The Head Office of the Company consists of a 752,000 square foot office complex located in Greenwood Village, Colorado. The office complex is owned by a subsidiary of the Company. The Company leases sales and claims offices throughout the United States.
The Company's 1999 and 1997 consolidated net income increased by $8.3 million and $21.1 million, respectively, due to changes in income tax provisions for these years. The current income tax provisions were decreased by $17.2 million and $42.2 million for 1999 and 1997, 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.
Of the amount released in 1999 and 1997, $8.9 million and $15.1 million, respectively, was attributable to participating policyholders and, therefore, had no effect on the net income of the Company.
In addition to the contingent tax liability release described above, the Company's income tax provision for 1997 also reflected an increase for additional contingent items related to open tax years where it was determined to be probable that additional tax liabilities could be owed based on changes in facts and circumstances. The increase in 1997 was $16.0 million, of which $10.1 million was attributable to participating policyholders and, therefore, had no effect on the net income of the Company.
The increased premium income in 1999 was comprised of growth in Employee Benefits premium income of $243.5 million, offset by a decrease in Financial Services premium income of $75.2 million. The growth in premium income in the Employee Benefits segment primarily reflected an increase of $205.9 million of premium income derived from Alta Health & Life Insurance Company ("Alta"), formerly known as Anthem Health & Life Insurance Company, which the Company acquired in July 1998 (see Other Matters). The decrease of $75.2 million in Financial Services premium income was due primarily to reinsurance transactions in 1998 of $46.2 million. There were no significant reinsurance transactions in 1999. 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 Alta. The decrease of $120.2 million in Financial Services premium income was primarily due to reinsurance transactions in 1997 of $155.8 million versus only $46.2 million in premiums due to reinsurance transactions in 1998.
Income tax expense decreased $15.6 million or 16% in 1999 when compared to the year ended December 31, 1998, which reflects a net $17.2 million release of contingent tax liabilities relating to prior open tax years, as discussed above. Income tax expense increased $49.0 million or 98% in 1998 when compared to the year ended December 31, 1997. The increase in income tax expense from 1997 to 1998 reflected higher earnings in 1998, as well as the fact that the 1997 income tax provision included a net $26.2 release 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 2% and 30% in 1999 and 1998, respectively. See Note 10 to the Consolidated Financial Statements for a discussion of the Company's effective tax rates.
Self-funded premium equivalents increased $372.7 million or 14% in 1999 when compared to the year ended December 31, 1998. The increase in 1999 was primarily due to an increase in self-funded premium equivalents from Alta of $155.2 million, with the remainder coming from the growth in business. Self-funded premium equivalents increased $567.1 million or 28% in 1998 when compared to the year ended December 31, 1997. Approximately half of the 1998 increase ($281.3 million) was due to the acquisition of Alta, with the remainder coming from sales growth.
Effective January 1, 2000, the Company coinsured the majority of General American Life Insurance Company's ("General American") group life and health insurance business, which primarily consists of administrative services only and stop loss policies. This added over 900,000 medical members representing approximately $1.7 billion of premium and premium equivalents. The agreement will convert to an assumption reinsurance agreement by January 1, 2001, subject to regulatory approval. On January 1, 2000, the Company assumed approximately $150 million of policy reserves and miscellaneous liabilities in exchange for an equal amount of cash and other assets from General American.
On October 6, 1999, the Company entered into an agreement with Allmerica Financial Corporation ("Allmerica") to acquire Allmerica's group life and health insurance business on March 1, 2000. This acquisition is anticipated to add 300,000 medical members and approximately $800 million of premium and premium equivalents. This business primarily consists of administrative services only and stop loss policies. The in-force business is expected to be underwritten and retained by the Company upon each policy renewal date. The purchase price is based on a percentage of the premium and administrative fees in force at March 1, 2000 and March 1, 2001.
401(k) premiums and deposits for 1999 and 1998 increased 11% and 14%, respectively, as the result of higher recurring deposits from existing customers and new sales. Assets under administration (including third-party administration) in 401(k) increased 26% over 1998 to $8.5 billion and 26% from 1997 to 1998, primarily due to strong equity markets. Equivalent premium revenue and fee income for group life and health increased 19% from 1998 levels as the result of a combination of price increases and the Alta acquisition. From 1997 to 1998, equivalent premium revenue and fee income had increased 32% as a result of a combination of increased sales and the Alta acquisition.
The Company experienced a 6% decrease in total health care membership from 2,266,700 at the end of 1998 to 2,130,400 at year-end 1999 as the result of certain large case terminations. Gatekeeper (i.e., POS and HMO) members grew 5% from 522,300 in 1998 to 549,900 in 1999. The Company expects this segment of the business to grow as additional HMO licenses are obtained and additional Alta members are converted.
Delivering cost-effective, value-added services via the Internet will continue to be a focus for the Company. The Company has already introduced online enrollment capability for 401(k) participants, and later in 2000 it will introduce the same capability for life and health members. In addition, the Company has signed an agreement with an online investment advisor to provide 401(k) participants with personal investment advice via the Internet. This action, combined with a very competitive product portfolio should result in an increase in new case sales.
Fee income related to savings products increased $10.3 million or 15%, from $71.0 million in 1998 to $81.3 million in 1999. Fee income increased $8.6 million or 14%, from $62.4 million in 1997 to $71.0 million in 1998. The growth in fee income in 1999 and 1998 was the result of new sales and increased fees on variable funds related to growth in equity markets.
Customer demand for investment diversification continued to grow during 1999. New contributions to variable business represented 64% of the total 1999 premiums versus 63% in 1998. The Company continues to expand the investment products available through Maxim Series Fund, Inc., and through partnership arrangements with external fund managers. Externally-managed funds offered to participants in 1999 included American Century, Ariel, Fidelity, Founders, INVESCO, Janus, Loomis Sayles, Templeton, T. Rowe Price and Vista.
During 2000, the Company expects to continue its growth of the third party administration business through FASCorp. The savings business will continue to improve customer service and, at the same time, lower unit costs through the use of Internet services.
The Company's real estate portfolio is composed primarily of the Head Office property ($91.1 million) and properties acquired through the foreclosure of troubled mortgages ($10.1 million). The Company operates a wholly-owned real estate subsidiary, which attempts to maximize the value of these properties through rehabilitation, leasing and sale. The Company added a third tower to its Head Office complex during the first quarter of 2000.
The Company uses certain derivatives, such as futures, options and swaps, for purposes of hedging interest rate and foreign exchange risk. These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, when used for hedging, these instruments typically reduce risk. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures. The Company has also developed controls within its operations to ensure that only Board authorized transactions are executed. Note 6 to the Consolidated Financial Statements contains a summary of the Company's outstanding financial hedging derivatives.
We have audited the accompanying consolidated balance sheets of Great-West Life & Annuity Insurance Company (an indirect wholly-owned subsidiary of The Great-West Life Assurance Company) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
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, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997 (Amounts in Thousands, except Share Amounts) ===============================================================================
Fixed maturities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the net unrealized gains and losses reported as accumulated other comprehensive income (loss) in stockholder's equity. The net unrealized gains and losses on derivative financial instruments used to hedge available-for-sale securities are also included in other comprehensive income (loss).
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 $43,512, $51,724, and $44,298 in 1999, 1998, and 1997, respectively.
Life Insurance and Annuity Reserves - Life insurance and annuity policy reserves with life contingencies of $7,169,885 and $6,866,478 at December 31, 1999 and 1998, 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 $4,468,685 and $4,908,964 at December 31, 1999 and 1998, respectively, are established at the contractholder's account value.
Repurchase Agreements and Securities Lending - The Company enters into repurchase agreements with third-party broker/dealers in which the Company sells securities and agrees to repurchase substantially similar securities at a specified date and price. Such agreements are accounted for as collateralized borrowings. Interest expense on repurchase agreements is recorded at the coupon interest rate on the underlying securities. The repurchase fee received or paid is amortized over the term of the related agreement and recognized as an adjustment to investment income.
Although derivative financial instruments taken alone may expose the Company to varying degrees of market and credit risk when used solely for hedging purposes, these instruments typically reduce overall market and interest rate risk. The Company controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures. As the Company generally enters into transactions only with high quality institutions, no losses associated with non-performance on derivative financial instruments have occurred or are expected to occur.
Stock Options - The Company applies the intrinsic value measurement approach under APB Opinion No. 25 to stock-based compensation awards to employees.
On July 8, 1998, the Company paid $82,669 in cash to acquire all of the outstanding shares of Alta Health & Life Insurance Company (Alta), formerly known as Anthem Health & Life Insurance Company. The purchase price was based on Alta's adjusted book value, and was subject to further minor adjustments. The results of Alta's operations, which had an insignificant effect on net income in 1998, have been combined with those of the Company since the date of acquisition.
In connection with this transaction, the Parent Corporation made a capital contribution of $3,200 to the Company.
In connection with this transaction, the Parent Corporation made a capital contribution of $11,000 to the Company.
Effective January 1, 1997, all employees of the U.S. operations of the Parent Corporation and the related benefit plans were transferred to the Company. All related employee benefit plan assets and liabilities were also transferred to the Company (see Note 9). The transfer did not have a material effect on the Company's operating expenses as the actual costs associated with the employees and the benefit plans were charged previously to the Company under administrative service agreements between the Company and the Parent Corporation.
Interest expense attributable to these related party obligations was $11,053, $9,891, and $9,758 for the years ended December 31, 1999, 1998 and 1997, respectively.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. 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, 1999 and 1998, the reinsurance receivable had a carrying value of $173,322 and $192,958, respectively.
Mortgage loans fair value estimates generally are based on discounted cash flows. A discount rate "matrix" is incorporated whereby the discount rate used in valuing a specific mortgage generally corresponds to that mortgage's remaining term. The rates selected for inclusion in the discount rate "matrix" reflect rates that the Company would quote if placing loans representative in size and quality to those currently in the portfolio.
The estimated fair value of due to Parent Corporation is based on discounted cash flows at current market rates on high quality investments.
The carrying amounts for receivables and liabilities reported in the balance sheet approximate fair value due to their short term nature.
Temporary differences which give rise to the deferred tax assets and liabilities as of December 31, 1999 and 1998 are as follows:
The Company's valuation allowance was increased (decreased) in 1999, 1998, and 1997 by $(17), $(1,792), and $34, respectively, as a result of the re-evaluation by management of future estimated taxable income in its subsidiaries.
1999 1998 1997 -------------- --------------- --------------- (Unaudited) Net income 253,123 $ 225,863 $ 181,312 Capital and surplus 1,007,245 727,124 759,429
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 $1,039, $727, and $608, in 1999, 1998, and 1997, 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 assumptions used for those options granted in 1999, 1998, and 1997, respectively: dividend yields of 3.63%, 3.0% and 3.0%, expected volatility of 32.4%, 34.05%, and 24.04%, risk-free interest rates of 6.65%, 4.79%, and 4.72%, and expected lives of 7.5 years.
The Company has two reportable segments: Employee Benefits and Financial Services. The Employee Benefits segment markets group life and health and 401(k) products to small and mid-sized corporate employers. The Financial Services segment markets and administers savings products to public and not-for-profit employers and individuals and offers life insurance products to individuals and businesses.