IDS Life Insurance Company is a stock life insurance company with four wholly-owned operating subsidiaries: IDS Life Insurance Company of New York, American Partners Life Insurance Company, American Enterprise Life Insurance Company and American Centurion Life Assurance Company. IDS Life Insurance Company is a wholly-owned subsidiary of Ameriprise Financial, Inc. (Ameriprise Financial).
o American Centurion Life Assurance Company (American Centurion Life) is a stock life insurance company domiciled in New York, which holds Certificates of Authority in New York, Alabama and Delaware. American Centurion Life issues fixed and variable annuity contracts primarily through financial institutions and independent broker- dealers. American Centurion Life also markets annuity products directly, generally to persons holding an American Express(R) Card.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 Income before taxes and accounting change declined 19% to $640.4 million for the year ended December 31, 2005. The decrease primarily reflects separation costs, higher other insurance and operating expenses and amortization of deferred policy acquisition costs (DAC), partially offset by increased mortality and expense risk and other fees, contractholder and policyholder charges and net realized gain on investments.
Net income for the year ended December 31, 2004 reflects the $70.6 million ($108.6 million pretax) cumulative effect of accounting change as a result of IDS Life's January 1, 2004 adoption of the American Institute of Certified Public Accountants Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" (SOP 03-1). SOP 03-1 requires insurance enterprises to establish liabilities for benefits that may become payable under variable annuity death benefit guarantees or other insurance or annuity contract provisions. See the "Recently Issued Accounting Standards" section in Note 1 to the Consolidated Financial Statements regarding the impact of adoption of SOP 03-1.
Disability income (DI) and long-term care insurance (LTC) premiums increased $11.5 million or 4% reflecting higher DI insurance in force levels.
Contractholder and policyholder charges increased $22.8 million or 4% as a result of a $13.2 million increase in the cost of insurance on higher average variable and fixed universal life policies in force, as well as an increase in surrender charges on annuities.
Mortality and expense risk and other fees increased $58.3 million or 14% reflecting higher average market values of separate account assets due to increased inflows and market appreciation.
Net realized gain on investments was $48.3 million in 2005 compared to $27.3 million in 2004. For the year ended December 31, 2005, $107.9 million of total investment gains were partially offset by $59.6 million of impairments and losses. Included in these total net investment gains and losses were $107.8 million of gross realized gains and $38.6 million of gross realized losses from sales of securities, as well as $19.4 million of other-than-temporary impairment losses on investments, classified as Available-for-Sale. Included in the net realized gain on investments classified as Available-for-Sale for 2005 were gross realized gains and losses of $39.2 million and $14.3 million, respectively, related to the sale of all of IDS Life's retained interest in a collateralized debt obligations (CDO) securitization trust.
BENEFITS AND EXPENSES Total benefits and expenses increased $285.9 million or 12%, reflecting separation costs, an increase in DAC amortization expense and higher other insurance and operating expenses, partially offset by lower interest crediting rates.
Interest credited to account values decreased $17.5 million or 2%, primarily due to lower interest crediting rates and average accumulation values of annuities, as well as the effect on equity indexed annuities of lower appreciation in the Standard & Poor's (S&P) 500 during 2005 versus 2004.
Other insurance and operating expenses increased $87.3 million or 17% reflecting increases in distribution costs and non-deferrable expenses related to product management and higher business investment initiatives.
Net investment income increased $72.3 million or 4%. Net investment income for the year ended December 31, 2003 includes $77.3 million of amortization expense of certain low income housing investments. See effective tax rate discussion below.
Contractholder and policyholder charges increased $24.2 million or 5% reflecting increased cost of insurance charges on variable universal life products as well as an increase in the amount of surrender charges on variable annuity products.
BENEFITS AND EXPENSES Total benefits and expenses decreased $55.8 million or 2%, reflecting lower interest crediting rates and the effect on equity indexed annuities of lower appreciation in the S&P 500 during 2004 versus 2003, a reduction in DAC amortization expense in conjunction with the adoption of SOP 03-1 and third quarter DAC adjustments, partially offset by higher other insurance and operating expenses.
DAC amortization expense decreased to $260.8 million in 2004 from $264.3 million in 2003. The decrease was primarily due to a $65.7 million adjustment associated with the lengthening of amortization periods for certain insurance and annuity products in conjunction with the adoption of SOP 03-1, and approximately $23.7 million in net favorable DAC adjustments in the third quarter of 2004 as a result of changes to DAC assumptions as compared to a $1.8 million net favorable DAC adjustment in the third quarter of 2003. See the "Deferred Policy Acquisition Costs" section for further discussion of DAC and related third quarter 2004 and 2003 adjustments.
Other insurance and operating expenses increased $50.8 million or 11% reflecting increases in distribution costs and non-deferrable expenses related to product management and business reinvestment initiatives. These increases were partially offset by a reduction related to the change in investment manager of the proprietary mutual funds from IDS Life to Ameriprise Financial. Effective with this change, the previously existing arrangement under which IDS Life compensated Ameriprise Financial for investment sub-advisory services was terminated.
For IDS Life's annuity and insurance products, the projections underlying the amortization of DAC require the use of certain assumptions, including interest margins, mortality and morbidity rates, persistency, maintenance expense levels and client asset value growth rates for variable products. Management routinely monitors a wide variety of trends in the business, including comparisons of actual and assumed experience. The client asset value growth rate is the rate at which contract values are assumed to appreciate in the future. The rate is net of asset fees and anticipates a blend of equity and fixed income investments. Management reviews and, where appropriate, adjusts its assumptions with respect to client asset value growth rates on a quarterly basis.
Management monitors other principal DAC amortization assumptions, such as interest margin, mortality and morbidity rates, persistency, and maintenance expense level assumptions, each quarter. Unless management identifies a significant deviation over the course of the quarterly monitoring, management reviews and updates these DAC amortization assumptions annually in the third quarter of each year. When assumptions are changed, the percentage of estimated gross profits used to amortize DAC might also change. A change in the required amortization percentage is applied retrospectively; an increase in amortization percentage will result in an increase in DAC amortization expense while a decrease in amortization percentage will result in a decrease in DAC amortization expense. The impact on results of operations of changing assumptions can be either positive or negative in any particular period and is reflected in the period in which such changes are made. As a result of these reviews, IDS Life took actions in both 2005 and 2004 that impacted the DAC balance and amortization expense.
In the third quarter 2005, these actions resulted in a net $67.0 million DAC amortization expense reduction consisting of the following:
o A $31.7 million reduction reflecting changes in previously assumed mortality rates;
o A $32.8 million reduction reflecting lower than previously assumed surrender rates and higher associated surrender charges;
o A $5.6 million reduction from the extension of the mean reversion period by one year; and
o A $9.1 million increase reflecting changes from previously assumed interest rate spreads, modeling changes, account maintenance expenses, and other miscellaneous items.
o A $92.0 million increase resulting from the recognition of a premium deficiency on IDS Life's LTC products; and
o A $11.6 million net increase across IDS Life's universal life, variable universal life and annuity products, reflecting lower than previously assumed interest rate spreads, separate account fee rates and account maintenance expense.
During the first quarter of 2004 and in conjunction with the adoption of SOP 03-1, IDS Life (1) established additional liabilities for insurance benefits that may become payable under variable annuity death benefit guarantees or on certain variable universal life and single pay universal life insurance contracts, which prior to January 1, 2004, were expensed when payable; and (2) extended the time periods over which DAC associated with certain insurance and annuity products are amortized to coincide with the liability funding periods in order to establish the proper relationships between these liabilities and DAC associated with the same contracts. As a result, IDS Life recognized a $108.6 million pretax charge due to an accounting change on establishing the future liability under death benefit guarantees and recognized a $65.7 million pretax reduction in DAC amortization expense to reflect the lengthening of the amortization periods for certain products impacted by SOP 03-1.
In addition to the DAC balances shown above and in conjunction with IDS Life's adoption of SOP 03-1, sales inducement costs previously included in DAC were reclassified from DAC and presented as a separate line item in the consolidated balance sheets. Deferred sales inducement costs were $370 million and $303 million at December 31, 2005 and 2004, respectively. Sales inducement costs consist of bonus interest credits and deposit credits added to certain annuity contract values. These benefits are capitalized to the extent they are incremental to amounts that would be credited on similar contracts without the applicable feature. The amounts capitalized are amortized using the same methodology and assumptions used to amortize DAC.
DEFERRED POLICY ACQUISITION COSTS DAC represents the costs of acquiring new business, principally direct sales commissions and other distribution and underwriting costs that have been deferred on the sale of annuity and life, DI and LTC insurance products. These costs are deferred to the extent they are recoverable from future profits. For annuity and insurance products, DAC is amortized over periods approximating the lives of the business, principally as a percentage of premiums or estimated gross profits or as a portion of product interest margins depending on the product's characteristics.
For IDS Life's annuity and life, DI and LTC insurance products, the DAC balances at any reporting date are supported by projections that show management expects there to be adequate premiums or estimated gross profits after that date to amortize the remaining DAC balances. These projections are inherently uncertain because they require management to make assumptions about financial markets, anticipated mortality and morbidity levels, and policyholder behavior over periods extending well into the future. Projection periods used for IDS Life's annuity products are typically 10 to 25 years, while projection periods for IDS Life's life, DI and LTC insurance products are often 50 years or longer. Management regularly monitors financial market conditions and actual policyholder behavior experience and compares them to its assumptions.
For other life, DI and LTC insurance products, the assumptions made in calculating the DAC balance and DAC amortization expense are consistent with those used in determining the liabilities and therefore are intended to provide for adverse deviations in experience and are revised only if management concludes experience will be so adverse that DAC is not recoverable. If management concludes that DAC is not recoverable, DAC is reduced to the amount that is recoverable based on best estimate assumptions and there is a corresponding expense recorded in the Consolidated Statements of Income.
For annuity and life, DI and LTC insurance products, key assumptions underlying these long-term projections include interest rates (both earning rates on invested assets and rates credited to policyholder accounts), equity market performance, mortality and morbidity rates and the rates at which policyholders are expected to surrender their contracts, make withdrawals from their contracts and make additional deposits to their contracts. Assumptions about interest rates are the primary factor used to project interest margins, while assumptions about rates credited to policyholder accounts and equity market performance are the primary factors used to project client asset value growth rates and assumptions about surrenders, withdrawals and deposits comprise projected persistency rates. Management must also make assumptions to project maintenance expenses associated with servicing its annuity and insurance business during the DAC amortization period.
The client asset value growth rate is the rate at which contract values are assumed to appreciate in the future. The rate is net of asset fees and anticipates a blend of equity and fixed income investments. Management reviews and, where appropriate, adjusts its assumptions with respect to client asset value growth rates on a quarterly basis. IDS Life uses a mean reversion method as a monthly guideline in setting near-term client asset value growth rates based on a long-term view of financial market performance as well as actual historical performance. In periods when market performance results in actual contract value growth at a rate that is different than that assumed, IDS Life will reassess the near-term rate in order to continue to project its best estimate of long-term growth. The near-term growth rate is reviewed to ensure consistency with management's assessment of anticipated equity market performance. Management is currently assuming a 7% long-term client asset value growth rate. If IDS Life increased or decreased its assumption related to this growth rate by 100 basis points, the impact on annual DAC amortization expense would be a decrease or increase of approximately $65 million.
For details regarding the balances of and changes in DAC for the years ended December 31, 2005, 2004 and 2003, see Note 4 to the Consolidated Financial Statements.
The majority of the variable annuity contracts offered by IDS Life contain guaranteed minimum death benefit (GMDB) provisions. When market values of the client's accounts decline, the death benefit payable on a contract with a GMDB may exceed the contract accumulation value. IDS Life also offers variable annuities with death benefit provisions that gross up the amount payable by a certain percentage of contract earnings; these are referred to as gain gross-up (GGU) benefits. In addition, IDS Life offers contracts containing guaranteed minimum withdrawal benefit (GMWB), guaranteed minimum income benefit (GMIB), and guaranteed minimum accumulation benefit (GMAB) provisions.
Liabilities for equity indexed deferred annuities issued in 1999 or later are equal to the accumulation of host contract values covering guaranteed benefits and the market value of embedded equity options. Liabilities for equity indexed deferred annuities issued before 1999 are equal to the present value of guaranteed benefits and the intrinsic value of index-based benefits. Accounting for equity indexed deferred annuities issued before 1999 differs from those issued in 1999 and later due to the treatment of embedded equity options within the contracts. Embedded equity options are considered embedded derivatives under SFAS 133. However, SFAS 133 allowed companies to elect whether to separately account for embedded derivatives related to contracts issued prior to January 1, 1999. IDS Life elected not to separately account for embedded derivatives related to contacts issued prior to January 1, 1999.
Liabilities for fixed annuities in a benefit or payout status are based on future estimated payments using established industry mortality tables and interest rates, ranging from 4.6% to 9.5% at December 31, 2005, depending on year of issue, with an average rate of approximately 6.0%.
Liabilities for fixed and variable universal life insurance are equal to accumulation values which are the cumulative deposits, credited interest, and fund performance less withdrawals and mortality and expense risk charges. Liabilities for future benefits on term and whole life insurance are based on the net level premium method, using anticipated premium payments, mortality rates, policy persistency and interest rates earned on the assets supporting the liability. Anticipated mortality rates are based on established industry mortality tables, with modifications based on IDS Life's experience. Anticipated policy premium payments and persistency rates vary by policy form, issue age and policy duration. Anticipated interest rates range from 4.0% to 10.0% at December 31, 2005, depending on policy form, issue year and policy duration. IDS Life issues only non-participating life insurance policies, which do not pay dividends to policyholders from the insurers' earnings.
For derivative financial instruments that do not qualify for hedge accounting, or are not designated as hedges, changes in fair value are reported in current period earnings, generally as a component of net investment income. These derivatives primarily provide economic hedges to equity market exposures. An example includes options and futures that economically hedge the equity components of certain annuities. For further details on the types of derivatives IDS Life uses and how it accounted for them, see Note 10 to the Consolidated Financial Statements.
In connection with the provision for income taxes, the Consolidated Financial Statements reflect certain amounts related to deferred tax assets and liabilities, which result from temporary differences between the assets and liabilities measured for financial statement purposes versus the assets and liabilities measured for tax return purposes. Among IDS Life's deferred tax assets is a significant deferred tax asset relating to capital losses realized for tax return purposes and capital losses that have been recognized for financial statement purposes but not yet for tax return purposes. Under current U.S. federal income tax law, capital losses generally must be used against capital gain income within five years of the year in which the capital losses are recognized for tax purposes.
Separate account assets represent funds held for the exclusive benefit of variable annuity contractholders and variable life insurance policyholders. These assets are generally carried at market value, and separate account liabilities are equal to separate account assets. IDS Life earns administration and other fees from the related accounts. The increase in separate account assets and liabilities to $37.9 billion as of December 31, 2005 compared to $32.5 billion as of December 31, 2004, resulted from net inflows of $3.1 billion and market appreciation.
IDS Life holds reserves for current and future obligations that are related to fixed annuities, certain guaranteed payments under variable annuities and life, DI and LTC insurance. Reserves related to fixed annuities, guarantees under variable annuities and life, DI and LTC insurance are reflected in future policy benefits in the Consolidated Balance Sheets. Reserves for fixed annuities and universal life contracts are equal to the underlying contract accumulation values. Reserves for other life, DI and LTC insurance products are based on various assumptions, including mortality rates, morbidity rates and policy persistency.
CAPITAL STRATEGY The liquidity requirements of IDS Life are generally met by funds provided by investment income, maturities and periodic repayments of investments, deposits, premiums and proceeds from sales of investments as well as capital contributions from Ameriprise Financial. The primary uses of funds are policy benefits, commissions, other product-related acquisition and sales inducement costs, operating expenses, policy loans, dividends to Ameriprise Financial and investment purchases. IDS Life routinely reviews its sources and uses of funds in order to meet its ongoing obligations. In connection with the separation, IDS Life received a capital contribution of $650 million from Ameriprise Financial during the third quarter of 2005 to support its current financial strength ratings and to cover the allocated separation costs. During the fourth quarter of 2005, IDS Life approved and paid dividends to Ameriprise Financial of $380 million. During the second and fourth quarter of 2004, IDS Life approved and paid dividends to Ameriprise Financial of $430 million and $500 million, respectively. IDS Life expects to continue to maintain adequate capital to meet internal and external RBC requirements.
IDS Life has developed an asset/liability management approach with separate investment objectives to support specific product liabilities, such as insurance and annuities. As part of this approach, IDS Life develops specific investment guidelines that are designed to optimize trade offs between risk and return and help ensure IDS Life is able to support future benefit payments under its insurance and annuity obligations. These same objectives must be consistent with management's overall investment objectives for the general account investment portfolio.
As part of IDS Life's investment process, management, with the assistance of its investment advisors, conducts a quarterly review of investment performance. The review process conducted by IDS Life's Investment Committee involves the review of certain invested assets which the committee evaluates to determine whether or not any investments are other-than-temporarily impaired and/or which specific interest earning investments should be put on an interest non-accrual basis.
IDS Life has entered into swaptions or other interest floors and caps to mitigate the impact of increasing interest rates related to the forecasted interest payments of future annuity sales to clients. Such annuities generally contain fixed interest rate provisions, which are set at the time of the future issuance, and impact the total interest payment cash flows related to the annuities. Therefore, this strategy allows IDS Life to "lock in" interest rate risk associated with the forecasted annuity sale cash flows at a specified market rate in the event that interest rates rise but not "lock in" the interest rate risk in the event that interest rates decline. The total notional of derivatives outstanding under this risk management strategy was $1.2 billion as of December 31, 2005 and 2004. The total fair value of these derivative financial instruments was $8.4 million and $27.3 million as of December 31, 2005 and 2004, respectively. IDS Life recognized $1.8 million of losses in the Consolidated Statements of Income for the year ended December 31, 2005. No losses were recognized for the years ended December 31, 2004 and 2003, respectively. No cash was paid for the years ended December 31, 2005 and 2004. Total cash paid was $71.8 million for the year ended December 31, 2003.
EQUITY MARKET RISK IDS Life has three primary exposures to the general level of equity markets. One exposure is that IDS Life earns fees from variable annuity and variable life insurance products. The amount of fees is generally based on the value of the portfolios, and thus is subject to fluctuation with the general level of equity market values. To reduce the sensitivity of IDS Life's fee revenues to the general performance of equity markets, IDS Life may from time to time enter into various combinations of financial instruments such as equity market put and collar options that mitigate the negative effect on fees that would result from a decline in the equity markets.