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, 2011, 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.
The selected consolidated financial information for the years ended December 31, 2011, 2010 and 2009 and at December 31, 2011 and 2010 has been derived in part from the Company’s audited consolidated financial statements included in Item 8. The selected consolidated income statement data for the years ended December 31, 2008 and 2007 and the selected consolidated balance sheet data at December 31, 2009, 2008 and 2007 have been derived in part from the Company’s consolidated financial statements not included elsewhere herein.
During 2011, the Company introduced a single premium universal life (“SPUL”) product as an alternative to the single premium whole life (“SPWL”) product previously offered. The decision to introduce the SPUL product was based on market conditions including prevailing interest rates. SPUL is considered an investment contract while SPWL is considered an insurance contract. Due to the change in product mix sold in 2011, premium income decreased as sales in the SPWL product marketed through banks decreased by $280 million and was replaced by the SPUL product which had deposits of $196 million for the year ended December 31, 2011.
· Valuation of investments in the absence of quoted market values (including derivative financial instruments);
· Accounting for income taxes and the valuation of deferred tax assets.
If an other-than-temporary impairment has occurred, the impairment amount is bifurcated into two components: the amount related to the credit loss and the amount attributed to other factors (referred to as the non-credit portion). The calculation of expected cash flows utilized during the impairment evaluation and bifurcation process is determined using judgment and the best information available to the Company including default rates, credit ratings, collateral characteristics and current levels of subordination.
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 assumptions employed, additional liabilities may be required, resulting in a charge to current period earnings.
The Company sponsors pension and other post retirement benefit plans in various forms covering employees who meet specified eligibility requirements. The obligations and expenses associated with these plans require an extensive use of estimates and assumptions, such as the discount rate, expected rate of return on plan assets, rate of future compensation increases, healthcare cost trend rates, as well as assumptions regarding participant demographics such as rate and age of retirements, withdrawal rates and mortality. Management, in consultation with its independent consulting actuarial firm, determines these assumptions based upon a variety of factors such as historical performance of the plan and its assets, currently available market and industry data and expected benefit payout streams. The assumptions used will differ, and may differ materially, from actual results due to, among other factors, changing market and economic conditions, higher or lower withdrawal rates and changes in participant demographics. These assumptions are subjective in many cases and have an important effect on the Company’s pension and post retirement benefit obligations.
The Company’s effective tax rate is based upon expected income, statutory income tax rates and prudent available tax planning opportunities. In the determination of the Company’s effective income tax rate, management considers judgments regarding its business plans, planning opportunities and expectations about their future outcomes. Certain changes or future events, such as changes in tax legislation and the commencement or completion of tax audits, could have an impact on management’s estimates and the Company’s effective tax rate.
Accounting and tax regulations require that items be included in income tax returns at different times from when they are reflected in financial statements. These timing differences give rise to deferred tax assets and liabilities. A deferred tax liability is recognized for temporary differences that will result in
taxable amounts or nondeductible expenses in future years. A deferred tax asset is recognized for temporary differences that will result in tax deductible amounts or nontaxable income in future years, including loss carryforwards.
The application of GAAP requires management to evaluate the realization of its deferred tax assets. The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. Valuation allowances are established when management determines, based on available information, that it is more likely than not that deferred income tax assets will not be realized. Factors in management’s determination consider the performance of the business including the ability to generate capital gains. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. When making such determination, consideration is given to, among other things, the following:
The following is a summary of certain financial data of the Company for the years ended December 31, 2011 and 2010:
The Company’s consolidated income from continuing operations increased by $9 million, or 4%, to $214 million for the year ended December 31, 2011 when compared to 2010. The increase is primarily due to a decrease in policyholder benefits of $277 million offset partially by a decrease in revenues of $211 million and an increase in expenses of $29 million. Income tax expense has increased by $28 million primarily as a result of an increase of $37 million in income before taxes. Additionally, the Company had a $13 million tax benefit in 2010 related to the closing of Internal Revenue Service (“IRS”) examinations.
Fee income increased by $40 million, or 9%, to $487 million for the year ended December 31, 2011 when compared to 2010. The increase is primarily related to higher variable fee income as a result of higher average account balances due to the performance of the U.S. equities market. The equities market performance is evidenced by the average S&P 500 index which increased by 11% in 2011 as compared to 2010.
Net investment income remained relatively constant, decreasing by $16 million, or 1%, to $1,159 million for the year ended December 31, 2011 when compared to 2010. The decrease is primarily due to an increase in unrealized loss of $18 million on derivatives and held for trading assets offset by an increase in interest income of $2 million.
Net realized investment gains (losses) increased by $48 million from a loss of $24 million during the year ended December 31, 2010 to a gain of $24 million during the year ended December 31, 2011. The $24 million gain in 2011 is due to $38 million of net realized gains on the sale of investments, including dollar rolls, offset by $5 million increase in the allowance for mortgage loan credit losses due to the increase in mortgage loans and $9 million of credit related OTTI losses primarily on fixed maturity investments. The $24 million loss in 2010 is primarily due to $81 million of write-downs primarily on fixed maturity securities guaranteed by Ambac Financial Group, Inc. (“Ambac”) offset by $57 million of net realized gains on the sale of investments.
The Company’s consolidated income from continuing operations increased by $80 million, or 64%, to $205 million for the year ended December 31, 2010 when compared to 2009. The increase is primarily related to a $61 million increase in fee income, an improvement in net interest margins, a $35 million decrease in net realized and unrealized investment losses, net of policyholder related amounts, a $17 million release of future policyholder benefits in the Individual Markets segment and a $8 million increase in earnings of the reinsurance business of the Other segment. These are partially offset by $64 million higher general insurance expenses primarily in the Retirement Services segment.
Premium income increased by $246 million, or 44%, to $806 million for the year ended December 31, 2010 when compared to 2009. This increase is primarily related to a $224 million increase in sales of the SPWL product in the Company’s Individual Markets segment.
Total benefits and expenses increased by $266 million, or 14%, to $2,127 million for the year ended December 31, 2010 when compared to 2009. The increase is primarily attributable to an increase in future policy benefits and expenses of $268 million in the Company’s Individual Markets segment due to increased sales. This increase is offset by a $14 million decrease in benefits and expenses in the reinsurance business of the Other segment.
Income tax expense increased by $30 million, or 71%, to $72 million for the year ended December 31, 2010 when compared to 2009. This increase is primarily due to the $110 million increase in income before income taxes in 2010 when compared to 2009, offset by a $13 million prior year tax benefit recorded in 2010 primarily related to the closing of IRS examinations.
The following is a summary of the Individual Markets segment participant accounts at December 31, 2011 and 2010:
Income from continuing operations for the Individual Markets segment increased by $25 million, or 31%, to $105 million for the year ended December 31, 2011 when compared to 2010. The increase is primarily related to a decrease in benefits and expenses of $312 million partially offset by a decrease in revenues of $266 million. Income tax expense has increased by $21 million primarily as a result of of an increase of $46 million in income before taxes. Additionally, the Company had a $3 million tax benefit in 2010 related to the closing of IRS examinations.
Net realized investment gains (losses) increased by $22 million from a loss of $1 million during the year ended December 31, 2010 to a gain of $21 million during the year ended December 31, 2011. The $21 million gain in 2011 is due to $26 million of net realized gains on the sale of investments offset by $2 million increase in the allowance for mortgage loan credit losses due to the increase in mortgage loans and $3 million of credit related OTTI losses primarily on fixed maturity investments. The $1 million loss in 2010 is due to $34 million of write-downs primarily on fixed maturity securities guaranteed by Ambac offset by $33 million of net realized gains on the sale of investments.
Premium income increased by $248 million, or 58%, to $676 million for the year ended December 31, 2010 when compared to 2009. The increase is primarily related to sales in the SPWL product marketed through banks which increased by $224 million.
Fee income increased by $6 million, or 12%, to $56 million for the year ended December 31, 2010 when compared to 2009. The increase is primarily related to higher fees as a result of higher sales of the business-owned product.
Net investment income increased by $13 million, or 2%, to $731 million for the year ended December 31, 2010 when compared to 2009. The increase is primarily related to increased interest income of $15 million due to higher invested asset balances offset by $2 million higher unrealized losses on derivatives and held for trading assets.
Fee income increased by $30 million, or 8%, to $417 million for the year ended December 31, 2011 when compared to 2010. The increase is primarily related to higher variable fee income as a result of higher average account balances due to the performance of the U.S. equities market. The equities market performance is evidenced by the average S&P 500 index which increased by 11% in 2011 as compared to 2010.
Net investment income remained unchanged at $399 million during the years ended December 31, 2011 and 2010. This is primarily related to increased interest income of $12 million due to higher invested asset balances offset by $12 million higher unrealized losses on derivatives and held for trading assets.
Net realized investment gains (losses) increased by $26 million from a loss of $23 million during the year ended December 31, 2010 to a gain of $3 million during the year ended December 31, 2011. The $3 million gain in 2011 is due to $12 million of net realized gains on the sale of investments offset by a $3 million increase in the allowance for mortgage loan credit losses, due to the increase in mortgage loans and $6 million of credit related OTTI losses primarily on fixed maturity securities. The $23 million loss in 2010 is due to $47 million of write-downs primarily on fixed maturity securities guaranteed by Ambac offset by $24 million of net realized gains on the sale of investments.
Income tax expense increased by $17 million, or 45%, to $55 million during the year ended December 31, 2011 when compared to 2010. The increase is primarily due to a $18 million, or 12% increase in income before income taxes. Additionally, the Company had a $5 million tax benefit in 2010 related to the closing of IRS examinations.
The following table provides information for the Retirement Services’ participant account values at December 31, 2011 and 2010:
Account values invested in the general account fixed investment options have increased by $674 million, or 9%, at December 31, 2011 compared to December 31, 2010 primarily due to new sales.
Account values invested in the proprietary mutual fund investment options have increased by $144 million, or 5%, at December 31, 2011 compared to December 31, 2010. The increase is primarily due to new sales.
Participant account values invested in unaffiliated retail investment options and participant account values where only administrative services and recordkeeping functions are provided have increased by $2,801 million, or 2%, at December 31, 2011 compared to December 31, 2010. The increase is primarily due to new sales.
Income from continuing operations for the Retirement Services segment increased by $42 million, or 55%, to $118 million during the year ended December 31, 2010 when compared to 2009. The increase is primarily related to a $56 million increase in fee income, $17 million lower amortization of DAC and an improvement in net interest margins partially offset by a $46 million increase in general insurance expenses due to increased participants.
Net investment income increased by $16 million, or 4%, to $399 million for the year ended December 31, 2010 when compared to 2009. The increase is due to increased interest income of $15 million due to higher invested asset balances in addition to $1 million higher unrealized gains on derivatives and held for trading assets.
The following table provides information for the Retirement Services’ participant account values at December 31, 2010 and 2009:
Account values invested in the proprietary mutual fund investment options have increased by $1,280 million, or 92 %, at December 31, 2010 compared to December 31, 2009. The increase is primarily due to new sales and an overall increase in the U.S. equity markets.
The Company’s Other reporting segment is substantially comprised of activity of the GWSC operating segment, corporate items not directly allocated to the other operating segments and interest expense on long-term debt. Income (loss) from continuing operations for the Company’s Other segment decreased by $17 million from a gain of $7 million during the year ended December 31, 2010 to a loss of $10 million during the year ended December 31, 2011. The decrease of $17 million is primarily due to an increase in operating expenses of $27 million caused by a $8 million increase in commissions expense at GWSC, a $2 million increase in guarantee fund assessment, an $11 million increase in expenses on strategic initiatives, and a $6 million increase in other operating expenses. This increase in operating expense was partially offset by a decrease in income tax expense of $11 million dollars which is due to the decrease in income before income taxes.
A summary of the Company’s general account investment assets and the assets as a percentage of total general account investments at December 31, 2011 and 2010 follows:
One of the Company’s primary objectives is to ensure that its fixed maturity portfolio is maintained at a high average credit quality to limit credit risk. All securities are internally rated by the Company on a basis intended to be similar to that of the rating agencies. The Company’s internal rating methodology generally takes into account ratings from Standard & Poor’s Ratings Services, Fitch Ratings and Moody’s Investor Services, Inc. In addition, the NAIC implemented a ratings methodology for RMBS, CMBS and other structured securities. The Company may also utilize inputs from this ratings process to develop its internal rating.
The distribution of the Company’s fixed maturity portfolio by the Company’s internal credit rating at December 31, 2011 and 2010 is summarized as follows:
Due to market conditions beginning in 2008 which have continued into 2011, the Company uses internal models to determine fair value for asset-backed securities backed by home improvement loans. Using these models instead of an external source resulted in a decrease to unrealized losses of $24 million and $58 million at December 31, 2011 and 2010, respectively. The internal models utilize asset-backed index spread assumptions versus credit default spread assumptions used by the external pricing source.
All cash collateral related to the securities lending program, repurchase agreements and dollar repurchase agreement practices is invested in U.S. Government or U.S. Government Agency securities. Some cash collateral may be invested in short-term repurchase agreements which are also collateralized by U.S. Government or U.S. Government Agency securities. In addition, the securities lending agent indemnifies the Company against borrower risk, meaning that the lending agent agrees contractually to replace securities not returned due to a borrower default. As of December 31, 2011 and 2010, the Company had $7 million and $51 million, respectively, of securities out on loan and $2 million and $657 million, respectively, in short-term repurchase agreements, all of which are fully collateralized as described above. During the year ended December 31, 2011, the Company had an average balance of dollar repurchase agreements of $742 million while the balance at year end was zero. At December 31, 2010, the Company had $937 million in dollar repurchase agreements. The decrease in dollar repurchase agreements during the year ended December 31, 2011 was due to the Company’s review and management of capital resources. The Company does not enter into these types of transactions for liquidity purposes, but rather for yield enhancement on its investment portfolio.
The weighted average loan-to-value ratio for the Company’s mortgage loans on real estate was 53% at both December 31, 2011 and 2010. The debt service coverage ratio was 2.10 and 2.00 times at December 31, 2011 and 2010, respectively. During the years ended December 31, 2011 and 2010, the Company originated 69 and 29 new loans with aggregate principal balances of $900 million and $347 million, respectively. At origination, the weighted average loan-to-value ratio was 54% and 50% and the debt service coverage ratio was 2.31 and 2.43 times at December 31, 2011 and 2010, respectively.
The Company originates interest only and amortizing commercial mortgage loans. During the years ended December 31, 2011 and 2010, the Company originated mortgage loans structured with an interest only component in the amount of $550 million and $212 million, respectively, compared to a total mortgage loan portfolio at December 31, 2011 and 2010 of $2,513 million and $1,722 million, respectively. The weighted average loan-to-value ratio of the interest only loans originated in 2011 and 2010 was 54% and 48%, respectively.
Generally, the Company has met its operating requirements by utilizing cash flows from operations and maintaining appropriate levels of liquidity in its investment portfolio. Liquidity for the Company has remained strong, as evidenced by the amounts of short-term investments and cash that totaled $340 million and $969 million as of December 31, 2011 and 2010, respectively. In addition, 99% and 98% of the fixed maturity portfolio carried an investment grade rating at December 31, 2011 and 2010, respectively, thereby providing significant liquidity to the Company’s overall investment portfolio.
The Company continues to be well capitalized, with sufficient borrowing capacity. Additionally, the Company expects that our cash on hand and expected net cash generated by operating activities will exceed the anticipated needs of the business over the next 12 months. 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 had $98 million and $92 million of commercial paper outstanding at December 31, 2011 and 2010, respectively. The commercial paper has been given a rating of A-1+ by Standard & Poor’s Ratings Services and a rating of P-1 by Moody’s Investors Service, each being the highest rating available. Through the recent financial market volatility, the Company continued to have the ability to access the capital markets for funds. The loss of this access in the future would not have a significant impact to the Company’s liquidity as the commercial paper is not used to fund daily operations and is an insignificant amount in relation to total invested assets.
The Company also has available a revolving credit facility agreement, which expires on May 26, 2013, in the amount of $50 million for general corporate purposes. The Company had no borrowings under this credit facility during December 31, 2011. The Company does not anticipate the need for borrowings under this facility and the loss of its availability would not significantly impact its liquidity.
The Company maintains a corporate credit facility agreement in the amount of $50 million for general corporate purposes. The Company had no borrowings under the credit facility at either December 31, 2011 or 2010.
The following table summarizes the Company’s major contractual obligations at December 31, 2011:
(1),(2) Future policy benefits and policy and contract claims - The Company has estimated payments to be made to policy and contractholders for future policy benefits. Insurance and investment contract liabilities include various investment-type products with contractually scheduled maturities, including periodic payments of a term certain nature. However, a significant portion of policy benefits and claims to be paid do not have stated contractual maturity dates and ultimately may not result in any payment obligation.
(7) Related party long-term debt interest - One long-term surplus note bears interest at a fixed rate through maturity. The second surplus note bears interest initially at a fixed rate that will change in the future based upon the then current three-month London Interbank Offering Rate. The interest payments shown in this table are calculated based upon the contractual rates in effect on December 31, 2011 and do not consider the impact of future interest rate changes.
(8) Commercial paper - The Company’s obligations under its commercial paper program are short-term in nature. The amounts presented represent the amounts due upon maturity of the instrument. The obligations related to these liabilities are presented in the table above in the less than one year category as presented in the Company’s consolidated balance sheet.
(10) Investment purchase obligations - The Company commits to fund limited partnership interests, mortgage loan and other investments in the normal course of its business. As the timing of the fulfillment of the commitment to fund partnership interests cannot be predicted, such obligations are presented in the less than one year category. The timing of the funding of mortgage loans is based on the expiration date of the commitment.
(12) Other liabilities - Other liabilities include those other liabilities which represent contractual obligations not included elsewhere in the table above. If the timing of the payment of any other liabilities was sufficiently uncertain, the amounts were included in the less than one year category. Other liabilities presented in the table above include:
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, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Certain amounts have been reclassified to conform to current year presentation.
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These accounting principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are required to account for items and matters such as, but not limited to, the valuation of investments in the absence of quoted market values (including derivative financial instruments), impairment of investments, accounting for derivative financial instruments, valuation of policy benefit liabilities, valuation of deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”), accounting for employee benefits plans and accounting for income taxes and the valuation of deferred tax assets. Actual results could differ from those estimates. However, in the opinion of management, these consolidated financial statements include normal recurring adjustments necessary for the fair presentation of the Company’s financial position and the results of its operations.
repurchase the security may be restricted. Amounts owed to brokers under these arrangements are included in repurchase agreements. The liability is collateralized by securities with approximately the same fair value.
7. 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. The Company does not enter into these types of transactions for liquidity purposes, but rather for yield enhancements on its investment portfolio. The borrower can return and the Company can request the loaned securities at any time. The Company maintains ownership of the securities at all times and is entitled to receive from the borrower any payments for interest received on such securities during the loan term. Securities lending transactions are accounted for as collateralized borrowings. The securities lending agent indemnifies the Company against borrower risk, meaning that the lending agent agrees contractually to replace securities not returned due to a borrower default. 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. Such collateral is used to replace the securities loaned in event of default by the borrower. Acceptable collateral is generally defined as government securities, letters of credit and/or cash collateral. Some cash collateral may be invested in short-term repurchase agreements which are also collateralized by U.S. Government or U.S. Government Agency securities.
8. The Company’s other-than-temporary impairments accounting policy requires that a decline in the value of a security below its cost or amortized cost basis be assessed to determine if the decline is other-than-temporary. The assessment of whether an other-than-temporary impairment has occurred on fixed maturity investments where 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.
loss, which is recognized in current period earnings; and the amount attributed to other factors (referred to as the non-credit portion), which is recognized as a separate component in accumulated other comprehensive income (loss). The calculation of expected cash flows utilized during the impairment evaluation process are determined using judgment and the best information available to the Company including default rates, credit ratings, collateral characteristics and current levels of subordination. After the recognition of an other-than-temporary impairment, a fixed maturity investment is accounted for as if it had been purchased on the measurement date of the other-than-temporary impairment, with an amortized cost basis equal to the previous amortized cost basis less the other-than-temporary impairment recognized in earnings. The Company accretes the new cost basis to estimated future value over the remaining life of the security based on the future estimated cash flows by adjusting the security’s yield.
Certain assets and liabilities are recorded at fair value on the Company’s consolidated balance sheets. The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company categorizes its assets and liabilities measured at fair value into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The Company’s assets and liabilities recorded at fair value have been categorized based upon the following fair value hierarchy:
· Level 2 inputs utilize other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. The fair values for some Level 2 securities are obtained from pricing services. The inputs used by the pricing services are reviewed at least quarterly or when the pricing vendor issues updates to its pricing methodology. For fixed maturity securities and separate account assets and liabilities, inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, evaluated bids, offers and reference data including market research publications. Additional inputs utilized for assets and liabilities classified as Level 2 are:
· Derivative instruments - reported trades, swap curves, credit spreads, recovery rates, restructuring, currency volatility, net present value of cash flows and news sources.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. All transfers between levels are recognized at the beginning of the reporting period in which the transfer occurred.
The Company enters into derivative transactions which include the use of interest rate swaps, interest rate swaptions, cross-currency swaps, U.S. government treasury futures contracts, Eurodollar futures contracts, futures on equity indices and interest rate swap futures. The Company uses these derivative instruments to manage various risks, including interest rate and foreign exchange risk associated with its invested assets and liabilities. Derivative instruments are not used for speculative reasons.
The Company controls the credit risk of its derivative contracts through credit approvals, limits, monitoring procedures and in many cases, requiring collateral. The Company’s exposure is limited to the portion of
Certain derivatives in a net asset position have cash pledged as collateral to the Company in accordance with the collateral support agreements with the counterparty. This collateral is held in a custodial account for the benefit of the Company. This unrestricted cash collateral is included in other assets and the obligation to return it is included in other liabilities. The cash collateral is reinvested in a government money market fund. Cash collateral pledged is included in other assets.
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 its estimated useful life. Capitalized internal use software development costs, net of accumulated amortization, in the amounts of $33,021 and $24,196, are included in other assets at December 31, 2011 and 2010, respectively. The Company capitalized $16,676, $9,816 and $8,014 of internal use software development costs during the years ended December 31, 2011, 2010 and 2009, respectively.
DAC, which primarily consists of sales commissions and costs associated with the Company’s sales representatives related to the production of new business or through the acquisition of insurance or annuity contracts through indemnity reinsurance transactions, has been deferred to the extent recoverable. VOBA represents the estimated fair value of insurance or annuity contracts acquired either directly through the acquisition of another insurance company or through the acquisition of insurance or annuity contracts through assumption reinsurance transactions. The recoverability of such costs is dependent upon the future profitability of the related business. DAC and VOBA associated with the annuity products and flexible premium universal life insurance products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits. DAC and VOBA associated with traditional life insurance are amortized over the premium-paying period of the related policies in proportion to premium revenues recognized. DAC and VOBA, for applicable products, are adjusted for the impact of unrealized gains or losses on investments as if these gains or losses had been realized, with corresponding credits or charges included in accumulated other comprehensive income (loss).
Goodwill is the excess of cost over the fair value of assets acquired and liabilities assumed in connection with an acquisition and 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.
Life insurance and annuity future benefits with life contingencies in the amounts of $13,051,532 and $12,395,926 at December 31, 2011 and 2010, 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 benefits without life contingencies in the amounts of $8,727,286 and $7,976,954 at December 31, 2011 and 2010, respectively, are established at the contractholder’s account value.
Participating life and annuity policy benefit liabilities are $6,705,462 and $6,544,238 at December 31, 2011 and 2010, respectively. Participating business comprises approximately 8% and 9% of the Company’s individual life insurance in-force at December 31, 2011 and 2010, respectively, and 19%, 13% and 19% of individual life insurance premium income for the years ended December 31, 2011, 2010 and 2009, respectively. The policyholder’s share of net income on participating policies is excluded from stockholder’s equity and recorded as undistributed earnings on participating business in the consolidated balance sheet.
Life insurance premiums are recognized when due. Annuity contract premiums with life contingencies are recognized as received. Revenues for annuity and other contracts without significant life contingencies consist of contract charges for the cost of insurance and contract administration and surrender fees that have been assessed against the contract account balance during the period and are recognized when earned. Fees from assets under management, which consist of contract maintenance fees, administration fees and mortality and expense risk charges, are recognized when due. Benefits and expenses on policies with life contingencies are associated with earned premiums so as to result in recognition of profits over the life of the contracts. Premiums and policyholder benefits and expenses are presented net of reinsurance.
Lifeco maintains the Great-West Lifeco Inc. Stock Option Plan (the “Lifeco plan”) that provides for the granting of options on its common shares to certain of its officers and employees and those of its subsidiaries, including the Company. The Company uses the fair value method to recognize the cost of share-based employee compensation under the Lifeco plan.
In April 2010, the FASB issued ASU No. 2010-15 “How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments” (“ASU No. 2010-15”). ASU No. 2010-15 clarifies that an insurance company should not consider any separate account interests in an investment held for the benefit of policyholders to be its interests and that those interests should not be combined with interests of its general account in the same investment when assessing the investment for consolidation. ASU No. 2010-15 also provides that an insurance company is required to consider a separate account as a subsidiary for purposes of evaluating whether the retention of specialized accounting for investments in consolidation is appropriate. ASU No. 2010-15 is effective for fiscal years beginning after December 15, 2010. The Company adopted ASU No. 2010-15 for its fiscal year beginning on January 1, 2011. The adoption of ASU No. 2010-15 did not have an impact on the Company’s consolidated financial position or the results of its operations.
In July 2010, the FASB issued ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU No. 2010-20”). ASU No. 2010-20 provides for entities to disclose credit quality indicators, aging of past due amounts, the nature and extent of troubled debt restructurings, modifications as a result of troubled debt restructurings and significant sales or purchases, by disaggregated class, for its financing receivables. ASU No. 2010-20 is effective for fiscal periods ending after December 15, 2010. The Company adopted ASU No. 2010-20 for its fiscal year ended December 31, 2010. The provisions of ASU No. 2010-20 related to troubled debt restructurings have been clarified in ASU No. 2011-02, see below. The provisions of ASU No. 2010-20 relate only to financial statement disclosures regarding financing receivables and, accordingly, its adoption did not have an impact on the Company’s consolidated financial position or the results of its operations.
In April 2011, the FASB issued ASU No. 2011-02 “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU No. 2011-02”). ASU No. 2011-02 clarifies and defines the criteria to be met in a debt modification in order to be considered a troubled debt restructuring. It also clarifies whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructures. ASU No. 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011 with early adoption permitted and is to be applied retrospectively to the beginning of the annual period of adoption. The Company adopted ASU No. 2011-02 for its fiscal period ended September 30, 2011. The provisions of ASU No. 2011-02 related only to financial statement disclosure and, accordingly, did not have an impact on the Company’s consolidated financial position or the results of operations.
In May 2011, the FASB issued ASU No. 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU No. 2011-04”). ASU No. 2011-04 does not extend the use of the existing concepts or guidance regarding fair value. It results in common fair value measurements and disclosures between accounting principles generally accepted in the United States and those of International Financial Reporting Standards. ASU No. 2011-04 expands disclosure requirements for Level 3 inputs to include a quantitative description of the unobservable inputs used, a description of the valuation process used and a qualitative description about the sensitivity of the fair value measurements. ASU No. 2011-04 is effective for interim or annual periods beginning on or after December 15, 2011. The Company will adopt ASU No. 2011-04 for its fiscal year beginning January 1, 2012. The adoption of ASU No. 2011-04 will not have an impact on the Company’s consolidated financial position or the results of operations.
The Company provides administrative and operational services for the United States operations of The Great-West Life Assurance Company (“GWL”) and the United States operations of The Canada Life Assurance Company (“CLAC”), wholly-owned subsidiaries of Lifeco. The Company also provides investment services for London Reinsurance Group, an indirect subsidiary of GWL. The following table presents revenue and expense reimbursement from related parties for services provided pursuant to these service agreements for the years ended December 31, 2011, 2010 and 2009. These amounts, in accordance with the terms of the various contracts, are based upon estimated costs incurred, including a profit charge, and resources expended based upon the number of policies, certificates in-force and/or administered assets.
Interest expense attributable to these related party debt obligations was $37,163 for the year ended December 31, 2011 and $37,042 for each of the years ended December 31, 2010 and 2009. Included in other liabilities on the consolidated balance sheets at December 31, 2011 and 2010 is $4,701 of interest payable attributable to these related party debt obligations.
The Company’s wholly owned subsidiary, Great-West Life & Annuity Insurance Company of South Carolina (“GWSC”) and CLAC are parties to a reinsurance agreement pursuant to which GWSC assumes term life insurance from CLAC. GWL&A Financial obtained two letters of credit for the benefit of the Company as collateral under the GWSC and CLAC reinsurance agreement for policy liabilities and capital support. The first letter of credit is for $1,128,500 and renews annually until it expires on December 31, 2025. The second letter of credit is for $70,000 and renews annually for an indefinite period of time. At December 31, 2011 and 2010 there were no outstanding amounts related to the letters of credit.
The following tables summarize fixed maturity investments classified as available-for-sale and the amount of other-than-temporary impairments (“OTTI”) classified as the non-credit-related component of previously impaired fixed maturity investments that the Company does not intend to sell included in accumulated other comprehensive income (loss) (“AOCI”) at December 31, 2011 and 2010:
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 for asset-backed securities was in an unrealized gain position of $23,837 at December 31, 2011 due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.
Indicates the amount of any OTTI (gain) loss included in AOCI that is included in gross unrealized gains and losses.
Mortgage-backed (commercial and residential) and asset-backed securities, including those issued by U.S. government and U.S. agencies, include collateralized mortgage obligations that consist primarily of sequential and planned amortization classes with legal final stated maturities of up to thirty years and expected average lives of up to fifteen years.
The Company has a corporate fixed maturity security with a fair value of $9,949 and $8,845 that has been non-income producing for the twelve months preceding December 31, 2011 and 2010, respectively. This security was written down to its fair value in the period it was deemed to be other-than-temporarily impaired.
Of the total principal balance in the mortgage loan portfolio, $2,067 and $8,470 related to impaired loans at December 31, 2011 and 2010, respectively. The decrease in the impaired loans balance was due to four loans that were foreclosed upon and one loan that was paid in full offset by one loan that was deemed non-performing during the year ended December 31, 2011.
The following table summarizes the recorded investment of the mortgage loan portfolio by risk assessment category as of December 31, 2011 and 2010:
Limited partnership and other corporation interests - The Company invests in limited partnership interests, which include limited partnerships established for the purpose of investing in low-income housing that qualify for federal and state tax credits, and other corporation interests. At December 31, 2011 and 2010, the Company had $169,233 and $210,146, respectively, invested in limited partnership and other corporation interests.
The Company has determined its 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.
The Company participates in a securities lending program whereby securities are loaned to third parties. Securities with a cost or amortized cost in the amounts of $7,266 and $45,000 and estimated fair values in the amounts of $6,823 and $50,807 were on loan under the program at December 31, 2011 and 2010, respectively. The Company received restricted cash collateral in the amounts of $7,099 and $51,749 at December 31, 2011 and 2010, respectively.
Fixed maturity investments - Total unrealized losses and other-than-temporary impairment losses decreased by $73,343, or 20%, from December 31, 2010 to December 31, 2011. This decrease in unrealized losses was across most asset classes and reflects recovery in market liquidity and lower interest rates, although the economic uncertainty in certain asset classes still remains.
Unrealized losses on corporate debt securities increased by $9,773 from December 31, 2010 to December 31, 2011. The valuation of these securities has been influenced by market conditions with widening credit spreads in the finance sector resulting in generally lower valuations of these fixed income securities. The finance sector accounts for 91% of the corporate debt securities unrealized loss at December 31, 2011.
Other-than-temporary impairment recognition - The Company recorded other-than-temporary impairments on fixed maturity investments for the years ended December 31, 2011, 2010 and 2009 as follows:
The other-than-temporary impairments of 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:
The following table summarizes net investment income for the years ended December 31, 2011, 2010 and 2009:
Included in net investment income and realized investment gains (losses) are amounts allocable to the participating fund account. This allocation is based upon the activity in a specific block of investments that are segmented for the benefit of the participating fund account. The amounts of net investment income allocated to the participating fund account were $4,095, $4,481 and $4,799 for the years ended December 31, 2011, 2010 and 2009, respectively. The amounts of realized investment gains (losses) allocated to the participating fund account were $279, $438 and $234 for the years ended December 31, 2011, 2010 and 2009, respectively.
Derivative transactions, excluding cross-currency swaps, are entered into pursuant to master agreements and other contracts that provide for a single net payment to be made by one party to the other on a daily basis, periodic payment dates, or at the due date, expiration or termination of the agreement.
The Company holds $11,985 and $7,790 of unrestricted cash collateral from derivative counterparties to satisfy collateral netting agreements at December 31, 2011 and 2010, respectively. For a complete discussion of the Company’s policy surrounding derivative collateral, refer to Note 1, Organization and Significant Accounting Policies.
(1) The estimated fair value of all derivatives in an asset position are reported within other assets and the estimated fair value of all derivatives in a liability position are reported within other liabilities in the consolidated balance sheets.
(1) The estimated fair value of all derivatives in an asset position are reported within other assets and the
estimated fair value of all derivatives in a liability position are reported within other liabilities in the consolidated balance sheets.
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. Notional amounts are not paid or received.
The Company had 143 and 117 swap transactions with an average notional amount of $16,361 and $19,745 during the years ended December 31, 2011 and 2010, respectively. The Company added one cross-currency swap during the year ended December 31, 2011. The Company had 1,678 and 979 futures transactions with an average number of contracts per transaction of 18 and 26 during the years ended December 31, 2011 and 2010, respectively. The Company had 44 swaption transactions with an average notional amount of $5,986 during the year ended December 31, 2011. During the year ended December 31, 2010, the Company had three swaptions expire.
· The net decrease of $486,837 in interest rate swaps, interest rate futures and interest rate swaptions was primarily the result of a decrease in interest rates.
· The increase of $39,030 in cross-currency swaps was due to a new swap added to hedge a floating rate British pound asset.
The following tables present the effect of derivative instruments in the consolidated statement of income for the years ended December 31, 2011, 2010 and 2009 reported by cash flow hedges, fair value hedges and economic hedges:
(B) Income statement location: Realized investment gains (losses), net. Represents realized gains (losses) on closed positions.
(1) Hedge ineffectiveness of $(2,128), $1,517 and $215 for the years ended December 31, 2011, 2010 and 2009 respectively, was recognized.
The following tables summarize the carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2011 and 2010:
The policy loans accrue interest at variable rates which approximate current market interest rates. Additionally, policy loans are fully collateralized by the cash surrender value of the underlying insurance policy. Given the absence of borrower credit risk and the short time period between interest rate resets, carrying value approximates fair value.
Other investments include the Company’s percentage ownership of foreclosed lease interests in aircraft. The estimated fair value is based on the present value of anticipated lease payments plus the residual value of the aircraft. Real estate held for investments is also included in other investments. The estimated fair value for real estate is based on appraised value.
Included in other assets and other liabilities is cash collateral received from derivative counterparties and the obligation to return the cash collateral to the counterparties. The amortized cost of the collateral is a reasonable estimate of fair value.
Included in other assets and other liabilities are derivative financial instruments. The estimated fair values of OTC derivatives, primarily consisting of interest rate swaps and interest rate swaptions which are held for other than trading purposes, 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, counterparty credit risk and other relevant factors.
Separate account assets 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.
The following tables present the Company’s financial assets and liabilities carried at fair value on a recurring basis by fair value hierarchy category as of December 31, 2011 and 2010:
Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. The failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 2011 and 2010, the reinsurance receivables had carrying values in the amounts of $616,336 and $594,997, respectively. Included in these amounts are $502,093 and $483,564 at December 31, 2011 and 2010, respectively, associated with reinsurance agreements with related parties. At December 31, 2011 and 2010, 81% and 73%, respectively, of the total reinsurance receivable was due from CLAC, a related party.
The following table summarizes activity in DAC and VOBA for the years ended December 31, 2011, 2010 and 2009:
The estimated future amortization of VOBA for the years ended December 31, 2012 through December 31, 2016 is approximately $4,000 per annum.
The following tables summarize other intangible assets, all of which are within the Retirement Services segment, as of December 31, 2011 and 2010:
At December 31, 2011 and 2010, the Company had 50,000,000 shares of $1 par value preferred stock authorized, none of which were issued or outstanding at either date. In addition, the Company has 50,000,000 shares of $1 par value common stock authorized, 7,032,000 of which were issued and outstanding at both December 31, 2011 and 2010.
GWLA’s net income and capital and surplus, as determined in accordance with statutory accounting principles and practices as prescribed by the National Association of Insurance Commissioners, for the years ended December 31, 2011, 2010 and 2009 are as follows:
(3) As filed in an amended filing with the Colorado Division of Insurance
Dividends are paid as determined by the Board of Directors, subject to restrictions as discussed below. During the years ended December 31, 2011, 2010 and 2009, the Company paid dividends in the amounts of $206,353, $160,917 and $24,682, respectively, to its parent company, GWL&A Financial.
The following tables present the composition of other comprehensive income (loss) for the years ended December 31, 2011, 2010 and 2009:
The Company has a noncontributory Defined Benefit Pension Plan covering substantially all of its employees that were hired before January 1, 1999. Pension benefits are based principally on an employee’s years of service and compensation levels near retirement. The Company’s policy for funding the defined benefit pension plans is to make annual contributions, which equal or exceed regulatory requirements.
The following table provides information regarding amounts in accumulated other comprehensive income (loss) that have not yet been recognized as components of net periodic benefit cost at December 31, 2011:
The following tables present the weighted average interest rate assumptions used in determining benefit obligations of the Defined Benefit Pension, Post-Retirement Medical and the Supplemental Executive Retirement plans at December 31, 2011 and 2010:
The following tables present the weighted average interest rate assumptions used in determining the net periodic benefit/cost of the Defined Benefit Pension, Post-Retirement Medical and the Supplemental Executive Retirement plans for the years ended December 31, 2011 and 2010:
The following table presents how the Company’s Defined Benefit Pension Plan assets are invested at December 31, 2011 and 2010:
The following tables present information about the Defined Benefit Retirement Plan’s assets measured at fair value on a recurring basis as of December 31, 2011 and 2010 and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value:
The following tables present additional information at December 31, 2011 and 2010 about assets of the Defined Benefit Retirement Plan measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:
Management estimates the value of these investments will be recoverable. The Company does not expect any plan assets to be returned to it during the year ended December 31, 2012. The Company expects to make payments of approximately $650 with respect to its Post-Retirement Medical Plan and $3,611 with respect to its Supplemental Executive Retirement Plan during the year ended December 31, 2012. The Company will make a contribution at least equal to the minimum contribution of $22,000 to its Defined Benefit Pension Plan during the year ended December 31, 2012.
The Company has an executive deferred compensation plan providing key executives with the opportunity to participate in an unfunded deferred compensation program. Under the program, participants may defer base compensation and bonuses and earn interest on the amounts deferred. The program is not qualified under Section 401 of the Internal Revenue Code. Participant balances, which are reflected in other liabilities in the accompanying consolidated balance sheets, are $13,330 and $14,139 at December 31, 2011 and 2010, respectively. The participant deferrals earned interest at the average rates of 6.72% and 7.55% during the years ended December 31, 2011 and 2010, respectively. The interest rate is based on the Moody’s Average Annual Corporate Bond Index rate plus 0.45% for actively employed participants and fixed rates ranging from 6.37% to 7.91% for retired participants.
Amounts presented for investment assets above include ($264,078) and ($145,517) related to the net unrealized losses (gains) on the Company’s investments, which are classified as available-for-sale at December 31, 2011 and 2010, respectively.
Included in due from parent and affiliates at December 31, 2011 and 2010 is $115,300 and $199,884, 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, 2011 and 2010 is $9,019 and $10,311, respectively, of income taxes receivable in other assets primarily related to the separate state income tax returns filed by certain subsidiaries.
The following table summarizes the status of, and changes in, the Lifeco plan options granted to Company employees which are outstanding at December 31, 2011. The options granted relate to underlying stock traded in Canadian dollars on the Toronto Stock Exchange, therefore, the amounts, which are presented in United States dollars, will fluctuate as a result of exchange rate fluctuations.
(1) The aggregate intrinsic value is calculated as the difference between the market price of Lifeco common shares on December 31, 2011 and the exercise price of the option (only if the result is positive) multiplied by the number of options.
The following table summarizes the Company’s estimated future contractual obligations as of December 31, 2011:
(2) Related party long-term debt interest - One long-term surplus note bears interest at a fixed rate through maturity. The second surplus note bears interest initially at a fixed rate that will change in the future based upon the then current three-month London Interbank Offering Rate. The interest payments shown in this table are calculated based upon the contractual rates in effect on December 31, 2011 and do not consider the impact of future interest rate changes.
(3) Investment purchase obligations - The Company commits to fund limited partnership interests, mortgage loan and other investments in the normal course of its business. As the timing of the fulfillment of the commitment to fund partnership interests cannot be predicted, such obligations are presented in the less than one year category. The timing of the funding of mortgage loans is based on the expiration date of the commitment.
(4) 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 incurred rent expense, net of sublease income, of $5,645, $6,047 and $6,767 for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company has a revolving credit facility agreement in the amount of $50,000 for general corporate purposes. The credit facility matures on May 26, 2013. Interest accrues at a rate dependent on various conditions and terms of borrowings. The agreement requires, among other things, the Company to maintain a minimum adjusted net worth, as defined, of $1,000,000 plus 50% of its net income, if positive and as defined in the credit facility agreement (both compiled on the unconsolidated statutory accounting basis prescribed by the National Association of Insurance Commissioners), for each quarter ending after March 31, 2010. The Company was in compliance with all covenants at December 31, 2011 or 2010.
The Company makes commitments to fund partnership interests and mortgage loans on real estate and other investments in the normal course of its business. The amounts of these unfunded commitments at December 31, 2011 and 2010 were $97,694 and $95,688, respectively, all of which is due within one year from the dates indicated.