OVERVIEW RiverSource Life Insurance Company, formerly known as IDS Life Insurance Company, is a stock life insurance company with one wholly-owned operating subsidiary, RiverSource Life Insurance Co. of New York ("RiverSource Life of NY"). RiverSource Life Insurance Company is a wholly-owned subsidiary of Ameriprise Financial, Inc. ("Ameriprise Financial").
o RiverSource Life Insurance Company is domiciled in Minnesota and holds Certificates of Authority in American Samoa, the District of Columbia and all states except New York. RiverSource Life Insurance Company issues insurance and annuity products.
Also on December 31, 2006, American Centurion Life Assurance Company ("American Centurion Life") merged with and into IDS Life Insurance Company of New York ("IDS Life of New York"). As a result of the merger, American Centurion Life ceased to exist. Prior to the merger, American Centurion Life was a wholly-owned operating subsidiary of IDS Life Insurance Company. Immediately following the merger, IDS Life of New York changed its name to RiverSource Life Insurance Co. of New York.
RiverSource Life Insurance Company and its subsidiary are referred to collectively in this Form 10-K as "RiverSource Life".
Premiums for disability income ("DI") and long term care ("LTC") insurance increased $27 million or 9.2% including $15 million as a result of a review of RiverSource Life's LTC reinsurance arrangements during the third quarter of 2006. Higher DI insurance in force levels also contributed to the increase in premiums.
Net investment income decreased $128 million or 7.2% to $1.7 billion for the year ended December 31, 2006 reflecting a decrease in both the average yield and the average level of invested assets. The lower level of invested assets reflects declining fixed annuity account values due to a shift in sales from fixed to variable products. Also, the decrease reflects unfavorable mark-to-market adjustments on derivatives economically hedging guaranteed minimum withdrawal benefit ("GMWB") riders and equity method investments in hedge funds. Fluctuations in the value of the GMWB embedded derivative which partially offsets the mark-to-market of the GMWB hedges are reported in the death and other benefits for investment contracts and universal life-type insurance line item on RiverSource Life's Consolidated Statements of Income. These changes were partially offset by favorable mark-to-market adjustments on derivatives economically hedging equity index annuities ("EIA"). Fluctuations in the EIA embedded derivative are reported in interest credited to account values on RiverSource Life's Consolidated Statements of Income.
Contractholder and policyholder charges increased $60 million or 10.4% to $637 million for the year ended December 31, 2006 primarily due to an increase in the cost of insurance charges on variable universal life products and charges for variable annuity GMWB riders as well as $18 million from recognizing previously deferred cost of insurance revenues.
Death and other benefits for traditional life insurance decreased $14 million or 33.3% to $28 million for the year ended December 31, 2006 reflecting lower claims volume.
Death and other benefits for investment contracts and universal life-type insurance increased $35 million or 15.1% to $267 million for the year ended December 31, 2006 reflecting a net increase in guaranteed minimum death benefit ("GMDB") costs of $17 million, $26 million of additional claims expense (including $7 million in connection with the recognition of the previously deferred cost of insurance revenues discussed above), the impact of $12 million in deferred acquisition costs ("DAC") unlocking reserve for certain variable plans, higher sales inducement costs of $6 million and other increases in costs and benefits of $5 million, partially offset by a net decrease in GMWB costs of $31 million.
The accounting and reporting policies that RiverSource Life uses affect its Consolidated Financial Statements. Certain accounting and reporting policies are critical to an understanding of RiverSource Life's financial condition and results of operations and, in some cases, the application of these policies can be significantly affected by the estimates, judgments and assumptions made by management during the preparation of the Consolidated Financial Statements. The accounting and reporting policies RiverSource Life has identified as fundamental to a full understanding of its financial condition and results of operations are described below. See Note 2 to the Consolidated Financial Statements for further information about RiverSource Life's accounting policies.
The most significant component of investments is Available-for-Sale securities, which RiverSource Life generally carries at fair value within its Consolidated Balance Sheets. The fair value of approximately 95% of RiverSource Life's Available-for-Sale securities at December 31, 2006 was determined by quoted market prices. RiverSource Life records unrealized securities gains (losses) in accumulated other comprehensive income (loss), net of income tax provision (benefit) and net of adjustments in other asset and liability balances, such as DAC, to reflect the expected impact on their carrying values had the unrealized securities gains (losses) been realized as of the respective balance sheet dates. At December 31, 2006, RiverSource Life had net unrealized pretax losses on Available-for-Sale securities of $293 million. RiverSource Life recognizes gains and losses in results of operations upon disposition of the securities. RiverSource Life also recognizes losses in results of operations when management determines that a decline in value is other-than-temporary. This determination requires the exercise of judgment regarding the amount and timing of recovery. Indicators of other-than-temporary impairment for debt securities include issuer downgrade, default or bankruptcy. RiverSource Life also considers the extent to which cost exceeds fair value and the duration of that difference and management's judgment about the issuer's current and prospective financial condition, as well as its ability and intent to hold until recovery. As of December 31, 2006, there were $514 million in gross unrealized losses that related to $18.7 billion of Available-for-Sale securities, of which $16.4 billion has been in a continuous unrealized loss position for 12 months or more. These investment securities had a ratio of 97% of fair value to cost at December 31, 2006. As part of RiverSource Life's ongoing monitoring process, management determined that a majority of the gross unrealized losses on these securities is attributable to changes in interest rates. Additionally, because RiverSource Life has the ability as well as the intent to hold these securities for a time sufficient to recover its cost, RiverSource Life concluded that none of these securities was other-than-temporarily impaired at December 31, 2006.
For RiverSource Life's annuity and life, DI and LTC insurance products, the DAC balances at any reporting date are supported by projections that show that 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 RiverSource Life's annuity products are typically 10 to 25 years, while projection periods for RiverSource 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.
The client asset value growth rate is the rate at which variable annuity and variable universal life insurance 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 regular basis. RiverSource Life uses a mean reversion method as a 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, RiverSource Life reassesses 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. DAC amortization expense recorded in a period when client asset value growth rates exceed our near-term estimate will typically be less than in a period when growth rates fall short of our near-term estimate. The long-term client asset value growth rate is based on an equity return assumption of 8%, net of management fees, with adjustments made for fixed income allocations. If RiverSource Life increased or decreased its assumption related to this growth rate by 100 basis points, the impact on the DAC balance would be an increase or decrease of approximately $35 million.
Management monitors other principal DAC amortization assumptions, such as persistency, mortality, morbidity, interest margin and maintenance expense levels each quarter and, when assessed independently, each could impact RiverSource Life's DAC balances. For example, if RiverSource Life increased or decreased its interest margin on its universal life insurance and on the fixed portion of its variable universal life insurance products by 10 basis points, the impact on the DAC balance would be an increase or decrease of approximately $5 million. Additionally, if RiverSource Life extended or reduced the amortization periods by one year for variable annuities to reflect changes in premium paying persistency and/or surrender assumptions, the impact on the DAC balance would be an increase or decrease of approximately $32 million. The amortization impact of extending or reducing the amortization period any additional years is not linear.
In periods prior to 2007, RiverSource Life's policy has been to treat certain internal replacement transactions as continuations and to continue amortization of DAC associated with the existing contract against revenues from the new contract. RiverSource Life will account for many of these transactions differently as a result of adopting American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts" ("SOP 05-1") effective January 1, 2007. See Note 3 to the Consolidated Financial Statements for additional information about the effect of RiverSource Life's adoption of SOP 05-1.
The majority of the variable annuity contracts offered by RiverSource Life contain GMDB provisions. When market values of the customer's accounts decline, the death benefit payable on a contract with a GMDB may exceed the contract accumulation value. RiverSource 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, RiverSource Life offers contracts containing guaranteed minimum income benefit ("GMIB"), GMWB and guaranteed minimum accumulation benefit ("GMAB") provisions.
GMWB and GMAB provisions are considered embedded derivatives and are recorded at fair value. The fair value of these embedded derivatives is based on the present value of future benefits less applicable fees charged for the provision. Changes in fair value are reflected in death and other benefits for investment contracts and universal life-type insurance.
Future policy benefits and policy claims and other policyholders' funds related to life, DI and LTC insurance include liabilities for fixed account values on fixed and variable universal life policies, liabilities for unpaid amounts on reported claims, estimates of benefits payable on claims incurred but not yet reported and estimates of benefits that will become payable on term life, whole life, DI and LTC policies as claims are incurred in the future.
Liabilities for unpaid amounts on reported life insurance claims are equal to the death benefits payable under the policies. Liabilities for unpaid amounts on reported DI and LTC claims include any periodic or other benefit amounts due and accrued, along with estimates of the present value of obligations for continuing benefit payments. These amounts are calculated based on claim continuance tables which estimate the likelihood an individual will continue to be eligible for benefits. Present values are calculated at interest rates established when claims are incurred. Anticipated claim continuance rates are based on established industry tables, adjusted as appropriate for RiverSource Life's experience. Interest rates used with DI claims range from 3.0% to 8.0% at December 31, 2006, with an average rate of 5.0%. Interest rates used with LTC claims range from 4.0% to 7.0% at December 31, 2006, with an average rate of 4.4%.
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 RiverSource 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.
For information regarding recent accounting pronouncements and their expected impact on future consolidated financial condition or results of operations, see Note 3 to the Consolidated Financial Statements.
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. RiverSource Life earns administration and other fees from the related accounts. The increase in separate account assets and liabilities to $49.3 billion as of December 31, 2006 compared to $37.9 billion as of December 31, 2005, resulted from net inflows of $5.3 billion and market appreciation.
RiverSource 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.
The liquidity requirements of RiverSource 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. Other liquidity sources RiverSource Life has established are repurchase agreements and an available line of credit with Ameriprise Financial aggregating $200 million. 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. RiverSource Life routinely reviews its sources and uses of funds in order to meet its ongoing obligations. RiverSource Life of NY paid ordinary dividends to RiverSource Life during the second quarter of 2006 of $23 million.
As a result of the mergers described in the Overview, both RiverSource Life Insurance Company and RiverSource Life of NY were able to release certain statutory reserves previously held as a result of asset adequacy testing. RiverSource Life Insurance Company and RiverSource Life of NY reduced statutory reserves by $112 million and $22 million, respectively, as of December 31, 2006.
The contractual obligations identified in the table below include balance sheet transactions that represent material expected or contractually committed future obligations of RiverSource Life. Payments due by period as of December 31, 2006 are as follows:
In accordance with regulatory investment guidelines, RiverSource Life Insurance Company and RiverSource Life of NY, through their respective boards of directors or board of directors' investment committees or staff functions, review models projecting different interest rate scenarios, risk/return measures, and their effect on profitability in order to guide the management of the general account assets. They also review the distribution of assets in the portfolio by type and credit risk sector. The objective is to structure the investment securities portfolio in the general account to meet contractual obligations under the insurance and annuity products and achieve targeted levels of profitability within defined risk parameters.
Interest rate and equity price risks are the market risks to which RiverSource Life has material exposure. To evaluate interest rate and equity price risk RiverSource Life performs sensitivity testing which measures the impact on pretax income from the sources listed below for a 12 month period following a 100 basis point increase in interest rates and a 10% decline in equity markets.
At December 31, 2006, aggregating RiverSource Life's exposure from all sources of interest rate risk net of financial derivatives hedging that exposure detailed below, RiverSource Life estimates a negative impact of $23 million on pretax income for the 12 month period if, hypothetically, interest rates had increased by 100 basis points and remain at that level for 12 months. This compares with an estimate of $27 million made at December 31, 2005 for 12 months following a 100 basis point increase in interest rates at December 31, 2005.
At December 31, 2006, aggregating RiverSource Life's exposure from all sources of equity price risk net of financial derivatives hedging that exposure detailed below, RiverSource Life estimates a negative impact of $79 million on pretax income for the 12 month period if, hypothetically, equity markets had declined by 10% and remain at that level for 12 months. This compares with an estimate of $51 million made at December 31, 2005 for 12 months following a hypothetical 10% drop in equity markets at December 31, 2005.
The numbers below show RiverSource Life's estimate of the pretax impact of these hypothetical market moves, net of hedging, as of December 31, 2006. Following the table is a discussion by source of risk and the portfolio management techniques and derivative financial instruments RiverSource Life uses to mitigate these risks.
Actual results could differ materially from those illustrated above as they are based on a number of estimates and assumptions. These include assuming the composition of invested assets and liabilities does not change in the 12 month period following the market shock and assuming the increase in interest rates produces a parallel shift in the yield curve. The selection of a 100 basis point interest rate increase and a 10% equity market decline should not be construed as a prediction of future market events.
The GMWB create obligations which are carried at fair value separately from the underlying host variable annuity contract. Changes in fair value of the GMWB are recorded through earnings with fair value calculated based on projected, discounted cash flows over the life of the contract, including projected, discounted benefits and fees. Increases in interest rates reduce the fair value of the GMWB liability. At December 31, 2006, if interest rates had increased by 100 basis points and remain at that level for 12 months, RiverSource Life estimates that the fair value would decrease by $57 million with a favorable impact to pretax income. The GMWB interest rate exposure is hedged with a portfolio of customized equity index puts and interest rate swaps. At December 31, 2006, RiverSource Life had equity puts with a notional amount of $1.4 billion, and interest rate swaps with a notional amount of $359 million. Terms of the swaps designate RiverSource Life as the variable rate payor. If interest rates were to increase, RiverSource Life would have to pay more to the swap counterparty, and the fair value of equity puts would decrease, resulting in a negative impact to pretax income. For a hypothetical 100 basis point increase in interest rates sustained for a 12 month period, RiverSource Life estimates that the negative impact of the derivatives on pretax income would be $53 million. The net impact on pretax income after hedging would be a favorable $4 million.
GMAB creates interest rate risk in the same way as the GMWB discussed above - the fair value of the guaranteed benefits changes with changes in interest rates. For a hypothetical 100 basis point increase in interest rates at December 31, 2006, sustained for 12 months, the fair value of the GMAB would decrease by $8 million, with a corresponding favorable impact on pretax income. RiverSource Life does not hedge the interest rate exposure on GMAB.
Interest rate exposures arise primarily with respect to the fixed account portion of RiverSource Life's annuity and insurance products and its investment portfolio. RiverSource Life guarantees an interest rate to the holders of these products. Premiums collected from clients are primarily invested in fixed rate securities to fund the client credited rate with the spread between the rate earned from investments and the rate credited to clients recorded as earned income. Client liabilities and investment assets generally differ as it relates to basis, repricing or maturity characteristics. Rates credited to clients' accounts generally reset at shorter intervals than the yield on underlying investments.
If interest rates had increased by 100 basis points at December 31, 2006 and remain at that level for 12 months, RiverSource Life estimates the impact on pretax income for the 12 month period to be a negative $22 million.
RiverSource Life's equity indexed annuity product is a single premium annuity issued with an initial term of seven years. The annuity guarantees the contractholder a minimum return of 3% on 90% of the initial premium or end of prior term accumulation value upon renewal plus a return that is linked to the performance of the S&P 500 Index.
Most of the proceeds from the sale of equity indexed annuities are invested in fixed income securities with the return on those investments intended to fund the 3% guarantee. RiverSource Life earns income from the difference between the return earned on invested assets and the 3% guarantee rate credited to customer accounts. The spread between return earned and amount credited is affected by changes in interest rates. RiverSource Life estimates that if, hypothetically, interest rates had increased by 100 basis points at December 31, 2006 and remain at that level for 12 months, the unhedged exposure would be a negative impact of $2 million on pretax income for the 12 month period offset by a positive impact of nearly $2 million from its hedging strategy for an immaterial net exposure.
The equity-linked return to investors creates equity price risk as the amount credited depends on changes in equity markets. To hedge this exposure, a portion of the proceeds from the sale of equity indexed annuities are used to purchase futures, calls and puts which generate returns to replicate what RiverSource Life must credit to client accounts. In conjunction with purchasing puts, RiverSource Life also writes puts. Pairing purchased puts with written puts allows RiverSource Life to better match the characteristics of the liability. For this product, RiverSource Life estimates that if, hypothetically, the equity markets had declined by 10% at December 31, 2006 and remain at that level for 12 months, the impact to pretax income for the 12 month period without hedging would be a positive $15 million. The impact of its hedging strategy offsets that gain for an immaterial net exposure.
An increase in interest rates would result in a significant decrease in guaranteed living benefit reserves associated with RiverSource Life's variable annuity products, with the decrease partially offset by changes in hedge asset values. This would result in increased estimated gross profits and increased DAC amortization. RiverSource Life estimates that if, hypothetically, interest rates had increased by 100 basis points at December 31, 2006 and remain at that level for 12 months, the negative impact to pretax income from increased DAC amortization would be $8 million.
This report contains forward-looking statements that reflect RiverSource Life's plans, estimates and beliefs. RiverSource Life's actual results could differ materially from those described in these forward-looking statements. The words "believe," "expect," "anticipate," "optimistic," "intend," "plan," "aim," "will," "may," "should," "could," "would," "likely" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from such statements. RiverSource Life cautions the reader that the following list of factors is not exhaustive. There may also be other risks that RiverSource Life is unable to predict at this time that may cause actual results to differ materially from those in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. RiverSource Life undertakes no obligation to update or revise any forward-looking statements.
A further description of these and other risks and uncertainties can be found under "Item 1A - Risk Factors".
February 28, 2007 By /s/ Mark E. Schwarzmann - ----------------- -------------------------------------------------- Date Mark E. Schwarzmann, Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
February 28, 2007 /s/ Gumer C. Alvero - ----------------- ----------------------------------------------- Date Gumer C. Alvero, Director and Executive Vice President - Annuities
February 28, 2007 /s/ Timothy V. Bechtold - ----------------- ----------------------------------------------- Date Timothy V. Bechtold, Director and President
February 28, 2007 /s/ Kevin E. Palmer - ----------------- ----------------------------------------------- Date Kevin E. Palmer, Director, Vice President and Chief Actuary
February 28, 2007 /s/ Mark E. Schwarzmann - ----------------- ----------------------------------------------- Date Mark E. Schwarzmann, Director, Chairman of the Board and Chief Executive Officer
The following exhibits are filed as part of this Annual Report or, where indicated, were already filed and are hereby incorporated by reference.
2.1 Copy of Articles of Merger by and between IDS Life Insurance Company and American Enterprise Life Insurance Company dated March 17, 2006, filed electronically as Exhibit 99.1 to Form 8-K filed on Jan. 5, 2007 is incorporated by reference.
3.1 Copy of Certificate of Incorporation of IDS Life Insurance Company filed as Exhibit 3.1 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated by reference.
3.2 Copy of Amended and Restated By-Laws of RiverSource Life Insurance Company dated June 22, 2006, filed electronically as Exhibit 27(f)(2) to Post-Effective Amendment No. 28 to Registration Statement No. 333-69777 is incorporated by reference.
*10.1 Copy of Principal Underwriter Agreement for Variable Annuities and Variable Life Insurance between RiverSource Life Insurance Company and RiverSource Distributors, Inc. effective Jan. 1, 2007.
*10.2 Copy of Selling Agreement by and among RiverSource Life Insurance Company, RiverSource Distributors, Inc. and Ameriprise Financial Services, Inc. effective Jan. 1, 2007.
*10.4 Copy of Investment Management and Services Agreement between RiverSource Investments, LLC and RiverSource Life Insurance Company effective Jan. 1, 2007.
*10.7 Copy of Management, Service & Marketing Support Agreement by and between RiverSource Investments, LLC, RiverSource Service Corporation and RiverSource Life Insurance Company effective Jan. 1, 2007.
*10.8 Copy of RiverSource Variable Portfolio Funds Service Agreement by and between RiverSource Distributors, Inc. and RiverSource Life Insurance Company effective Jan. 1, 2007.
*32.1 Certification of Mark E. Schwarzmann, Chief Executive Officer, and Brian J. McGrane, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.