Pursuant to a required change in accounting policy, the Company capitalized $18.4 million of software development costs (see Note 1 to the consolidated financial statements), which increased the 1999 consolidated net income.
The increased fee income in 1999 was comprised of growth in Employee Benefits fee income and Financial Services fee income of $103.9 million and $15.2 million, respectively. The growth in Employee Benefits fee income reflected an increase of $42.0 million of fee income derived from Alta during 1999. The remaining increase was the result of new group health sales and increased fees on 401(k) variable funds related to growth in equity markets. The increase in fee income in 1998 was comprised of Employee Benefits fee income and Financial Services fee income of $86.6 million and $8.7 million, respectively. The growth in Employee Benefits fee income reflected $31.6 million of fee income derived from the acquisition of Alta. The remaining increase was the result of new group health sales and increased fees on 401(k) variable funds related to growth in equity markets.
Deposits for investment-type contracts decreased $709.6 million or 53% in 1999 when compared to the year ended December 31, 1998. Deposits for investment-type contracts increased $686.0 million or 104% in 1998 when compared to the year ended December 31, 1997. The decrease in 1999 was primarily due to two indemnity reinsurance agreements with Great-West Life whereby the Company reinsured by coinsurance certain Great-West Life individual non-participating life insurance policies during 1998. This transaction increased deposits by $519.6 million in 1998 and accounted for (73)% and 76% of the increase (decrease) in 1999 and 1998, respectively.
The majority of Alta's customers are in the Company's target market of small to mid-size employers who prefer to self-fund their benefit plans. New and existing customers have been migrated to the Company's One Health Plan network, which provided substantial new growth for the One Health Plan subsidiary organization.
401(k) premiums and deposits for 1999 and 1998 increased 11% and 14%, respectively, as the result of higher recurring deposits from existing customers and new sales. Assets under administration (including third-party administration) in 401(k) increased 26% over 1998 to $8.5 billion and 26% from 1997 to 1998, primarily due to strong equity markets.
Equivalent premium revenue and fee income for group life and health increased 19% from 1998 levels as the result of a combination of price increases and the Alta acquisition. From 1997 to 1998, equivalent premium revenue and fee income had increased 32% as a result of a combination of increased sales and the Alta acquisition.
o significant growth in participants and separate account funds primarily attributable to the public/non-profit business, o very strong persistency in all lines of business, and o increased sales of BOLI.
Deposits to separate accounts decreased $2.9 million or 0.4%, from $640.6 million in 1998 to $637.7 million in 1999. Deposits to separate accounts decreased $101.5 million or 14%, from $742.1 million in 1997 to $640.6 million in 1998. The decrease in 1998 was the result of 1997 being inflated by the receipt of a large single deposit in the amount of $120.0 million.
The Company continued to limit sales of GICs and to allow this block of business to contract in response to the highly competitive GIC market. As a result, GIC assets decreased 62% in 1999, to $104.7 million. In 1998, GIC assets decreased 33% from 1997, to $274.8 million.
Customer participation in guaranteed separate accounts increased, as many customers prefer the security of fixed income securities and separate account assets. Assets under management for guaranteed separate account funds were $653.7 million in 1999, compared to $562.3 million in 1998 and $466.2 million in 1997.
FASCorp administered records for approximately 1,595,000 participants in 1999 versus 1,307,000 in 1998. FASCorp's fee income was $53.8 million, $44.0 million and $36.1 million at December 31, 1999, 1998 and 1997, respectively.
The Company continued its conservative approach to the manufacture and distribution of traditional life insurance products, while focusing on customer retention and expense management.
The Company will continue to emphasize the development of the institutional life insurance and annuity markets. Internet sales and service is also expected to play a significant role in the life insurance business lines. Increased emphasis was placed on improving Internet functionality during 1999, and it will continue to be a focus in the coming year in the bank and institutional markets.
The distribution of the fixed maturity portfolio (both available for sale and held to maturity) by credit rating is summarized as:
At December 31, 1999 and 1998, the Company owned no bonds in default.
During 1999, the mortgage portfolio declined 14% to $1.0 billion, net of impairment reserves. The Company has not actively sought new loan opportunities since 1989 and, as such, has experienced an ongoing reduction in this portfolio's balance.
Occasionally, the Company elects to restructure certain loans if the economic benefits to the Company are believed to be more advantageous than those achieved by acquiring the collateral through foreclosure. At December 31, 1999 and 1998, the Company's loan portfolio included $75.7 million and $52.9 million, respectively, of non-impaired restructured loans.
The common stock portfolio is composed of mutual fund seed money and some private equity investments. The Company anticipates a limited participation in the stock markets in 2000.
General economic conditions continued to remain strong during 1999. The Company does not expect to recognize any asset writedowns or restructurings in 2000 that would result in a material adverse effect upon the Company's financial condition.
Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio and utilizing positive cash flows from operations. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash, which totaled $502.0 million and $596.5 million as of December 31, 1999 and 1998, respectively.
The Company's financial strength provides the capacity and flexibility to enable it to raise funds in the capital markets through the issuance of commercial paper. The Company continues to be well capitalized, with sufficient borrowing capacity to meet the anticipated needs of its business. The Company had no commercial paper outstanding at December 31, 1999, compared with $39.7 million at December 31, 1998. The commercial paper has been given a rating of A-1+ by Standard & Poor's Corporation and a rating of P-1 by Moody's Investors Service, each being the highest rating available.
We have audited the accompanying consolidated balance sheets of GWL&A Financial Inc. (an indirect wholly-owned subsidiary of The Great-West Life Assurance Company) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of GWL&A Financial Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles.
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997 (Dollars in Thousands)
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997 (Dollars in Thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997 (Dollars in Thousands)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997 (Amounts in Thousands, except Share Amounts) ================================================================================
Organization - GWL&A Financial Inc. (GWL&A Financial or the Company) is an indirect wholly-owned subsidiary of The Great-West Life Assurance Company (the Parent Corporation). GWL&A Financial was incorporated in the state of Delaware on September 16, 1998 to act as a holding company for Great-West Life & Annuity Insurance Company (GWL&A) and its subsidiaries, and was capitalized through a $250 cash investment in exchange for shares of common stock. GWL&A, a Colorado life insurance company, offers a wide range of life insurance, health insurance, and retirement and investment products to individuals, businesses and other private and public organizations throughout the United States. In December 1998, all of the outstanding common stock of GWL&A, which was owned by the Parent Corporation, was contributed to GWL&A Financial. The contribution has been accounted for as a pooling of interests as it represents a combination of entities under common control, and accordingly, the financial statements have been restated for all periods to include the combined financial results of GWL&A Financial and GWL&A.
7. Gains and losses realized on disposal of investments are determined on a specific identification basis.
Internal Use Software - Effective January 1, 1999, the Company adopted Statement of Position (SOP) No. 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use". SOP 98-1 provides guidance on accounting for costs associated with computer software developed or obtained for internal use. As a result of the adoption of SOP 98-1, the Company capitalized $18,373 in internal use software development costs for the year ended December 31, 1999.
Separate Accounts - Separate account assets and related liabilities are carried at fair value. The Company's separate accounts invest in shares of Maxim Series Fund, Inc. and Orchard Series Fund, Inc., both diversified, open-end management investment companies which are affiliates of the Company, shares of other external mutual funds, or government or corporate bonds. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contractholders and, therefore, are not included in the Company's statements of income. Revenues to the Company from the separate accounts consist of contract maintenance fees, administrative fees, and mortality and expense risk charges.
Recognition of Premium and Fee Income and Benefits and Expenses - Life insurance premiums are recognized when due. Annuity premiums with life contingencies are recognized as received. Accident and health premiums are earned on a monthly pro rata basis. Revenues for annuity and other contracts without significant life contingencies consist of contract charges for the cost of insurance, contract administration, and surrender fees that have been assessed against the contract account balance during the period. Fee income is derived primarily from contracts for claim processing or other administrative services and from assets under management. Fees from contracts for claim processing or other administrative services are recorded as the services are provided. Fees from assets under management, which consist of contract maintenance fees, administration fees and mortality and expense risk charges, are recognized when due. Benefits and expenses on policies with life contingencies impact income by means of the provision for future policy benefit reserves, resulting in recognition of profits over the life of the contracts. The average crediting rate on annuity products was approximately 6.2%, 6.3%, and 6.6% in 1999, 1998, and 1997.
Income Taxes - Income taxes are recorded using the asset and liability approach, which requires, among other provisions, the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events (other than the enactments or changes in the tax laws or rules) are considered. Although realization is not assured, management believes it is more likely than not that the deferred tax asset, net of a valuation allowance, will be realized.
Interest rate swap agreements are used to convert the interest rate on certain fixed maturities from a floating rate to a fixed rate. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amount. Interest rate floors and caps are interest rate protection instruments that require the payment by a counter-party to the Company of an interest rate differential. The differential represents the difference between current interest rates and an agreed-upon rate, the strike rate, applied to a notional principal amount. Foreign currency exchange contracts are used to hedge the foreign exchange rate risk associated with bonds denominated in other than U.S. dollars. Written call options are stock conversion protection agreements that require the counter-party to automatically call the bond for cash when the issuer elects to convert the bond to common stock. Equity swap transactions generally involve the exchange of variable market performance of a basket of securities for a fixed interest rate.
The Financial Accounting Standards Board has issued Statement No. 133, "Accounting for Derivative Instruments and for Hedging Activities", which, as amended, is required to be adopted in years beginning after June 15, 2000. This Statement provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. Although management has not completed its analysis of the impact of this Statement, management does not anticipate that the adoption of the new Statement will have a significant effect on earnings or the financial position of the Company because of the Company's minimal use of derivatives.
================================================================================ In connection with this transaction, the Parent Corporation made a capital contribution of $5,608 to the Company.
On June 30, 1997, the Company recaptured all remaining pieces of an individual participating insurance block of business previously reinsured to the Parent Corporation on December 31, 1992. The Company recorded $155,798 in premium income and increase in reserves as a result of this transaction. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at June 30, 1997 as a result of this transaction:
Interest expense attributable to these related party obligations was $2,665, $9,891, and $9,758 for the years ended December 31, 1999, 1998 and 1997, respectively.
Fixed maturities owned at December 31, 1999 are summarized as follows:
See Note 8 for additional information on policies regarding estimated fair value of fixed maturities.
The Company engages in hedging activities to manage interest rate, market and foreign exchange risk. The following table summarizes the 1999 financial hedge instruments:
As part of an active loan management policy and in the interest of maximizing the future return of each individual loan, the Company may from time to time modify the original terms of certain loans. These restructured loans, all performing in accordance with their modified terms, aggregated $75,691 and $52,913 at December 31, 1999 and 1998, respectively.
The Company has a commercial paper program that is partially supported by a $50,000 standby letter-of-credit. At December 31, 1999, no commercial paper was outstanding. At December 31, 1998, commercial paper outstanding had maturities ranging from 69 to 118 days and interest rates ranging from 5.10% to 5.22%.
8. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S JUNIOR SUBORDINATED DEBENTURES
The fair value of the guaranteed preferred beneficial interests in the Company's junior subordinated debentures reflects the price determined in the public market at December 31, 1999.
The estimated fair value of financial hedge instruments, all of which are held for other than trading purposes, is the estimated amount the Company would receive or pay to terminate the agreement at each year-end, taking into consideration current interest rates and other relevant factors. Included in the net loss position for interest rates swaps are $772 and $0 of unrealized losses in 1999 and 1998, respectively. Included in the net gain position for foreign currency exchange contracts are $518 and $932 of loss exposures in 1999 and 1998, respectively.
The carrying amounts for receivables and liabilities reported in the balance sheet approximate fair value due to their short nature.
Effective January 1, 1997, all employees of the U.S. operations of the Parent Corporation and the related benefit plans were transferred to the Company. See Note 3 for further discussion.
In addition to this release of contingent tax liabilities, the Company's income tax provision for 1997 also reflects increases for other contingent items relating to open tax years where the Company determined it was probable that additional taxes could be owed based on changes in facts and circumstances. The increase in 1997 was $16,000, of which $10,100 was attributable to participating policyholders and therefore had no effect on the net income of the Company. This increase in contingent tax liabilities has been reflected as a component of the deferred income tax provisions as the Company does not expect near term resolution of these contingencies.
Other comprehensive loss at December 31, 1999 is summarized as follows:
Dividends of $0, $6,692, and $8,854 were paid on preferred stock in 1999, 1998, and 1997, respectively. In addition, dividends of $88,950, $73,344, and $62,540 were paid on common stock in 1999, 1998, and 1997, respectively. Dividends are paid as determined by the Board of Directors.
Great-West Lifeco Inc. (Lifeco) is the parent of the Parent Corporation. Lifeco has a stock option plan (the Lifeco plan) that provides for the granting of options for common shares of Lifeco to certain officers and employees of Lifeco and its subsidiaries, including the Company. Options may be awarded at no less than the market price on the date of the grant. Termination of employment prior to vesting results in forfeiture of the options, unless otherwise determined by a committee that administers the Lifeco plan. As of December 31, 1999, 1998, and 1997, stock available for award to Company employees under the Lifeco plan aggregated 885,150, 1,424,400, and 3,440,000 shares.