Management's discussion and analysis of financial condition and results of operations of the Company for the year ended December 31, 1998 and the period April 4, 1997 through December 31, 1997 follows.
Annuity contract charges and premiums were $78 thousand in 1998 versus $21 thousand in 1997 (sales of the annuity product began in the second half of 1997). Interest for BOLI account balances is credited directly to the balance sheet and accordingly, only the cost of insurance and contract administration fees related to the policies are included in premiums on the income statement.
During 1998 the Company received approval from the New York Department of Insurance to market its BOLI product. The Company is authorized to sell up to $100 million of BOLI. BOLI deposits in 1998 totaled $62.5 million.
Net income grew from $33 thousand in 1997 to $792 thousand in 1998. The increase in 1998 was primarily due to higher investment income. The Company's effective tax rate was 43.2% in 1998 compared to 35% in 1997, due to the effect of state income taxes on the higher level of income.
The distribution of the fixed maturity portfolio (both available-for-sale and held-to-maturity) by credit rating is summarized as:
Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio. Liquidity for the Company is strong, as evidenced by significant amounts of short-term investments and cash, which totaled $1.4 million and $2.0 million as of December 31, 1998 and December 31, 1997, respectively.
On the basis of currently available information, the expense incurred by GWL&A, including anticipated future expenses, related to the Y2K issue has not and is not expected to be material to GWL&A's financial condition or results of operations. GWL&A has spent approximately $9.7 million on its Y2K project through the end of December 1998 and expects to spend up to approximately $15.3 million on its Y2K project. All of these funds will come from GWL&A's cash flow from operations. GWL&A has continued other scheduled non-Y2K information systems changes and upgrades. Although work on Y2K issues may have resulted in minor delays on the other projects, the delays are not expected to have a material adverse effect on the Company's financial condition or results of operations.
The most reasonably likely worst case Y2K scenario is that GWL&A and/or the Company will experience isolated internal or third party computer failures and will be temporarily unable to process insurance and annuity benefit transactions. All of GWL&A's Y2K efforts have been designed to prevent such an occurrence. However, if GWL&A identifies internal or third party Y2K issues which cannot be timely corrected, there can be no assurance that GWL&A and/or the Company can avoid Y2K problems or that the cost of curing the problem will not be material.
In our opinion, such financial statements present fairly, in all material respects, the financial position of First Great-West Life & Annuity Insurance Company as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the year ended December 31, 1998 and the period from April 4, 1997 [inception] to December 31, 1997 in conformity with generally accepted accounting principles.
STATEMENTS OF STOCKHOLDER'S EQUITY FOR THE YEAR ENDED DECEMBER 31, 1998 AND THE PERIOD FROM APRIL 4, 1997 [INCEPTION] TO DECEMBER 31, 1997 [Dollars in thousands except for share information]
STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1998 AND THE PERIOD FROM APRIL 4, 1997 [INCEPTION] TO DECEMBER 31, 1997 [Dollars in thousands]
Organization - First Great-West Life & Annuity Insurance Company (the Company) is a wholly-owned subsidiary of Great-West Life & Annuity Insurance Company (the Parent Corporation). The Company was incorporated as a stock life insurance company in the State of New York and was capitalized on April 4, 1997, through a $6,000 cash investment from the Parent Corporation for 2,000 shares of common stock. On December 29, 1997, the Company issued an additional 500 shares of common stock to the Parent Corporation for $500. The Company was licensed as an insurance company in the State of New York on May 28, 1997. The Company operates in one business segment.
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 in stockholder's equity.
Deferred Policy Acquisition Costs - Policy acquisition costs, which consist of sales commissions related to the production of new and renewal business, have been deferred to the extent recoverable. 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 was immaterial to the financial statements in 1998.
Due to Parent Corporation - Due to Parent Corporation includes amounts due on demand.
Policy Reserves - Life insurance reserves of $64,228 at December 31, 1998 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 $92 and $84 are carried at contractholders' account value at December 31, 1998 and 1997, respectively. The carrying value of policy reserves is a reasonable estimate of fair value.
Recognition of Premium Income and Expenses - Life insurance premiums are recognized when due. Revenues for annuity and other contracts without significant life contingencies are recognized as received. They consist of contract charges for the cost of insurance, contract administration, and surrender fees that have been assessed against the contract account balance during the period. Fee income is derived primarily from assets under management, consisting of contract maintenance fees, administration fees and mortality and expense risk charges, and is recognized when due. Benefits and expenses on policies with life contingencies impact premium income by means of the provision for future policy benefit reserves, resulting in recognition of profits over the life of the contracts.
During 1998, the Company sold life insurance policies to two customers and collected deposits of $50,000 and $12,500, respectively, which are included as a component of policy reserves on the balance sheet. These two customers accounted for 49% and 12%, respectively, of the Company's net income during 1998.
Regulatory Requirements - In accordance with the requirements of the State of New York, the Company must demonstrate adequate capital. At December 31, 1998, the Company was in compliance with the requirement.
The Company is also required to maintain an investment deposit in the amount of $5,000 in cash or investment certificates with the New York Insurance Commissioner for the protection of policyholders in the event the Company is unable to satisfactorily meet its contractual obligations. A United States Treasury obligation, whose cost approximates market value, was designated to meet this requirement at December 31, 1998.
The Company and the Parent Corporation have service agreements whereby the Parent Corporation administers, distributes, and underwrites business for the Company and administers the Company's investment portfolio and the Company provides services for the Parent Corporation. The amounts recorded are based upon management's best estimate of actual costs incurred and resources expended based upon number of policies and/or certificates in force. These transactions are summarized as follows:
Years Ended December 31, ------------------------ 1998 1997 ----------- ----------- Investment management expense (included in net investment income) 47 4 Administrative and underwriting revenue (included in operating expenses) (48) (15)
The Company and the Parent Corporation have an agreement whereby the Parent Corporation provides certain financial support related to maintaining adequate regulatory surplus and liquidity.
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; consequently, allowances are established for amounts deemed uncollectible. 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, 1998 and 1997, the reinsurance receivable had a carrying value of $123 and $0, respectively.
Total reinsurance premiums ceded to the Parent Corporation in 1998 and 1997 were $61 and $0, respectively.
See Note 6 for additional information on policies regarding estimated fair value of fixed maturities.
The amortized cost and estimated fair value of fixed maturity investments at December 31, 1998, by projected maturity, are shown below. Actual maturities will likely differ from these projections because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The estimated fair value of financial instruments have been determined using available information and appropriate valuation methodologies. However, considerable judgement is necessarily required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Income taxes are recorded using and asset and liability approach, which requires, among other provisions, 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.
1998 1997 ---------------- -------------- Federal tax rate 35.0 % 35.0 % Change in tax rate resulting from: State taxes 6.8 % Prior year tax adjustment 1.4 % ================ ============== Total 43.2 % 35.0 % ================ ==============
Temporary differences, which give rise to the deferred tax assets and liabilities as of December 31, 1998 and 1997, are as follows:
Amounts related to investment assets above include $642 and $3 related to the unrealized gains on the Company's fixed maturities available-for-sale at December 31, 1998 and 1997, respectively. Although realization is not assured, management believes that it is more likely than not that all of the deferred tax asset will be realized.
As an insurance company domiciled in the State of New York, the Company is required to maintain a minimum of $6,000 of capital and surplus. In addition, the maximum amount of dividends, which can be paid to stockholders, is subject to restrictions relating to statutory surplus and statutory adjusted net investment income. The Company should be able to pay dividends of $1,281 in 1999. The Company paid no dividends in 1998 and 1997. Dividends are paid as determined by the Board of Directors.