were reduced to their guaranteed minimums.
Commission Expenses. Commission expense increased $25 million to $1,163 million for the year ended December 31, 2002 from $1,138 million in the year ended December 31, 2001. The increase is primarily a result of commissions associated with sales of fixed annuities, term life, long-term care insurance and accident and health products. These increases are partially offset by lower sales of variable annuities primarily as a result of market volatility.
General Expenses. General expenses decreased $54 million to $1,847 million for year ended December 31, 2002 from $1,901 million for year ended December 2001. The decrease in 2002 and 2001 primarily relates to reduced compensation and benefit costs and other cost savings initiatives including office and advertising expenses resulting from integration and consolidation activities. This was offset in part by increases primarily related to consulting and certain other general expenses.
Amortization of intangibles, net. Our significant intangible assets consist primarily of two components, the excess of purchase price over the fair value of identified net assets of the acquired entities, Present Value of Future Profits (“PVFP”), and goodwill. Amortization of intangibles decreased $172 million to $344 million for year ended December 31, 2002. This decrease is primarily a result of the cessation of goodwill amortization expense, in accordance with Statement of Financial Accounting Standard (“SFAS”) 142 adopted January 1, 2002.
Provisions for income taxes. Provisions for income taxes decreased $210 million to $440 million for year ended December 31, 2002 from $650 million for year ended December 31, 2001. Our effective tax rate was 23.1% and 33.0% for years ended December 31, 2002 and 2001, respectively. As indicated earlier, we reached a favorable settlement with the Internal Revenue Service regarding the treatment of certain reserves for obligations to policyholders on life insurance contracts resulting in a benefit of $152 million. The benefits associated with the settlement are non-recurring. Discontinuing the amortization of goodwill also contributed to our lower effective tax rate.
Premiums. Premiums were $6,551 million in 2001, an increase of $499 million from $6,052 million in 2000. The 2001 increase primarily resulted from growth in our structured settlement contracts, long-term care insurance and certain accident and health insurance products. These increases were partially offset by decreased premiums from the run-off of policies assumed as part of the Toho Transfer. Surrender activity in this block of business in 2000 resulted in a substantial reduction of 2001 premiums.
Net Realized Investment Gains. Net realized investment gains were $300 million in 2001 and $233 million in 2000. Net investment gains are comprised of gross investment gains and gross investment (losses), respectively, of $830 million and $(530) million in 2001, $425 million and $(192) million in 2000. We seek to offset investment losses realized from other than temporary impairments and portfolio repositioning with investment gains. Included in the gross realized investment gains are $145 million and $67 million in 2001 and 2000, respectively, resulting from the securitization of certain financial assets.
Our weighted average crediting rates for annuities decreased to 5.51% in 2001 from 6.14% in 2000. Changes in our base crediting rates are implemented in response to changes in market conditions, the prevailing interest rate environment, contractual provisions and other factors. We monitor market conditions closely and reset interest crediting rates as deemed appropriate in accordance with the terms of the underlying contracts.
Commission Expenses. Commission expense decreased $98 million in 2001 in $1,138 million from $1,236 million in 2000. The overall decrease in 2001 is primarily a result of lower sales of variable annuities as a result of market volatility in addition to lower new term life sales. These decreases are partially offset by commissions associated with additional sales on long-term care insurance and certain fixed annuities.
Interest Expense. Interest expense increased $3 million in 2001 to $146 million from $143 million in 2000. This increase relates primarily to higher average debt outstanding as a result of the Toho Transfer and the Travelers Transaction. This increase was partially offset by lower interest rates on commercial paper.
Provision for Income Taxes. Our provision for income taxes increased $53 million to $650 million from $597 million in 2000. Our effective tax rates were 33.0% and 32.3% in 2001 and 2000, respectively.
Revenues for this segment decreased by $68 million from the prior year primarily as a result of lower surrender fee and premium income related to the run-off of policies assumed as part of the Toho Transfer partially offset by higher realized investment gains.
Operating income from this segment represented 45.5%, 54.0% and 57.1% of our total operating income for the years ending December 31, 2002, 2001 and 2000, respectively. Our operating income from the Wealth Accumulation and Transfer segment decreased 18.6% in 2002 to $866 million, and increased 0.8% in 2001 to $1,064 million from $1,056 million in 2000. The decrease in 2002 was primarily related to a decrease in revenues resulting from lower surrender income as discussed above and an increase in interest credited primarily related to sales of GICs and Funding Agreements.
Revenues for this segment decreased in 2002 as a result of an increase in ceded premiums under third party captive reinsurance agreements and, to a lesser extent, to higher lapse rates. Approximately 58% of our primary insurance in force at December 31, 2002 was subject to captive mortgage reinsurance, compared to approximately 44% at December 31, 2001. Premiums ceded to these reinsurers in 2002 were approximately $114 million, compared to $79 million in 2001. We experienced lapse rates of 43% and 36% in 2002 and 2001, respectively. The decrease in revenues resulting from the high lapse rates was partially offset by high volumes of new flow mortgage insurance written in both 2002 and 2001. Mortgage delinquencies and reserve per delinquency declined in 2002 from the prior year, resulting in a reduction in benefits and other changes in reserves.
Mortgage Insurance products generated premiums of $550 million, $600 million, and $587 million for 2002, 2001 and 2000, respectively. Operating income from this segment represented 32.2%, 29.3%, and 36.3% of total operating income for the years ended December 31, 2002, 2001 and 2000, respectively. Our operating income for the Mortgage Insurance segment increased 6.1% to $613 million in 2002 and decreased 13.7% to $578 million in 2001 from $670 million in 2000. The mortgage insurance industry is subject to economic cycles that can significantly impact earnings.
Revenues increased in 2002 from 2001 primarily as a result of increased demand for our long-term care insurance products in conjunction with an increase in the number of dedicated agents selling the product and continued heightened market awareness of the need for this type of insurance coverage. This increase was partially offset by a decline in sales of consumer protection packages due to lower demand for these products and selective product exits. Revenues increased in 2001 from 2000 primarily as a result of increased long-term care insurance premiums attributable to the Travelers Transaction.
Operating income from this segment represented 19.0 %, 14.0% and 7.6%, of our total operating income for the years ended December 31, 2002, 2001 and 2000, respectively. Our operating income from the Lifestyle Protection and Enhancement segment increased 31.2% in 2002 to $362 million, and increased 97.1% in 2001 from $140 million in 2000. The 2002 and 2001 increases are primarily attributable to higher premiums resulting from increased demand for our long-term care insurance offset by increases in related reserves.
The following table sets forth certain summarized financial data for our Auto and Home Insurance segment for the years ended December 31:
Operating income from this segment represented 3.3%, 2.6%, and (1.1)%, of our total operating income for the years ending December 31, 2002, 2001 and 2000, respectively. Our operating income from this segment increased to $62 million in 2002, an increase of $10 million from 2001 operating income of $52 million. Operating income in 2001 increased $72 million from the operating loss of $(20) million in 2000. The 2002 increase is primarily attributable to decreased expenses.
Interest rate changes may affect the sale and profitability of the annuity, universal life, and other products we offer. For example, if interest rates rise, competing investments (such as annuities or life insurance offered by our competitors, certificates of deposit, mutual funds, and similar instruments) may become more attractive to potential purchasers of our products. Also, our insurance subsidiaries may be forced to adjust certain crediting rates on their product lines in order to meet competitive pressures. We constantly monitor interest earnings on existing assets and yields available on new investments and sell policies and annuities that permit flexible and timely responses to interest rate changes as part of our management of interest spreads.
We manage our exposure to changes in interest rates in part by funding our company with an appropriate mix of fixed and variable rate debt. In order to minimize the impact of currency fluctuations we fund local currency denominated assets with debt denominated in those same currencies
To match the currency of invested assets and the liabilities they support;
To protect against the early termination of an asset or liability.
As a matter of policy, we do not engage in derivative market-making, speculative derivative trading or other speculative derivatives activities. More detailed information regarding these financial instruments, as well as the strategies and policies for their use, is contained in Notes 1, 9 and 12 to the Consolidated Financial Statements.
Our established practices require that derivative financial instruments relate to specific asset, liability or equity transactions or to currency exposures. Substantially all derivative transactions are centrally executed by GE Capital’s Treasury Department or GEAM on our behalf, who maintain controls on all exposures, adhere to stringent counterparty credit standards and actively monitor marketplace exposures.
We manage counterparty credit risk on an individual counterparty basis, which means that gains and losses are netted for each counterparty to determine the amount at risk. When a counterparty exceeds credit exposure limits in terms of amounts owed to us, typically as a result of changes in market conditions (see table below), no additional transactions are executed until the exposure with that counterparty is reduced to an amount that is within the established limit. All swaps are executed under master swap agreements containing mutual credit downgrade provisions that provide the ability to require assignment or termination in the event either party is downgraded below A3 or A-.
Swaps, purchased options and forwards with contractual maturities longer than one year are conducted within the credit policy constraints provided in the table below. Our policy allows for derivative transactions with lower rated counterparties (Moody’s Aa3 and S&P’s AA-) if the agreements governing such transactions require both parties to provide collateral supporting exposures above the unsecured credit limit. Foreign exchange forwards with contractual maturities shorter than one year must be executed with counterparties having an A-1/P-1 credit rating and the credit limit for these transactions is $150 million.
Following is an analysis of credit risk exposures as of December 31, 2002, 2001, and 2000:
The SEC requires that registrants provide information about potential effects of changes in interest rates and currency exchange. Although the rules offer alternatives for presenting this information, none of the alternatives is without limitations. The following discussion is based on so-called “shock-tests,” which model effects of interest rate and currency shifts on the reporting company. Shock tests, while probably the most meaningful analysis permitted, are constrained by several factors, including the necessity to conduct the analysis based on a single point in time and by their inability to include the extraordinarily complex market reactions that normally would arise from the market shifts modeled. While the following results of shock tests for changes in interest rates and currency exchange rates may have some limited use as benchmarks, they should not be viewed as forecasts.
One means of assessing exposure to interest rate changes is a duration-based analysis that measures the potential loss in net earnings resulting from a hypothetical decrease in interest rates of 100 basis points across all maturities (sometimes referred to as a parallel shift in the yield curve). Under this model, with all else constant, we estimated that such a decrease, including repricing effects in the securities portfolio, would decrease our 2003 net earnings based on year-end 2002 positions by approximately $38 million.
Our cash and cash equivalents aggregated $2.1 billion at December 31, 2002, an increase of $0.4 billion from $1.7 billion at December 31, 2002. We generated $2.8 billion in cash from operating activities, primarily as a result of an increase in future annuity and contract benefits. We also generated $6.2 billion in cash from financing activities primarily as a result of $2.4 billion of cash received as a result of the Saison Life acquisition and cash proceeds in excess of cash redemptions and benefit payments from the issuance of investment contracts of $3.9 billion.
The major rating agencies also evaluate the financial strength of GE Financial Assurance’s insurance companies by analyzing our ability to meet contractual obligations to policyholders and annuitants. Contractual obligations include payments of claims under outstanding insurance policies and annuities, contract withdrawals, and surrender benefits. The primary sources for meeting these contractual obligations are investment activities and cash generated from operating activities. In addition, to meet short-term variations in contractual obligations, we maintain cash and short-term investments. For insurer financial strength ratings of our principal insurance subsidiaries see “Ratings”.
For the years ended December 31, 2002, 2001 and 2000, cash flows provided by (used in) operating and certain financing activities were $6,966 million, $6,606 million, and $(2,140) million, respectively. These amounts include net cash provided by financing activities relating to investment contract issuances accounted for as deposit liabilities under U. S. GAAP and redemptions of $3,884 million, $2,667 million and $2,617 million, for the years ended December 31, 2002, 2001 and 2000, respectively.
The nature and quality of the various types of investments purchased by an insurance company must comply with the statutes and regulations imposed by the various jurisdictions in which those entities are incorporated. Following is a breakdown of the credit quality of our fixed maturity portfolio at December 31, 2002.
Certain of our products contain provisions for penalty charges for surrender of the policy. These charges range from 5% to 8% at policy origination and decrease to zero over predetermined periods ranging up to ten years. In addition, certain of our funding agreements have termination provisions. We have established a line of credit with our parent to provide liquidity in the event of an unusual level of early terminations.
QSPE’s raise cash by issuing beneficial interests (rights to cash flows from the assets) primarily to GE Capital-sponsored special purpose entities that issue highly-rated commercial paper to third-party large institutional investors. GE Capital’s sponsored special purpose entities use commercial paper proceeds to obtain beneficial interests in the financial assets of SPE’s, including QSPE’s that have acquired financial assets from us, as well as financial assets originated by multiple third parties.
In accordance with our contractual commitments to the QSPE’s, we thoroughly underwrite and service the associated assets transferred by us. Support activities include ongoing review, credit monitoring and collection activities to ensure that the financial assets meet strict investment risk criteria the same support activities that we employ for our own assets.
None of these QSPE’s are permitted to hold GE stock and there are no commitments or guarantees that provide for the potential purchase of GE stock. These entities do not engage in speculative activities of any description and are not used to hedge any GE positions. Under GE integrity policies, no company employee or an employee of any other GE company is permitted to invest in any GE Capital sponsored or qualifying entity.
Management has extensive experience in evaluating economic, liquidity and credit risk. In view of this experience, the high quality of assets in these qualifying entities, the historically robust quality of commercial paper markets, the historical reliability of controls applied both to asset servicing and to activities in the credit markets, management believes that, under any reasonable future economic developments, the likelihood is remote that any such arrangements could have other than an inconsequential negative effect on our operations, cash flows or financial position.
Under FIN 46, Consolidation of Variable Interest Entities, new consolidation criteria will be applied to certain SPEs, which it defines as “Variable Interest Entities.” Additional information about entities that fall within the scope of FIN 46 is provided in Notes 1 and 13.
Timing of our contractual commitments, related to leases and debt, follow.
Accounting policies discussed in this section are those that we consider to be critical to an understanding of our financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results. For all of these policies, we caution that the future events rarely develop as forecast, and the best estimates routinely require adjustment.
Goodwill is tested for impairment at least annually using a fair value approach, which requires the use of estimates and judgement. To the extent the carrying amount at a reporting unit’s goodwill exceeds its fair value, an impairment charge would be recorded. Further information on these assets is provided in Notes 1, 4 and 5.
Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies related to revenue recognition, financial instruments and business combinations require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standard setters and regulators. Although no specific conclusion reached by these standard setters appear likely to cause a material change in our accounting policies, outcomes cannot be predicted with confidence. Also see Note 1, Summary of Significant Accounting Policies, which discusses accounting policies that we have selected from acceptable alternatives.
We have audited the accompanying consolidated balance sheets of GE Financial Assurance Holdings, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholder’s interest, and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
As discussed in Notes 1 and 12 to the consolidated financial statements, the Company changed its method of accounting for derivative instruments and hedging activities in 2001.
Presented net of deferred taxes of $(8) and $(101) for 2002 and 2001, respectively.
As of December 31, 2002, all of our outstanding common stock was owned by General Electric Capital Corporation (“GE Capital”), a wholly-owned subsidiary of General Electric Capital Services, Inc. (“GE Capital Services”), which in turn is wholly-owned, directly or indirectly, by General Electric Company.
GE Financial Assurance is an insurance holding company that, through its subsidiaries, sells a variety of insurance and investment-related products almost entirely in North America and Japan. In accordance with FAS 131, we redefined our operating segments, effective January 1, 2002. As a result, we now report four operating segments: (i) Wealth Accumulation and Transfer, (ii) Mortgage Insurance, (iii) Lifestyle Protection and Enhancement and (iv) Auto and Home Insurance.
Wealth Accumulation and Transfer products are investment vehicles and insurance contracts intended to increase the policyholder’s wealth, transfer wealth to beneficiaries or provide a means for replacing the income of the insured in the event of premature death. Our principal product lines under the Wealth Accumulation and Transfer segment are deferred annuities (fixed and variable), immediate annuities (structured settlements and retirement), life insurance (universal, term, ordinary and group), guaranteed investment contracts (GICs), and funding agreements.
Auto and Home Insurance products are intended to protect against damage to property or injury to the insured or third parties. Our principal product line under the Auto and Home segment is private passenger automobile insurance.
We distribute products through four primary channels: intermediaries (such as brokerage general agents (“BGAs”), banks, securities brokerage firms and financial planning firms); dedicated sales forces, who distribute certain of our products on an exclusive basis, some of whom are not our employees; worksite brokers; and direct and affinity based marketing.
Certain of our subsidiaries and certain policies and contracts offered by them are subject to regulation under the federal securities laws administered by the U.S. Securities and Exchange Commission and certain state securities laws. Certain of these products offer customers a guaranteed interest rate for a predetermined time period and subject customers to a market value adjustment on early withdrawals. Other products offer customers numerous investment options, including, but not limited to, purchases of shares of various mutual funds.
Investment income is recorded when earned. Realized investment gains and losses are calculated on the basis of specific identification. Premiums on short-duration insurance contracts are reported as revenue over the terms of the related insurance policies. In general, earned premiums are calculated on a pro-rata basis or are recognized in proportion to expected claims. Premiums on long-duration insurance products are recognized as earned when due or, in the case of life contingent immediate annuities, when the contracts are issued. Premiums received under annuity contracts without significant mortality risk and premiums received on universal life products are not reported as revenues but as deposits and included in liabilities for future annuity and contract benefits. Mortgage insurance policies are amortized over the policy life in accordance with the expiration of risk. Surrender fee income consists of charges recognized as income when the policy is surrendered. Policy fees and other income consists primarily of insurance charges made against universal life contracts, club membership revenues, fees assessed against policyholder account values and commission income. Consumer protection package dues are recognized as income over the membership period. Charges to policyholder accounts for universal life cost of insurance is recognized as revenue when due. Variable product fees are charged to variable annuity and variable life policyholders based upon the daily net assets of the policyholder’s account values and are recognized as revenue when charged.
We have designated our fixed maturities (bonds, notes, and redeemable preferred stock) and our equity securities (common and non-redeemable preferred stock) as available-for-sale. The fair value for regularly traded fixed maturities and equity securities is based on quoted market prices. For fixed maturities not regularly traded, fair values are estimated using values obtained from independent pricing services or discounted expected cash flow using market rates commensurate with credit quality and maturity of the investment.
Consumer protection packages-Acquisition costs consist primarily of marketing costs and are amortized in proportion to the anticipated revenue to be recognized from club memberships.
Goodwill-As of January 1, 2002, we adopted Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (SFAS 142). Under SFAS 142, goodwill is no longer amortized but is tested for impairment using a fair value approach, at the “reporting unit” level. A reporting unit is the operating segment, or a business one level below that operating segment (the “component” level) if discrete financial information is prepared and regularly reviewed by management at the component level. An impairment charge is recognized for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its fair value. We used discounted cash flows to establish fair values. When available and as appropriate, we used comparative market multiples to corroborate discounted cash flow results. When a business within a reporting unit is disposed of, goodwill is allocated to the gain or loss on disposal using the relative fair value methodology.
We amortize the costs of other intangibles over their estimated useful lives unless such lives are deemed indefinite. Amortizable intangible assets are tested for impairment based on undiscounted cash flows and, if impaired, written down to fair value based in either discounted cash flows or appraised values. Intangible assets with indefinite lives are tested for impairment and written down to fair value as required.
Our non-life insurance subsidiaries are included in the consolidated federal income tax return of General Electric Company. These subsidiaries are subject to a tax-sharing arrangement that allocates tax on a separate company basis, but provides benefit for current utilization of losses and credits. Our U.S. life insurance subsidiaries file a consolidated life insurance federal income tax return and are subject to a separate tax-sharing agreement, as approved by state insurance regulators, which also allocates taxes on a separate company basis but provides benefit for current utilization of losses and credits.
We have not established any U.S. deferred income taxes on temporary differences related to the financial statement carrying amounts and tax bases of investments in foreign subsidiaries. We have elected to permanently reinvest the earnings of our material foreign subsidiaries. Our foreign subsidiaries record foreign income taxes in accordance with SFAS 109, Accounting for Income Taxes.
Future annuity and contract benefits consist of the liability for investment contracts, insurance contracts and accident and health contracts. Investment contract liabilities are generally equal to the policyholder’s current account value. The liability for insurance and accident and health contracts is calculated based upon actuarial assumptions as to mortality, morbidity, interest, expense and withdrawals, with experience adjustments for adverse deviation where appropriate. For our mortgage insurance policies, reserves are established for loans that are delinquent (including loans that are delinquent but have not yet been reported) by forecasting the percentage of delinquent loans where we will ultimately pay claims and the average claim that will be paid based on our historical experience.
The separate account assets and liabilities represent funds held, and the related liabilities for, the exclusive benefit of the variable annuity contract holders and variable life policyholders. We receive mortality risk fees and administration charges from the variable mutual fund portfolios. The separate account assets are carried at fair value and are equal to the liabilities that represent the policyholders’ equity in those assets.
Minority interest in and equity of consolidated subsidiaries includes $82 representing perpetual subordinated debt acquired as part of the Saison acquisition. This instrument bears interest at yen-based LIBOR (London Interbank Offered Rate) plus 50 basis points to 150 basis points not to exceed 2% until June 30, 2032, and yen-based LIBOR plus 250 basis points thereafter, which amounted to 0.6% for 2002. $200 represents 200,000 shares of non-redeemable, cumulative preferred stock and certain ownership interests held by unrelated parties in other consolidated subsidiaries. The preferred stock, issued by a subsidiary to a related party in September 2001, has an annual dividend rate of 7.25%.
Under SFAS 142, goodwill is no longer amortized but is tested for impairment using a fair value methodology. We stopped amortizing goodwill effective January 1, 2002.
As a matter of policy, we ensure that funding, including the effect of derivatives, of our investment and other financial asset positions are substantially matched in character (e.g., fixed vs. floating) and duration. As a result, declines in the fair values of these effective derivatives are offset by unrecognized gains on the related financing assets and hedged items, and future net earnings will not be subject to volatility arising from interest rate changes.
In April 2002, GE Edison acquired Saison Life Insurance Company Limited (“Saison Life”) from Credit Saison Co., Ltd., Saison Group, Ltd. and its other shareholders for 7.8 billion yen, or approximately $61, representing 12.8 billion yen payments to shareholders less 5.0 billion yen of contingent debt. On the date of acquisition, Saison Life had approximately $4.3 billion of assets, including $2.4 billion of cash and $1.9 billion of other assets, and $4.3 billion of liabilities and equity, including $82 of perpetual subordinated debt (included in minority interest). We have reflected our initial allocation of purchase price based on our estimated fair values according to preliminary valuations. Such estimated values may change as additional information is obtained and the valuation is finalized.
Effective March 2000, GE Edison acquired, by means of a comprehensive transfer (“the Transfer”) in accordance with the Insurance Business Law of Japan (“IBL”), the insurance policies and related assets of Toho Mutual Life Insurance Company (“Toho”). GE Edison assumed $21.6 billion of policyholder liabilities, $0.3 billion of accounts payable and accrued expenses, and acquired $20.3 billion of cash, investments and other tangible assets. The $1.6 billion difference between acquired assets and assumed liabilities represents PVFP on the transferred insurance policies. In connection with the Transfer, we terminated reinsurance arrangements we had with Toho. Certain amounts in the Consolidated Statements of Income for the year ended December 31, 2000 reflect the impact of terminating such reinsurance arrangements. The termination of the reinsurance arrangements did not have a significant effect on net earnings for the year ended December 31, 2000.
For the years ended December 31, sources of investment income were as follows:
For the years ended December 31, sales proceeds and gross realized investment gains and losses resulting from the sales of investment securities available-for-sale were as follows:
Impairments were $(416), $(277), and $(77) in 2002, 2001 and 2000, respectively.
Net unrealized gains and losses on investment securities classified as available-for-sale and other invested assets are reduced by deferred income taxes and adjustments to PVFP and deferred acquisition costs that would have resulted had such gains and losses been realized. Net unrealized gains and losses on available-for-sale investment securities reflected as a separate component of shareholder’s interest at December 31 are summarized as follows:
The change in the net unrealized gains (losses) on investment securities classified as available-for-sale and other invested assets reported in the accumulated non-owner changes in equity is as follows:
At December 31, the amortized cost, gross unrealized gains and losses, and fair value of our fixed maturities and equity securities available-for-sale were as follows:
At December 31, 2002, $8,531 of our investments (excluding mortgage and asset-backed securities) were subject to certain call provisions.
At December 31, 2002, we did not hold any fixed maturity securities in any single issuer, other than securities issued or guaranteed by the U.S. government, which exceeded 10% of shareholder’s interest.
The credit quality of the fixed maturity portfolio at December 31, 2002 and 2001 follows. The categories are based on the higher of the ratings published by Standard & Poor’s or Moody’s.
At December 31, 2002 and 2001, our U.S. mortgage loan portfolio was $5,302 and $4,499 net of allowance of $44 and $58, respectively. Our non-U.S. mortgage and other loan portfolio at December 31, 2002 and 2001 was $1,930 and $1,556 net of allowance of $38 and $86, respectively.
At December 31, 2002 and 2001, respectively, we held $5,312 and $4,576 of mortgage loans secured by commercial real estate and $156 and $333 of mortgage loans secured by residential real estate. In addition, we held $1,764 and $1,146 of other individual and corporate loans at December 31, 2002 and 2001, respectively.
The estimated percentage of the December 31, 2002 balance, before the effect of unrealized investment gains or losses, to be amortized over each of the next five years is as follows:
The effect on net earnings of excluding such goodwill amortization from 2001 and 2000 follow:
Our goodwill balance by segment and activity during the year follows:
Other adjustments include the reclassification of certain intangible assets into goodwill upon the adoption of SFAS 142 and the impact of foreign exchange translation adjustments.
Certain policy risks are reinsured with other insurance companies to limit the amount of loss exposure. Reinsurance contracts do not relieve us from our obligations to policyholders. In the event that the reinsurers are unable to meet their obligations, we remain liable for the reinsured claims. We monitor both the financial condition of individual reinsurers and risk concentrations arising from similar geographic regions, activities and economic characteristics of reinsurers to lessen the risk of default by such reinsurers. We do not have significant concentrations of reinsurance with any one reinsurer that could have a material impact on our results of operations.
The maximum amount of individual ordinary life insurance normally retained by the Company on any one life policy is $1. Net life insurance in force as of December 31 is summarized as follows:
Insurance contracts are broadly defined to include contracts with significant mortality and/or morbidity risk. The liability for future benefits of insurance contracts is the present value of such benefits less the present value of future net premiums based on mortality, morbidity, and other assumptions which were appropriate at the time the policies were issued or acquired. These assumptions are periodically evaluated for potential reserve deficiencies. Reserves for cancelable accident and health insurance are based upon unearned premiums, claims incurred but not reported, and claims in the process of settlement. This estimate is based on the experience of the insurance industry and us, adjusted for current trends. Any changes in the estimated liability are reflected in income as the estimates are revised.
The following chart summarizes the major assumptions underlying our recorded liabilities for future annuity and contract benefits:
Principally modifications of the 1965-70 or 1975-80 Select and Ultimate Tables, 1958 and 1980 Commissioner’s Standard Ordinary Tables or Fifth Japanese Experience Table and (IA) Standard Table 1996 (modified).
Changes in the liability for policy and contract claims for the years ended December 31:
For each of the three years presented above, the change in prior years incurred liabilities primarily relates to positive development in claims incurred but not reported for private passenger automobile insurance and certain accident and health insurance. In general, our insurance contracts are not subject to premiums experience adjustments as a result of prior-year effects.
Includes fixed rate borrowings and $1.1 billion ($1.1 billion in 2001) notional long-term interest rate swaps that effectively convert the floating-rate nature of short term borrowings into fixed rate borrowings.
In 2002, we reached a favorable settlement with the Internal Revenue Service regarding the treatment of certain reserves for obligations to policyholders on life insurance contacts resulting in a benefit of $152. The benefits associated with the settlement are non-recurring.
Federal income tax law allows mortgage guaranty insurance companies to deduct from current taxable income amounts added to statutory contingency loss reserves required by state law or regulation, subject to certain limitations. This federal tax deduction is permitted only to the extent that U.S. Mortgage Guaranty Insurance Company Tax and Loss Bonds (“Tax and Loss Bonds”) are purchased in the amount of the tax benefit attributable to the deduction. Tax and Loss Bonds are non-interest bearing and mature ten years from the designated issue date. Unrecaptured amounts previously deducted for statutory contingency loss reserves must be included in federal taxable income in the tenth subsequent tax year. Tax and Loss Bond redemptions in December 2002 reduced the deferred tax liability for statutory contingency reserves by $404.
At December 31, 2002 and December 31, 2001, we held a note receivable from GE Capital with a balance of $175. This note bears interest at 6.63% and matures in August 2003.
At December 31, 2002 and December 31, 2001, long-term debt included a note payable to affiliates with a balance of $27. The note bears interest at 2.25% and matures in April 2008. In addition, a guarantee fee of 0.50% is being paid annually to GE Capital as guarantor.
At December 31, 2002 and December 31, 2001, long-term debt included a note payable to GE Capital with a balance of $440. This note bears interest at an effective fixed rate of 2.64% and matures in March 2008.
At December 31, 2002 and December 31, 2001, we had a line of credit with GE Capital that has an aggregate borrowing line of $2,500 with balances of $0 and $285, respectively.
During each of 2002, 2001 and 2000 we collected $21, of premiums from various GE affiliates for long-term care insurance provided to employees of such affiliates.
Under an agreement with a non-consolidated affiliate, the Mortgage Insurance segment sells properties acquired through claim settlement at a price equal to the property’s fair value times an agreed upon price factor. During 2002 and 2001, proceeds from these transactions were $13 and $11, respectively.
We provide excess of loss reinsurance covering the insurance portfolios of affiliates in Australia and the United Kingdom. These amounted to $2.1 and $1.6 and December 31, 2002 and 2001, respectively.
During 2002, we made loans to GE Capital in the aggregate amount of 119.8 Great British Pounds, which approximates $200 and is included in other assets at December 31, 2002. These loans were made pursuant to two notes, the terms of which are as follows:
All other instruments. Based on comparable market transactions, discounted future cash flows, quoted market prices, and/or estimates of the cost to terminate or otherwise settle obligations.
On January 1, 2001 we adopted SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as discussed in Note 1. The paragraphs that follow provide additional information about derivatives and hedging relationships in accordance with SFAS 133.
A reconciliation of current period changes for the years ended December 31, 2002 and 2001, net of applicable income taxes in the separate component of shareholder’s interest labeled “derivatives qualifying as hedges”, follows:
Derivatives and Hedging. Our global business activities routinely deal with fluctuations in interest rates, in currency exchange rates and in other asset prices. We follow GE and GE Capital’s strict policies to managing each of these risks, including prohibition on, derivatives market-making, speculative derivatives trading or other speculative derivatives activities. These policies require the use of derivative instruments in concert with other techniques to reduce or eliminate these risks.
Cash flow hedges. Under SFAS 133, cash flow hedges are hedges that use simple derivatives to offset the variability of expected future cash flows. Variability can appear in floating rate assets, floating rate liabilities or from certain types of forecasted transactions, and can arise from changes in interest rates or currency exchange rates. For example, we often borrow funds at a variable rate of interest. If we need these funds to make a floating rate loan, there is no exposure to interest rate changes, and no hedge is necessary. However, if a fixed rate loan is made, we will contractually commit to pay a fixed rate of interest to a counterparty who will pay us a variable rate of interest
Fair value hedges. Under SFAS 133, fair value hedges are hedges that eliminate the risk of changes in the fair values of assets, liabilities and certain types of firm commitments. For example, we will use an interest rate swap in which we receive a fixed rate of interest and pay a variable rate of interest to change the cash flow profile of a fixed rate borrowing to match the variable rate financial asset that we are funding. Changes in fair value of derivatives designated and effective as fair value hedges are recorded in earnings and are offset by corresponding changes in the fair value of the hedged item.
We use interest rate swaps, currency swaps and interest rate and currency forwards to hedge the effect of interest rate and currency exchange rate changes on local and non functional currency denominated fixed rate borrowings and certain types of fixed rate assets. Equity options are used to hedge price changes in equity indexed annuity liabilities.
We use option contracts, including floors, as an economic hedge of changes in interest rates, currency exchange rates and equity prices on certain types of liabilities. For example, we use equity options to hedge the risk of changes in equity prices embedded in insurance liabilities associated with certain annuity contracts. Although these instruments are considered to be derivatives under SFAS 133, our economic risk is similar to, and managed on the same basis as other equity instruments we hold.
At December 31, 2002, the fair value of derivatives in a gain position and recorded in “All other assets” is $339 and the fair value of derivatives in a loss position and recorded in “All other liabilities” is $1,334.
The following table summarizes the current balance of assets sold to QSPE’s at December 31:
We evaluate the economic, liquidity and credit risk related to the above SPEs and believe that the likelihood is remote that any such arrangements could have a significant adverse effect on our operations, cash flows, or financial position. Financial support for certain SPE’s is provided under credit support agreements, in which GE Financial Assurance provides limited recourse for a maximum of $119 million of credit losses in qualifying entities. Assets with credit support are funded by demand notes that are further enhanced with support provided by GE Capital. We may record liabilities for such guarantees based on our best estimate of probable losses. To date, none of our QSPE’s have incurred a loss.
Sales of securitized assets to QSPEs result in a gain or loss based on the difference between sales proceeds, the carrying amount of net assets sold, the fair value of servicing rights and retained interests and an allowance for losses. Beneficial interests and recourse obligations related to such sales that are recognized in our financial statements are as follows:
Servicing assets. Following a securitization transaction, we retain the responsibility for servicing the receivables, and, as such, are entitled to receive an ongoing fee based ont ehon the outstanding principal balances of the receivables. There are no servicing assets nor liabilities recorded as the benefits of servicing the assets are adequate to compensate an independent servicer for its servicing responsibilities.
Insurance companies are restricted by states as to the aggregate amount of dividends they may pay to their parent in any consecutive twelve-month period without regulatory approval. Generally, dividends may be paid out of earned surplus without approval with thirty days prior written notice within certain limits. The limits are generally based on 10% of the prior year surplus (net of adjustments in some cases) and prior year statutory income (net gain from operations, net income adjusted for realized capital gains, or net investment income). Dividends in excess of regulatory prescribed limits are deemed “extraordinary” and require formal state insurance department approval. Based on statutory results as of December 31, 2002, we are able to receive $446 in dividends in 2003 without obtaining regulatory approval.
Our insurance subsidiaries file financial statements with state insurance regulatory authorities and the National Association of Insurance Commissioners (“NAIC”) that are prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Statutory accounting practices differ from U.S. GAAP in several respects, causing differences in reported net income and shareholder’s interest. Permitted statutory accounting practices encompass all accounting practices not so prescribed but that have been specifically allowed by state insurance authorities. Our insurance subsidiaries have no significant permitted accounting practices.
Combined statutory net income for our U.S. domiciled insurance subsidiaries for the years ended December 31, 2002, 2001 and 2000 was $26, $648 and $741, respectively. The combined statutory capital and surplus as of December 31, 2002 and 2001 was $7,213 and $5,647, respectively.
We conduct our operations almost entirely in two geographic regions: (1) North America and (2) Japan. See Note (1)(c) for further discussion of our principal product lines distributed in these two segments.
We, like other insurance companies, are involved in lawsuits, including class action lawsuits. In some class action and other lawsuits involving insurance companies, substantial damages have been sought and/or material settlement payments have been made. Except for the McBride case described below, the ultimate outcome of which, and any effect on us, cannot be determined at this time, management believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse impact on our Consolidated Financial Statements.
On March 5, 2003, GE Capital contributed all of our outstanding common stock to GEI, Inc., a newly formed holding company. GEI, Inc. is a wholly-owned subsidiary of GE Capital.
Under date of February 7, 2003, except for Note 19 which is as of March 5, 2003, we reported on the consolidated balance sheets of GE Financial Assurance Holdings, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholder’s interest, and cash flows for each of the years in the three-year period ended December 31, 2002, which are included herein. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules included herein. These financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.
At December 31, 2002, all of the outstanding common stock of GE Financial Assurance Holdings, Inc., (“GE Financial Assurance”) was owned by General Electric Capital Corporation (“GE Capital”), a wholly owned subsidiary of General Electric Capital Services, Inc., which in turn is wholly owned, directly or indirectly, by General Electric Company.