The Head Office of the Company consists of a 517,633 square foot office complex located in Englewood, Colorado. The office complex is owned by a subsidiary of the Company. The Company leases sales and claims offices throughout the United States.
Management's discussion and analysis of financial condition and results of operations of the Company for the three years ended December 31, 1998 follows.
The Company's consolidated net income increased $24.2 million or 18% in 1997 when compared to the year ended December 31, 1996. In 1997, the Employee Benefits segment contributed $3.0 million or 12% to the overall growth and the Financial Services segment contributed $21.2 million or 88% to the overall growth.
The Company's 1997 and 1996 consolidated net income increased by $21.1 million and $25.6 million, respectively, due to changes in income tax provisions for these years. The current income tax provisions were decreased by $42.2 million and $31.2 million for 1997 and 1996, respectively, due to the release of a contingent liability relating to taxes of Great-West Life's U.S. branch associated with the blocks of business that had been transferred from Great-West Life's U.S. branch to the Company, as discussed below.
Certain reclassifications, primarily related to the classification of the release of the contingent liability described above (see Note 10 to the Consolidated Financial Statements), have been made to the 1997 and 1996 financial statements.
In 1998 total revenues increased $301.1 million or 14% to $2.4 billion when compared to the year ended December 31, 1997. The growth in revenues in 1998 was comprised of increased premium income of $161.7 million, increased fee income of $95.3 million, increased net investment income of $15.7 million and increased realized gains on investments of $28.4 million. In 1997 total revenues increased $154.8 million or 8% to $2.1 billion when compared to the year ended December 31, 1996. The growth in revenues in 1997 was comprised of increased premium income of $3.7 million, increased fee income of $73.2 million, increased net investment income of $47.0 million and realized gains on investments of $9.8 million in 1997 versus realized losses in 1996 of $21.1 million.
The increased premium income in 1998 was comprised of growth in Employee Benefits premium income of $281.8 million, offset by a decrease in Financial Services premium income of $120.1 million. The growth in premium income in the Employee Benefits segment primarily reflected $209.5 million of premium income derived from the acquisition of Anthem Health & Life Insurance Company ("AH&L") in July 1998 (see Other Matters below). The decrease of $120.1 million in Financial Services premium income was due primarily to reinsurance transactions in 1997 of $155.8 million versus only $46.2 million in premiums due to reinsurance transactions in 1998. The increased premium income in 1997 was comprised of a decrease in Employee Benefits premium income of $21.4 million, offset by growth in Financial Services premium income of $25.1 million. The decrease in Employee Benefits was attributable to terminations in 1996 which impacted 1997 premiums (see Item 7(B) - Employee Benefits Results of Operations). The increase in Financial Services premium income was attributable to participating individual insurance.
The increased fee income in 1998 was comprised of growth in Employee Benefits fee income and Financial Services fee income of $86.6 million and $8.7 million, respectively. The growth in Employee Benefits fee income reflected $31.6 million of fee income derived from the acquisition of AH&L. The remaining increase was the result of new sales and increased fees on variable funds related to growth in equity markets. The increase in fee income in 1997 was comprised of Employee Benefits fee income and Financial Services fee income of $36.9 million and $36.3 million, respectively. The increase in both segments was attributable to new sales and increased fees on variable funds related to growth in equity markets.
In October 1996, the Company recaptured certain pieces of an individual participating block of business previously reinsured to Great-West Life. In June 1997, the Company recaptured all remaining pieces of that block of business. The Company recorded various assets and liabilities related to the recaptures as discussed in Note 3 to the Consolidated Financial Statements. In recording the recaptures, both life insurance premiums and benefits were increased by the amounts recaptured ($155.8 million and $164.8 million in 1997 and 1996, respectively). Consequently, the net income of the Company was not impacted by the reinsurance transactions.
Income tax expense increased $49.0 million or 98% in 1998 when compared to the year ended December 31, 1997. Income tax expense increased $19.5 million or 64% in 1997 when compared to the year ended December 31, 1996. The increase in income tax expense in 1998 reflects higher earnings in 1998, as well as the fact that the 1997 income tax provision includes a net $26.2 million release of contingent tax liabilities relating to prior open tax years, as discussed above. The increase in income tax expense from 1996 to 1997 was partially attributable to a growth in earnings in 1997, but also reflects net releases in 1997 and 1996 of $26.2 million and $25.6 million of contingent tax liabilities relating to prior open tax years, as discussed above. Excluding these contingent tax releases, the Company's income tax expense increased 30% and 27% in 1998 and 1997. See Note 10 to the Consolidated Financial Statements for a discussion of the Company's effective tax rates.
In evaluating its results of operations, the Company also considers net changes in deposits received for investment-type contracts, deposits to separate accounts and self-funded equivalents. Self-funded equivalents represent paid claims under minimum premium and administrative services only contracts, which amounts approximate the additional premiums that would have been earned under such contracts if they had been written as traditional indemnity or HMO programs.
Deposits for investment-type contracts increased $686.0 million or 104% in 1998 when compared to the year ended December 31, 1997. Deposits for investment-type contracts decreased $157.4 million or 19% in 1997 when compared to the year ended December 31, 1996. The increase in 1998 was primarily due to two indemnity reinsurance agreements with Great-West Life whereby the Company reinsured by coinsurance certain Great-West Life individual non-participating life insurance policies. This transaction increased deposits by $519.6 million in 1998 and accounted for 78% of the growth. The 19% decrease in 1997 was the result of decreased deposits related to COLI sales (see Item 7(C) - Financial Services Results of Operations).
Deposits for separate accounts increased $63.7 million or 3% in 1998 when compared to the year ended December 31, 1997. The increase in 1998 reflected a continuing movement toward variable funds and away from fixed options. Deposits for separate accounts increased $706.9 million or 49% in 1997 when compared to the year ended December 31, 1996. The increase in 1997 was primarily due to increased deposits in the Financial Services segment (see Item 7(C) - Financial Services Results of Operations).
Self-funded premium equivalents increased $567.1 million or 28% in 1998 when compared to the year ended December 31, 1997. Self-funded premium equivalents increased $98.6 million or 5% in 1997 when compared to the year ended December 31, 1996. Approximately half of the 1998 increase ($281.3 million) was due to the acquisition of AH&L, with the remainder coming from the growth in business.
Net income for Employee Benefits increased 9% in 1998 and 2% in 1997. The improvement in earnings in 1998 and 1997 reflects increased fee income from the variable 401(k) assets and improved group life mortality experience which more than offset unfavorable morbidity experience and the increased level of operating expenses associated with building the HMO network in 1998 and 1997. The changes in income tax provisions discussed above under "Company Results of Operations" resulted in increases in net income for the Employee Benefits segment of $17.6 million and $18.2 million in 1997 and 1996, respectively.
Equivalent premium revenue and fee income for group life and health increased 32% from 1997 levels as the result of a combination of increased sales (41%) and the AH&L acquisition (59%). From 1996 to 1997, equivalent premium revenue and fee income had increased 4% as growth was constrained by competitive pressures.
The Company experienced a 35% increase in total health care membership, including the AH&L acquisition, from 1,675,800 at the end of 1997 to 2,266,700 at year-end 1998. Excluding the AH&L acquisition, which added 450,000 members, total health care membership increased 8%. Gatekeeper (i.e., POS and HMO) members grew 34% from 414,500 in 1997 to 556,800 in 1998 including 61,800 AH&L members. Excluding the AH&L acquisition, gatekeeper members increased 19%. The Company expects this segment of the business to grow as additional HMO licenses are obtained.
The number of new 401(k) case sales (employer groups), including third-party administration business generated through the Company's marketing and administration arrangement with New England, decreased 33% to 800 in 1998 from 1,200 in 1997 (1,200 in 1996). The decrease in 1998 was the result of a shift in emphasis to group life and health sales. The 401(k) block of business under administration total 6,100 employer groups and more than 475,000 individual participants, compared to 5,700 employer groups and 430,000 individual participants in 1997, and 4,900 employer groups and 355,000 individual participants in 1996.
During 1998, the in-force block of 401(k) business continued to perform well, with customer retention of 93% versus 94% in 1997. This, combined with strong equity markets, resulted in a 26% and 39% increase in assets under management during 1998 and 1997, respectively.
(Millions) Years Ended December 31, --------------------------------------- INCOME STATEMENT 1998 1997 1996 ------------ ----------- ---------- DATA Premiums 248 368 343 Fee income 71 62 26 Net investment income 802 782 747 Realized investment gains 30 7 (18) (losses) ------------ ----------- ---------- Total Revenues 1,151 1,219 1,098
Deposits for investment-type contracts 1,307 633 781 Deposits to separate accounts 640 742 329
The Financial Services segment's core savings business is in the public/non-profit pension market. The assets of the public/non-profit business, including separate accounts but excluding Guaranteed Investment Contracts ("GICs"), increased 9% and 8% during 1998 and 1997 to $7.8 billion and $7.2 billion, respectively. Much of the growth came from the variable annuity business, which was driven by premiums and deposits and strong investment returns in the equity markets.
The Financial Services segment again experienced a very high retention rate in public/non-profit contract renewals in 1998, renewing 100% of its own large case state contracts. Part of this customer loyalty comes from initiatives to provide high-quality service while controlling expenses.
FASCorp administered records for approximately 1,304,000 participants in 1998 versus 1,000,000 in 1997.
Individual life insurance revenue premiums and deposits of $1.3 billion in 1998 increased 71% from 1997 primarily due to reinsurance transactions with Great-West Life, which resulted in $565.8 million of premiums and deposits in 1998 versus $155.8 million in 1997. Excluding these reinsurance transactions, individual life insurance revenue premiums and deposits increased 14% from 1997 to 1998. The Company also experienced strong BOLI sales in 1998 which more than offset reductions in COLI premiums. Individual life insurance premiums and deposits decreased 14% from 1996 to 1997 due to the reduction of COLI premiums associated with 1996 legislative changes.
During 1999, the Company expects to continue its growth in the third party administration area through FASCorp. Emphasis will also be placed on developing the institutional insurance and annuity markets. During 1997, communications were provided to policyholders in the public/non-profit market through the use of the internet. Increased emphasis will be placed on improving internet functionality during the upcoming year to improve this service for our customers.
The Company's primary investment objective is to acquire assets whose durations and cash flows reflect the characteristics of the Company's liabilities, while meeting industry, size, issuer and geographic diversification standards. Formal liquidity and credit quality parameters have also been established.
Occasionally, the Company elects to restructure certain loans if the economic benefits to the Company are believed to be more advantageous than those achieved by acquiring the collateral through foreclosure. At December 31, 1998 and 1997, the Company's loan portfolio included $52.9 million and $64.4 million, respectively, of non-impaired restructured loans.
General economic conditions continued to remain strong during 1998. The Company does not expect to recognize any asset writedowns or restructurings in 1999 that would result in a material adverse effect upon the Company's financial condition.
Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio and utilizing positive cash flows from operations. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash, which totaled $596.3 million and $525.4 million as of December 31, 1998 and 1997, respectively.
The Company's financial strength provides the capacity and flexibility to enable it to raise funds in the capital markets through the issuance of commercial paper. The Company continues to be well capitalized, with sufficient borrowing capacity to meet the anticipated needs of its business. The Company had $39.7 million of commercial paper outstanding at December 31, 1998, compared with $54.1 million at December 31, 1997. The commercial paper has been given a rating of A-1+ by Standard & Poor's Corporation and a rating of P-1 by Moody's Investors Service, each being the highest rating available.
The Year 2000 ("Y2K") problem arises when a computer performing date-based computations or operations produces erroneous results due to the historical practice of using two digit years within computer hardware and software. This causes errors or misinterpretations of the century in date calculations. Virtually all businesses, including the Company, are required to determine the extent of their Y2K problems. Systems that have a Y2K problem must then be converted or replaced by systems that will operate correctly with respect to the year 2000 and beyond.
The Company has a written plan that encompasses all computer hardware, software, networks, facilities (embedded systems) and telephone systems. The plan also includes provisions for identifying and verifying that major vendors and business partners are Y2K compliant. The Company is developing contingency plans to address the possibility of both internal and external failures as well. The plan calls for full Y2K compliance for core systems by June 30, 1999 and full Y2K compliance for all Company systems by October 31, 1999.
The Company's plan establishes five phases for becoming Y2K compliant. Phase 1 is "impact analysis" which includes initial inventory and preliminary assessment of Y2K impact. Phase 2 is "solution planning" which includes system by system planning to outline the approach and timing for reaching compliance. Phase 3 is "conversion/renovation" which means the actual process of replacing or repairing non-compliant systems. Phase 4 is "testing" to ensure that the systems function correctly under a variety of different date scenarios including current dates, year 2000 and leap year dates. Phase 5 is "implementation" which means putting Y2K compliant systems back into production.
As of December 31, 1998, the Company had completed impact analysis (phase 1) and solution planning (phase 2) for all of its core systems and was more than 95% complete for phases 1 and 2 with respect to its systems as a whole. In addition, the Company was approximately 87% complete with respect to conversion and renovation (phase 3), 79% complete with respect to testing (phase 4), and 78% complete with respect to implementation (phase 5).
In addition to ensuring that the Company's own systems are Y2K compliant, the Company has identified third parties with which the Company has significant business relationships in order to assess the potential impact on the Company of the third parties' Y2K issues and plans. The Company expects to complete this process during the first quarter of 1999 and will conduct system testing with third parties throughout 1999. The Company does not have control over these third parties and cannot make any representations as to what extent the Company's future operating results may be adversely affected by the failure of any third party to address successfully its own Y2K issues.
On the basis of currently available information, the expense incurred by the Company, including anticipated future expenses, related to the Y2K issue has not and is not expected to be material to the Company's financial condition or results of operations. The Company has spent approximately $9.7 million on its Y2K project through the end of December 1998 and expects to spend up to approximately $15.3 million on its Y2K project. All of these funds will come from the Company's cash flow from operations. The Company has continued other scheduled non-Y2K information systems changes and upgrades. Although work on Y2K issues may have resulted in minor delays on the other projects, the delays are not expected to have a material adverse effect on the Company's consolidated financial condition or results of operations.
The most reasonably likely worst case Y2K scenario is that the Company will experience isolated internal or third party computer failures and will be temporarily unable to process insurance and annuity benefit transactions. All of the Company's Y2K efforts have been designed to prevent such an occurrence. However, if the Company identifies internal or third party Y2K issues which cannot be timely corrected, there can be no assurance that the Company can avoid Y2K problems or that the cost of curing the problem will not be material.
In an effort to mitigate risks associated with Y2K failures, the Company is in the process of developing contingency plans to address core functions, including relations with third parties. It is the Company's expectation that contingency plans will address possible failures generated internally, by vendors or business partners, and by customers. Possible general approaches include manual processing, payments on an estimated basis and use of disaster recovery facilities.
The following are the Company's Consolidated Financial Statements for the Years Ended December 31, 1998, 1997, and 1996 and the Independent Auditors' Report thereon.
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY (An indirect wholly-owned subsidiary of The Great-West Life Assurance Company)
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Great-West Life & Annuity Insurance Company and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
1998 1997 ------------- ------------ LIABILITIES AND STOCKHOLDER'S EQUITY POLICY BENEFIT LIABILITIES: Policy reserves Related party 555,300 17,774 Other 11,284,414 11,084,945 Policy and contract claims 491,932 375,499 Policyholders' funds 181,779 165,106 Provision for policyholders' dividends 69,530 62,937 GENERAL LIABILITIES: Due to Parent Corporation 52,877 126,656 Repurchase agreements 244,258 325,538 Commercial paper 39,731 54,058 Other liabilities 761,505 689,967 Undistributed earnings on participating business 143,717 141,865 Separate account liabilities 10,099,543 7,847,451 ------------- ------------ Total Liabilities 23,924,586 20,891,796 ------------- ------------
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Amounts in Thousands, except Share Amounts)
The amortized cost of fixed maturities classified as held-to-maturity or available-for-sale is adjusted for amortization of premiums and accretion of discounts using the effective interest method over the estimated life of the related bonds. Such amortization is included in net investment income. Realized gains and losses, and declines in value judged to be other-than-temporary are included in net realized gains (losses) on investments.
Deferred Policy Acquisition Costs - Policy acquisition costs, which primarily consist of sales commissions related to the production of new and renewal business, have been deferred to the extent recoverable. Other costs capitalized include expenses associated with the Company's group sales representatives. These costs are variable in nature and are dependent upon sales volume. Deferred costs associated with the annuity products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits. Deferred costs associated with traditional life insurance are amortized over the premium paying period of the related policies in proportion to premium revenues recognized. Amortization of deferred policy acquisition costs totaled $51,724, $44,298, and $47,089 in 1998, 1997, and 1996, respectively.
Life Insurance and Annuity Reserves - Life insurance and annuity policy reserves with life contingencies of $6,866,478 and $5,741,596 at December 31, 1998 and 1997, respectively, are computed on the basis of estimated mortality, investment yield, withdrawals, future maintenance and settlement expenses, and retrospective experience rating premium refunds. Annuity contract reserves without life contingencies of $4,908,964 and $5,346,516 at December 31, 1998 and 1997, respectively, are established at the contractholder's account value.
Recognition of Premium and Fee Income and Benefits and Expenses - Life insurance premiums are recognized when due. Annuity premiums with life contingencies are recognized as received. Accident and health premiums are earned on a monthly pro rata basis. Revenues for annuity and other contracts without significant life contingencies consist of contract charges for the cost of insurance, contract administration, and surrender fees that have been assessed against the contract account balance during the period. Fee income is derived primarily from contracts for claim processing or other administrative services and from assets under management. Fees from contracts for claim processing or other administrative services are recorded as the services are provided. Fees from assets under management, which consist of contract maintenance fees, administration fees and mortality and expense risk changes, are recognized when due. Benefits and expenses on policies with life contingencies impact premium income by means of the provision for future policy benefit reserves, resulting in recognition of profits over the life of the contracts. The average crediting rate on annuity products was approximately 6.3%, 6.6%, and 6.8% in 1998, 1997, and 1996.
The Company implemented Statement of Financial Accounting Standards (SFAS) No. 125 "Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities" in 1998 as it relates to repurchase agreements and securities lending arrangements. The implementation of this statement had no material effect on the Company's financial statements.
Derivatives - The Company makes limited use of derivative financial instruments to manage interest rate, market, and foreign exchange risk. Such hedging activity consists of interest rate swap agreements, interest rate floors and caps, foreign currency exchange contracts and equity swaps. The differential paid or received under the terms of these contracts is recognized as an adjustment to net investment income on the accrual method. Gains and losses on foreign exchange contracts are deferred and recognized in net investment income when the hedged transactions are realized.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for Derivative Instruments and for Hedging Activities". This Statement provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. This Statement is effective for the Company beginning January 1, 2000, and earlier adoption is encouraged. The Company has not adopted this Statement as of December 31, 1998. Management has not determined the impact of the Statement on the Company's financial position or results of operations.
Stock Options - In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", which was effective for the Company beginning January 1, 1996. This Statement requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company has continued to apply APB Opinion No. 25 to stock-based compensation awards to employees and has disclosed the required pro forma effect on net income (see Note 13).
On December 31, 1998, the Company and the Parent Corporation entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured by coinsurance certain Parent Corporation individual non-participating life insurance policies. The Company recorded $859 in premium income and an increase in reserves, associated with certain policies, as a result of this transaction. Of the $137,638 in reserves that were recorded as a result of this transaction, $136,779 was recorded under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments" ("SFAS No. 97"), accounting principles. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at December 31, 1998 as a result of this transaction:
Cash 24,600 Policy reserves 137,638 Deferred income taxes 3,816 Policy loans 82,649 Due from Parent Corporation 19,753 Other 6,820 ----------- ----------- 137,638 137,638
In connection with this transaction, the Parent Corporation made a capital contribution of $5,608 to the Company.
On June 30, 1997, the Company recaptured all remaining pieces of an individual participating insurance block of business previously reinsured to the Parent Corporation on December 31, 1992. The Company recorded $155,798 in premium income and an increase in reserves as a result of this transaction. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at June 30, 1997 as a result of this transaction:
On October 31, 1996, the Company recaptured certain pieces of an individual participating insurance block of business previously reinsured to the Parent Corporation on December 31, 1992. The Company recorded $164,839 in premium income and an increase in reserves as a result of this transaction. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at October 31, 1996 as a result of this transaction:
Cash 162,000 Policy reserves 164,839 Mortgages 19,753 Due to Parent Corporation 16,180 Other 118 Deferred income taxes 1,283 Undistributed earnings on participating business (431) ------------ -------------- 181,871 181,871
Held-to-Maturity Available-for-Sale ------------------------------ --------- -------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value ------------- -------------- ------------ -------------- Due in one year or less 316,174 321,228 235,842 252,067 Due after one year through five years 925,016 961,592 1,279,123 1,309,202 Due after five years through ten years 675,444 722,685 769,278 803,498 Due after ten years 130,480 138,119 449,273 457,785 Mortgage-backed securities 10,135 9,941 2,257,376 2,313,490 Asset-backed securities 142,569 145,371 1,761,640 1,800,684 ============= ============== ============= ============= 2,199,818 2,298,936 6,752,532 6,936,726 ============= ============== ============= =============
Proceeds from sales of securities available-for-sale were $6,169,678, $3,174,246, and $3,569,608 during 1998, 1997, and 1996, respectively. The realized gains on such sales totaled $41,136, $20,543, and $24,919 for 1998, 1997, and 1996, respectively. The realized losses totaled $8,643, $10,643, and $40,748 for 1998, 1997, and 1996, respectively. During the years 1998, 1997, and 1996 held-to-maturity securities with an amortized cost of $9,920, $0, and $0 were sold due to credit deterioration with insignificant gains and losses.
The Company engages in hedging activities to manage interest rate and exchange risk. The following table summarizes the 1998 financial hedge instruments:
As part of an active loan management policy and in the interest of maximizing the future return of each individual loan, the Company may from time to time modify the original terms of certain loans. These restructured loans, all performing in accordance with their modified terms that are not impaired, aggregated $52,913 and $64,406 at December 31, 1998 and 1997, respectively.
Balance, beginning of year 67,242 65,242 63,994 Provision for loan losses 642 4,521 4,470 Chargeoffs (787) (2,521) (3,468) Recoveries 145 246 ============= ============= ============== Balance, end of year 67,242 67,242 65,242 ============= ============= ==============
The estimated fair value of financial hedge instruments, all of which are held for other than trading purposes, is the estimated amount the Company would receive or pay to terminate the agreement at each year-end, taking into consideration current interest rates and other relevant factors. Included in the net gain position for interest rates swaps are $0 of unrealized losses in 1998 and 1997. Included in the net gain position for foreign currency exchange contracts are $932 and $0 of loss exposures in 1998 and 1997, respectively.
Assumed health care cost trend rates have a significant effect on the amounts reported for the medical plan. For measurement purposes, a 6.5% annual rate of increase in the per capita cost of covered health care benefits was assumed. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
1-Percentage 1-Percentage Point Point Increase Decrease -------------- ---------------- Effect on total of service and interest cost on components 649 1,140 Effect on post-retirement benefit obligation 4,129 3,098
The Company sponsors a defined contribution 401(k) retirement plan which provides eligible participants with the opportunity to defer up to 15% of base compensation. The Company matches 50% of the first 5% of participant pre-tax contributions. Company contributions for the years ended December 31, 1998 and 1997 totaled $3,915 and $3,475, respectively.
The Company also provides a supplemental executive retirement plan (SERP) to certain key executives. This plan provides 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. The incremental expense for this plan for 1998 and 1997 was $2,840 and $2,531, respectively. The total liability of $9,349 and $6,509 as of December 31, 1998 and 1997 is included in other liabilities.
The following is a reconciliation between the federal income tax rate and the Company's effective rate after giving effect to the reclassifications discussed below:
1998 1997 1996 ----------- ----------- --------- Federal tax rate 35.0 % 35.0 % 35.0 % Change in tax rate resulting from: Settlement of Parent tax exposures (20.2) (18.9) Provision for contingencies 7.7 3.4 Prior year tax adjustment (1.5) 0.5 (1.4) Other, net (0.1) 0.9 0.3 =========== =========== ========= Total 33.4 % 23.9 % 18.4 % =========== =========== =========
Excluding the effect of the 1997 and 1996 tax items discussed above, the effective tax rates for 1997 and 1996 were 34.1% and 33.9%, respectively.
Temporary differences which give rise to the deferred tax assets and liabilities as of December 31, 1998 and 1997 are as follows:
The Company files a separate tax return and, therefore, losses incurred by subsidiaries cannot be offset against operating income of the Company. At December 31, 1998, the Company's subsidiaries had approximately $8,193 of net operating loss carryforwards, expiring through the year 2011. The tax benefit of subsidiaries' net operating loss carryforwards, net of a valuation allowance of $0 and $1,809 are included in the deferred tax assets at December 31, 1998 and 1997, respectively.
Effective September 30, 1998, the Company purchased all of its outstanding series of preferred stock, which were owned by the Parent Corporation, for $121,800.
1998 1997 1996 --------------- ------------- ------------- (Unaudited) Net income 225,863 $ 181,312 $ 180,634 Capital and surplus 727,124 759,429 713,324
The Company is an indirect subsidiary of Great-West Lifeco Inc. (Lifeco). Lifeco has a stock option plan (the Lifeco plan) that provides for the granting of options for common shares of Lifeco to certain officers and employees of Lifeco and its subsidiaries, including the Company. Options may be awarded at no less than the market price on the date of the grant. Termination of employment prior to vesting results in forfeiture of the options, unless otherwise determined by a committee that administers the Lifeco plan. As of December 31, 1998, 1997 and 1996, stock available for award under the Lifeco plan aggregated 1,424,400, 3,440,000 and 6,244,000 shares.
The plan provides for the granting of options with varying terms and vesting requirements. The basic options under the plan become exercisable twenty percent per year commencing on the first anniversary of the grant and expire ten years from the date of grant. Options granted in 1997 and 1998 totaling 1,832,000 and 278,000, respectively, become exercisable if certain long-term cumulative financial targets are attained. If exercisable, the exercise period runs from April 1, 2002 to June 26, 2007. Additional options granted in 1998 totaling 380,000 become exercisable if certain sales or financial targets are attained. During 1998, 30,000 of these options vested and accordingly, the Company recognized compensation expense of $116. If exercisable, the exercise period runs from the date that the particular options become exercisable until January 27, 2008.
Of the exercisable Lifeco options, 1,622,424 relate to basic option grants and 30,000 relate to variable grants.
Power Financial Corporation (PFC), which is the parent corporation of Lifeco, has a stock option plan (the PFC plan) that provides for the granting of options for common shares of PFC to key employees of PFC and its affiliates. Prior to the creation of the Lifeco plan in April 1996, certain officers of the Company participated in the PFC plan. Under the PFC plan, options may be awarded at no less than the market price on the date of the grant. Termination of employment prior to vesting results in forfeiture of the options, unless otherwise determined by a committee that administers the PFC plan. As of December 31, 1998, 1997 and 1996, stock available for award under the PFC plan aggregated 4,400,800, 4,400,800 and 5,440,800 shares.
The following table summarizes the status of, and changes in, PFC options outstanding and the weighted-average exercise price (WAEP) for the years ended December 31. As the options granted relate to Canadian stock, the values, which are presented in U.S. dollars, will fluctuate as a result of exchange rate fluctuations:
As of December 31, 1998, the PFC options outstanding have exercise prices between $2.25 and $3.44 and a weighted-average remaining contractual life of 2.99 years.
The Company accounts for stock-based compensation using the intrinsic value method prescribed by APB No. 25, "Accounting for Stock Issued to Employees", under which compensation expenses for stock options are generally not recognized for stock option awards granted at or above fair market value. Had compensation expense for the Company's stock option plan been determined based upon fair values at the grant dates for awards under the plan in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's net income, would have been reduced by $727, $608, and $257, in 1998, 1997, and 1996, respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumption used for those options granted in 1998, 1997, and 1996, respectively: dividend yield of 3.00%, expected volatility of 34.05%, 24.04%, and 15.61%, risk-free interest rates of 4.79%, 4.72%, and 4.67%, and expected lives of 7.5 years.