The following is a summary of certain consolidated financial information for the Company. This summary has been derived in part from, and should be read in conjunction with, the Company's audited consolidated financial statements for the years indicated and Item 1, Part B, regarding the acquisition of CLICA and CLINY and the reinsurance agreement with CLAC. Note 1 to the consolidated financial statements discusses the significant accounting policies of the Company. Significant estimates are required to account for policy reserves, allowances for credit losses, deferred policy acquisition costs and valuation of privately placed fixed maturities. Actual results could differ from those estimates.
This Form 10-K contains forward-looking statements. Forward-looking statements are statements not based on historical information and that relate to future operations, strategies, financial results, or other developments. In particular, statements using verbs such as "expected," "anticipate," "believe," or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements that represent the Company's beliefs concerning future or projected levels of sales of its products, investment spreads or yields, or the earnings or profitability of the Company's activities. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates, some of which may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation and others of which may relate to the Company specifically, such as credit, volatility and other risks associated with its investment portfolio and other factors. Readers are also directed to consider other matters, including any risks and uncertainties, discussed in documents filed by the Company and certain of its subsidiaries with the SEC. This discussion should be read in conjunction with the Company's consolidated financial statements included in Item 8.
Management's discussion and analysis of financial condition and results of operations of the Company for the three years ended December 31, 2004 follows. This management discussion and analysis should be read in conjunction with the financial data contained in Item 6, Selected Financial Data, and in Item 8, Financial Statements and Supplementary Data.
In assessing the performance of the Great-West Healthcare segment, management considers its profitability and the level of membership (number of individuals covered under health contracts with employers) to be its primary points of focus. Increased membership is expected to improve the Company's ability to obtain health care provider network discounts, which will enable it to enhance pricing competitiveness and earnings.
In assessing the performance of the Financial Services segment, management considers the ability to continue to expand its presence in the United States defined contribution and institutional insurance markets to be its primary points of focus. The life insurance, savings and investments marketplace is also highly competitive. Competitors include mutual fund companies, insurance companies, banks, investment advisors and certain service and professional organizations.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company's management to make a significant variety of estimates and assumptions. These estimates and assumptions affect, among other things, the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results can differ from the amounts previously estimated, which were based on the information available at the time the estimates were made.
Life Insurance and Annuity Reserves - The Company's liability for contract and policy benefits is the largest liability included in its consolidated balance sheets. They represented 54.1% and 56.7% of total liabilities at December 31, 2004 and 2003, respectively. Life insurance and annuity policy reserves with life contingencies are computed on the basis of estimated mortality, investment yield, withdrawals, future maintenance and settlement expenses and retrospective experience rating premium refunds. If actual experience is different than estimated, adjustments to such reserves may be required. Annuity contract reserves without life contingencies are established at the contractholder's account value.
Reinsurance - The Company enters into reinsurance transactions as both a provider and a purchaser of reinsurance. Policy reserves ceded to other insurance companies are carried as reinsurance receivable on the Company's consolidated balance sheets. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations under these contracts 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 defaults. In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The Company retains a maximum of $3.5 million of coverage per individual life.
The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on amounts receivable related to uninsured accident and health plan claims paid on behalf of policyholders, premiums in course of collection and to absorb credit losses on its impaired mortgage loans. Management's judgment is based on past loss experience and current and projected economic conditions and, as relates to mortgages, extensive situational analysis of each individual loan. The measurement of impaired loans is based on the fair value of the collateral. Because receivables from policyholders are not subject to concentration in individual companies, general economic trends and the Company's operating practices can impact the adequacy of allowances for such receivables. Individual mortgage and related collateral characteristics have a more pronounced impact on the ultimate adequacy of the allowance for mortgage loans.
Policy acquisition costs, which primarily consist of sales commissions and costs associated with the Company's sales representatives related to the production of new business, have been deferred to the extent recoverable. The recoverability of such costs is dependent upon the future profitability of the related business. Deferred costs associated with 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, which can be affected by such factors as investment yield, realized investment gains and losses, and policyholder retention. Deferred costs associated with traditional life insurance are amortized over the premium-paying period of the related policies in proportion to premium revenues recognized.
The Company's consolidated net income increased $8 million or 2.5% to $326 million for the year ended December 31, 2004 from $318 million in 2003. The net income increase reflects a $32 million increase from the Financial Services segment, partially offset by a decrease of $24 million from the Great-West Healthcare segment. The Great-West Healthcare segment experienced a combination of weaker morbidity results primarily from lower customer deficit recoveries and a decrease in premium income, partially offset by an increase in fee income. The Financial Services segment increase reflected higher fee income and improved margins on invested assets. In addition, the Financial Services segment included the results of CLFC businesses for twelve months in the year ended December 31, 2004, compared with less than six months in 2003.
In the year ended December 31, 2004, total revenues decreased $1.5 billion or 37.4% to $2.6 billion when compared to the year ended December 31, 2003. The decrease in revenues in 2004 was primarily the result of the effect of the one-time increase of $1,427 million to premium revenue in 2003 related to the CLAC Indemnity Reinsurance Agreement. Also, the group life and health portion of this reinsurance agreement was recaptured by CLAC on February 29, 2004, as previously discussed. The Company recorded an income statement impact of $256 million of negative premium income and change in reserves associated with these policies.
Fee income is derived from the management of separate account assets, the administration of group health administrative services only business and third party administration fees. Fee income in 2004 was comprised of Great-West Healthcare fee income and Financial Services fee income of $649 million and $267 million, increases of 6.9% and 14.5%, respectively, when compared to 2003. Administrative fees also include the impact of increased pharmacy benefit management revenue due to higher utilization combined with favorable contract amendments.
Net investment income increased by $45 million to $1,033 million during the year ended December 31, 2004 when compared to 2003. The increase was primarily the result of the inclusion of CLFC's business for twelve months for the year ended December 31, 2004 compared with less than six months in 2003. This increase was partially offset by generally lower interest rates and the impact of the change in the embedded derivative on CLFC funds withheld which decreased investment income by $27.4 million in 2004 compared to 2003.
Benefit expenses include amounts paid or credited to policyholders, changes in policy liabilities, claims, surrenders and annuity and maturity payments. Total benefits decreased $1.5 billion or 57.7% in the year ended December 31, 2004 when compared to 2003. The decrease was primarily attributed to the one-time adjustment increasing benefit reserves in 2003 associated with the CLAC Indemnity Reinsurance Agreement, and its subsequent group life and health recapture on February 29, 2004, as mentioned above.
Operating expenses include general and administrative expenses, commissions and premium taxes. Total operating expenses remained stable, increasing $3.0 million to $968 million in the year ended December 31, 2004 when compared to 2003.
Income tax expense decreased $4 million or 2.6% in the year ended December 31, 2004 when compared to 2003. This decrease was primarily due to the decrease in the Company's 2004 effective tax rate, from 32.6% to 31.5% in the years ended December 31, 2003 and 2004, respectively, which resulted primarily from tax credits realized from investments in low income housing assets.
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. These amounts approximate the additional premiums, which would have been earned under such contracts if they had been written as traditional indemnity or HMO programs.
Deposits for investment-type contracts increased $35 million or 5.2% in the year ended December 31, 2004 when compared to 2003. The increase was primarily attributable to a net increase in participant accounts in the retirement products area in 2004.
Year ended December 31, 2003 compared with the year ended December 31,
The $1.1 billion increase in premium income in 2003 was comprised of a $1.6 billion increase from the Canada Life activity and a $12.4 million increase in the Financial Services segment's non-Canada life activity, offset by a $468.1 million decrease in the Great-West Healthcare segment's non-Canada Life activity. The decline in premium income in the Great-West Healthcare segment reflected the reinsurance agreement with Allianz discussed under "Other" below, and a 15% decline in medical members from 2.2 million in 2002 to 1.9 million in 2003.
Income tax expense increased $23.4 million or 18.0% in 2003 when compared to 2002. This increase was primarily due to the increase in net income from operations. The 2003 effective tax rate differs from the corporate tax rate of 35% primarily due to a reduction in a tax contingency and certain investment income not being subject to federal income tax.
Deposits for separate accounts decreased $244.1 million or 10% in 2003 when compared to 2002. This decrease in 2003 is primarily due to a combination of decreased sales of the BOLI product and the net decrease in contributions in the group retirement services market.
Excluding customers associated with Canada Life, the Great-West Healthcare segment experienced a net increase of 3.8% or 186 group health care customers (employer groups) during 2004. There was an 8.9% increase in total health care membership from 1.856 million at the end of 2003 to 2.021 million at year-end 2004. Point of service ("POS") and HMO members decreased 6.5% from approximately 244,000 at December 31, 2003 to approximately 228,000 at December 31, 2004.
The overall increase in membership is primarily the result of improved persistency, increased sales productivity and an enhanced product portfolio. The persistency increase from 74.1% at December 31, 2003 to 82.2% at December 31, 2004 is the result of more competitive pricing of renewals and increased service efforts.
Excluding total benefits and expenses associated with the CLAC reinsurance and the Allianz reinsurance, total benefits and expenses decreased $206 million or 14% in 2003 when compared to 2002. While increased utilization and higher medical costs increased benefits on in-force cases, the decrease in overall membership, combined with pricing actions taken in 2002, resulted in a reduction of benefits.
The Company recorded $18.5 million ($12.0 million, net of tax) of restructuring costs during 2002 related to the costs associated with the consolidation of benefit payment offices and sales offices throughout the United States. The charges relate to severance of $4.3 million, disposal of furniture and equipment of $4.9 million, and termination of leasing agreements of $9.3 million.
Excluding customers associated with Canada Life, the Great-West Healthcare segment experienced a net decrease of 959 group health care customers (employer groups) during 2003. There was a 15% decrease in total health care membership from 2.2 million at the end of 2002 to 1.9 million at year-end 2003. POS and HMO members decreased 29.7% from approximately 346,900 in 2002 to approximately 244,000 in 2003.
The Company recognizes that the health care marketplace continues to change. An enhanced product portfolio, increased sales productivity and improved case persistency has helped drive membership growth during 2004 despite this changing environment.
Efforts surrounding provider re-contracting and additional disease management programs will continue to enhance the Company's medical cost and market positions. These efforts are key elements in controlling health care costs for clients and members. The Company's disease management programs focus on asthma, cancer, diabetes, emphysema, heart disease and premature births. These programs benefit employers and members by reducing hospitalization costs, employee absences and increasing productivity. To further enhance the disease management programs and increase participation, Great-West Healthcare contracted with CorSolutions, Inc. ("CorSolutions"), the nation's leading provider of health intelligence solutions. CorSolutions assists with data analysis, risk assessment and predictive modeling for client groups and provides an interactive health and wellness website for members. This service is expected to provide additional growth and revenue in the coming year.
Great-West Healthcare is also expanding its specialty-risk market group. In this market, selected third party administrators sell the Company's stop-loss service and offer their clients access to the Company's provider network and medical management services. In 2004, Great-West Healthcare entered into such an arrangement with Acordia National, one of the nation's largest third party administrators. Great-West Healthcare continues to explore alternative distribution and delivery channels to enhance growth.
Effective July 10, 2003, the Company acquired CLICA and CLINY. The results of operations for the life insurance and annuity business of these subsidiaries have been included in the results of the Financial Services segment for the year ended December 31, 2004 and the period from July 10 through December 31, 2003. In addition, under the terms of the Indemnity Reinsurance Agreement, as previously discussed, the results of operations of certain life insurance and annuity business of the United States branch of CLAC were included in the results of the Financial Services segment for twelve months and four months for the years ended December 31, 2004 and 2003, respectively. Under the terms of this reinsurance agreement, on August 31, 2003, the Financial Services segment recorded a one-time increase in premiums and reserves in the amount of $1,174 million.
The Financial Services segment net income increased $32 million or 22.1% to $177 million for the year ended December 31, 2004 from $145 million in 2003. The increase in this segment's earnings was the result of a combination of the inclusion of Canada Life in the Individual Markets line of business for the full twelve months of 2004 and higher fee income and improved investment margins on invested assets transferred from variable rate to fixed rate products within Great-West Retirement Services.
Variable fee income fluctuates with changes in the United States equities markets as these fees are typically assessed on account balances. Variable fee income is also affected by fluctuations in the participant account balances associated with cash flows to and from the separate accounts, participation in plans and with the types of services offered. Fixed fees, expense recoveries on annuities and insurance products also fluctuate with changes in the participant or policyholder account balances due to cash flows, participation and services. Fees from third-party administration and record keeping services fluctuate with the number of participants and with services provided.
The amount of fixed annuity products in force is measured by policy reserves. The following table shows group and individual annuity policy reserves for the years indicated as well as the annuity balances in the separate accounts:
The Financial Services segment net income decreased $3 million or 2% to $145 million for the year ended December 31, 2003 from $148 million in 2002. The results of operations for the life insurance and annuity business of CLINY and CLICA have been included in the Income Statement Data above for the period since their acquisition, July 10, 2003. The life insurance and annuity reinsurance transactions related to the CLAC reinsurance agreement effective August 31, 2003, have also been included in the above Income Statement Data.
Net income for the Financial Services segment (excluding the Canada Life activity discussed above) decreased $10 million or 7% from 2002. The decrease was primarily related to a decrease in interest margins on fixed or general account products (see discussion below) and poor mortality (death benefits exceed actuarial reserves released) experienced on the individual insurance lines in 2003.
The term life insurance product marketed through banks and other financial institutions experienced significant growth over the past several years. Policies in force totaled 116,739 and 74,080 in the years ended 2003 and 2002, respectively. Although the sales of term life insurance were improved in 2003 and 2002, the premiums on these policies are smaller and, therefore, were not a significant offset to the large decrease in BOLI premiums.
Policyholder benefits decreased $51 million or 6% during 2003 excluding the impact of the Canada Life activity. The decrease is due to fluctuations in the amount of interest credited to policyholders or participant account balances, from the difference between charges for mortality and actual death claims and from fluctuations in premiums and cash flows to and from general account products.
At December 31, 2003 and 2002, the Company had $8.9 billion and $7.1 billion, respectively, of policy reserves on individual insurance on the balance sheet. The following table summarizes individual life insurance in force prior to reinsurance ceded for the years indicated:
The Financial Services segment continues to enhance its relationships with key consultants and to develop new marketing materials to communicate its proprietary strengths and expertise.
During 2005, the Individual Markets line of business plans to continue to focus on core strengths, increasing the number of placed policies, improving retention and increasing its partnership base. Plans are also underway to introduce new market driven products and value added service enhancements to existing partners. The legislative environment has stabilized considerably and the economic outlook appears to be improving.
In 2004, Great-West Retirement Services completed its integration of the operations of Emjay Corporation ("Emjay"). This acquisition was made by the Company in late 2003 and will create additional infrastructure to support the growth experienced in the Great-West Retirement Services business line. Several key partnerships were established in 2004, including with Fifth Third Bank. In 2004, the 401(k) marketing group developed a new product in conjunction with another leading provider of defined contribution services, designed for employers with $5 million to $50 million in plan assets. The product bundles investment options, administration, education and recordkeeping services.
In late 2004, Advised Assets Group, LLC ("AAG"), the Company's registered investment advisory subsidiary, introduced Reality Investing, a program that expands AAG's participant level advice tool into a suite of investment advisory services. Reality Investing provides access to a range of advice services including professional account management at the participant level. AAG partnered with Ibbotson Associates, an industry leader in asset allocation and investment analytics, to develop the new advice and managed account services.
During 2004, the mortgage loan portfolio decreased 18.5% to $1,544 million, net of allowances for credit losses.
Occasionally, the Company elects to restructure certain mortgage loans if the economic benefits to it are believed to be more advantageous than those achieved by acquiring the collateral through foreclosure. At December 31, 2004 and 2003, the Company's mortgage loan portfolio included $18.9 million and $34.9 million, respectively, of non-impaired restructured loans. The Company anticipates limited participation in the real estate market in 2005.
o Fair value is significantly below cost. o The decline in fair value is attributable to specific adverse conditions affecting a particular instrument, its issuer, an industry, or a geographic area. o The decline in fair value has existed for an extended period of time. o A debt security has been downgraded by a rating agency. o The financial condition of the issuer has deteriorated. o Dividends have been reduced/eliminated or scheduled interest payments have not been made.
For the years ended December 31, 2004 and 2003, the Company recorded other-than-temporary impairments in the fair value of its fixed maturity investments of $13.2 million and $14.2 million, respectively. The writedowns in the year ended December 31, 2004 generally related to securities in the airline industry while the writedowns recorded in 2003 were not concentrated in any one industry. No impairments were recorded on equity securities for either of the years ended December 31, 2004 or 2003.
The Company's investment portfolio is well positioned for the current interest rate environment. The portfolio is diversified and comprised of high quality, relatively stable assets. The Company took advantage of the steep yield curve in the first half of 2004, adding modestly to portfolio duration. Investment grade corporate securities and structured securities with moderate interest rate sensitivity were added to the investment portfolio. It is the Company's philosophy and intent to maintain its proactive portfolio management policies in an ongoing effort to ensure the quality and performance of its investments.
The principal sources of the Company's liquidity are premium and annuity considerations, investment and fee income and investment maturities and sales. The principal uses of the Company's liquidity relate to benefit payments, claim payments, payments to policy and contract holders in connection with surrenders and withdrawals, purchase of investments, commissions and general and administrative expenses.
Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio and utilizing cash flows from operations. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash that totaled $819.3 million and $1,003.5 million as of December 31, 2004 and 2003, respectively. In addition, as of both December 31, 2004 and 2003, 97% of the bond portfolio carried an investment grade rating, thereby providing significant liquidity to the Company's overall investment portfolio.
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 $95.0 million and $96.4 million of commercial paper outstanding at December 31, 2004 and 2003, 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.
The following table summarizes the Company's major contractual obligations at December 31, 2004:
In January 2004, Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46R"), was reissued by the Financial Accounting Standards Board ("FASB"). FIN 46R addresses consolidation by business enterprises of variable interest entities ("VIE"), which have one or both of the following characteristics: a) insufficient equity investment at risk, or b) insufficient control by equity investors. This guidance, as reissued, is effective for VIE's created after January 31, 2003, and for pre-existing VIEs as of March 31, 2004. In conjunction with the issuance of this guidance, the Company conducted a review of its involvement with VIEs and confirmed it does not have any investments or ownership in VIEs.
In July 2003, the Accounting Standards Executive Committee (the "AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 03-01, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). AcSEC developed SOP 03-1 to address the evolution of product designs since the issuance of Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by Insurance Enterprises," and Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 03-1 provides guidance related to the reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits, such as guaranteed minimum death benefits, and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1 addresses certain issues related to the presentation and reporting of separate accounts, as well as rules concerning the capitalization and amortization of sales inducements. SOP 03-1 was effective on January 1, 2004. The adoption of SOP 03-1 did not have a material effect on the Company's consolidated financial position or results of operations.
We have audited the accompanying consolidated balance sheets of Great-West Life & Annuity Insurance Company and subsidiaries as of December 31, 2004 and 2003, 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, 2004. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, 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.
/s/Deloitte & Touche LLP Deloitte & Touche LLP Denver, Colorado February 25, 2005
Organization - Great-West Life & Annuity Insurance Company (the "Company") is a direct wholly-owned subsidiary of GWL&A Financial Inc. ("GWL&A Financial"), a holding company formed in 1998. GWL&A Financial is an indirect wholly-owned subsidiary of Great-West Lifeco, Inc. ("Lifeco"). The Company offers a wide range of life insurance, health insurance and retirement and investment products to individuals, businesses and other private and public organizations throughout the United States. The Company is an insurance company domiciled in the State of Colorado, and is subject to regulation by the Colorado Division of Insurance.
1. The Company has classified its fixed maturity investments as available-for-sale and carries them at fair value with the net unrealized gains and losses (net of deferred taxes) reported as accumulated other comprehensive income (loss) in stockholder's equity. Net unrealized gains and losses related to participating contract policies are recorded as undistributed earnings on participating business.
7. From time to time, the Company may employ a trading strategy that involves the sale of securities with a simultaneous agreement to repurchase similar securities at a future date at an agreed-upon price. Proceeds of the sale are reinvested in other securities and may enhance the current yield and total return. The difference between the sales price and the future repurchase price is recorded as an adjustment to interest income. During the period between the sale and repurchase, the Company will not be entitled to receive interest and principal payments on the securities sold. Losses may arise from changes in the value of the securities or if the counterparty files for bankruptcy or becomes insolvent. In such cases, the Company's right to repurchase the security may be restricted. Amounts owing to brokers under these arrangements are included in repurchase agreements on the accompanying consolidated balance sheets. At December 31, 2004 and 2003, this liability was $563,247 and $389,715, respectively. The liability is collateralized by securities with approximately the same value.
Internal use software - Capitalized internal use software development costs, net of accumulated depreciation, in the amount of $74,021 and $68,244 are included in other assets at December 31, 2004 and 2003, respectively. The Company capitalized $21,484, $27,882 and $20,091 of internal use software development costs for the years ended December 31, 2004, 2003 and 2002, respectively.
Separate accounts - Separate account assets and related liabilities are carried at fair value. The Company's separate accounts invest in shares of Maxim Series Fund, Inc. an, open-end management investment company, which is an affiliate of the Company, and shares of other non-affiliated mutual funds and government and corporate bonds. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contract holders and, therefore, are not included in the Company's statements of income. Revenues to the Company from the separate accounts consist of contract maintenance fees, administrative fees and mortality and expense risk charges.
Life insurance and annuity reserves - Life insurance and annuity policy reserves with life contingencies in the amount of $12,115,519 and $12,111,180 at December 31, 2004 and 2003, 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 in the amount of $4,831,428 and $5,157,776 at December 31, 2004 and 2003, respectively, are established at the contract holder's account value.
Reinsurance - Policy reserves and policy and contract claims ceded to other insurance companies are carried as a reinsurance receivable on the consolidated balance sheets. The cost of reinsurance related to long duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies (See Note 5).
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 and are recognized when earned. Fee income is derived primarily from contracts for claim processing or other administrative services related to uninsured business 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 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. This association is accomplished by means of the provision for future policy benefit reserves. The average crediting rate on annuity products was approximately 4.3%, 5.2%, and 5.9%, in 2004, 2003 and 2002, respectively.
Income taxes - Income taxes are recorded using the asset and liability approach, which the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events (other than the enactments or changes in the tax laws or rules) are considered. Although realization is not assured, management believes it is more likely than not that the deferred tax asset will be realized.
Regulatory requirements - In accordance with the requirements of the State of Colorado, the Company must demonstrate adequate capital. At December 31, 2004, the Company was in compliance with the requirement (See Note 13).
In July 2003, the Accounting Standards Executive Committee (the "AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 03-01, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1"). AcSEC developed SOP 03-1 to address the evolution of product designs since the issuance of Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by Insurance Enterprises," and Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 03-1 provides guidance related to the reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits, such as guaranteed minimum death benefits, and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1 addresses certain issues related to the presentation and reporting of separate accounts, as well as rules concerning the capitalization and amortization of sales inducements. SOP 03-1 was effective on January 1, 2004. The adoption of SOP 03-1 did not have a material effect on the Company's consolidated financial position or results of operations.
On August 31, 2003, the Company and The Canada Life Assurance Company ("CLAC"), a wholly owned subsidiary of Canada Life, entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured 80% (45% coinsurance and 35% coinsurance with funds withheld) of certain United States life, health and annuity business of CLAC's United States Branch. The Company recorded $1,426,362 in premium income and increase in reserves associated with these policies.
The Company recorded, at fair value, the following at August 31, 2003 as a result of this transaction:
The reinsurance receivable relates to the amount due to the Company for reserves ceded by coinsurance with funds withheld. The Company's return on this reinsurance receivable will be the interest and other investment returns earned, as defined by the agreement, on a segregated pool of investments of the CLAC's United States branch. Pursuant to an interpretation of Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), as amended, the Company has identified an embedded derivative for its exposure to interest rate and credit risk on the segregated pool of investments. As this embedded derivative does not qualify for hedge accounting, the Company's net income decreased $5,282 and increased $7,387 during the years ended December 31, 2004 and 2003, respectively.
The Company performs administrative services for the United States operations of The Great-West Life Assurance Company ("GWL"), a wholly-owned subsidiary of Lifeco. Beginning in 2003, the Company began providing administrative and operational services for the United States operations of Canada Life. Beginning in 2002, the Company began performing investment services for London Reinsurance Group, an indirect subsidiary of GWL. The following table represents revenue from related parties for services provided pursuant to these service agreements. 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.
At December 31, 2004 and 2003, due to GWL includes $1,321 and $5,612 due on demand and, at each date, $25,338 of a note payable, which matures on October 1, 2006. The note may be prepaid in whole or
in part at any time without penalty. The issuer may not demand payment before the maturity date. The note payable bears interest at 5.4%.
At December 31, 2004 due from GWL&A Financial Inc. includes $55,915 due on demand and due to GWL&A Financial includes a surplus note with a face amount and carrying value of $195,000 and $194,164, respectively. At December 31, 2003 due to GWL&A Financial Inc. includes $691 due on demand and a $175,000 subordinated note. The surplus note, which bears interest at the rate of 6.675% per annum, matures on November 14, 2034. On November 15, 2004, GWL&A Financial issued a $175,000 deferrable debenture through an affiliated limited partnership ("Great-West LP") to qualified institutional investors. Also on November 15, 2004, Lifeco and 2023308 Ontario Inc. ("Ontario"), a wholly-owned subsidiary of Lifeco, made equity contributions in the combined amount of $23,000 to Great-West LP. Great-West LP in turn, invested the proceeds from the sale of the deferrable debentures together with a portion of the equity contributions from Lifeco and Ontario in certain junior subordinated deferrable debentures of GWLA Financial. On November 15, 2004, GWL&A Financial used the proceeds from the sale of its junior subordinated deferrable debentures to purchase the surplus note from the Company. On December 16, 2004, the Company used the proceeds from the sale of the surplus note to redeem the $175,000 subordinated note payable to GWL&A Financial and for general corporate purposes. Payments of principal and interest under the surplus note shall be made only out of surplus funds of the Company and only with prior written approval of the Commissioner of Insurance of the State of Colorado when the Commissioner of Insurance is satisfied that the financial condition of the Company warrants such action pursuant to applicable Colorado law. Payments of principal and interest on the surplus note are payable only if at the time of such payment and after giving effect to the making thereof, the Company's surplus would not fall below two and one half times the authorized control level as required by the most recent risk-based capital calculations.
Interest expense attributable to these related party obligations were $15,189, $14,345 and $14,976 for the years ended December 31, 2004, 2003 and 2002, respectively.
The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on amounts receivable related to uninsured accident and health plan claims and premiums in course of collection. Management's judgment is based on past loss experience and current and projected economic conditions.
In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The Company retains a maximum liability of $3,500 of coverage per individual life.
In addition to the Indemnity Reinsurance Agreement entered into with CLAC (see Note 2), the Great-West Healthcare division of the Company entered into a reinsurance agreement during 2003 with Allianz Risk Transfer (Bermuda) Limited ("Allianz") to cede 90% in 2003 and 75% in 2004 of group health stop-loss and excess loss activity. This Allianz agreement was retroactive to January 1, 2003.
The following table summarizes life insurance in force and life and accident/health premiums at, and for the year ended, December 31, 2004:
Mortgage-backed and asset-backed securities include collateralized mortgage obligations that consist primarily of sequential and planned amortization classes with final stated maturities of two to thirty years and expected average lives of less than one to fifteen years. Prepayments on all mortgage-backed securities are monitored monthly and amortization of the premium and/or the accretion of the discount associated with the purchase of such securities are adjusted by such prepayments.
The Company makes limited use of derivative financial instruments to manage interest rate, market credit and foreign exchange risk associated with its invested assets. Derivatives are not used for speculative purposes.
Hedge ineffectiveness in the amounts of $3,534, $125 and $177, determined in accordance with SFAS No. 133, was recorded as a decrease to net investment income for the years ended December 31, 2004, 2003 and 2002 respectively.
The Company also uses derivatives to synthetically create investments that are either more expensive to acquire or otherwise unavailable in the cash markets. These securities, called replication synthetic asset transactions, are a combination of a derivative and a cash security to synthetically create a third replicated security. As of December 31, 2004, the Company has one such security that has been created through the combination of a credit default swap and a United States Government Agency security.
The following table summarizes information with respect to impaired mortgage loans at December 31, 2004 and 2003:
The Company participates in a securities lending program whereby securities, which are included in invested assets, are loaned to third parties. The Company requires a minimum of 102% of the fair value of the loaned securities to be separately maintained as collateral for the loans. Securities with a cost or amortized cost of $336,949 and $288,834 and an estimated fair value of $340,755 and $299,521 were on loan under the program at December 31, 2004 and 2003, respectively. The Company was liable for collateral under its control of $349,913 and $317,376 at December 31, 2004 and 2003, respectively.
The assessment of whether an other-than-temporary impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors, as described below, about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential.
o Fair value is significantly below cost. o The decline in fair value is attributable to specific adverse conditions affecting a particular instrument, its issuer, an industry or a geographic area. o The decline in fair value has existed for an extended period of time. o A debt security has been downgraded by a rating agency. o The financial condition of the issuer has deteriorated. o Dividends have been reduced/eliminated or scheduled interest payments have not been made.
While all available information is taken into account, it is difficult to predict the ultimate recoverable amount of a distressed or impaired security.
Policy loans accrue interest generally at variable rates with no fixed maturity dates and therefore, estimated fair value approximates carrying value.
Included in fixed maturities and short-term investments are derivative financial instruments with a net liability position of $16,630 in 2004 and $1,967 in 2003. The estimated fair value of over-the-counter derivatives, primarily consisting of interest rate swaps 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.
During 2003, Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the "Act"), which made significant changes to the federal Medicare Program. The Act provides for drug benefits under a new Medicare Part D program.
The measurement of the accumulated post-retirement benefit obligation and the net post-retirement benefit cost included in these financial statements do not reflect the effects that this legislation may have on the plan. Authoritative guidance on the accounting for this issue is currently pending and when issued, could require the Company to revise previously reported information.
The Company-sponsored post-retirement medical plan (the "medical plan") provides health benefits to retired employees. The medical plan is contributory and contains other cost sharing features, which may be adjusted annually for the expected general inflation rate. The Company's policy is to fund the cost of the medical plan benefits in amounts determined at the discretion of management. The Company made no contributions to this plan in 2004, 2003 or 2002.
Assumed health care cost trend rates have a significant effect on the amounts reported for the medical plan. For measurement purposes, a 10% annual rate of increase in the per capita cost of covered health care benefits was assumed and that the rate would gradually decrease to a level of 5.25% by 2014. Additionally, it was assumed that the Company's cost for retirees eligible for health care benefits under Medicare would be limited to an increase of 3% starting in 2003, due to a plan change.
The Company has a deferred compensation plan for regional sales managers and individual sales managers and a deferred compensation plan for producers providing select regional group managers, individual sales managers and producers with the opportunity to participate in an unfunded deferred
Effective January 1, 2005, this program will no longer accept deferrals. Participant deferrals, which are reflected in other liabilities, are $6,339 and $6,576 at December 31, 2004 and 2003, respectively. The participant deferrals earned interest at the average rate of 4.50% during 2004. The interest rate is based on an annual rate determined by the Company. The interest expense related to this plan was $291, $362 and $ 374 for the years ended December 31, 2004, 2003 and 2002, respectively.
The Company also provides a supplemental executive retirement plan 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 expense for this plan was $2,966, $3,073 and 2,494 for the years ended December 31, 2004, 2003 and 2002, respectively. The total liability of $27,185 and $24,942 at December 31, 2004 and 2003, respectively, is included in other liabilities.
The following table presents a reconciliation between the statutory federal income tax rate and the Company's effective income tax rate for the years 2004, 2003 and 2002:
The Company has reduced its liability in each of the last three years for tax contingencies due to the completion of Internal Revenue Service examinations.
Amounts included for investment assets above include $75,726 and $74,326 related to the unrealized gains on the Company's fixed maturities available-for-sale at December 31, 2004 and 2003, respectively.
At December 31, 2004 and 2003, the Company had 1,500 authorized shares each of Series A, Series B, Series C and Series D cumulative preferred stock; and 2,000,000 authorized shares of non-cumulative preferred stock.
The Lifeco plan provides for the granting of options with varying terms and vesting requirements. The majority of basic options under the Lifeco plan vest and become exercisable twenty percent per year commencing on the first anniversary of the grant and expire ten years from the date of grant. Other basic options vested and became exercisable one-third per year commencing on various dates from December 31, 2000 to September 30, 2004 and expire ten years from the date of grant. Variable options granted to Company employees totaling 556,000 and 3,664,000 in 1998 and 1997, respectively, became exercisable, if certain cumulative financial targets were attained by the end of 2001. A total of 351,022 options vested and became exercisable. The exercise period runs from June 26,
The Company has two reportable segments: Great-West Healthcare and Financial Services. The Great-West Healthcare segment markets group life and health insurance to small and mid-sized corporate employers. The Financial Services segment markets and administers savings products to individuals, public and not-for-profit employers and corporations, and offers life insurance products to individuals and businesses. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately as each segment has unique distribution channels.
The accounting policies of the segments are the same as those described in Note 1. The Company evaluates performance of its reportable segments based on their profitability from operations after income taxes.
The following table summarizes segment financial information for the year ended and as of December 31, 2004: