The selected consolidated financial information for the years ended December 31, 2013, 2012 and 2011 and at December 31, 2013 and 2012 has been derived in part from the Company’s audited consolidated financial statements included in Item 8. The selected consolidated income statement data for the years ended December 31, 2010 and 2009 and the selected consolidated balance sheet data at December 31, 2011, 2010 and 2009 have been derived in part from the Company’s consolidated financial statements not included elsewhere herein.
The Company’s operations are organized into three reporting segments: Individual Markets, Retirement Services and Other. 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 highly competitive. Competitors include insurance companies, banks, investment advisors, mutual fund companies and certain service and professional organizations.
On January 1, 2013, the Company terminated its reinsurance agreement with an affiliate, CLAC, pursuant to which it had ceded certain participating life business on a coinsurance basis. Participating policyholders share in the financial results of the participating business in the form of policyholder dividends. The policyholder dividends can be distributed directly to the policyholders in the form of cash or through an increase in benefits such as paid-up additions. The participating policyholder earnings that cannot be distributed to the shareholder are not included in the Company’s condensed consolidated net income and are reflected in liabilities in undistributed earnings on participating business in the Company’s condensed consolidated balance sheets.
Variable asset-based fees earned by the Company fluctuate with changes in participant account balances. Participant account balances change due to cash flow and unrealized market gains and losses, which are primarily associated with changes in the United States equities market. The Company uses derivative financial instruments to hedge the economic risks of the fee revenue based on equity market performance. Gains and losses of such derivatives are recorded in net investment income. Fee income increased by $83 million, or 15%, to $619 million for the year ended December 31, 2013 when compared to 2012. The increase is primarily related to higher variable fee income as a result of higher average account balances due to the improved average performance of the U.S. equities market.
gross unrealized losses of $135 million and a decrease in gross unrealized gains of $634 million during the year ended December 31, 2013. This resulted in a decrease to accumulated other comprehensive income (loss), net of policyholder related amounts and deferred taxes.
The Company employs hedging strategies for the purpose of managing the interest rate, foreign currency exchange rate and equity market risks impacting the Company’s business. For some derivative instruments, hedge accounting is not elected; therefore all gains or losses from these transactions are recorded in the consolidated statement of income. As a result, fluctuations in interest rates, foreign currencies or equity markets may cause the Company to experience volatility in net income. For the year ended December 31, 2013, the Company recorded realized losses on forward settling to be announced (“TBA”) securities of $57 million. For the year ended December 31, 2013, the Company recorded losses in net investment income on cross-currency swaps of $50 million.
The fair values for fixed maturity investments are based upon market prices from independent pricing services. In cases where market prices are not readily available, such as for private fixed maturity investments, fair values are estimated by the Company. To determine estimated fair value for these instruments, the Company generally utilizes discounted cash flows calculated at current market rates on investments of similar quality and term. Fair value estimates are made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts of the Company’s financial instruments.
The fair value of derivatives is determined by quoted market prices or through the use of pricing models. The determination of fair value, when quoted market values are not available, is based on valuation methodologies and assumptions deemed appropriate under the circumstances. Values can be affected
by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads, market volatility and liquidity.
Assumptions and estimates about the issuer’s operations and ability to generate future cash flows are inherent in management’s evaluation of investments for other-than-temporary impairments (“OTTI”). The assessment of whether an OTTI has occurred on securities where management does not intend to sell the investment and it is not more likely than not the Company will be required to sell the investment before recovery of its amortized cost basis, is based upon management’s case-by-case evaluation of the underlying reasons for the decline in fair value of each individual security. Management considers a wide range of factors regarding the security issuer and uses its best judgment in evaluating the cause of the decline in its estimated fair value and in assessing the prospects for near-term recovery. While all available information is taken into account, it is difficult to predict the ultimate recoverable amount from a distressed or impaired security. The evaluation of impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, the effects of changes in interest rates or credit spreads and the recovery period.
The determination of the calculation and the adequacy of the mortgage provision allowance and mortgage impairments involve judgments that incorporate qualitative and quantitative Company and industry mortgage performance data. Management’s periodic evaluation and assessment of the adequacy of the mortgage provision allowance and the need for mortgage impairments is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the fair value of the underlying collateral, composition of the loan portfolio, current economic conditions, loss experience and other relevant factors.
assumptions employed, additional liabilities may be required, resulting in a charge to current period earnings.
DAC associated with annuity and investment-type products is being amortized over the life of the contracts in proportion to the emergence of estimated gross profits. DAC associated with traditional life insurance products is amortized over the premium-paying period of the related policies in proportion to the present value of estimated premium revenues recognized.
Premium income increased by $42 million, or 10%, to $464 million for the year ended December 31, 2013 when compared to 2012. This increase is primarily related to the $40 million increase in the Company’s Individual Markets segment which is driven by the $42 million received in conjunction with the termination of the reinsurance agreement with CLAC. The increase in premium from the CLAC agreement was partially offset by a decrease in premium income primarily related to sales of the single premium whole life (“SPWL”) product marketed through banks. In 2011, the Company began replacing the SPWL product with a SPUL product. The SPWL product is considered an insurance contract, and SPWL product sales are recognized as premium income. Conversely, the SPUL product is considered an investment contract, and SPUL product sales are recognized as deposits rather than as premium income.
Realized investment gains (losses), net, changed by $131 million from a gain of $117 million in 2012 to a loss of $14 million in 2013. The fluctuation is driven primarily by a $72 million increase in losses from forward settling TBA security transactions. There was also a $20 million increase in losses from the sales of certain perpetual debt investments which consisted of junior subordinated debt instruments, a $33 million decrease in gains on other bonds, and an $11 million decrease in gains on mortgage investments primarily due to a decrease in the mortgage provision allowance in 2012 that did not reoccur in 2013.
Fee income increased by $49 million, or 10%, to $536 million for the year ended December 31, 2012 when compared to 2011. The increase is primarily related to improved variable fee income resulting from higher average account balances generated by sales growth and the elevated performance of the
U.S. equities market. The equities market performance is evidenced by the 9% increase in the average S&P 500 index during the year ended December 31, 2012 as compared to 2011.
Net investment income increased by $32 million, or 3%, to $1,191 million for the year ended December 31, 2012 when compared to 2011. The primary drivers of the change are a $23 million increase in unrealized gains primarily generated by derivative and hedging activities and a $10 million increase in investment income due to a higher invested assets balance partially offset by lower yields.
Realized investment gains (losses), net, increased by $93 million to $117 million during the year ended December 31, 2012 when compared to 2011. Of the increase, $9 million was due to forward settling TBA security transactions, $37 million resulted from derivative and hedging activities and $18 million resulted from increased realized gains on sales of investments. Additionally, there was a net $17 million decrease in the mortgage provision allowance in 2012 as compared to a $5 million increase in the mortgage provision allowance in 2011. The mortgage provision allowance decrease resulted from revised assumptions primarily related to the improvement in general economic conditions, the stability of loss levels within the commercial real estate market and the stability of the Company’s own commercial mortgage portfolio.
Total benefits and expenses decreased by $4 million to $1,893 million for the year ended December 31, 2012 when compared to 2011. The decrease in benefits and expense is attributable to a $27 million decrease in the Company’s Individual Markets segment, which is primarily driven by a reduction in policyholder benefits reflecting the change in mix of sales mentioned in premiums above. Offsetting that decrease are higher mortality losses and operating expenses primarily resulting from an increase in the amortization of deferred acquisition expenses. Additionally, the Other segment had a decrease in benefits and expense of $16 million primarily due to lower operating expenses. These decreases in the Individual Markets and Other segments are partially offset by a $39 million increase in the Retirement Services segment, primarily driven by higher asset-based commission expense and other general operating expense due to segment growth in 2012. Partially offsetting the increase in Retirement Services expense is a decline in policyholder benefits primarily driven by a decrease in interest paid to policyholders due to lower credited rates.
Net income for the Individual Markets segment decreased by $39 million, or 38%, to $65 million for the year ended December 31, 2013 when compared to 2012. The decrease in earnings is primarily due to a decrease in realized investment gains (losses), net, due to forward settling TBA security transactions and a decrease in net investment income primarily due to unrealized losses from derivatives as compared to unrealized gains in 2012 as well as lower yields. Additionally, there was an increase in operating expenses. These decreases in earnings are partially offset by an increase in fee income from the SPUL and certain executive benefits products.
Realized investment gains (losses), net, decreased by $37 million, or 66%, to $19 million during the year ended December 31, 2013 when compared to 2012. Of the decrease, $21 million resulted from increases in losses on forward settling TBA security transactions with the remainder primarily due to lower gains of $16 million on bonds and lower gains of $2 million on mortgage investments due to a decrease in the mortgage provision allowance in 2012 that did not recur in 2013.
Total benefits and expenses increased by $43 million, or 4%, to $1,063 million for the year ended December 31, 2013 when compared to 2012. The change in benefits and expenses is primarily attributable to a $38 million, or 4%, increase in policyholder benefits. The change in policyholder benefits is due to $47 million which was incurred in conjunction with the termination of the reinsurance agreement with CLAC offset by a decrease in policyholder benefits of $9 million due to the change in the mix of sales mentioned in premiums and improved persistency in 2013 as compared to 2012. Operating expenses increased by $5 million, or 4%, due to higher general and administrative expense as a result of overall segment growth in 2013.
Net investment income increased by $16 million, or 2%, to $730 million for the year ended December 31, 2012 when compared to 2011. The primary drivers of the change are an $11 million increase in unrealized gains primarily generated by derivative and hedging activities and a $5 million increase in
investment income due to the strengthening of the invested assets balance partially offset by lower yields.
Income tax expense increased by $2 million, or 4%, to $51 million during the year ended December 31, 2012 when compared to 2011, primarily due to the increase in net income before income taxes.
Net income for the Retirement Services segment decreased by $85 million, or 53%, to $75 million for the year ended December 31, 2013 when compared to 2012. The decrease in earnings is primarily due to lower realized gains (losses) related to forward settling TBA security transactions and a decrease in net investment income primarily due to unrealized losses from derivatives as compared to unrealized gains in 2012 as well as lower yields. Additionally, there was an increase in operating expenses due to growth in the segment. These decreases in earnings are partially offset by an increase in fee income due to increased average asset levels driven by higher average equity market levels and growth in the block of business.
Fee income increased by $64 million, or 14%, to $520 million for the year ended December 31, 2013 when compared to 2012. The increase is primarily related to improved variable fee income due to
Net investment income decreased by $63 million, or 15%, to $351 million for the year ended December 31, 2013 when compared to 2012. The decrease is due to a $32 million change in derivatives due to unrealized losses in 2013 as compared to unrealized gains in 2012. There was also a $3 million decrease in unrealized gains from bonds. Additionally, there was a $26 million decrease in investment income earned on bonds, mortgages and policy loans as a result of lower yields partially offset by higher invested assets balances.
Realized investment gains (losses), net, changed by $94 million from a gain of $61 million in 2012 to a loss of $33 million in 2013. The fluctuation is driven primarily by a $52 million increase in losses from forward settling TBA security transactions. There was also a $20 million increase in losses from the sales of certain perpetual debt investments which consisted of junior subordinated debt instruments, an $18 million decrease in gains on other bonds, and an $8 million decrease in gains on mortgage investments primarily due to a decrease in the mortgage provision allowance in 2012 that did not recur in 2013.
Income tax expense decreased by $45 million, or 58%, to $33 million during the year ended December 31, 2013 when compared to 2012. The decrease is primarily due to the decrease in net income before income taxes.
Fee income increased by $39 million, or 9%, to $456 million for the year ended December 31, 2012 when compared to 2011. The increase is primarily related to improved variable fee income resulting from higher average account balances attributable to sales growth and the improved performance of the U.S. equities market. The equities market performance is evidenced by a 9% increase in the average S&P 500 index during the year ended December 31, 2012 as compared to 2011.
Net investment income increased by $15 million, or 4%, to $414 million for the year ended December 31, 2012 when compared to 2011. The primary drivers of the change are a $13 million increase in unrealized gains primarily generated by derivative and hedging activities and a $2 million increase due to a higher invested assets balance partially offset by lower yields.
Realized investment gains (losses), net, increased by $58 million to $61 million during the year ended December 31, 2012 when compared to 2011. Of the increase, $11 million was due to forward settling TBA security transactions, $25 million resulted from derivative and hedging activities and $6 million resulted from increased realized gains on sales of investments. Additionally, there was a net $9 million decrease in the mortgage provision allowance in 2012 as compared to a $3 million increase in the mortgage provision allowance in 2011. The mortgage provision allowance decrease resulted from revised assumptions primarily related to the improvement in general economic conditions, the stability of loss levels within the commercial real estate market and the stability of the Company’s own commercial mortgage portfolio.
Total benefits and expenses increased by $39 million, or 6%, to $697 million for the year ended December 31, 2012 when compared to 2011. The increase in benefits and expenses is primarily attributable to a $58 million, or 13%, increase in operating expenses driven by higher asset-based commission expense reflecting sales growth in the block of business and improved performance of the U.S. equities market. The higher operating expenses are also due to an increase in other general operating expense due to segment growth in 2012. Offsetting the increase in operating expenses is a $19 million, or 9%, decline in policyholder benefits primarily driven by a decrease in interest paid to policyholders due to lower credited rates.
result of an $11 million adjustment to taxes included in the 2012 expense related to the 2008 tax year IRS examination.
One of the Company’s primary objectives is to ensure that its fixed maturity portfolio is maintained at a high average credit quality to limit credit risk. All securities are internally rated by the Company on a basis intended to be similar to that of the rating agencies. The Company’s internal rating methodology generally considers ratings from Standard & Poor’s Ratings Services, Fitch Ratings and Moody’s Investor Services, Inc. In addition, the NAIC implemented a ratings methodology for residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and other structured securities. The Company may also utilize inputs from this ratings process to develop its internal rating.
Cash collateral related to the securities lending program is invested in U.S. Government or U.S. Government Agency securities. In addition, the securities lending agent indemnifies the Company against borrower risk, meaning that the lending agent agrees contractually to replace securities not returned due to a borrower default. As of December 31, 2013 and 2012, the Company had $27 million and $138 million, respectively, of securities out on loan, all of which are fully collateralized as described above. The Company does not enter into these types of transactions for liquidity purposes, but rather for yield enhancement on its investment portfolio.
The Company uses certain derivatives, such as futures, swaps and interest rate swaptions, for purposes of managing the interest rate, foreign currency exchange rate and equity market risks impacting the Company’s business. These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, since used for hedging purposes, these instruments are intended to reduce risk. For derivative instruments where hedge accounting is not elected, changes in interest rates, foreign currencies or equity markets may generate derivative gains or losses which may cause the Company to experience volatility in net income. The Company also uses forward settling TBA securities to gain exposure to the investment risk and return of agency mortgage-backed securities
The yield on average invested assets decreased in 2013 compared to 2012 and in 2012 compared to 2011 primarily due to the Company earning lower yields on new investments as the U.S. Treasury curve shifted lower during the years in conjunction with charging lower interest rates on policy loans.
Generally, the Company has met its operating requirements by utilizing cash flows from operations and maintaining appropriate levels of liquidity in its investment portfolio. Liquidity for the Company has remained strong, as evidenced by the amounts of short-term investments and cash that totaled $302 million and $278 million as of December 31, 2013 and 2012, respectively. In addition, 99% and 98% of the fixed maturity portfolio carried an investment grade rating at December 31, 2013 and 2012, respectively, thereby providing significant liquidity to the Company’s overall investment portfolio.
The Company continues to be well capitalized, with sufficient borrowing capacity. Additionally, the Company anticipates that cash on hand and expected net cash generated by operating activities will exceed the forecasted needs of the business over the next 12 months. The Company’s financial strength provides the capacity and flexibility to enable it to raise funds in the capital markets through the issuance of commercial paper. The Company had $99 million and $98 million of commercial paper outstanding at December 31, 2013 and 2012, respectively. The commercial paper has been given a rating of A-1+ by Standard & Poor’s Ratings Services and a rating of P-1 by Moody’s Investors Service, each being the highest rating available. Through the recent financial market volatility, the Company
continued to have the ability to access the capital markets for funds. The loss of this access in the future would not have a significant impact to the Company’s liquidity as commercial paper is not used to fund daily operations and is an insignificant amount in relation to total invested assets.
The Company also has available a revolving credit facility agreement, which expires on March 1, 2018, in the amount of $50 million for general corporate purposes. The Company had no borrowings under this credit facility as of or during the year ended December 31, 2013. The Company does not anticipate the need for borrowings under this facility and the loss of its availability would not significantly impact its liquidity.
The Company makes commitments to fund partnership interests, mortgage loans on real estate and other investments in the normal course of its business. The amounts of these unfunded commitments at December 31, 2013 and 2012 were $197 million and $127 million, respectively. The precise timing of the fulfillment of the commitment cannot be predicted; however, these amounts are due within one year of the dates indicated. There are no other obligations or liabilities arising from such arrangements that are reasonably likely to become material.
The Company maintains a corporate credit facility agreement in the amount of $50 million for general corporate purposes. The Company had no borrowings under the credit facility either at or during the years ended December 31, 2013 or 2012.
Policy and contract claims consist of liabilities associated with installment claims on certain long-term disability policies. Because the timing of the payment of these obligations is based upon assumptions of disability recovery rates, the amounts presented could differ from actual results.
control of the Company, the obligations related to these liabilities are presented in the table above in the less than one year category in the amounts of the liabilities presented in the Company’s consolidated balance sheet.
(7) Related party long-term debt interest - One long-term surplus note bears interest at a fixed rate through maturity. The second surplus note bears interest initially at a fixed rate that will change in the future based upon the then current three-month London Interbank Offering Rate. The interest payments shown in this table are calculated based upon the contractual rates in effect on December 31, 2013 and do not consider the impact of future interest rate changes.
(9) Payable under securities lending agreements - The Company accepts both cash and non-cash collateral in connection with its securities lending program. Since the securities lending transactions generally terminate within one year or the timing of the return of the collateral is uncertain, the obligations related to these liabilities are presented in the table above in the less than one year category in the amounts of the liabilities presented in the Company’s consolidated balance sheet.
(12) Other liabilities - Other liabilities include those other liabilities which represent contractual obligations not included elsewhere in the table above. If the timing of the payment of any other liabilities
was sufficiently uncertain, the amounts were included in the less than one year category. Other liabilities presented in the table above include:
· Expected contributions to the Company’s defined benefit pension plan and benefit payments for the post-retirement medical plan and supplemental executive retirement plan through 2023
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, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, 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.
(1) Other comprehensive income (loss) includes the non-credit component of impaired losses on fixed maturities available-for-sale, net of future policy benefits, DAC and VOBA adjustments and income taxes, in the amounts of $18,388, $26,583 and $13,590 for the years ended December 31, 2013, 2012 and 2011, respectively.
The Company identified an error in its historical accounting for certain cross currency and interest rate swaps accounted for as cash flow hedges, as there was an initial net investment at the inception of the hedges that was deemed an other-than-insignificant financing element at inception and the fair value at inception was not zero or somewhat near zero. Accordingly, the Company determined that it was using an incorrect effectiveness measure, and the swaps did not qualify for hedge accounting. During the fourth quarter of 2013, $21,469 previously presented in accumulated other comprehensive income, has been recorded as an out-of-period adjustment to net investment income. The Company believes the effects of this error are immaterial to prior periods.
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These accounting principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are required to account for items and matters such as, but not limited to, the valuation of investments and derivatives in the absence of quoted market values, impairment of investments, accounting for derivative financial instruments, valuation of DAC, valuation of unearned revenue liabilities (“URL”), valuation of policy benefit liabilities, valuation of employee benefits plan obligation and the valuation of deferred tax assets or liabilities, net. Actual results could differ from those estimates.
1. The Company classifies the majority of its fixed maturity investments as available-for-sale. Included in fixed maturities are perpetual debt investments which primarily consist of junior subordinated debt instruments that have no stated maturity date but pay fixed or floating interest in perpetuity. All available-for-sale fixed maturity investments are recorded at fair value with the related net unrealized gain or loss, net of policyholder related amounts and deferred taxes, recorded in accumulated other comprehensive income (loss) (“AOCI”). The Company recognizes the acquisition of its public fixed maturity investments on a trade
· Performing - generally indicates the loan has standard market risk and is within its original underwriting guidelines.
4. Policy loans are carried at their unpaid balances. Interest income on policy loans is recognized in net investment income at the contract interest rate when earned. Policy loans are fully collateralized by the cash surrender value of the associated insurance policy.
6. The Company participates in a securities lending program in which the Company lends securities that are held as part of its general account investment portfolio to third parties. The Company does not enter into these types of transactions for liquidity purposes, but rather for yield enhancements on its investment portfolio. The borrower can return and the Company can request the loaned securities at any time. The Company maintains ownership of the securities at all times and is entitled to receive from the borrower any payments for interest received on such securities during the loan term. Securities lending transactions are accounted for as secured borrowings. The securities lending agent indemnifies the Company against borrower risk, meaning that the lending agent agrees contractually to replace securities not returned due to a borrower default. The Company generally requires initial collateral in an amount greater than or equal to 102% of the fair value of domestic securities loaned and 105% of foreign securities loaned. Such collateral is used to replace the securities loaned in event of default by the borrower. Acceptable collateral is generally defined as government securities, letters of credit and/or cash collateral. Some cash collateral may be invested in short-term repurchase agreements which are also collateralized by U.S. Government or U.S. Government Agency securities.
7. The Company’s other-than-temporary impairments (“OTTI”) accounting policy requires that a decline in the value of a security below its cost or amortized cost basis be assessed to determine if the decline is other-than-temporary. The assessment of whether an OTTI has occurred on fixed maturity investments where
· Downgrade of a fixed maturity investment by a credit rating agency;
If either (a) management has the intent to sell a fixed maturity investment or (b) it is more likely than not the Company will be required to sell a fixed maturity investment before its anticipated recovery, a charge is recorded in net realized investment losses equal to the difference between the fair value and cost or amortized cost basis of the security. If management does not intend to sell the security and it is not more likely than not the Company will be required to sell the fixed maturity investment before recovery of its amortized cost basis, but the present value of the cash flows expected to be collected (discounted at the effective interest rate implicit in the fixed maturity investment prior to impairment) is less than the amortized cost basis of the fixed maturity investment (referred to as the credit loss portion), an OTTI is considered to have occurred. In this instance, total OTTI is bifurcated into two components: the amount related to the credit loss, which is recognized in current period earnings; and the amount attributed to other factors (referred to as the non-credit portion), which is recognized as a separate component in AOCI. The expected cash flows utilized during the impairment evaluation process are determined using judgment and the best information available to the Company including default rates, credit ratings, collateral characteristics and current levels of subordination. After the recognition of an OTTI, a fixed maturity investment is accounted for as if it had been purchased on the measurement date of the OTTI, with an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. The difference between the new amortized cost basis and the future cash flows is accreted into net investment income. The Company continues to estimate the present value of cash flows expected to be collected over the life of the security.
· Separate account assets and liabilities - exchange rates, various index data and news sources, amortized cost (which approximates fair value), trading activity, swap curves, credit spreads, recovery rates, restructuring, currency volatility, net present value of cash flows and quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
· Common collective trusts - the net asset value based on the underlying trust investments.
· Level 3 inputs are unobservable and include situations where there is little, if any, market activity for the asset or liability. In general, the prices of Level 3 securities are obtained from single broker quotes and internal pricing models. If the broker’s inputs are largely unobservable, the valuation is classified as a Level 3. Broker quotes are validated through an internal analyst review process, which includes validation through known market conditions and other relevant data, as noted below. Internal models are usually cash flow based utilizing characteristics of the underlying collateral of the security such as default rate and other relevant data. Inputs utilized for securities classified as Level 3 are as follows:
· Asset-backed securities - internal models utilizing asset-backed securities index spreads.
Overall, transfers between levels are attributable to a change in the observability of inputs. Assets and liabilities are transferred to a lower level in the hierarchy when a significant input cannot be corroborated with market observable data. This may occur when market activity decreases and underlying inputs cannot be observed, current prices are not available, and/or when there are significant variances in quoted prices, thereby affecting transparency. Assets and liabilities are transferred to a higher level in the hierarchy when circumstances change such that a significant input can be corroborated with market observable data. This may be due to a significant increase in market activity including recent trades, a specific event, or one or more significant input(s)
becoming observable. All transfers between levels are recognized at the beginning of the reporting period in which the transfer occurred.
The policies and procedures utilized to review, account for and report on the value and level of the Company’s securities were determined and implemented by the Finance division. The Investments division is responsible for the processes related to security purchases and sales and provides valuation and leveling input to the Finance division when necessary. Both divisions within the Company have worked in conjunction to establish thorough pricing, review, approval, accounting and reporting policies and procedures around the securities valuation process.
All derivatives, regardless of hedge accounting treatment, are recorded in other assets and other liabilities at fair value. At inception of a derivative transaction, the hedge relationship and risk management objective is documented and the designation of the derivative is determined based on specific criteria of the transaction. Accounting for the ongoing changes in the fair value of a derivative depends on the intended use of the derivative. If the derivative is designated as a cash flow hedge, the effective portions of the changes in the fair value of the derivative are recorded in AOCI and are recognized in the consolidated income statements when the hedged item affects earnings. If the derivative is designated as a fair value hedge, the changes in its fair value and of the fair value of the hedged item attributable to the hedged risk are recognized in earnings in net investment income. Changes in the fair value of derivatives not qualifying for hedge accounting or where hedge accounting is not elected and the over effective portion of cash flow hedges are recognized in net investment income in the period of the change. Termination of derivative contracts prior to expiration generally result in investment gains and losses. Fluctuations in interest rates, foreign currencies or equity markets may cause the Company to experience volatility in net income.
Collateral agreements are regularly entered into as part of the underlying agreements with counterparties to mitigate counterparty credit risk.
Book overdrafts occur when checks have been issued by the Company, but have not been presented to the Company’s disbursement bank accounts for payment. These bank accounts allow the Company to delay funding of the issued checks until they are presented for payment. This delay in funding results in a temporary source of financing. The activity related to book overdrafts is included in the financing activities in the consolidated statement of cash flows. The book overdrafts, in the amount of $13,840 and zero, are included in other liabilities at December 31, 2013 and 2012, respectively.
Annuity contract benefits without life contingencies in the amounts of $10,263,043 and $9,622,357 at December 31, 2013 and 2012, respectively, are established at the contract holder’s account value, which is equal to cumulative deposits and credited interest, less withdrawals and mortality and expense and/or administrative service charges. The Company’s general account also has some immediate annuities. Future benefits for immediate annuities without life contingent payouts are computed on the basis of assumed investment yield and expenses.
Policy and contract claims include provisions for claims incurred but not reported and claims in the process of settlement. The provision for claims incurred but not reported is valued based primarily on the Company’s prior experience. Claims in the process of settlement are valued in accordance with the terms of the related policies and contracts.
Participating life and annuity policy benefit liabilities were $6,754,435 and $6,748,375 at December 31, 2013 and 2012, respectively. Participating business composes approximately 9% of the Company’s individual life insurance in-force at December 31, 2013 and 2012, and 32%, 20% and 19% of individual life insurance premium income for the years ended December 31, 2013, 2012 and 2011, respectively. The policyholder’s share of net income on participating policies that cannot be distributed to the Company’s stockholder is excluded from stockholder’s equity and recorded as undistributed earnings on participating business in the consolidated balance sheet.
Interest income from fixed maturities and mortgage loans on real estate is recognized when earned.
The Company maintains a Performance Share Unit Plan (“PSU plan”) for senior executives of the Company. Under the PSU plan, performance share units are granted to certain senior executives of the Company, having a value equal to the participants’ deferred incentive compensation for the period. The Company uses the fair value method to recognize the cost of share-based employee compensation under the PSU plan.
2. Restatement of the December 31, 2012 and 2011 Statements of Cash Flows
· The Company purchases interests in limited partnerships in order to obtain low-income housing tax credits. It accounts for the low-income housing partnerships utilizing the effective yield method as prescribed in ASC 323-740 Investments - Equity Method and Joint Ventures - Income Taxes. The Company has previously classified the amortization of low-income housing partnerships under the effective yield method as proceeds from the sales, maturities and redemptions of investments within investing activities. In 2013 it was determined that the amortization of the low-income housing partnerships should have been classified as an adjustment to reconcile net income to net cash provided by operating activities. As a result of this misstatement, net cash provided by operating activities was understated by $39,621 and $43,070 for the years ended December 31, 2012 and 2011, respectively, and the cash provided by investing activities was overstated by the same amounts for the same periods. The Company believes the effects of this error are immaterial to the prior periods.
· The Company holds certain forward settling to be announced (“TBA”) securities that are accounted for as derivative instruments as the Company does not regularly accept delivery of such securities when issued. In certain limited circumstances, the Company will accept delivery of the securities from one broker and then immediately deliver the securities to another broker. In these limited circumstances, the Company recorded the purchase and sale of the securities as an equal and offsetting purchase and sale of investments in the net cash provided by investing activities. Because the Company did not hold the securities as an investment, the cash flows should be accounted for net within operating activities. As a result of this misstatement, both proceeds from sales, maturities and redemptions of investments and purchases of investments were overstated by $4,123,283 and $3,036,701 for the years ended December 31, 2012 and 2011, respectively. The Company believes the effects of this error are immaterial to the prior periods.
In the normal course of its business, the Company enters into reinsurance agreements with related parties. Included in the consolidated balance sheets are the following related party amounts:
(1) Future policy benefits have been restated from $1,990,579 at December 31, 2012. The Company believes the effects of this error are immaterial to the prior period.
(3) Increase (decrease) in future policy benefits has been restated from $70,554 for the year ended December 31, 2011. The Company believes the effects of this error are immaterial to the prior period.
(4) Related party premiums ceded have been restated from $6,912 for the year ended December 31, 2011. The Company believes the effects of this error are immaterial to the prior period.
The Company provides certain administrative and operational services and investment services for The Great-West Life Assurance Company (“GWL”) and The Canada Life Assurance Company (“CLAC”), wholly-owned subsidiaries of Lifeco. Additionally, the Company receives payroll-related services from GWL. The Company also provides investment services for London Reinsurance Group, an indirect subsidiary of GWL. The following table presents revenue, expenses incurred and expense reimbursement 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.
The Company’s wholly owned subsidiary, Great-West Life & Annuity Insurance Company of South Carolina (“GWSC”) and CLAC are parties to a reinsurance agreement pursuant to which GWSC assumes term life insurance from CLAC. GWL&A Financial obtained two letters of credit for the benefit of the Company as collateral under the GWSC and CLAC reinsurance agreement for policy liabilities and capital support. The first letter of credit is for $1,173,000 and renews annually until it expires on December 31, 2027. The second letter of credit is for $70,000 and renews annually for an indefinite period of time. At December 31, 2013 and 2012 there were no outstanding amounts related to the letters of credit.
Included within reinsurance receivable in the consolidated balance sheets are $495,140 and $486,514 of funds withheld assets as of December 31, 2013 and 2012, respectively. CLAC pays the Company, on a quarterly basis, interest on the funds withheld balance at a rate of 4.55% per annum. The interest income, in the amount of $20,876, $19,382 and $18,376, is included in net investment income for the years ended December 31, 2013 2012 and 2011, respectively.
A subsidiary of the Company, Great-West Capital Management, LLC, serves as a Registered Investment Advisor to Great-West Funds, Inc., an affiliated open-end management investment company, to several affiliated insurance company separate accounts and to Great-West Trust Company, LLC, an affiliated trust company. Great-West Trust Company, LLC, serves as trustee to several collective investment trusts. Included in fee income on the consolidated statements of income are $107,854, $84,137 and $69,172 of advisory, management and trustee fee income from these affiliated entities for the years ended December 31, 2013, 2012 and 2011, respectively.
Participating policyholders share in the financial results of the participating business in the form of policyholder dividends. The policyholder dividends can be distributed directly to the policyholders in the form of cash or through an increase in benefits such as paid-up additions. The participating policyholder earnings that cannot be distributed to the shareholder are not included in the Company’s condensed consolidated net income and are
(1) Proceeds from sales have been restated from $6,821,062 and $3,958,589 for the years ended December 31, 2012 and 2011, respectively. The Company believes the effects of this error are immaterial to the prior periods.
The carrying value and maximum exposure to loss in relation to the activities of the VIEs was $31,563 and $71,370 at December 31, 2013 and 2012, respectively.
Unrealized losses on fixed maturity investments classified as available-for-sale - The following tables summarize unrealized investment losses, including the non-credit-related portion of OTTI losses reported in AOCI, by class of investment:
Asset-backed securities account for 16% of the unrealized losses and OTTI greater than twelve months. The present value of the cash flows expected to be collected is not less than amortized cost and management does not have the intent to sell these assets; therefore, an OTTI was not recognized in earnings.
Other-than-temporary impairment recognition - The Company recorded OTTI on fixed maturity investments as follows:
(1) All of the $6,264 in credit related OTTI is bifurcated credit loss recognized on one asset-backed fixed maturity.
In 2012 and 2011, the realized gains (losses) on the provision for mortgage impairments, net of recoveries, was $17,248 and $(4,830), respectively. The 2012 and 2011, realized gains (losses) on mortgage loan activity not related to the provision was $4,223 and $197 and was included in Other. In the current year, all mortgage loan activity has been included in a single line item.
Derivative transactions are generally entered into pursuant to master agreements and other contracts with approved counterparties that provide for a single net payment to be made by one party to the other on a daily basis, periodic payment dates, or at the due date, expiration or termination of the agreement.
Certain derivative master agreements contain provisions that would allow the counterparties to require immediate settlement of all derivative instruments in a net liability position if the Company were to default on any debt obligations over a certain threshold. The aggregate fair value of derivative instruments with credit-risk-related contingent features that were in a net liability position was $167,743 and $55,875 as of December 31, 2013 and 2012, respectively. The Company had pledged collateral related to these derivatives of $143,540 and $43,360 as of December 31, 2013 and 2012, respectively, in the normal course of business. If the credit-risk-related contingent features were triggered on December 31, 2013 the fair value of assets that could be required to settle the derivatives in a net liability position was $24,203.
At December 31, 2013, the Company estimated $7,841 of net derivative gains related to cash flow hedges included in AOCI will be reclassified into net income within the next twelve months.
Interest rate swap agreements are used to convert the interest rate on certain debt securities from a floating rate to a fixed rate. Interest rate futures are used to manage the interest rate risks of forecasted acquisitions of fixed
The Company enters into certain transactions in which derivatives are hedging an economic risk but hedge accounting is not elected. These derivative instruments include: exchange-traded interest rate swap futures, OTC interest rate swaptions, OTC interest rate swaps, exchange-traded Eurodollar interest rate futures and treasury interest rate futures. Certain of the Company’s OTC derivatives are cleared and settled through a central clearing counterparty while others are bilateral contracts between the Company and a counterparty.
· The net decrease of $337,307 in interest rate swaps, interest rate swaptions and futures was primarily due to (i) a change in the Company’s interest rate risk hedging strategy and (ii) the closing of fair value hedges associated with the concurrent sales of certain fixed rate maturity investments.
· The increase of $235,973 in cross-currency swaps was due to additional swaps opened to hedge newly purchased assets denominated in British pounds and Euros.
The Company enters into derivative transactions with several approved counterparties. The Company’s derivative transactions are generally governed by International Swaps and Derivatives Association (“ISDA”) Master Agreements which provide for legally enforceable set-off and close-out netting in the event of default or bankruptcy of the Company’s counterparties. The Company’s ISDA Master Agreements generally include Credit Support Annex provisions which require both the pledging and accepting of collateral in connection with its derivative transactions. These provisions have the effect of securing each party’s position to the extent of collateral held. The following tables summarize the effect of master netting arrangements on the Company’s financial position in the normal course of business and in the event of default or bankruptcy of the Company’s counterparties:
(3) The estimated fair value of derivative instrument liabilities is reported in other liabilities in the consolidated balance sheets and includes income and expense accruals.
Limited partnership interests, accounted for using the cost method, represent the Company’s minor ownership interests in pooled investment funds. These funds employ varying investment strategies that principally make private equity investments across diverse industries and geographical focuses. The estimated fair value was determined using the partnership financial statement reported capital account or net asset value adjusted for other relevant information which may impact the exit value of the investments. Distributions by these investments are generated from investment gains, from operating income generated by the underlying investments of the funds and from liquidation of the underlying assets of the funds which are estimated to be liquidated over the next one to 10 years. The estimated fair value was classified as Level 3.
The estimated fair value of the notes payable to GWL&A Financial is based upon quoted market prices from independent pricing services of securities with characteristics similar to those of the notes payable. The estimated fair value was classified as Level 2.
(1) Reinsurance ceded has been restated from $(11,138,163) at December 31, 2012. The Company believes the effects of this error are immaterial to the prior period.
At December 31, 2013 and 2012, the Company had 50,000,000 shares of $1 par value preferred stock authorized, none of which was issued or outstanding at either date. In addition, the Company has 50,000,000 shares of $1 par value common stock authorized, 7,032,000 of which were issued and outstanding at both December 31, 2013 and 2012.
The Company’s net income and capital and surplus, as determined in accordance with statutory accounting principles and practices as prescribed by the National Association of Insurance Commissioners (“NAIC”), is as follows:
Regulatory compliance is determined by a ratio of a company’s total adjusted capital (“TAC”) to its authorized control level risk-based capital (“ACL”), as determined in accordance with statutory accounting principles and practices as prescribed by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The minimum level of TAC before corrective action commences is 200% of ACL. The Company’s risk-based capital ratio was in excess of the required amount as of December 31, 2013.
Dividends are paid as determined by the Board of Directors, subject to restrictions as discussed below. During the years ended December 31, 2013, 2012 and 2011, the Company paid dividends in the amounts of $102,436, $184,401 and $206,353, respectively, to its parent company, GWL&A Financial.
The following tables present the accumulated balances for each classification of other comprehensive income (loss):
The Company has a noncontributory Defined Benefit Pension Plan covering substantially all of its employees that were hired before January 1, 1999. Prior to December 31, 2012, the Company accounted for the Defined Benefit Pension Plan as the direct legal obligation of the Company and accounted for the corresponding plan obligations on its Balance Sheet and Statements of Income. Effective December 31, 2012, the Company transferred the sponsorship of the Defined Benefit Pension Plan to GWL&A Financial, the Company’s immediate parent. Despite the change in sponsorship of the Defined Benefit Pension Plan, the Company will continue to account for the corresponding plan obligations on its Balance Sheet and Statements of Income.
Benefits for the Defined Benefit Pension Plan are based principally on an employee’s years of service and compensation levels near retirement. The Company’s policy for funding the Defined Benefit Pension Plans is to make annual contributions, which equal or exceed regulatory requirements.
The following table presents amounts recognized in the consolidated balance sheets for the Company’s Defined Benefit Pension, Post-Retirement Medical and Supplemental Executive Retirement plans:
The following table provides information regarding amounts in AOCI that have not yet been recognized as components of net periodic benefit cost at December 31, 2013:
The following table provides information regarding amounts in AOCI that are expected to be recognized as components of net periodic benefit costs during the year ended December 31, 2014:
The following tables present the assumptions used in determining benefit obligations of the Defined Benefit Pension, Post-Retirement Medical and the Supplemental Executive Retirement plans:
The following table presents the ranges the Company targets for the allocation of invested Defined Benefit Pension Plan assets at December 31, 2014:
Management estimates the value of these investments will be recoverable. The Company does not expect any plan assets to be returned to it during the year ended December 31, 2014. The Company expects to make payments of approximately $640 with respect to its Post-Retirement Medical Plan and $3,450 with respect to its Supplemental Executive Retirement Plan during the year ended December 31, 2014. The Company expects to make a contribution of $13,525 to its Defined Benefit Pension Plan during the year ended December 31, 2014.
The Company has an executive deferred compensation plan providing key executives with the opportunity to participate in an unfunded deferred compensation program. Under the program, participants may defer base compensation and bonuses and earn interest on the amounts deferred. The program is not qualified under Section 401 of the Internal Revenue Code. Participant balances, which are reflected in other liabilities in the accompanying consolidated balance sheets, are $11,240 and $12,430 at December 31, 2013 and 2012, respectively. The participant deferrals earned interest at the average rates of 6.53% and 7.17% during the years ended December 31, 2013 and 2012, respectively. The interest rate is based on the Moody’s Average Annual Corporate Bond Index rate plus 0.45% for actively employed participants and fixed rates ranging from 5.13% to 7.91% for retired participants.
The Company offers an unfunded, non-qualified deferred compensation plan to a select group of management and highly compensated individuals. Participants defer a portion of their compensation and realize potential market gains or losses on the invested contributions. The program is not qualified under Section 401 of the Internal Revenue Code. Participant balances, which are included in other liabilities in the accompanying consolidated balance sheets are $14,536 and $12,239 at December 31, 2013 and 2012, respectively.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in current income tax expense. The Company recognized approximately $(286), $208 and $2,629 in interest and penalties related to the uncertain tax positions during the years ended December 31, 2013, 2012 and 2011, respectively. The Company had approximately $4,126 and $4,412 accrued for the payment of interest and penalties at December 31, 2013 and 2012, respectively.
The Individual Markets reporting and operating segment distributes life insurance and individual annuity products to both individuals and businesses through various distribution channels. Life insurance products in-force include participating and non-participating term life, whole life, universal life and variable universal life.
Lifeco, of which the Company is an indirect wholly-owned subsidiary, maintains the Great-West Lifeco Inc. Stock Option Plan (the “Lifeco plan”) that provides for the granting of options on its common shares to certain of its officers and employees and those of its subsidiaries, including the Company. Options are granted with exercise prices not less than the average market price of the shares on the five days preceding the date of the grant. The Lifeco plan provides for the granting of options with varying terms and vesting requirements with vesting commencing on the first anniversary of the grant, exercisable within 10 years from the date of grant.
If the performance share units vest, they are payable in cash equal to the average closing price of Lifeco common stock for the twenty trading days prior to the date following the last day of the three-year performance period. The estimated fair value of the performance unit is based on the average closing price of Lifeco common stock for the twenty trading days prior to the grant. The performance share units generally vest in their entirety at the end of the three-year performance period based on continued service. The PSU plan contains a provision that permits all unvested performance share units to become vested upon death or retirement.
The following table presents the total unrecognized compensation expense related to stock-based compensation at December 31, 2013 and the expected weighted average period over which these expenses will be recognized:
(1) The aggregate intrinsic value is calculated as the difference between the market price of Lifeco common shares on December 31, 2013 and the exercise price of the option (only if the result is positive) multiplied by the number of options.
The following table summarizes the Company’s future purchase obligations and commitments:
(3) Investment purchase obligations - The Company makes commitments to fund partnership interests, mortgage loans on real estate and other investments in the normal course of its business. As the timing of the fulfillment of the commitment to fund partnership interests cannot be predicted, such obligations are presented in the less than one year category. The timing of the funding of mortgage loans on real estate is based on the expiration date of the commitment. The amounts of these unfunded commitments at December 31, 2013 and 2012 were $196,933 and $127,255, of which $7,498 and $11,031 was related to cost basis limited partnership interests, respectively, all of which is due within one year from the dates indicated.
(4) Operating leases - The Company is obligated to make payments under various non-cancelable operating leases, primarily for office space. Contractual provisions exist that could increase the lease obligations presented, including operating expense escalation clauses. Management does not consider the impact of any such clauses to be material to the Company’s operating lease obligations. The Company incurred rent expense, net of sublease income, of $5,439, $5,764 and $5,645 for the years ended December 31, 2013, 2012 and 2011, respectively and is recorded in general insurance expense. The Company’s total future operating lease obligation will be reduced by minimum reimbursement of $10,905 due in the future under non-cancelable agreements.
· Expected contributions to the Company’s defined benefit pension plan and benefit payments for the Post-Retirement Medical Plan and Supplemental Executive Retirement Plan through 2023.
The Company has a revolving credit facility agreement in the amount of $50,000 for general corporate purposes. The credit facility expires on March 1, 2018. Interest accrues at a rate dependent on various conditions and terms of borrowings. The agreement requires, among other things, the Company to maintain a minimum adjusted net worth, as defined, of $1,147,500 plus 50% of its net income, if positive and as defined in the credit facility agreement (both compiled on the unconsolidated statutory accounting basis prescribed by the NAIC), for each quarter ending after December 31, 2012. The Company was in compliance with all covenants at December 31, 2013 and 2012. At December 31, 2013 and 2012 there were no outstanding amounts related to the current and prior credit facilities.
On February 6, 2014, the Company’s Board of Directors declared dividends of $50,000 and $42,800, payable on March 14 and March 31, 2014, respectively, to its sole shareholder, GWL&A Financial.