10-K/A 1 gwla10ka.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A (Amendment No. 1) (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 ---------------------------------------------------------------------------- OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from to -------------------------------- ---------------------------------- Commission file number 333-1173 ---------------------------------- GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY ---------------------------------------------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Colorado 84-0467907 --------------------------------------------------------------------- --------------------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number) 8515 East Orchard Road, Greenwood Village, CO 80111 ---------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) [303] 737-4128 ---------------------------------------------------------------------------- (Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----------------- ----------------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer as defined in ss.240.12(b)-2 of this chapter. Yes No X ----------------- ----------------- The public may read and copy any of the registrant's reports filed with the SEC at the SEC's Public Reference Room, 450 Fifth Street NW, Washington DC 20549, telephone 1-800-SEC-0330 or online at (http://www.sec.gov). As of June 30, 2003, the aggregate market value of the registrant's voting stock held by non-affiliates of the registrant was $0. As of March 1, 2004, 7,032,000 shares of the registrant's common stock were outstanding, all of which were owned by the registrant's parent company. NOTE: This Form 10-K/A is filed by the registrant only as a consequence of the sale by the registrant of a market value adjusted annuity product. Explanatory Note Subsequent to the issuance of its consolidated financial statements for the year ended December 31, 2003, the Company determined that certain disclosures required by EITF 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," were omitted. This amendment is being filed to include this information in a restatement of Item 8, and to reflect the correction of certain information required to be provided in Items 1, 6, and 7. The restatement of Item 8 is further discussed in Note 7 to the consolidated financial statements. The remainder of the information contained in the original filing is not amended hereby. This Amendment No. 1 continues to speak as of the date of the original filing and the Company has not updated the disclosures contained therein to reflect any events that occurred at a later date. TABLE OF CONTENTS Page Part I Item 1. Business.....................................................................................1 A. Organization And Corporate Structure....................................................1 B. Business Of The Company.................................................................1 C. Great-West Healthcare...................................................................4 D. Financial Services......................................................................6 E. Investment Operations...................................................................9 F. Regulation.............................................................................11 G Ratings................................................................................13 H. Miscellaneous..........................................................................13 Item 2. Properties..................................................................................13 Item 3. Legal Proceedings...........................................................................13 Item 4. Submission Of Matters To A Vote Of Security Holders.........................................13 Part II Item 5. Market For Registrant's Common Equity And Related Stockholder Matters.........................................................................14 A. Equity Security Holders And Market Information.........................................14 B. Dividends..............................................................................14 Item 6. Selected Financial Data.....................................................................14 Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations...................................................................15 A. Critical Accounting Policies And Estimates.............................................15 B. Company Results Of Operations..........................................................17 C. Great-West Healthcare Results Of Operations............................................19 D. Financial Services Results Of Operations...............................................21 E. Investment Operations..................................................................24 F. Liquidity And Capital Resources........................................................26 G. Off-Balance Sheet Arrangements.........................................................27 H. Obligations Relating To Debt And Leases................................................27 I. Accounting Pronouncements..............................................................27 Item 7A. Quantitative And Qualitative Disclosures About Market Risk.................................................................................29 Item 8. Financial Statements And Supplementary Data.................................................30 Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure.........................................................64 Item 9A. Controls And Procedures.....................................................................64 Part III Item 10. Directors And Executive Officers Of The Registrant..........................................64 A. Identification Of Directors............................................................64 B. Identification Of Executive Officers...................................................65 C. Code Of Ethics.........................................................................67 D. Audit Committee Financial Expert.......................................................67 Item 11. Executive Compensation......................................................................68 A. Summary Compensation Table.............................................................68 B. Options................................................................................69 C. Pension Plan Table.....................................................................70 D. Compensation Of Directors..............................................................70 E. Compensation Committee Interlocks And Insider Participation............................70 Item 12. Security Ownership Of Certain Beneficial Owners And Management..................................................................................71 A. Security Ownership Of Certain Beneficial Owners........................................71 B. Security Ownership Of Management.......................................................71 Item 13. Certain Relationships And Related Transactions..............................................73 Item 14. Principal Accounting Fees And Services......................................................73 A. Principal Accounting Fees..............................................................73 B. Pre-Approval Policies And Procedures...................................................74 Part IV Item 15. Exhibits, Financial Statement Schedules, And Reports On Form 8-K.................................................................................74 A. Index To Financial Statements..........................................................74 B. Index To Exhibits......................................................................74 C. Reports On Form 8-K....................................................................76 Signatures..................................................................................77
PART I ITEM 1. BUSINESS A. ORGANIZATION AND CORPORATE STRUCTURE Great-West Life & Annuity Insurance Company (the Company) is a stock life insurance company originally organized on March 28, 1907. The Company is domiciled in Colorado. The Company is a wholly owned subsidiary of GWL&A Financial Inc. (GWL&A Financial), a Delaware holding company. The Company is indirectly owned by Great-West Lifeco Inc. (Lifeco), a Canadian holding company. Lifeco operates in the U.S. through the Company and The Canada Life Assurance Company (CLAC), and in Canada through The Great-West Life Assurance Company (Great-West Life) and its subsidiaries, London Life Insurance Company and CLAC. Lifeco is a subsidiary of Power Financial Corporation (Power Financial), a Canadian holding company with substantial interests in the financial services industry. Power Corporation of Canada (Power Corporation), a Canadian holding and management company, has voting control of Power Financial. Mr. Paul Desmarais, through a group of private holding companies that he controls, has voting control of Power Corporation. Shares of Lifeco, Power Financial, and Power Corporation are traded publicly in Canada. B. BUSINESS OF THE COMPANY The Company is authorized to engage in the sale of life insurance, accident and health insurance, and annuities. It is qualified to do business in all states in the United States (except New York) and in the District of Columbia, Puerto Rico, Guam, and the U.S. Virgin Islands. The Company conducts business in New York through its subsidiaries, First Great-West Life & Annuity Insurance Company (First GWL&A) and Canada Life Insurance Company of New York (CLINY). The Company is also a licensed reinsurer in the state of New York. The Company operates the following two business segments: Great-West Healthcare - Employee benefits products and services for group clients Financial Services - Savings products and administrative and recordkeeping services for public, private and non-profit employers, corporations and individuals (including 401(a), 401(k), 403(b), 408, and 457 plans), and life insurance products for individuals and businesses On July 10, 2003, Lifeco completed its acquisition of Canada Life Financial Corporation (CLFC), the parent company of CLAC, Canada Life Insurance Company of America (CLICA) and CLINY. Immediately thereafter, Lifeco transferred all of the common shares of CLFC it acquired to its subsidiary, Great-West Life. On December 31, 2003, CLAC transferred all of the outstanding common shares of CLICA and CLINY owned by it to the Company. CLAC, CLICA and CLINY sell individual and group insurance and annuity products in the United States. Since the time of its acquisition by Lifeco, this insurance and annuity business in the United States has been managed by the Company. In connection with this management, the Company provides certain corporate and operational administrative services for which it receives a fee. Sales of new individual products by CLAC, CLICA and CLINY were discontinued in 2003, shortly after the acquisition of CLFC by Lifeco. They are now being operated as closed blocks of business. On January 14, 2004, Lifeco announced the sale of CLAC's and CLINY's U.S. group business, excluding medical stop loss policies, to Jefferson Pilot Corporation. The Canada Life acquisitions have been accounted for as a "reorganization of businesses under common control." Accordingly, the assets and liabilities of CLICA and CLINY were recorded at Lifeco's cost basis, and the results of operations of CLICA and CLINY from July 10, 2003 through December 31, 2003 are included in the Company's financial statements. The Company recorded as of December 31, 2003, the following (in thousands) as a result of the acquisition of CLICA and CLINY: Assets Liabilities and Stockholder's Equity ---------------------------------------------------- -------------------------------------------------------- Fixed maturities $ 1,937,218 Policy reserves $ 2,991,407 Equity investments 23,680 Policyholders' funds 2,407 Mortgage loans 1,145,494 Policy and contract claims 899 Real estate 550 Provision for policyholders' dividends 2,800 Policy loans 13,621 Other liabilities 439,439 ------------------- Short-term investments 65,537 Total liabilities 3,436,952 Cash (net of acquisition cost) (232,803) Investment income Accumulated other due and accrued 32,147 comprehensive income (14,433) Other assets 439,864 Retained earnings 2,789 -------------- Total stockholder's equity (11,644) ----------------- ------------------- $ 3,425,308 $ 3,425,308 ================= ===================
The Company's statement of operations for the year ended December 31, 2003 includes the following (in thousands) related to CLICA and CLINY for the period from July 10, 2003 to December 31, 2003: Total revenues $ 105,868 Benefits 92,193 Operating expenses 9,385 ------------------ Total benefits and expenses 101,578 Income from operations 4,290 Income taxes 1,501 ------------------ Net income $ 2,789 ================== On August 31, 2003, the Company and CLAC entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured 80% (45% coinsurance and 35% coinsurance with funds withheld) of certain United States life, health and annuity business of CLAC's U.S. branch. The Company recorded $1,427 million in premium income and increase in reserves associated with these policies. The Company recorded, at fair value, the following (in thousands) at August 31, 2003 as a result of this transaction: Assets Liabilities and Stockholder's Equity ----------------------------------------------------- ------------------------------------------------- Fixed Maturities $ 635,061 Policy reserves $ 2,926,497 Mortgage loans 451,725 Policy and contract claims 45,229 Policy loans 278,152 Policyholders' funds 65,958 Reinsurance receivable 1,320,636 Deferred policy acquisition costs acquired 313,364 Investment income Due and accrued 17,280 Premiums in course of collection 21,466 ------------------ ---------------- $ 3,037,684 $ 3,037,684 ================== ================
The reinsurance receivable relates to the amount due the Company for reserves ceded by coinsurance with funds withheld. The Company's return on this reinsurance receivable will be the interest and other investment returns earned net of realized gains and losses on a segregated pool of investments of CLAC's U.S. branch. Pursuant to Statement of Financial Accounting Standards (SFAS) No. 133, the Company has identified an embedded derivative for the Company's exposure to interest rate and credit risk on the segregated pool of investments. This embedded derivative does not qualify for hedge accounting. The table that follows summarizes premiums and deposits for the years indicated. For further consolidated financial information concerning the Company, see Item 6 (Selected Financial Data), and Item 8 (Financial Statements and Supplementary Data). For commentary on the information in the following table, see Item 7 (Management's Discussion and Analysis of Financial Condition and Results of Operations). [Millions] (1) 2003 2002 2001 ----------------------------------------------- --------------- -------------- ---------------- Premium Income Great-West Healthcare Group life & health $ 838 $ 960 $ 1,034 --------------- -------------- ---------------- Total Great-West Healthcare 838 960 1,034 --------------- -------------- ---------------- Financial Services Retirement Services 1 4 Individual Markets 1,414 160 166 --------------- -------------- ---------------- Total Financial Services 1,415 160 170 --------------- -------------- ---------------- Total premium income $ 2,253 $ 1,120 $ 1,204 =============== ============== ================ Fee Income Great-West Healthcare Group life & health $ 607 $ 660 $ 713 --------------- -------------- ---------------- Total Great-West Healthcare 607 660 713 --------------- -------------- ---------------- Financial Services Retirement Services 200 197 208 Individual Markets 33 26 26 --------------- -------------- ---------------- Total Financial Services 233 223 234 --------------- -------------- ---------------- Total fee income $ 840 $ 883 $ 947 =============== ============== ================ Deposits for investment-type contracts - Financial Services (2) $ 676 $ 691 $ 627 =============== ============== ================ Deposits to Separate Accounts - Financial Services $ 2,217 $ 2,461 $ 3,240 =============== ============== ================ Self-funded equivalents - Great-West Healthcare (3) $ 4,674 $ 5,228 $ 5,721 =============== ============== ================
(1) All information in the preceding table and other tables herein is derived from information that has been prepared in conformity with accounting principles generally accepted in the United States of America, unless otherwise indicated. (2) Investment-type contracts are contracts that include significant cash build-up features, as discussed in FASB Statement No. 97. (3) Self-funded equivalents generally represent paid claims under minimum premium and administrative services only contracts, which amounts approximate the additional premiums that could have been earned under such contracts if they had been written as traditional indemnity or HMO programs. C. GREAT-WEST HEALTHCARE 1. Principal Products The Great-West Healthcare segment of the Company provides employee benefits products and services to approximately 5,000 employers across the United States. The Company's product line includes traditional group health plans as well as consumer-driven plans that are supported by the Company's disease management program. Other products and services include COBRA, HIPAA and flexible spending account administration (Internal Revenue Code Sections 125/129); dental and vision plans; life insurance benefits; and short and long-term disability coverage. The Company's health care business is primarily self-funded, whereby the employer assumes all or a significant portion of the risk. For companies with better than average claims experience, this can result in significant health care cost savings. During 2003, the Great-West Healthcare division reorganized into market segments: Select, focusing on employers with 50-250 employees; Mid-market, focusing on employers with 250-2,500 employees; National Accounts, focusing on employers with over 2,500 employees; and Specialty Risk, a new market segment exploring new business opportunities outside the Company's typical target market. In 2003 the Company adopted the new brand name, "Great-West Healthcare," which refers to all employee benefit products and services offered by what was previously known as the Employee Benefits division of the Company and the following subsidiaries: Alta Health & Life Insurance Company (Alta), First GWL&A, and the HMO companies. The new name is intended to eliminate potential market confusion over different carriers and networks. In 2003 the Company introduced a consumer-driven tiered benefit health plan that covers preventive care at 100 percent, provides high-level coverage for medically complex or catastrophic services, and gives members more financial responsibility for discretionary services. The Company also began offering Health Reimbursement Accounts (HRA), through which employers contribute a set annual amount for each employee to spend on health care expenses. Funds remaining at the end of the year can be rolled over for future use. The Company continues to offer a range of other health coverage options including Health Maintenance Organization (HMO) plans, Point of Service (POS) plans, Preferred Provider Organization (PPO) plans, and Open Access plans. Medical management programs are offered to complement each health plan the Company offers, along with a nurse hotline and online educational and comparison tools to help members manage their health and make medically and financially sound treatment choices. The Company's disease management program services enrolled members with asthma, diabetes, cardiac and other conditions. Sales of group life insurance consist principally of renewable term coverage, the amounts of which are usually linked to individual employee wage levels. The following table shows group life insurance in force prior to reinsurance ceded for the year indicated: As of December 31, --------------------------------------------------------------------------- [Millions] 2003 2002 2001 2000 1999 ----------------------- ------------ ----------- ----------- ----------- ------------ In force $ 102,721 $ 58,572 $ 66,539 $ 96,311 $ 82,930
Note: Includes $52,745 of in force group life insurance obtained from the CLAC activity for the year ended December 31, 2003. Also includes $9,049 and $11,237 for the years ended December 31, 2003 and 2002, respectively of in force group life insurance obtained from the acquisition of General American Life Insurance Company (General American). The 2002 figure was influenced by a decline in total health care membership. The 2001 figure was influenced by a decline in total health care membership and the Company's decision to discontinue certain group life insurance business obtained through acquisitions. 2. Method of Distribution The Company distributes its products and services through field sales staff. As of December 31, 2003, the sales staff was located in 31 sales offices throughout the United States. Each sales office works with insurance brokers, agents, and consultants in its local market. 3. Competition The employee benefits industry is highly competitive. The highly competitive marketplace creates pricing pressures that encourage employers to seek competitive bids each year. Although most employers are looking for affordably priced employee benefits products, they also want to offer product choices because employee needs differ. In many cases it is more cost-effective and efficient for an employer to contract with a carrier such as the Company that offers multiple product lines and centralized administration. In addition to price, there are a number of other factors that influence employer decision-making. These factors include: quality of services; scope, cost-effectiveness and quality of provider networks; product responsiveness to customers' needs; cost-containment services; and the effectiveness of marketing and sales. 4. Reserves For group whole life and term insurance products, policy reserve liabilities are equal to the present value of future benefits and expenses less the present value of future net premiums using best estimate assumptions for interest, mortality, and expenses (including margins for adverse deviation). For disability waiver of premium and paid up group whole life contracts (included within the group life family of products offered by the Company), the policy reserves equal the present value of future benefits and expenses using best estimate assumptions for interest, mortality, morbidity, and expenses (including margins for adverse deviation). For group universal life (included within the group life family of products offered by the Company), the policy reserves equal the accumulated fund balance (that reflects cumulative deposits plus credited interest less charges thereon). Reserves for long-term disability products are established for lives currently in payment status, or that are approved for payment but are in a waiting period, using industry and Company morbidity factors, and interest rates based on Company experience. In addition, reserves are held for claims that have been incurred but not reported and for long term disability claims that have been reported but not yet adjudicated. For fully insured medical and dental insurance products, reserves reflect the ultimate cost of claims including, on an estimated basis, (i) claims that have been reported but not settled, and (ii) claims that have been incurred but not reported. Claim reserves are based upon factors derived from past experience. Reserves also reflect a retrospective experience rating that is done on certain types of business. Assumptions for mortality and morbidity experience are periodically reviewed against published industry data and company experience. The above mentioned reserves are computed amounts that, with additions from premiums and deposits to be received, and with interest on such reserves, are expected to be sufficient to meet the Company's policy obligations such as paying expected death or retirement benefits or surrender requests and to generate profits. 5. Reinsurance The Company seeks to limit its exposure on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The maximum amount of group life insurance retained on any one life is $1.5 million and $1.0 million for accidental death coverage. The maximum amount of group monthly disability income benefit at risk on any one life is $6,000 per month. The Company has a marketing and administrative services arrangement with New England Financial (NEF). Effective January 1, 2002, the Company renegotiated this arrangement to assume the full risk on this block of business. The Company pays a per member fee to NEF. D. FINANCIAL SERVICES 1. Principal Products The Financial Services business segment of the Company develops and administers products under two general categories: Retirement Services and Individual Markets. These areas distribute retirement and life insurance products and services for public, private and non-profit employers, corporations and individuals. Retirement Services In 2003 the division launched the new brand name of "Great-West Retirement Services" to bring together multiple products and services under one name. Under the Great-West Retirement Services brand, the Company provides enrollment services, communication materials, investment options, and education services to employer sponsored defined contribution and voluntary 403(b) plans, as well as comprehensive administrative and recordkeeping services for financial institutions and employers. Defined contribution plans provide for benefits based upon the value of contributions to, and investment returns on, the individual's account. This has been the fastest growing portion of the pension marketplace in recent years. The marketing focus is directed towards providing services and investment products under Internal Revenue Code Sections 401(a), 401(k), 403(b), 408, and 457 to state and local governments, hospitals, non-profit organizations, public school districts, corporations and individuals. Recordkeeping and administrative services for defined contributions plans may also be provided to this target market. Through a subsidiary, Financial Administrative Services Corporation (FASCorp), the Company is focused on partnering with other large institutions to provide third-party recordkeeping and administration services. The Company offers both guaranteed interest rate investment options for various lengths of time and variable annuity products designed to meet the specific needs of the customer. In addition, for larger cases the Company offers both customized annuity and non-annuity products. For the guaranteed interest rate option, the Company earns investment margins on the difference between the income earned on investments in the Company's general account and the interest credited to the participant's account balance. The general account assets of the Company support the guaranteed investment product. The Company also manages separate account fixed interest rate options where the Company is paid a management fee. The Company's variable investment options provide the opportunity for participants to assume the risks of, and receive the benefits from, the investment of retirement assets. The variable product assets are invested, as designated by the participant, in separate accounts that in turn invest in shares of underlying funds managed by a subsidiary of the Company or by selected external fund managers. The Company is compensated by separate account fees for mortality and expense risks pertaining to the variable annuity contract and for providing administrative services. The Company is reimbursed by external mutual funds for marketing, sales and service costs under various revenue sharing agreements. The Company also receives fees for providing third-party administrative and recordkeeping services to financial institutions and employer-sponsored retirement plans. Customer retention is a key factor for the profitability of group annuity products. To encourage customer retention, annuity contracts may impose a surrender charge on policyholder balances withdrawn for a period of time after the contract's inception. The period of time and level of the charge vary by product. Existing federal tax penalties on distributions prior to age 59 1/2 provide an additional disincentive to premature surrenders of annuity balances, but do not impede transfers of those balances to products of competitors. Individual Markets In the Individual Markets area, the Company 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. Participating policyholders share in the financial results (differences in experience of actual financial results versus pricing expectations) of the participating business in the form of dividends. The Company no longer actively markets participating products. The provision for participating policyholder earnings is reflected in liabilities in undistributed earnings on participating policyholders in the consolidated balance sheets of the Company. Participating policyholder earnings are not included in the consolidated net income of the Company. Term life provides coverage for a stated period and pays a death benefit only if the insured dies within the period. Whole life provides guaranteed death benefits and level premium payments for the life of the insured. Universal life products include a cash value component that is credited with interest at regular intervals. The Company's earnings result from the difference between the investment income and interest credited on customer cash values and from differences between charges for mortality and actual death claims. Universal life cash values are charged for the cost of insurance coverage and for administrative expenses. Sales of life insurance products typically have initial marketing expenses, which are deferred. Therefore, retention is an important factor in profitability and is encouraged through product features. For example, the Company's universal and whole life insurance contracts typically impose a surrender charge on policyholder balances withdrawn within the first ten years of the contract's inception. The period of time and level of the charge vary by product. In addition, more favorable credited rates may be offered after policies have been in force for a period of time. Through the acquisition of Canada Life discussed earlier, Individual Markets has expanded its in force blocks of individual protection (participating and non-participating whole life, term and universal life insurance) and wealth management products (variable annuities, single premium immediate annuities, structured settlements, and guaranteed investment contracts). The area is focused on fully integrating the operational units and systems and providing excellent customer service to support retention efforts. In 2003, the Company continued its efforts to partner with large financial institutions to provide individual term and whole life insurance to the general population. Some of the institutional partners include Huntington National Bank, US Bank, Citibank, SunTrust Bank, AmSouth Bank, Affiliated Financial Services and Colonial Bank. At both December 31, 2003 and 2002, the Company had $3.8 billion of policy reserves on individual insurance products sold to corporations to provide coverage on the lives of certain employees, also known as Corporate-Owned Life Insurance (COLI). Due to legislation enacted during 1996 that phased out the interest deductions on COLI policy loans over a two-year period ending 1998, leveraged COLI product sales have ceased. The Company has shifted its emphasis to the Business-Owned Life Insurance (BOLI) market. BOLI was not affected by the 1996 legislation. These products are interest-sensitive whole life, universal life and variable universal life policies that indirectly fund post-retirement benefits for employees and non-qualified executive benefits. At December 31, 2003, the Company had $1.5 billion of fixed and $1.5 billion of separate account BOLI policy reserves compared to $1.5 billion of fixed and $1.4 billion of separate account reserves at December 31, 2002. The Company also has a marketing agreement with Charles Schwab & Co., Inc. (Schwab) to sell individual fixed and variable qualified and non-qualified deferred annuities. The fixed product is a Guarantee Period Fund that was established as a non-unitized separate account in which the owner does not participate in the performance of the assets. The assets accrue solely to the benefit of the Company and any gain or loss in the Guarantee Period Fund is borne entirely by the Company. The Company is currently offering guarantee period durations of three to ten years. Distributions from the amounts allocated to a Guarantee Period Fund more than six months prior to the maturity date result in a market value adjustment (MVA). The MVA reflects the relationship as of the time of its calculation between the current U.S. Treasury Strip ask side yield and the U.S. Treasury Strip ask side yield at the inception of the contract. On a very limited basis, the Company also offers single premium annuities and guaranteed certificates that provide guarantees of principal and interest with a fixed maturity date. Customer retention is a key factor for the profitability of individual annuity products. To encourage customer retention, annuity contracts typically impose a surrender charge on policyholder balances withdrawn for a period of time after the contract's inception. The period of time and level of the charge vary by product. Existing federal tax penalties on distributions prior to age 59 1/2 provide an additional disincentive to premature surrenders of annuity balances, but do not impede transfers of those balances to products of competitors. Certain of the Company's life insurance and group annuity products allow policy owners to borrow against their policies. At December 31, 2003, approximately 10% (10% in 2002 and 7% in 2001) of outstanding policy loans were on individual life policies that had fixed interest rates ranging from 5% to 8%. The remaining 90% of outstanding policy loans had variable interest rates averaging 6.54% at December 31, 2003. Investment income from policy loans was $195.6 million, $209.6 million, and $200.5 million for the years ended December 31, 2003, 2002, and 2001, respectively. 2. Method of Distribution Great-West Retirement Services distributes pension products through its subsidiary, GWFS Equities, Inc., as well as over 200 pension consultants, representatives and service personnel. Recordkeeping and administrative services are also distributed through institutional partners. The Individual Markets area distributes individual life insurance through marketing agreements with various retail financial institutions. BOLI is distributed through Clark Consulting primarily, and recently through SunTrust. Individual life insurance and annuity products are also offered through Schwab. 3. Competition The life insurance, savings, and investments marketplace is highly competitive. The Company's competitors include mutual fund companies, insurance companies, banks, investment advisers, and certain service and professional organizations. No one competitor or small number of competitors is dominant. Competition focuses on service, technology, cost, and variety of investment options, investment performance, product features, price, and financial strength as indicated by ratings issued by nationally recognized agencies. For more information on the Company's ratings, see Item 1(G) (Ratings). 4. Reserves Reserves for investment-type policies are equal to cumulative deposits, less withdrawals and mortality and expense charges, plus credited interest. Reserves for all fixed individual life insurance contracts are computed on the basis of assumed investment yield, mortality, morbidity, and expenses (including a margin for adverse deviation). These reserves are calculated as the present value of future benefits (including dividends) and expenses less the present value of future net premiums. The assumptions used in calculating the reserves generally vary by plan, year of issue, and policy duration. For all life insurance contracts, reserves are established for claims that have been incurred but not reported based on factors derived from past experience. Reserves for limited payment contracts (immediate annuities) are computed on the basis of assumed investment yield, mortality (where payouts are contingent on survivorship) and expenses. These assumptions generally vary by plan, year of issue, and policy duration. Reserves for investment contracts (deferred annuities and 401(k)) are equal to the participants' account balances. Reserves for immediate annuities without life contingent payouts are computed on the basis of assumed investment yield and expenses. The mentioned reserves are computed amounts that, with additions from premiums and deposits to be received, and with interest on such reserves, are expected to be sufficient to meet the Company's policy obligations (such as paying expected death or retirement benefits or surrender requests) and to generate profits. 5. Reinsurance The Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The Company retains a maximum of $1.5 million of coverage per individual life. Under the Company's marketing and administrative services arrangement with NEF, NEF issues 401(k) products and then immediately reinsures nearly 100% of its guaranteed 401(k) business with the Company. E. INVESTMENT OPERATIONS The Company's investment division manages or administers the Company's general and separate accounts in support of cash and liquidity requirements of the Company's insurance and investment products. Total investments at December 31, 2003, were $32.9 billion, comprised of general account assets of $19.7 billion and separate account assets of $13.2 billion. Total investments at December 31, 2002, were $25.9 billion, comprised of general account assets of $14.6 billion and separate account assets of $11.3 billion. The Company's general account investments are in a broad range of asset classes, primarily domestic and international fixed maturities. Fixed maturity investments include public and privately placed corporate bonds, government bonds, redeemable preferred stocks and mortgage-backed securities and asset-backed securities. The Company manages the characteristics of its investment assets, such as liquidity, currency, yield, and duration, to reflect the underlying characteristics of related insurance and policyholder liabilities that vary among the Company's principal product lines. The Company observes strict asset and liability matching guidelines designed to ensure that the investment portfolio will appropriately meet the cash flow and income requirements of its liabilities. In connection with its investment strategy, the Company makes limited use of derivative instruments in hedging transactions to manage certain portfolio related risks. The Company also utilizes derivative instruments to engage in replicated synthetic asset transactions. Derivative instruments are not used for speculative purposes. For more information on derivatives see Notes 1 and 7 to the consolidated financial statements of the Company (the Consolidated Financial Statements) that are included in Item 8 (Financial Statements and Supplementary Data). The Company routinely monitors and evaluates the status of its investments in light of current economic conditions, trends in capital markets, and other factors. These other factors include investment size, quality, concentration by issuer and industry and other diversification considerations relevant to the Company's fixed maturity investments. The Company's fixed maturity investments comprised 67% of its investment assets, as of December 31, 2003. The Company reduces credit risk for the portfolio as a whole by investing primarily in investment-grade fixed maturities. As of both December 31, 2003 and 2002, 97% of the bond portfolio carried an investment grade rating. The Company's equity investments increased from 1% at December 31, 2002, to 2% at December 31, 2003. The Company made a significant investment in an exchange-traded fund investing in debt securities. This investment provides both liquidity and diversification at relatively low risk levels. This fund has an investment grade debt rating. In addition, the Company invested in various limited partnerships and limited liability companies that make equity investments in affordable-housing projects throughout the United States. The Company's mortgage loan portfolio constituted 10% and 3% of investment assets as of December 31, 2003 and 2002, respectively. The increase is a result of the asset transfer associated with the Indemnity Reinsurance Agreement entered into with CLAC as well as the assets associated with the acquisition of CLICA and CLINY. At December 31, 2003, 17% of investment assets were invested in policy loans, 4% were invested in short-term investments, and less than 1% were invested in real estate compared to 20%, 5%, and 1%, respectively, in 2002. The following table sets forth the distribution of invested assets, cash and accrued investment income for the Company's general account as of the end of the years indicated: Carrying Value in Millions 2003 2002 2001 2000 1999 --------------------------- ------------ ------------ ------------ ------------ ------------ Debt Securities: U.S. government securities and obligations of U.S. government agencies $ 3,199 $ 2,710 $ 3,075 $ 2,315 $ 1,859 Bonds 9,880 7,618 7,013 7,055 7,078 Foreign governments 58 43 28 50 51 ------------ ------------ ------------ ------------ ------------ Total debt securities 13,137 10,371 10,116 9,420 8,988 Other Investments: Equity investments 428 90 73 95 69 Mortgage loans 1,886 417 613 843 975 Real estate 8 4 12 107 104 Policy loans 3,389 2,964 3,001 2,810 2,681 Short-term Investments 852 710 425 414 241 ------------ ------------ ------------ ------------ ------------ Total investments $ 19,700 $ 14,556 $ 14,240 $ 13,689 $ 13,058 ============ ============ ============ ============ ============ Cash $ 188 $ 155 $ 214 $ 154 $ 268 Accrued investment Income 165 133 131 139 138
The following table summarizes the Company's general account investment results: [Millions] Net Earned Net Investment Investment For the year: Income Income Rate ------------------------- ----------------- ---------------- 2003 $ 988 6.23 % 2002 919 6.83 % 2001 935 7.10 % 2000 925 7.34 % 1999 876 6.96 %
F. REGULATION 1. Insurance Regulation The business of the Company is subject to comprehensive state and federal regulation and supervision throughout the United States that primarily provides safeguards for policyholders. The laws of the various state jurisdictions establish supervisory agencies with broad administrative powers with respect to such matters as admittance of assets, premium rating methodology, policy forms, establishing reserve requirements and solvency standards, maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values, the type, amounts and valuation of investments permitted, and HMO operations. The Company's operations and accounts are subject to examination by the Colorado Division of Insurance (CDOI) and other regulators at specified intervals. A financial examination by the CDOI was completed in 2002 and covered the five-year period ended December 31, 2000. The examination produced no significant adverse findings regarding the Company. The National Association of Insurance Commissioners (NAIC) has prescribed risk-based capital (RBC) rules and other financial ratios for life insurance companies. The calculations set forth in these rules, which are used by regulators to assess the sufficiency of an insurer's capital, measure the risk characteristics of an insurer's assets, liabilities, and certain off-balance sheet items. RBC is calculated by applying factors to various asset, premium and liability items. The application of the RBC levels contained within the rules is a regulatory tool which may indicate the need for possible corrective action with respect to an insurer, and is not intended as a means to rank insurers generally. Based on their December 31, 2003, statutory financial reports, the Company and its insurance subsidiaries have risk-based capital well in excess of that required by their regulators. The NAIC has also adopted the Codification of Statutory Accounting Principles (Codification). Codification was intended to standardize accounting and reporting to state insurance departments effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. The CDOI required adoption of Codification with certain modifications for the preparation of statutory financial statements effective January 1, 2001 (see Note 13 to the Consolidated Financial Statements). 2. Insurance Holding Company Regulations The Company and certain of its subsidiaries are subject to, and comply with, insurance holding company regulations in the applicable states. These regulations contain certain restrictions and reporting requirements for transactions between affiliates including the payment of dividends. They also regulate changes in control of an insurance company. 3. Securities Laws The Company is subject to various levels of regulation under federal securities laws. The Company's broker-dealer subsidiaries are regulated by the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers, Inc. The Company's investment adviser subsidiaries and transfer agent subsidiary are regulated by the SEC. Certain of the Company's separate accounts supporting its variable insurance and annuity products, as well its mutual fund subsidiaries, are registered under the Investment Company Act of 1940 while the securities they issue are registered under the Securities Act of 1933. 4. Guaranty Funds Under insurance guaranty fund laws existing in all states, insurers doing business in those states can be assessed (up to prescribed limits) for certain obligations of insolvent insurance companies. The Company has established a reserve of $1.1 million as of December 31, 2003 to cover future assessments of known insolvencies of other companies. The Company has historically recovered more than half of the guaranty fund assessments through statutorily permitted premium tax offsets. The Company has a prepaid asset associated with guaranty fund assessments of $2.8 million at December 31, 2003. 5. Potential Legislation United States federal and state legislative and regulatory developments in various areas, including health care and retirement services, could significantly and adversely affect the Company in the future. Congress continues to consider health care legislation relating to the uninsured, class action and medical liability reform, and mental health parity. Congress also continues to consider changes to various features of retirement plans, the taxation of BOLI, expanding access to investment advice, and increasing oversight of mutual funds. It is not possible to predict whether future legislation or regulation adversely affecting the business of the Company will be enacted and, if enacted, the extent to which such legislation or regulation will have an effect on the Company and its competitors. G. RATINGS The Company is rated by a number of nationally recognized rating agencies. The ratings represent the opinion of the rating agencies regarding the financial strength of the Company and its ability to meet ongoing obligations to policyholders. On July 10, 2003, Lifeco announced that it had closed its transaction to acquire the common shares of CLFC. As a result of this closing, several of the rating agencies have changed their ratings of Lifeco and certain of its subsidiaries, such as the Company. A.M. Best Company, Inc., Moody's Investors Service and Standard & Poor's Corporation lowered the financial strength rating of the Company by one rating notch. Rating Agency Measurement Current Rating ------------------------------------- -------------------------------------- ---------------------- A.M. Best Company, Inc. Financial strength, operating A+ (1) performance and business profile Fitch, Inc. Financial strength AA+ (2) Moody's Investors Service Financial strength Aa3 (3) Standard & Poor's Corporation Financial strength AA (4)
(1) Superior (highest category out of ten categories) (2) Very Strong (second highest category out of eight categories) (3) Excellent (second highest category out of nine categories) (4) Very strong (second highest category out of nine categories) H. MISCELLANEOUS No customer accounted for 10% or more of the Company's consolidated revenues in 2003, 2002 or 2001. In addition, no segment of the Company's business is dependent on a single customer or a few customers, the loss of which would have a significant effect on the Company or any of its business segments. The loss of business from any one, or a few, independent brokers or agents would not have a material adverse effect on the Company or any of its business segments. The Company had approximately 6,200 employees at December 31, 2003. ITEM 2. PROPERTIES The Head Office of the Company consists of a 752,000 square foot complex located in Greenwood Village, Colorado. The Company leases sales and claims processing offices throughout the United States. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted during the fourth quarter of 2003 to a vote of security holders. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS A. EQUITY SECURITY HOLDERS AND MARKET INFORMATION There is no established public trading market for the Company's common equity. GWL&A Financial is the sole shareholder of the Company's common equity securities. B. DIVIDENDS In the two most recent fiscal years the Company has paid quarterly dividends on its common shares. Dividends on common stock totaled $75.7 million in 2003 and $170.6 million in 2002. Under Colorado law the Company cannot, without the approval of the Colorado Commissioner of Insurance, pay a dividend if as a result of such payment, the total of all dividends paid in the preceding twelve months, would exceed the greater of (i) 10% of the Company's statutory surplus as regards policyholders as of the preceding December 31; or (ii) the Company's statutory net gain, not including realized capital gains, for the twelve-month period ending December 31 next preceding not including pro rata distributions of the insurer's own securities. ITEM 6. SELECTED FINANCIAL DATA The following is a summary of certain financial data of the Company. This summary has been derived in part from and should be read in conjunction with the Company's Consolidated Financial Statements. Note 1 to the consolidated financial statements discusses the significant accounting policies of the Company. Significant estimates are required to account for policy reserves, allowances for credit losses, deferred policy acquisition costs, and valuation of privately placed fixed maturities. Actual results could differ from those estimates. INCOME STATEMENT Years Ended December 31, ------------------------------------------------------------------------ DATA 2003 2002 2001 2000 1999 ------------------------------- ----------- ----------- ------------ ----------- ----------- [millions] Premium income $ 2,253 $ 1,120 $ 1,203 $ 1,332 $ 1,163 Fee income 840 884 947 872 635 Net investment income 988 919 935 925 876 Net realized investment gains 40 42 47 28 1 ----------- ----------- ------------ ----------- ----------- Total revenues 4,121 2,965 3,132 3,157 2,675 Policyholder benefits 2,684 1,593 1,696 1,746 1,582 Operating expenses 965 958 1,021 1,018 804 ----------- ----------- ------------ ----------- ----------- Total benefits and expenses excluding special charges 3,649 2,551 2,717 2,764 2,386 Income tax expense 154 130 141 134 83 ----------- ----------- ------------ ----------- ----------- Net income before special charges 318 284 274 259 206 Special charges (net) 81 ----------- ----------- ------------ ----------- ----------- Net income $ 318 $ 284 $ 193 $ 259 $ 206 =========== =========== ============ =========== =========== Deposits for investment- type contracts $ 675 $ 691 $ 627 $ 835 $ 634 Deposits to separate accounts 2,217 2,461 3,240 3,105 2,583 Self-funded premium equivalents 4,674 5,228 5,721 5,181 2,979 BALANCE SHEET December 31, ------------------------------------------------------------------------ DATA 2003 2002 2001 2000 1999 ------------------------------- ----------- ----------- ------------ ----------- ----------- [millions] Investment assets $ 19,700 $ 14,556 $ 14,240 $ 13,689 $ 13,058 Separate account assets 13,175 11,338 12,585 12,381 12,820 Total assets 36,453 27,656 28,818 27,897 27,530 Total policy benefit liabilities 19,149 13,007 12,931 12,825 12,341 Due to GWL 31 34 42 43 36 Due to GWL&A Financial 176 171 215 171 175 Total shareholder's equity 1,887 1,664 1,470 1,427 1,167
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Form 10-K contains forward-looking statements. Forward-looking statements are statements not based on historical information and that relate to future operations, strategies, financial results, or other developments. In particular, statements using verbs such as "expected," "anticipate," "believe," or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements that represent the Company's beliefs concerning future or projected levels of sales of the Company's products, investment spreads or yields, or the earnings or profitability of the Company's activities. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates, some of which may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation, and others of which may relate to the Company specifically, such as credit, volatility, and other risks associated with the Company's investment portfolio and other factors. Readers are also directed to consider other matters, including any risks and uncertainties, discussed in documents filed by the Company and certain of its subsidiaries with the SEC. Management's discussion and analysis of financial conditions and results of operations of the Company for the three years ended December 31, 2003 follows. This management discussion and analysis should be read in conjunction with the financial data contained in Item 6 and the Company's Consolidated Financial Statements. A. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company's management to make a variety of estimates and assumptions. These estimates and assumptions affect, among other things, the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results can differ from the amounts previously estimated, which were based on the information available at the time the estimates were made. The critical accounting policies described below are those that the Company believes are important to the portrayal of the Company's financial condition and results, and which require management to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. The Company believes that critical accounting policies include policy reserves, allowances for credit losses, deferred policy acquisition costs, and valuation of privately placed fixed maturities. Policy Reserves Life Insurance and Annuity Reserves - Life insurance and annuity policy reserves with life contingencies are computed on the basis of estimated mortality, investment yield, withdrawals, future maintenance and settlement expenses, and retrospective experience rating premium refunds. Annuity contract reserves without life contingencies are established at the contractholder's account value. Reinsurance - Policy reserves ceded to other insurance companies are carried as a reinsurance receivable on the balance sheet. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The Company retains a maximum of $1.5 million of coverage per individual life. Policy and Contract Claims - Policy and contract claims include provisions for reported life and health claims in process of settlement, valued in accordance with the terms of the related policies and contracts, as well as provisions for claims incurred and unreported based primarily on prior experience of the Company. Allowance For Credit Losses The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on its amounts receivable related to uninsured accident and health plan claims paid on behalf of policyholders and premiums in course of collection, and to absorb credit losses on its impaired loans. Management's judgment is based on past loss experience and current and projected economic conditions, and extensive situational analysis of each individual loan. The measurement of impaired loans is based on the fair value of the collateral. Deferred Policy Acquisition Costs Policy acquisition costs, which primarily consist of sales commissions and costs associated with the Company's sales representatives related to the production of new business, have been deferred to the extent deemed recoverable. These costs are variable in nature and are dependent upon sales volume. Deferred costs associated with the annuity products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits. Deferred costs associated with traditional life insurance are amortized over the premium paying period of the related policies in proportion to premium revenues recognized. Valuation Of Privately Placed Fixed Maturities The estimated fair values of financial instruments have been determined using available information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. To determine fair value for fixed maturities not actively traded, the Company utilizes discounted cash flows calculated at current market rates on investments of similar quality and term. B. COMPANY RESULTS OF OPERATIONS 1. Consolidated Results Net Income The Company's consolidated net income increased $34 million or 12% in 2003 when compared to 2002. The net income increase reflects a $10 million increase as a result of the Canada Life activity, a $34 million increase in the Great-West Healthcare segment excluding the CLAC reinsurance activity, and a $10 million decrease in the Financial Services segment excluding the impact of the CLAC reinsurance activity. The Company's consolidated net income decreased $8.8 million or 3.0% in 2002 when compared to 2001 (before one-time charges in 2001 of $80.9 million and operating losses of $18.7 million, net of tax, related to the Alta business). Alta was acquired by the Company on July 8, 1998. During 2001 and 2000, the Alta business continued to be run as a free-standing unit but was converted to the Company's systems and accounting processes. This conversion program resulted in significant issues related to pricing, underwriting, and administration of the business. The Company is transitioning Alta business to other Company products. All Alta sales and administration staff have become employees of the Company and the underwriting functions are conducted by the underwriting staff of the Company. Segment Contribution In 2003, the Great-West Healthcare segment (excluding Canada Life activity) contributed $170.2 million, the Financial Services segment (excluding Canada Life activity) contributed $138.1 million, and the Canada Life activity contributed $9.7 million to net income. Of total consolidated net income in 2003 and 2002, the Great-West Healthcare segment contributed 53% and 48%, respectively, the Financial Services segment contributed 44% and 52%, and the Canada Life activity contributed 3% and 0%, respectively. Revenues In 2003, total revenues increased $1.2 billion or 39% to $4.1 billion when compared to 2002. The increase in revenues in 2003 was comprised of increased premium income of $1.1 billion and increased net investment income of $69 million offset by decreased fee income of $43 million and decreased net realized gains on investments of $2 million. In 2002, total revenues decreased $167.8 million or 5.4% to $3.0 billion when compared to 2001. The decline in revenues in 2002 was comprised of decreased premium income of $83.5 million, decreased fee income of $63.7 million, decreased net investment income of $15.4 million, and a $5.2 million decrease in realized investment gains. The $1.1 billion increase in premium income in 2003 was comprised of a $1.6 billion increase from the Canada Life activity and a $12.4 million increase in the Financial Services segment's non-Canada life activity, offset by a $468.1 million decrease in the Great-West Healthcare segment's non-Canada Life activity. The decline in premium income in the Great-West Healthcare segment reflected the reinsurance agreement with Allianz discussed under "Other" below, and a 15% decline in medical members from 2.2 million in 2002 to 1.9 million in 2003. The decreased premium income in 2002 was comprised of a decline in Great-West Healthcare premium income and Financial Services premium income of $73.7 million and $9.8 million, respectively. The decline in premium income in the Great-West Healthcare segment reflected a 15.4% decline in medical members from 2.6 million in 2001 to 2.2 million in 2002. Financial Services experienced lower sales and higher terminations in 2002. Fee income in 2003 was comprised of Great-West Healthcare fee income, Financial Services fee income and Canada Life fee income of $607.2 million, $229.6 million and $3.3 million, respectively. Great-West Healthcare fee income, excluding the Canada Life activity, declined $53.2 million or 8.1% when compared to 2002, due to a decline in medical members. Financial Services fee income, excluding the Canada Life activity, increased $6.5 million or 2.9% when compared to 2002, primarily the result of an increase during 2003 of participant accounts including third-party administration and institutional accounts. Fee income in 2002 was comprised of Great-West Healthcare fee income and Financial Services fee income of $660.4 million and $223.1 million, respectively. Great-West Healthcare fee income declined $52.9 million or 7.4% when compared with 2001, due to a decline in medical members. Financial Services fee income declined $11.0 million or 4.7% when compared to 2001, primarily the result of weak U.S. equity markets, which reduced revenues from asset-based fees. Benefits Total benefits increased $1.1 billion or 68.5% in 2003 when compared to 2002, reflecting an increase of $1.6 billion resulting from the Canada Life activity offset by a decrease of $514 million in the Great-West Healthcare segment due primarily to the reinsurance agreement with Allianz and a decrease of $51 million in the Financial Services segment. Total benefits decreased $103.8 million or 6.1% in 2002 when compared to 2001, reflecting lower group life and health claims primarily as a result of the decline in membership in the Great-West Healthcare segment. Expenses Total expenses increased $7.5 million or 0.8% in 2003 when compared to 2002 primarily due to a $69.1 million increase related to the Canada Life acquisition, offset by a $62.6 million decrease in the Great-West Healthcare segment, excluding the Canada Life activity, due to process efficiencies and a decrease in membership. Total expenses decreased $63.0 million or 6.2% in 2002 when compared to 2001, before special charges, as the Company focused on reducing administrative costs. During 2002, Great-West Healthcare's operating expenses decreased $42.5 million due primarily to reduced administrative costs and medical membership. Financial Services' operating expenses decreased $20.4 million due primarily to effective expense management and lower commissions. Income tax expense increased $23.4 million or 18.0% in 2003 when compared to 2002. This increase was primarily due to the increase in net income from operations. Income tax expense before special charges decreased $10.9 million or 7.7% in 2002 when compared to 2001. The decrease reflects a reduction in the liability for tax contingencies due to the completion of the 1994 - 1996 Internal Revenue Service examination. See Note 11 to the Consolidated Financial Statements for a discussion of the Company's effective tax rates. Deposits for Investment-Type Contracts, Deposits to Separate Accounts and Self-Funded Equivalents In evaluating its results of operations, the Company also considers net changes in deposits received for investment-type contracts, deposits to separate accounts, and self-funded equivalents. Self-funded equivalents represent paid claims under minimum premium and administrative services only contracts. These amounts approximate the additional premiums which would have been earned under such contracts if they had been written as traditional indemnity or HMO programs. Deposits for investment-type contracts decreased $15.2 million or 2% in 2003 when compared to 2002. Deposits for investment-type contracts increased $64.3 million or 10% in 2002 when compared to 2001. The decrease in 2003 was primarily attributable to a net decrease in participant accounts in the retirement products area in 2003. The increase in 2002 was primarily attributable to one large case sale in the Financial Services segment. Deposits for separate accounts decreased $244.1 million or 10% in 2003 when compared to 2002. This decrease in 2003 is primarily due to a combination of decreased sales of the BOLI product and the net decrease in contributions in the group retirement services market. Deposits for separate accounts decreased $778.8 million or 24.0% in 2002 when compared to 2001. This decrease in 2002 is primarily due to a combination of lower 401(k) sales and higher 401(k) terminations as well as a decline in BOLI sales. Self-funded premium equivalents decreased $554.6 million or 11% in 2003 when compared to 2002. This decrease was due to improved morbidity as well as the decrease in membership. Self-funded premium equivalents decreased $492.4 million or 8.6% in 2002 when compared to 2001. This decrease was due to the membership decline in the Great-West Healthcare segment. 2. Other Prior to 2002, the 401(k) business unit had been included with the Great-West Healthcare segment. In order to capitalize on administrative system efficiencies and group pension expertise, beginning in 2002 the 401(k) business was administered by the Financial Services segment. As a result, prior period segment results have been reclassified to conform with this change. The Great-West Healthcare division of the Company entered into a reinsurance agreement during the third quarter of 2003 with Allianz Risk Transfer (Bermuda) Limited (Allianz) to cede 90% of direct written group health stop-loss and excess loss business. This Allianz agreement was retroactive to January 1, 2003. The net cost of the Allianz agreement was charged to the Financial Services division as part of the Canada Life integration. Effective January 1, 2000, the Company co-insured the majority of General American's group life and health insurance business which primarily consists of administrative services only and stop loss policies. The agreement converted to an assumption reinsurance agreement January 1, 2001. The Company assumed approximately $150 million of policy reserves and miscellaneous liabilities in exchange for $150 million of cash and miscellaneous assets from General American. C. GREAT-WEST HEALTHCARE RESULTS OF OPERATIONS The following is a summary of certain financial data of the Great-West Healthcare segment: Years Ended December 31, --------------------------------------------------------- INCOME STATEMENT DATA 2003 2002 2001 --------------------------------------------- ----------------- ----------------- ---------------- [millions] Premiums $ 838 $ 960 $ 1,033 Fee income 608 661 713 Net investment income 72 68 66 Net realized investment gains (losses) 10 9 16 ----------------- ----------------- ---------------- Total revenues 1,528 1,698 1,828 Policyholder benefits 568 762 859 Operating expenses 699 733 774 ----------------- ----------------- ---------------- Total benefits and expenses before special charges 1,267 1,495 1,633 Income tax expense 88 67 68 ----------------- ----------------- ---------------- Net income excluding special charges 173 136 127 Special charges (net) 81 ----------------- ----------------- ---------------- Net income $ 173 $ 136 $ 46 ================= ================= ================ Self-funded premium equivalents $ 4,674 $ 5,228 $ 5,721
Net income increased $37 million or 27% in 2003 when compared to 2002 primarily due to improved aggregate and specific stop loss morbidity. The CLAC reinsurance agreement contributed $3 million to net income in 2003. Net income, excluding special charges of $80.9 million after tax, increased 7.1% in 2002 when compared to 2001. This improvement in earnings reflected improved morbidity margins. Excluding premium and fee income associated with CLAC reinsurance and Allianz reinsurance, premium and fee income decreased $149 million or 9% in 2003 when compared to 2002. The decreases are primarily due to lower membership levels associated with lower case sales offset by an increase in revenue resulting from pricing actions taken during 2002 and 2003. Excluding total benefits and expenses associated with CLAC reinsurance and Allianz reinsurance, total benefits and expenses decreased $206 million or 14% in 2003 when compared to 2002. While increased utilization and higher medical costs increased benefits on in-force cases, the decrease in overall membership, combined with pricing actions taken in 2002, resulted in a reduction of benefits. Self-funded premium equivalents decreased $554.6 million or 11% in 2003 when compared to 2002. This decrease was due to improved morbidity experience as well as the decrease in membership. Self-funded premium equivalents decreased $492.4 million or 8.6% in 2002 when compared to 2001. This decrease was due to the membership decline in the Great-West Healthcare segment. The Company recorded $18.5 million ($12.0 million, net of tax) of restructuring costs during 2002 related to the costs associated with the consolidation of benefit payment offices and sales offices throughout the United States. The charges relate to severance of $4.3 million, disposal of furniture and equipment of $4.9 million, and termination of leasing agreements of $9.3 million. During 2001, the Company recorded a $127 million special charge ($80.9 million, net of tax), related to Alta. The principal components of the charge include a $46 million premium deficiency reserve related to under-pricing on the block of business, a $29 million reserve for doubtful premium receivables, a $28 million reserve for doubtful accident and health plan claim receivables, and a $24 million decrease in goodwill and other. The Company established a premium deficiency reserve of $46 million (included in special charges previously discussed) on the Alta block of business in 2001. Releases of $18.7 million in 2001, $6.2 million in the first quarter of 2002, and $2.1 million in the second quarter of 2002 were made to offset the underwriting losses incurred on the under-priced block of business. During the first quarter of 2002 the reserve was reduced by $15 million ($9.8 million net of tax) and during the second quarter of 2002 the reserve was reduced by $4 million ($2.6 million, net of tax) based on an analysis of emerging experience which was more favorable than originally estimated. The balance of the premium deficiency reserve at December 31, 2002 was zero. Excluding customers associated with Canada Life, the Great-West Healthcare segment experienced a net decrease of 959 group health care customers (employer groups) during 2003. There was a 15% decrease in total health care membership from 2.2 million at the end of 2002 to 1.9 million at year-end 2003. POS and HMO members decreased 29.7% from 346,900 in 2002 to 244,000 in 2003. The Great-West Healthcare segment experienced a net decrease of 1,766 group health care customers (employer groups) during 2002. There was a 16% decrease in total health care membership from 2.6 million at the end of 2001 to 2.2 million at year-end 2002. POS and HMO members decreased 30.7% from 500,600 in 2001 to 346,900 in 2002. Much of the health care decline in 2003 and 2002 can be attributed to terminations resulting from aggressive pricing related to target margins, as well as a decrease in the employee base for existing group health care customers and the general decline in the economy. Outlook The Company recognizes that the health care marketplace is changing. The Company has reduced its focus on its HMO product in most markets. The Company continues to explore product design options that reduce cost to the employer and provide incentives for employees to become more engaged in health care buying decisions. The Company has launched a consumer driven tiered benefits product called Great-West Healthcare Consumer Advantage, and also implemented its HRA capability. The Company will continue to explore further innovations in the consumer driven product area including health spending account models enabled through recent legislative changes. Efforts surrounding provider re-contracting and enhanced disease management will build on the success achieved during 2003 in enhancing the Company's medical cost and market positions. These efforts are a key element in controlling health care costs for members and enhancing the ability to attract new members in the future. During 2003, the Company was successful in its efforts to combine its multiple distribution channels under one name - Great-West Healthcare. Efforts to enhance brand awareness continue. Based on the Company's evaluation of the marketplace, the sales organization has been reorganized along market segments. New leadership has rebuilt the sales team and implemented a sales process to improve overall effectiveness of the sales organization. A new sales support function has been built and will continue to focus on supporting and improving the sales process and customer satisfaction. The Company continues to evaluate opportunities to enhance customer satisfaction and reduce administrative costs. The Company's successful implementation of HIPAA (Health Insurance Portability and Accountability Act of 1996) and focus on Web enabled technology will likely increase automated interactions with providers, employers and members. The Company plans on achieving further productivity improvements in 2004. Claims processing costs will likely decrease due to consolidation of claims processing and customer service locations, and the implementation of productivity improvement software (claims workflow software). A dedicated team has been formed to further explore and implement additional opportunities. D. FINANCIAL SERVICES RESULTS OF OPERATIONS The following is a summary of certain financial data of the Financial Services segment: Years Ended December 31, --------------------------------------------------------- INCOME STATEMENT DATA 2003 2002 2001 --------------------------------------------- ----------------- ----------------- ---------------- [millions] Premiums $ 1,415 $ 160 $ 170 Fee income 233 223 234 Net investment income 916 851 869 Net realized investment gains 29 33 31 ----------------- ----------------- ---------------- Total revenues 2,593 1,267 1,304 Policyholder benefits 2,116 831 837 Operating expenses 267 225 247 ----------------- ----------------- ---------------- Total benefits and expenses 2,383 1,056 1,084 ----------------- ----------------- ---------------- Income from operations 210 211 220 Income tax expense 65 63 73 ----------------- ----------------- ---------------- Net income $ 145 $ 148 $ 147 ================= ================= ================ Deposits for investment-type contracts $ 676 $ 691 $ 627 Deposits to separate accounts 2,217 2,461 3,240
Net income for Financial Services decreased $3 million or 2% in 2003 when compared to 2002. The results of operations for the life insurance and annuity business of CLINY and CLICA have been included in the Income Statement Data above for the period since the acquisition. The life insurance and annuity reinsurance transactions related to the CLAC reinsurance agreement have also been included in the above Income Statement Data. The impact of both of these transactions (Canada Life activity) on the Financial Services division results for 2003 was as follows: [Millions] Premiums $1,242 Fee income 3 Net investment income 144 Net realized gains on inv 2 ---------- Total revenues 1,391 Policyholder benefits 1,341 Operating expenses 41 --------- Total benefits and expenses 1,382 Income from operations 9 Income taxes 2 ---------- Net income $ 7 ========== Net income for the Financial Services division (excluding the Canada Life activity discussed above) decreased $10 million or 7% from 2002. The decrease was primarily related to a decrease in interest margins on fixed or general account products (see discussion below) and poor mortality (death benefits exceed actuarial reserves released) experienced on the individual insurance lines in 2003. Net income for Financial Services remained stable in 2002 when compared to 2001. During 2002, the Company experienced lower sales in most of its product areas and higher termination rates. The weak U.S. equity markets also negatively impacted the Company. Offsetting these challenges was a decrease in operating expenses and effective management of investment margins on products which resulted in a relatively flat net income for the year. Total premiums including deposits to investment-type contracts and deposits to separate accounts decreased $352 million or 11% in 2003 (excluding the Canada Life activity mentioned above). Premiums and deposits decreased $218 million in the Individual Markets area where the Company has experienced negligible sales of the BOLI product in 2003. The remaining difference was due to lower cash flows in 2003 on the variable annuity products driven by lower single premium deposits or rollovers in the Great-West Retirement Services area from new plans. In 2002, total premiums including deposits to investment-type contract and deposits to separate accounts decreased $725 million or 18%. The decreases were driven by lower cash flows on annuity products and decreased BOLI sales in the Individual Markets area. Variable fee income fluctuates with changes in the U.S. equities markets as these fees are typically assessed on account balances. Variable fee income is also affected by fluctuations in the participant account balances associated with cash flows to and from the separate accounts, participation in plans and with the types of services offered. Fixed fees (or expense recoveries on annuities and insurance products) also fluctuate with changes in the participant or policyholder account balances due to cash flows, participation and services. Fees from third-party administration and recordkeeping services fluctuate with the number of participants and with services provided. Fee income in 2003 increased $6.5 million or 2.9% (excluding the Canada Life activity discussed above). Fee income represents a combination of variable fee income from separate accounts and fee income charged on fixed investment options for mortality and expense risks and fees for third-party administrative and recordkeeping services to financial institutions and employer-sponsored retirement plans. In 2002, fee income decreased $11 million or 5% from 2001. The decrease was primarily associated with the challenges experienced in the U.S. equities markets resulting in a decrease in the variable participant account balances. These fluctuations also had a negative impact on the net cash flows to separate accounts. Retirement services participant accounts, including third-party administration and institutional accounts, increased 5% in 2003 from 2,159,910 at December 31, 2002 to 2,265,713 at December 31, 2003. Although the area experienced a decrease of 117,000 participant accounts from one large case termination in the first quarter of 2003, this was offset by growth from sales and increased participation in existing case sales during 2003. In 2002 Retirement Services participant accounts decreased from 2,191,264 at the end of 2001 to 2,159,910 at the end of 2002. The decrease was due to the termination of one large institutional client during 2002. The term life insurance product marketed through banks and other financial institutions experienced significant growth over the past several years. Policies in force totaled 116,739, 74,080 and 38,813 in the years ended 2003, 2002 and 2001, respectively. Although the sales of term life insurance were improved in 2003 and 2002, the premiums on these policies are smaller and, therefore, were not a significant offset to the large decrease in BOLI premiums. During 2003, net investment income and realized gains excluding the impact of the Canada Life activity decreased $85 million or 10% from 2002. This decrease represented a drop in the net earned rate on investments from 6.88% in 2002 to 6.23% in 2003. Offsetting this decrease was a corresponding decrease in the interest rate credited on policyholder general account products. In 2002, net investment income and realized gains decreased $16 million or 2% from the previous year. The decrease represented a drop in the net earned rate on investments from 7.1% in 2001 to 6.88% in 2002. On fixed products or general account products, earnings are generated from the difference between the net investment income earned on investments and the amount credited to policyholders' or participants' accounts. This difference is referred to as the "interest margins" or "margins" on fixed assets. The amount of fixed annuity products in force is measured by policy reserves. The following table shows group and individual annuity policy reserves for the years indicated as well as the balances in the separate accounts: Year ended Retirement Individual December 31, General Account Services Markets [millions] Annuity Reserves Separate Accounts Separate Accounts -------------------- ---------------------- -------------------- -------------------- 1999 $ 4,969 $ 11,425 $ 843 -------------------- -- ---------------------- -- -------------------- --- -------------------- 2000 4,738 10,753 950 -------------------- -- ---------------------- -- -------------------- --- -------------------- 2001 4,687 10,277 945 -------------------- -- ---------------------- -- -------------------- --- -------------------- 2002 4,612 8,859 808 -------------------- -- ---------------------- -- -------------------- --- -------------------- 2003 7,124 10,289 1,244 -------------------- -- ---------------------- -- -------------------- --- --------------------
Total policyholder benefits decreased $56 million or 7% during 2003 excluding the impact of the Canada Life activity. In 2002 total policyholder benefits decreased $6 million or 1% from 2001. Total policyholder benefits represent benefits on insurance and annuity products, interest paid or credited to policyholder and participant accounts, dividends paid, and change in actuarial reserves. Total policyholder benefits fluctuate with the amount of interest credited to policyholder or participant account balances (see discussion on net investment income above), from differences between charges for mortality and actual death claims and from fluctuations in premiums and cash flows to and from general account products. At December 31, 2003 and 2002, the Company had $8.9 billion (including $1.6 billion for Canada Life) and $7.1 billion, respectively, of policy reserves on individual insurance on the balance sheet. The following table summarizes individual life insurance in force prior to reinsurance ceded for the years indicated: As of December 31, --------------------------------------------------------------------------- [Millions] 2003 2002 2001 2000 1999 ----------------------- ----------- ----------- ----------- ----------- ------------ In force $ 67,645 $ 50,605 $ 50,769 $ 46,631 $ 43,831
Excluding the impact of the Canada Life activity, operating expenses increased $1 million in 2003 and decreased in 2002 by $22 million. The division created expense synergies by focusing on overall effective expense management and by consolidating similar operational functions (the 401(k) and Public/Non-Profit retirement services areas) under common management. Outlook During 2003, the Financial Services division was successful in its efforts in bringing together multiple products and services under one name - Great-West Retirement Services. Efforts to capitalize on brand awareness continue. During 2002, the division had assumed responsibility for the marketing, sales and administration of the Company's 401(k) product. At the beginning of 2003, the division established a new, focused marketing strategy for the 401(k) product. A new customer relationship management model has been established with the continued goal of establishing stronger relationships with existing 401(k) customers and improving persistency. In 2003, the Company formed a strategic institutional relationship with Wells Fargo. The first phase of the relationship transferred the ownership of a Wells Fargo subsidiary, EMJAY Corporation (EMJAY), from Wells Fargo to the Company. EMJAY provides retirement plan services to third party external brokers, registered investment advisers, and other investment professionals. The Company believes that the combination of its existing recordkeeping platform and administrative services, coupled with EMJAY's known expertise for compliance and customer service, will provide a competitive advantage in the 401(k) market. In the second phase of the relationship with Wells Fargo, the Company will provide private-label recordkeeping services for non-annuity 401(k) plans and will offer annuity contracts for those small 401(k) plans desiring annuity investment options. The acquisition of EMJAY has resulted in an additional 68,000 participants in 2003. In 2003, the Company continued its efforts to partner with large financial institutions to provide individual term and whole life insurance to the general population. With the anticipated expansion of the economy, the Company also expects the BOLI market to grow and will continue to focus on its partnership with Clark Consulting. E. INVESTMENT OPERATIONS The Company's primary investment objective is to acquire assets with duration and cash flow characteristics reflective of the Company's liabilities, while meeting industry, size, issuer, and geographic diversification standards. Formal liquidity and credit quality parameters have also been established. The Company follows rigorous procedures to control interest rate risk and observes strict asset and liability matching guidelines. These guidelines ensure that even under changing market conditions, the Company's assets will meet the cash flow and income requirements of its liabilities. Using dynamic modeling to analyze the effects of a range of possible market changes upon investments and policyholder benefits, the Company works to ensure that its investment portfolio is appropriately structured to fulfill financial obligations to its policyholders. A summary of the Company's general account invested assets follows: [Millions] 2003 2002 ---------------------------------------------------------------- ----------------- ----------------- Fixed maturities, available-for-sale, at fair value $ 13,137 $ 10,371 Equity investments, at fair value 428 90 Mortgage loans, on real estate 1,886 417 Real estate 8 4 Short-term investments 852 710 Policy loans 3,389 2,964 ----------------- ----------------- Total invested assets $ 19,700 $ 14,556 ================= =================
1. Fixed Maturities Fixed maturity investments include public and privately placed corporate bonds, government bonds, and mortgage-backed and asset-backed securities. The Company's strategy related to mortgage-backed and asset-backed securities is to focus on those investments with low prepayment risk and minimal credit risk. The Company does not invest in higher-risk collateralized mortgage obligations such as interest-only and principal-only strips, and currently has no plans to invest in such securities. Private placement investments are generally less marketable than publicly traded assets, yet they typically offer enhanced covenant protection that allows the Company, if necessary, to take appropriate action to protect its investment. The Company believes that the cost of the additional monitoring and analysis required by private placements is more than offset by their enhanced yield. One of the Company's primary objectives is to ensure that its fixed maturity portfolio is maintained at a high average quality, so as to limit credit risk. If not externally rated, the securities are rated by the Company on a basis intended to be similar to that of the rating agencies. At December 31, 2003, the Company had 19 bonds in default representing a carrying value of $18.4 million (0.1% of the total fixed maturity investment portfolio), compared to four bonds representing $24.3 million (0.2% of the total fixed maturity investment portfolio) for 2002. The distribution of the fixed maturity portfolio by credit rating is summarized as follows: Credit Rating 2003 2002 ----------------------------------------------------------- ----------------- ----------------- AAA 54.3% 58.9% AA 8.7 8.9 A 16.0 15.2 BBB 18.4 14.4 BB and below (non-investment grade) 2.6 2.6 ----------------- ----------------- TOTAL 100.0% 100.0% ================= =================
2. Mortgage Loans During 2003, the mortgage loan portfolio increased 352% to $1,886 million, net of impairment reserves primarily as a result of the assets associated with the Indemnity Reinsurance Agreement entered into with CLAC as well as the assets associated with the acquisition of CLICA and CLINY. The Company follows a comprehensive approach to the management of mortgage loans that includes ongoing analysis of key mortgage characteristics such as debt service coverage, net collateral cash flow, property condition, loan-to-value ratios, and market conditions. Collateral valuations are performed for those mortgages that after review are determined by management to present possible risks and exposures. These valuations are then incorporated into the determination of the Company's allowance for credit losses. The average balance of impaired loans decreased to $29.6 million in 2003 compared with $31.2 million in 2002, and no property was acquired through foreclosure in 2003 or 2002. The low levels of problematic mortgage loans relative to the Company's overall balance sheet are due to the Company's active loan management program. Occasionally, the Company elects to restructure certain mortgage 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, 2003 and 2002, the Company's mortgage loan portfolio included $34.9 million and $40.3 million, respectively, of non-impaired restructured loans. 3. Other Investments Other investments consist primarily of policy loans and short-term investments. The Company anticipates limited participation in the real estate and equity markets during 2004. 4. Derivatives The Company uses certain derivatives, such as futures, options, and swaps, for purposes of hedging interest rate, market and foreign exchange risks. These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, when used for hedging, these instruments typically reduce risk. The Company controls the credit risk of its financial contracts through established credit approvals, limits, and monitoring procedures. The Company has also developed controls within its operations to ensure that only Board of Directors authorized derivative transactions are executed. In addition, the Company uses derivatives to synthetically create investments that are either more expensive to acquire, or otherwise unavailable, in the cash markets. Note 1 to the Consolidated Financial Statements contains a discussion of the Company's outstanding derivatives. 5. Outlook The Company's investment portfolio is well positioned for the current interest rate environment. The portfolio is diversified and comprised of high quality, relatively stable assets. The Company took advantage of the steep yield curve in 2003, adding modestly to portfolio duration. Investment grade corporate securities and structured securities with moderate interest rate sensitivity were added to the investment portfolio. It is the Company's philosophy and intent to maintain its proactive portfolio management policies in an ongoing effort to ensure the quality and performance of its investments. F. LIQUIDITY AND CAPITAL RESOURCES The Company's operations have liquidity requirements that vary among its principal product lines. Life insurance and pension plan reserves are primarily long-term liabilities. Accident and health reserves, including long-term disability, consist of both short-term and long-term liabilities. Life insurance and pension plan reserve requirements are usually stable and predictable, and are supported primarily by long-term, fixed income investments. Accident and health claim demands are stable and predictable but generally shorter term, requiring greater liquidity. 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 that totaled $1,040.5 million and $864.4 million as of December 31, 2003 and 2002, respectively. In addition, as of both December 31, 2003 and 2002, 97% of the bond portfolio carried an investment grade rating, thereby providing significant liquidity to the Company's overall investment portfolio. Funds provided by premiums and fees, investment income and maturities of investment assets are reasonably predictable and normally exceed liquidity requirements for payment of claims, benefits, and expenses. However, since the timing of available funds cannot always be matched precisely to commitments, imbalances may arise when demands for funds exceed those on hand. Also, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities. The sources of the funds that may be required in such situations include the issuance of commercial paper and equity securities. 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 $96.4 million of commercial paper outstanding at December 31, 2003 compared with $96.6 million at December 31, 2002. The commercial paper has been given a rating of A-1+ by Standard & Poor's Corporation and a rating of P-1 by Moody's Investors Services, each being the highest rating available. In addition, the Company issued a surplus note to GWL&A Financial in 1999. The surplus note bears interest at 7.25% and is due June 20, 2048. Capital resources provide protection for policyholders and financial strength to support the underwriting of insurance risks, and allow for continued business growth. The amount of capital resources that may be needed is determined by the Company's senior management and Board of Directors, as well as by regulatory requirements. The allocation of resources to new long-term business commitments is designed to achieve an attractive return, tempered by considerations of risk and the need to support the Company's existing business. G. OFF-BALANCE SHEET ARRANGEMENTS The Company does not have any off-balance sheet arrangements. H. OBLIGATIONS RELATING TO DEBT AND LEASES Payments due by period ($ millions) Less than 1 1-3 Years 3-5 More than 5 Total year Years Years --------- ------------- ---------- --------- ------------- Long-term debt 200.0 25.0 175.0 Operating leases 129.2 25.6 62.5 41.1 --------- ------------- ---------- --------- ------------- Total 329.2 25.6 87.5 41.1 175.0 ========= ============= ========== ========= =============
The table above does not include obligations under the Company's insurance contracts, as the timing of cash requirements is largely dependent on the occurrence of future events. I. ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board (FASB) has issued Statement No 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement of FASB Statement No. 125" (SFAS No. 140), which revises the standards for accounting for securitizations and other transfers of financial assets and collateral, and requires certain disclosures. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. Certain disclosure requirements under SFAS No. 140 were effective December 15, 2000, and these requirements have been incorporated in the Company's financial statements. The adoption of SFAS No. 140 did not have a material effect on the financial position or results of operations of the Company. Effective January 1, 2001, the Company adopted FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), as amended by FASB Statement No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS 133 requires all derivatives, whether designated in hedging relationships or not, to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. 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 accumulated other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. The adoption of SFAS No. 133 resulted in an approximate $1.0 million after-tax increase to accumulated other comprehensive income, which has been included in the 2001 change in other comprehensive income in the Statement of Stockholder's Equity. This amount is not material to the Company's financial position or results of operations. Effective April 1, 2001, the Company adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financial Assets" (EITF 99-20). This pronouncement requires investors in certain asset-backed securities to record changes in their estimated yield on a prospective basis and to apply specific evaluation methods to these securities for an other-than-temporary decline in value. The adoption of EITF 99-20 did not have a material impact on the Company's financial position or results of operations. On June 29, 2001, Statement No.141, "Business Combinations" (SFAS No. 141) was approved by the FASB. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. The Company implemented SFAS No. 141 on July 1, 2001. Adoption of the Statement did not have a material impact on the Company's financial position or results of operations. On June 29, 2001, Statement No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142) was approved by the FASB. SFAS No. 142 changes the accounting for goodwill and certain other intangibles from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of this statement. The Company implemented SFAS No. 142 on January 1, 2002. Adoption of this statement did not have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued Statement No.144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No.144). SFAS No.144 superceded prior accounting guidance relating to impairment of long-lived assets and provides a single accounting methodology for long-lived assets to be disposed of, and also supercedes existing guidance with respect to reporting the effects of the disposal of a business. SFAS No.144 was adopted January 1, 2002 without a material impact on the Company's financial position or results of operations. In July 2001, the SEC released Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues (SAB 102). SAB 102 summarizes certain of the SEC's views on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses. Adoption of SAB 102 by the Company did not have a material impact on the Company's financial position or results of operations. In April 2002, the FASB issued Statement No. 145 "Rescission of FASB No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" (SFAS No. 145). FASB No. 4 required all gains or losses from extinguishment of debt to be classified as extraordinary items net of income taxes. SFAS No. 145 requires that gains and losses from extinguishment of debt be evaluated under the provision of Accounting Principles Board Opinion No. 30, and be classified as ordinary items unless they are unusual or infrequent or meet the specific criteria for treatment as an extraordinary item. This statement was effective January 1, 2003 and did not have a material effect on the Company's financial position or results of operations. In July 2002, the FASB issued Statement No. 146 "Accounting for Costs Associated With Exit or Disposal Activities" (SFAS No. 146). This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred, as opposed to when the entity commits to an exit plan under EITF 94-3. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. This statement did not have a material impact on the Company's financial position or results of operations. In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" to clarify accounting and disclosure requirements relating to a guarantor's issuance of certain types of guarantees. FIN 45 requires entities to disclose additional information about certain guarantees, or groups of similar guarantees, even if the likelihood of the guarantor's having to make any payments under the guarantee is remote. The disclosure provisions are effective for financial statements for fiscal years ended after December 15, 2002. For certain guarantees, the interpretation also requires that guarantors recognize a liability equal to the fair value of the guarantee upon its issuance. This initial recognition and measurement provision is to be applied only on a prospective basis to guarantees issued or modified after December 31, 2002. In the normal course, the Company may enter into agreements which may contain features which meet the FIN 45 definition of a guarantee, and while the maximum guarantee cannot always be determined, given the nature of the future events which may or may not occur, any such arrangements that were material have been previously disclosed by the Company. In January 2004, FASB reissued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities" as FIN 46R. This Interpretation addresses consolidation by business enterprises of variable interest entities (VIE), which have one or both of the following characteristics: a) insufficient equity investment at risk, or b) insufficient control by equity investors. This guidance, as reissued, is effective for VIEs created after January 31, 2003, and for pre-existing VIEs as of March 31, 2004. In conjunction with the issuance of this guidance, the Company conducted a review of its involvement with VIEs and does not have any investments or ownership in VIEs. In December 2002, the FASB issued Statement No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS No. 148). SFAS No. 148 amends the disclosures that a company is required to make in its annual financial statements and requires, for the first time, certain disclosures in interim financial reports. In addition to the disclosures required by SFAS No. 123, a company must disclose additional information as part of its Summary of Significant Policies. These disclosures are required regardless of whether a company is using the intrinsic value method under APB No. 25 or the fair value based method under SFAS No. 123 to account for its stock-based employee compensation. In April 2003, the FASB issued Statement No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain implementation guidance that is incorporated in SFAS No. 149 and already effective, SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company's financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with characteristics of both Liabilities and Equity" (SFAS No. 150). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), many of which were previously classified as equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003 and with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material effect on the Company's financial statements. In July 2003, the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 03-01, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." AcSEC developed the SOP to address the evolution of product designs since the issuance of SFAS No. 60, "Accounting and Reporting by Insurance Enterprises," and SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 03-1 provides guidance related to the reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits, such as guaranteed minimum death benefits, and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1 addresses certain issues related to the presentation and reporting of separate accounts, as well as rules concerning the capitalization and amortization of sales inducements. SOP 03-1 will be effective for the Company's financial statements on January 1, 2004. The Company is currently evaluating the impact of adopting SOP 03-1 on its consolidated financial position and results of operations. See Note 1 to the Consolidated Financial Statements for additional information regarding accounting pronouncements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's assets are purchased to fund future benefit payments to its policyholders and contractholders. The primary risk of these assets is exposure to rising interest rates. The Company's exposure to foreign currency exchange rate fluctuations is minimal as only nominal foreign investments are held. To manage interest rate risk, the Company invests in assets that are suited to the products that it sells. For products with fixed and highly predictable benefit payments such as certificate annuities and payout annuities, the Company invests in fixed income assets with cash flows that closely match the liability product cash flows. The Company is then protected against interest rate changes, as any change in the fair value of the assets will be offset by a similar change in the fair value of the liabilities. For products with uncertain timing of benefit payments such as portfolio annuities and life insurance, the Company invests in fixed income assets with expected cash flows that are earlier than the expected timing of the benefit payments. The Company also manages risk with interest rate derivatives such as interest rate caps that would pay the Company investment income if interest rates rise above the level specified in the cap. These derivatives are only used to reduce risk and are not used for speculative purposes. To manage foreign currency exchange risk, the Company uses currency swaps to convert foreign currency back to United States dollars. These swaps are purchased each time a foreign currency denominated asset is purchased. The Company has estimated the possible effects on its investments of interest rate changes at December 31, 2003. If interest rates increased by 100 basis points (1%), the fair value of the fixed income assets would decrease by approximately $641 million. This calculation uses projected asset cash flows, discounted back to December 31, 2003. The cash flow projections are shown in the table below. The table below shows cash flows rather than expected maturity dates because many of the Company's assets have substantial expected principal payments prior to the final maturity date. The fair value shown in the table below was calculated using spot discount interest rates that varied by the year in which the cash flows were expected to be received. These spot rates in the benchmark calculation ranged from 2.88% to 8.79%. Projected Cash Flows by Calendar Year [$ millions] There- Undiscounted Fair 2004 2005 2006 2007 2008 after Total Value ------- ------- ------ ------- -------- ------- ------------- --------- Benchmark 2,817 2,634 2,517 2,041 1,907 7,850 19,767 15,464 Interest rates up 1% 2,708 2,529 2,462 2,100 1,946 8,186 19,930 14,823
The Company administers separate account variable annuities for retirement savings products. The Company collects a fee from each account, and this fee is a percentage of the account balance. There is a market risk of lost fee revenue to the Company if equity and bond markets decline. If the equity and bond portfolios decline by 10%, the Company's fee revenue would decline by approximately $8.0 million per year. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY (A wholly-owned subsidiary of GWL&A Financial Inc.) Consolidated Financial Statements for the Years Ended December 31, 2003, 2002, and 2001 and Report of Independent Registered Public Accounting Firm REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholder of Great-West Life & Annuity Insurance Company: We have audited the accompanying consolidated balance sheets of Great-West Life & Annuity Insurance Company and subsidiaries as of December 31, 2003 and 2002, 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, 2003. 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. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. 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, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 7, the accompanying financial statements have been restated to include disclosures required by Emerging Issues Task Force 03-1. "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments." DELOITTE & TOUCHE LLP Denver, Colorado February 25, 2004 (October 29, 2004 as to the effects of the restatement discussed in Note 7) GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2003 AND 2002 (Dollars in Thousands) ====================================================================================================================== 2003 2002 ----------------------- ---------------------- ASSETS INVESTMENTS: Fixed maturities, available-for-sale, at fair value (amortized cost $12,757,614 and $9,910,662 ) $ 13,136,564 $ 10,371,152 Equity investments, at fair value (cost $407,797 and $102,862) 427,810 90,188 Mortgage loans on real estate (net of allowances of $31,889 and $55,654) 1,885,812 417,412 Real estate 7,912 3,735 Policy loans 3,389,534 2,964,030 Short-term investments, available-for-sale (cost $852,198 and $709,592) 852,198 709,804 ----------------------- ---------------------- Total Investments 19,699,830 14,556,321 ----------------------- ---------------------- OTHER ASSETS: Cash 188,329 154,600 Reinsurance receivable: Related party 1,312,139 3,104 Other 262,685 238,049 Deferred policy acquisition costs 284,866 267,846 Deferred ceding commission 285,165 Investment income due and accrued 165,417 133,166 Amounts receivable related to uninsured accident and health plan claims (net of allowances of $32,329 and $42,144) 129,031 86,228 Premiums in course of collection (net of allowances of $9,768 and $12,011) 75,809 54,494 Deferred income taxes 119,971 69,016 Other assets 754,160 754,869 SEPARATE ACCOUNT ASSETS 13,175,480 11,338,376 ----------------------- ---------------------- TOTAL ASSETS $ 36,452,882 $ 27,656,069 ======================= ====================== ===================================================================================================================== 2003 2002 ----------------- ----------------- LIABILITIES AND STOCKHOLDER'S EQUITY POLICY BENEFIT LIABILITIES: Policy reserves: Related party $ 3,429,873 $ 518,587 Other 15,220,205 11,732,627 Policy and contract claims 418,930 378,995 Policyholders' funds 368,076 299,730 Provision for policyholders' dividends 89,121 76,983 Undistributed earnings on participating business 177,175 170,456 GENERAL LIABILITIES: Due to GWL 30,950 33,841 Due to GWL&A Financial 175,691 171,416 Repurchase agreements 389,715 323,200 Commercial paper 96,432 96,645 Other liabilities 994,608 850,757 SEPARATE ACCOUNT LIABILITIES 13,175,480 11,338,376 ----------------- ----------------- Total Liabilities 34,566,256 25,991,613 ----------------- ----------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDER'S EQUITY: Preferred stock, $1 par value, 50,000,000 shares authorized, 0 shares issued and outstanding Common stock, $1 par value; 50,000,000 shares authorized; 7,032,000 shares issued and outstanding 7,032 7,032 Additional paid-in capital 722,365 719,709 Accumulated other comprehensive income 127,820 150,616 Retained earnings 1,029,409 787,099 ----------------- ----------------- Total Stockholder's Equity 1,886,626 1,664,456 ----------------- ----------------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 36,452,882 $ 27,656,069 ================= ================= See notes to consolidated financial statements.
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (Dollars in Thousands) ===================================================================================================================== 2003 2002 2001 ---------------- ----------------- ----------------- REVENUES: Premiums: Related party $ 1,595,357 $ 16,715 $ 18,144 Other (net of premiums ceded totaling $461,092, $83,789 and $82,028) 657,540 1,103,380 1,185,495 Fee income 840,072 883,562 947,255 Net investment income 988,400 919,365 934,756 Net realized gains on investments 39,560 41,626 46,825 ---------------- ----------------- ----------------- 4,120,929 2,964,648 3,132,475 BENEFITS AND EXPENSES: Life and other policy benefits (net of reinsurance recoveries totaling $410,430, $50,974 and $40,144) 573,976 936,215 1,029,495 Increase in reserves: Related party 1,450,185 15,934 12,475 Other 51,320 55,414 45,958 Interest paid or credited to contractholders 514,846 498,549 530,027 Provision for policyholders' share of earnings on participating business 1,159 7,790 2,182 Dividends to policyholders 92,118 78,851 76,460 ---------------- ----------------- ----------------- 2,683,604 1,592,753 1,696,597 Commissions 180,673 185,450 197,099 Operating expenses 753,336 741,979 787,110 Premium taxes 31,675 30,714 36,911 Special charges 127,040 ---------------- ----------------- ----------------- 3,649,288 2,550,896 2,844,757 INCOME BEFORE INCOME TAXES 471,641 413,752 287,718 PROVISION FOR INCOME TAXES: Current 173,181 126,222 136,965 Deferred (19,561) 3,993 (41,993) ---------------- ----------------- ----------------- 153,620 130,215 94,972 ---------------- ----------------- ----------------- NET INCOME $ 318,021 $ 283,537 $ 192,746 ================ ================= =================
See notes to consolidated financial statements. GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (Dollars in Thousands) ==================================================================================================================================== Accumulated Other Comprehensive Income (Loss) ------------------------------ Unrealized Minimum Additional Gains Pension Preferred Common Paid-in (Losses) Liability Retained Stock Stock Capital on Securities Adjustment Earnings Total ---------- ---------- ------------ -------------- ------------ ----------- ------------ BALANCES, JANUARY 1, 2001 $ 0 $ 7,032 $ 717,704 $ 33,672 $ $ 669,021 $ 1,427,429 Net income 192,746 192,746 Other comprehensive income 42,835 42,835 ------------ Total comprehensive income 235,581 ------------ Dividends (187,633) (187,633) Capital contributions adjustment - Parent stock options (12,098) (12,098) Income tax benefit on stock Compensation 7,195 7,195 ---------- ---------- ------------ -------------- ------------ ----------- ------------ BALANCES, DECEMBER 31, 2001 0 7,032 712,801 76,507 674,134 1,470,474 ---------- ---------- ------------ -------------- ------------ ----------- ------------ Net income 283,537 283,537 Other comprehensive income 86,993 (12,884) 74,109 ------------ Total comprehensive income 357,646 ------------ Dividends (170,572) (170,572) Income tax benefit on stock Compensation 6,908 6,908 ---------- ---------- ------------ -------------- ------------ ----------- ------------ BALANCES, DECEMBER 31, 2002 0 7,032 719,709 163,500 (12,884) 787,099 1,664,456 ---------- ---------- ------------ -------------- ------------ ----------- ------------ Net income 318,021 318,021 Other comprehensive income (26,369) 3,573 (22,796) ------------ Total comprehensive income 295,225 ------------ Dividends (75,711) (75,711) Income tax benefit on stock compensation 2,656 2,656 ---------- ---------- ------------ -------------- ------------ ----------- ------------ BALANCES, DECEMBER 31, 2003 $ 0 $ 7,032 $ 722,365 $ 137,131 $ (9,311) 1,029,409 $ 1,886,626 ========== ========== ============ ============== ============ =========== ============
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (Dollars in Thousands) ===================================================================================================================== 2003 2002 2001 ----------------- ----------------- ----------------- OPERATING ACTIVITIES: Net income $ 318,021 $ 283,537 $ 192,746 Adjustments to reconcile net income to net cash provided by operating activities: Earnings allocated to participating policyholders 1,159 7,790 2,182 Amortization of investments (64,126) (76,002) (82,955) Net realized gains on investments (39,560) (41,626) (46,825) Depreciation and amortization (including goodwill impairment in 2001) 59,375 37,639 62,101 Deferred income taxes (19,561) 3,993 (41,993) Stock compensation adjustment (12,098) Changes in assets and liabilities, net of effects from acquisitions: Policy benefit liabilities 516,019 622,854 334,025 Reinsurance receivable (13,064) 41,199 (48,384) Receivables (23,724) 89,686 153,350 Bank overdrafts 32,068 (41,901) (29,121) Other, net (26,405) (159,562) 157,228 ----------------- ----------------- ----------------- Net cash provided by operating activities $ 740,202 $ 767,607 $ 640,256 ----------------- ----------------- ----------------- (Continued)
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (Dollars in Thousands) ===================================================================================================================== 2003 2002 2001 ------------------ --------------- ----------------- INVESTING ACTIVITIES: Proceeds from sales, maturities and redemptions of investments: Fixed maturities available-for-sale: Sales $ 7,852,152 5,729,919 $ 5,201,692 Maturities and redemptions 6,033,863 1,456,176 1,244,547 Mortgage loans 188,341 210,224 224,810 Real estate 3,012 3,570 Equity investments 86,908 2,798 38,331 Purchases of investments: Fixed maturities available-for -sale (14,265,107) (7,369,364) (6,878,213) Mortgage loans (5,500) Real estate (6,190) (2,768) (3,124) Equity investments (369,650) (29,690) (27,777) Corporate owned life insurance (100,000) Other, net 96,155 (77,769) 95,808 Acquisitions, net of cash acquired (128,636) ------------------ --------------- ----------------- Net cash used in investing activities $ (514,652) (76,904) $ (203,926) ------------------ --------------- ----------------- (Continued)
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001, (Dollars in Thousands) ===================================================================================================================== 2003 2002 2001 ----------------- ---------------- ----------------- FINANCING ACTIVITIES: Contract withdrawals, net of deposits $ (180,346) $ (599,724) $ (483,285) Due to GWL (6,341) (8,033) (1,207) Due to GWL&A Financial 4,275 (43,415) 45,245 Dividends paid (75,711) (170,572) (187,633) Net commercial paper repayments (213) (401) (585) Net repurchase agreements borrowings 66,515 72,311 250,889 ----------------- ---------------- ----------------- Net cash used in financing activities (191,821) (749,834) (376,576) ----------------- ---------------- ----------------- NET INCREASE (DECREASE) IN CASH 33,729 (59,131) 59,754 CASH, BEGINNING OF YEAR 154,600 213,731 153,977 ----------------- ---------------- ----------------- CASH, END OF YEAR $ 188,329 $ 154,600 $ 213,731 ================= ================ ================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Income taxes $ 144,273 $ 164,863 $ 59,895 Interest 16,155 16,697 17,529 Non-cash financing activity: Effect on capital - Parent stock options (12,098) (Concluded)
See notes to consolidated financial statements. GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (Amounts in Thousands, except Share Amounts) ================================================================================ 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Organization - Great-West Life & Annuity Insurance Company (the Company) is a direct wholly-owned subsidiary of GWL&A Financial Inc. (GWL&A Financial), a holding company formed in 1998. GWL&A Financial is an indirect wholly-owned subsidiary of Great-West Lifeco, Inc. (Lifeco or the Parent). The 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. The Company is an insurance company domiciled in the State of Colorado, and is subject to regulation by the Colorado Division of Insurance. Basis of Presentation - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires 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 policy reserves, allowances for credit losses, deferred policy acquisition costs, and valuation of privately placed fixed maturities. Actual results could differ from those estimates. The consolidated financial statements include the accounts of the Company and its subsidiaries. All material inter-company transactions and balances have been eliminated in consolidation. Certain reclassifications have been made to the 2002 and 2001 financial statements and related footnotes to conform to the 2003 presentation. These changes in classification had no effect on previously reported stockholder's equity or net income. Investments - Investments are reported as follows: 1. Management has classified its fixed maturities as available for sale and carries them at fair value with the net unrealized gains and losses (net of deferred taxes) reported as accumulated other comprehensive income (loss) in stockholder's equity. Premiums and discounts are recognized as a component of net investment income using the effective interest method. Realized gains and losses, and declines in value judged to be other-than-temporary are included in net realized gains/(losses) on investments. 2. Mortgage loans on real estate are carried at their unpaid balances adjusted for any unamortized premiums or discounts and any allowances for uncollectible accounts. Interest income is accrued on the unpaid principal balance. Discounts and premiums are amortized to net investment income using the effective interest method. Accrual of interest is discontinued on any impaired loans where collection of interest is doubtful. The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on its impaired loans. Management's judgment is based on past loss experience, current and projected economic conditions and extensive situational analysis of each individual loan. The measurement of impaired loans is based on the fair value of the collateral. 3. Real estate is carried at cost. The carrying value of real estate is subject to periodic evaluation of recoverability. 4. Equity investments are carried at fair value with net unrealized gains and losses (net of deferred taxes) reported as accumulated other comprehensive income (loss) in stockholder's equity. The Company classifies its equity investments not accounted for under the equity method as available-for-sale. The Company uses the equity method of accounting for investments in which it has more than a minority interest, has influence in the entity's operating and financial policies, but does not have a controlling interest. 5. Policy loans are carried at their unpaid balances. 6. Short-term investments include securities purchased with initial maturities of one year or less and are carried at fair value. The Company considers short-term investments to be available-for-sale. 7. Gains and losses realized on disposal of investments are determined on a specific identification basis. Cash - Cash includes only amounts in demand deposit accounts. Internal Use Software - Capitalized internal use software development costs of $68,244 and $55,363 are included in other assets at December 31, 2003 and 2002, respectively. The Company capitalized, net of depreciation, $12,881, $10,448, and $6,896 of internal use software development costs for the years ended December 31, 2003, 2002 and 2001, respectively. Deferred Policy Acquisition Costs - Policy acquisition costs, which primarily consist of sales commissions and costs associated with the Company's sales representatives related to the production of new business, have been deferred to the extent recoverable. These costs are variable in nature and are dependent upon sales volume. Deferred costs associated with the annuity products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits. Deferred costs associated with traditional life insurance are amortized over the premium paying period of the related policies in proportion to premium revenues recognized. Amortization of deferred policy acquisition costs totaled $60,288, $38,707 and $44,096, in 2003, 2002 and 2001, respectively. 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, open-end management investment companies which are affiliates of the Company, shares of other non-affiliated mutual funds, and government and 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. Life Insurance and Annuity Reserves - Life insurance and annuity policy reserves with life contingencies of $12,111,180 and $8,029,337 at December 31, 2003 and 2002, respectively, are computed on the basis of estimated mortality, investment yield, withdrawals, future maintenance and settlement expenses, and retrospective experience rating premium refunds. Annuity contract reserves without life contingencies of $6,215,416 and $4,152,594 at December 31, 2003 and 2002, respectively, are established at the contractholder's account value. Reinsurance - Policy reserves ceded to other insurance companies are carried as reinsurance receivable on the balance sheet. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies (see Note 5). Policy and Contract Claims - Policy and contract claims include provisions for reported life and health claims in process of settlement, valued in accordance with the terms of the related policies and contracts, as well as provisions for claims incurred and unreported based primarily on prior experience of the Company. Participating Fund Account - Participating life and annuity policy reserves are $5,875,033 and $4,947,081 at December 31, 2003 and 2002, respectively. Participating business approximates 34.3%, 24.8% and 25.8% of the Company's ordinary life insurance in force and 66.4%, 80.2% and 85.4% of ordinary life insurance premium income for the years ended December 31, 2003, 2002 and 2001, respectively. The amount of dividends to be paid from undistributed earnings on participating business is determined annually by the Board of Directors. Earnings allocable to participating policyholders are consistent with established Company practice. The Company has established a Participating Policyholder Experience Account (PPEA) for the benefit of all participating policyholders which is included in the accompanying consolidated balance sheets. Earnings associated with the operation of the PPEA are credited to the benefit of all participating policyholders. In the event that the assets of the PPEA are insufficient to provide contractually guaranteed benefits, the Company must provide such benefits from its general assets. The Company has also established a Participation Fund Account (PFA) for the benefit of the participating policyholders previously transferred to the Company from The Great-West Life Assurance Company (GWL) under an assumption reinsurance transaction. The PFA is part of the PPEA. Earnings derived from the operation of the PFA, net of a management fee paid to the Company, accrue solely for the benefit of the transferred participating policyholders. Repurchase Agreements and Securities Lending - The Company enters into repurchase agreements with third-party broker/dealers in which it sells securities and agrees to repurchase substantially similar securities at a specified date and price. Such agreements are accounted for as collateralized borrowings. Interest expense on repurchase agreements is recorded at the coupon interest rate on the underlying securities. The repurchase fee is amortized over the term of the related agreement and recognized as an adjustment to net investment income. The Company receives collateral for lending securities that are held as part of its investment portfolio. The Company requires collateral in an amount greater than or equal to 102% of the market 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. The Company's securitized lending transactions are accounted for as collateralized borrowings. Derivatives - The Company makes limited use of derivative financial instruments to manage interest rate, market, and foreign exchange risk associated with invested assets. Derivatives are not used for speculative purposes. The Company controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures. As the Company generally enters into derivative transactions only with high quality institutions, no losses associated with non-performance on derivative financial instruments have occurred or are expected to occur. Derivative instruments typically used consist of interest rate swap agreements, credit default swaps, interest rate floors and caps, foreign currency exchange contracts, options and interest rate futures. Interest rate swap agreements are used to convert the interest rate on certain debt securities from a floating rate to a fixed rate or vice versa, to convert from a fixed rate to a floating rate. Credit default swaps may be used in conjunction with another purchased security to reproduce the investment characteristics of a cash investment in the same credit. 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 only if interest rates fall or rise to certain levels. 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 used in conjunction with interest rate swap agreements to effectively convert convertible, fixed rate bonds to non-convertible variable rate bonds as part of the Company's overall asset/liability matching program. Purchased put options are used to protect against significant drops in equity markets. Interest rate futures are used to hedge the interest rate risks of forecasted acquisitions of fixed rate fixed maturity investments. The Company also uses derivatives to synthetically create investments that are either more expensive to acquire or otherwise unavailable in the cash markets. These securities, called replication synthetic asset transactions, are a combination of a derivative and a cash security to synthetically create a third replicated security. As of December 31, 2003, the Company has one such security that has been created through the combination of a credit default swap and U.S. Government Agency security. These derivatives do not qualify as hedges and therefore, changes in fair value are recorded in earnings. Effective January 1, 2001, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), as amended by FASB Statement No. 138 (SFAS No. 138), "Accounting for Certain Derivative Instruments and Certain Hedging Activities." The adoption of SFAS No. 133 resulted in an approximate $1,000 after-tax increase to accumulated comprehensive income, which has been included in the 2001 change in other comprehensive income in the Statement of Stockholder's Equity. SFAS No. 133 and 138, as subsequently amended by SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities", require all derivatives, whether designated in hedging relationships or not, to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. 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 accumulated other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges and changes in fair value of derivatives not qualifying for hedge accounting are recognized in net investment income. The Company occasionally purchases a financial instrument that contains a derivative instrument that is "embedded" in the financial instrument. Upon purchasing the instrument, the Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e, the host contract) and whether a separate instrument with the same terms as the embedded instrument could meet the definition of a derivative instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and changes in its fair value are included in earnings. Hedge ineffectiveness of $125, $177 and $907 determined in accordance with SFAS No. 133, was recorded as a decrease to net investment income for the years ended December 31, 2003, 2002 and 2001, respectively. Derivative gains and losses included in accumulated other comprehensive income (OCI) are reclassified into earnings at the time interest income is recognized. Derivative gains of $1,024 and $563 were reclassified to net investment income in 2003 and 2002, respectively. The Company estimates that $975 of net derivative gains included in OCI will be reclassified into net investment income within the next twelve months. 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 and are recognized when earned. Fee income is derived primarily from contracts for claim processing or other administrative services related to uninsured business 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 are associated with earned premiums so as to result in recognition of profits over the life of the contracts. This association is accomplished by means of the provision for future policy benefit reserves. The average crediting rate on annuity products was approximately 5.2%, 5.9%, and 6.1%, in 2003, 2002 and 2001. 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 will be realized. Stock Options - The Company applies the intrinsic value measurement approach under Accounting Principle Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), to stock-based compensation awards to employees, as interpreted by AIN-APB 25 and amended by Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" (SFAS No. 123) as it relates to accounting for stock options granted by the Parent to employees of the Company (see Note 14). Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - FASB has issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A replacement of FASB Statement No. 125" (SFAS No. 140), which revises the standards for accounting for securitizations and other transfers of financial assets and collateral, and requires certain disclosures. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The adoption of SFAS No. 140 did not have a significant effect on the financial position or results of operations of the Company. Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financial Assets - Effective April 1, 2001, the Company adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financial Assets" (EITF 99-20). This pronouncement requires investors in certain asset-backed securities to record changes in their estimated yield on a prospective basis and to apply specific evaluation methods to these securities for an other-than-temporary decline in value. The adoption of EITF 99-20 did not have a material impact on the Company's financial position or results of operations. Business Combinations - On June 29, 2001, Statement of Financial Accounting Standards (SFAS) FAS No.141, "Business Combinations" (SFAS No.141) was approved by the FASB. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. The Company implemented SFAS No.141 on July 1, 2001. Adoption of the Statement did not have a material impact on the Company's financial position or results of operations. Goodwill and Other Intangible Assets - On June 29, 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142) was approved by the FASB. SFAS No. 142 changes the accounting for goodwill and certain other intangibles from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of this statement. The Company implemented SFAS No. 142 on January 1, 2002. Adoption of this Statement did not have a material impact on the Company's financial position or results of operations. Selected Loan Loss Allowance Methodology - In July 2001, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues" (SAB No. 102). SAB No. 102 summarizes certain of the SEC's views on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses. Adoption of SAB No. 102 by the Company did not have a material impact on the Company's financial position or results of operations. Long Lived Assets - In August 2001, the FASB issued SFAS No.144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No.144 supercedes current accounting guidance relating to impairment of long-lived assets and provides a single accounting methodology for long-lived assets to be disposed of, and also supercedes existing guidance with respect to reporting the effects of the disposal of a business. SFAS No. 144 was adopted January 1, 2002 without a material impact on the Company's financial position or results of operations. Technical Corrections - In April 2002, the FASB issued Statement No. 145 "Rescission of FASB Nos. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" (SFAS No. 145). FASB No. 4 required all gains or losses from extinguishment of debt to be classified as extraordinary items net of income taxes. SFAS No. 145 requires that gains and losses from extinguishment of debt be evaluated under the provisions of Accounting Principles Board Opinion No. 30, and be classified as ordinary items unless they are unusual or infrequent or meet the specific criteria for treatment as an extraordinary item. This statement is effective January 1, 2003. The Company does not expect this statement to have a material effect on the Company's financial position or results of operations. Costs Associated With Exit or Disposal Activities - In July 2002, the FASB issued Statement No. 146 "Accounting for Costs Associated With Exit or Disposal Activities" (SFAS No. 146). This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred, as opposed to when the entity commits to an exit plan under EITF 94-3. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect this statement to have a material impact on the Company's financial position or results of operations. In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" to clarify accounting and disclosure requirements relating to a guarantor's issuance of certain types of guarantees. FIN 45 requires entities to disclose additional information about certain guarantees, or groups of similar guarantees, even if the likelihood of the guarantor's having to make any payments under the guarantee is remote. The disclosure provisions are effective for financial statements for fiscal years ended after December 15, 2002. For certain guarantees, the interpretation also requires that guarantors recognize a liability equal to the fair value of the guarantee upon its issuance. This initial recognition and measurement provision is to be applied only on a prospective basis to guarantees issued or modified after December 31, 2002. In the normal course, the Company may enter into agreements which may contain features which meet the FIN 45 definition of a guarantee, and while the maximum guarantee cannot always be determined, given the nature of the future events which may or may not occur, any such arrangements that were material have been previously disclosed by the Company. In January 2004, FASB reissued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities" as FIN 46R. This Interpretation addresses consolidation by business enterprises of variable interest entities (VIE), which have one or both of the following characteristics: a) insufficient equity investment at risk, or b) insufficient control by equity investors. This guidance, as reissued, is effective for VIEs created after January 31, 2003, and for pre-existing VIEs as of March 31, 2004. In conjunction with the issuance of this guidance, the Company conducted a review of its involvement with VIEs and does not have any investments or ownership in VIEs. In December 2002, the FASB issued Statement No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS No. 148). SFAS No. 148 amends the disclosures that a company is required to make in its annual financial statements and requires, for the first time, certain disclosures in interim financial reports. In addition to the disclosures required by SFAS No 123, a company must disclose additional information as part of its Summary of Significant Policies. These disclosures are required regardless of whether a company is using the intrinsic value method under APB No. 25 or the fair value based method under SFAS No. 123 to account for its stock-based employee compensation. In April 2003, the FASB issued Statement No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain implementation guidance that is incorporated in SFAS No. 149 and already effective, SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company's financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with characteristics of both Liabilities and Equity" (SFAS No. 150). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), many of which were previously classified as equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003 and with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material effect on the Company's financial statements. In July 2003, the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position (SOP) 03-01, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." AcSEC developed the SOP to address the evolution of product designs since the issuance of SFAS No. 60, "Accounting and Reporting by Insurance Enterprises," and SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 03-1 provides guidance related to the reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits, such as guaranteed minimum death benefits (GMDB), and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1 addresses certain issues related to the presentation and reporting of separate accounts, as well as rules concerning the capitalization and amortization of sales inducements. SOP 03-1 will be effective for the Company's financial statements on January 1, 2004. The Company is currently evaluating the impact of adopting SOP 03-1 on its consolidated financial position and results of operations. EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments," was finalized to provide guidance on disclosures about investments with unrealized losses, which disclosures are included in Note 7. EITF Issue No. 03-1's guidance on the measurement and recognition of other-than-temporary impairment of investments in debt and equity securities has not been finalized and the Company cannot evaluate the ultimate impact of EITF 03-1. 2. ACQUISITIONS, DIVESTITURES AND SPECIAL CHARGES On July 10, 2003, Lifeco completed its acquisition of Canada Life Financial Corporation (Canada Life). Canada Life is a Canadian based holding company that is the owner of insurance companies with businesses principally in Canada, the United Kingdom, the United States and Ireland. On December 31, 2003 Canada Life sold two direct wholly-owned subsidiaries, Canada Life Insurance Company of New York (CLINY) and Canada Life Insurance Company of America (CLICA) to the Company for cash in the amount of $235 million. These acquisitions have been accounted for as a "reorganization of businesses under common control" and, accordingly the assets and liabilities of CLICA and CLINY were recorded at Lifeco's cost basis, and the results of operations of CLICA and CLINY from July 10, 2003 through December 31, 2003 are included in the Company's financial statements. CLINY and CLICA sell individual and group insurance and annuity products in the United States. Since the time of its acquisition by Lifeco, Canada Life's insurance and annuity businesses in the United States, including that conducted by its U.S. branch, have been managed by the Company whereby it provides certain corporate and operational administrative services for which it receives a fee. In the United States, Canada Life's subsidiary insurance companies' business includes individual and group insurance and annuity products. The Company recorded as of December 31, 2003, the following as a result of the acquisition (net of the $235 million purchase price) CLICA and CLINY: Assets Liabilities and Stockholder's Equity ------------------------------------------------------ ------------------------------------------------------ Fixed maturities $ 1,937,218 Policy reserves $ 2,991,407 Equity investments 23,680 Policyholders' funds 2,407 Mortgage loans 1,145,494 Policy and contract claims 899 Real estate 550 Provision for policyholders' dividends 2,800 Policy loans 13,621 Other liabilities 439,439 --------------------- Short-term investments 65,537 Total liabilities 3,436,952 Cash (232,803) Investment income Accumulated other due and accrued 32,147 comprehensive income (14,433) Other assets 439,864 Retained earnings 2,789 Total stockholder's equity (11,644) ------------------ --------------------- $ 3,425,308 $ 3,425,308 ================== =====================
The Company's statement of operations for the year ended December 31, 2003 includes the following related to CLICA and CLINY for the period from July 10, 2003 to December 31, 2003: Total revenues $ 105,868 Benefits 92,193 Operating expenses 9,385 ------------------ Total benefits and expenses 101,578 Income from operations 4,290 Income taxes 1,501 ------------------ Net income $ 2,789 ================== On August 31, 2003, the Company and The Canada Life Assurance Company (CLAC), a wholly owned subsidiary of Canada Life, entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured 80% (45% coinsurance and 35% coinsurance with funds withheld) of certain United States life, health and annuity business of CLAC's U.S. Branch. The Company recorded $1,427 million in premium income and increase in reserves associated with these policies. The Company recorded, at fair value, the following at August 31, 2003 as a result of this transaction: Assets Liabilities and Stockholder's Equity ------------------------------------------------------ ----------------------------------------------- Fixed maturities $ 635,061 Policy reserves $ 2,926,497 Mortgage loans 451,725 Policy and contract claims 45,229 Policy loans 278,152 Policyholders' funds 65,958 Reinsurance receivable 1,320,636 Deferred policy acquisition costs acquired 313,364 Investment income due and accrued 17,280 Premiums in course of collection 21,466 ------------------ ---------------- $ 3,037,684 $ 3,037,684 ================== ================
The reinsurance receivable relates to the amount due the Company for reserves ceded by coinsurance with funds withheld. The Company's return on this reinsurance receivable will be the interest and other investment returns earned net of realized gains and losses on a segregated pool of investments of the CLAC's U.S. branch. Pursuant to an interpretation of SFAS 133, the Company has identified an embedded derivative for the Company's exposure to interest rate and credit risk on the segregated pool of investments. As this embedded derivative does not qualify for hedge accounting the Company's net income increased $5.7 million. On July 8, 1998, the Company acquired Alta Health & Life Insurance Company (Alta). During 1999 and 2000, the Alta business continued to be run as a free-standing unit but was converted to the Company's system and accounting processes. This conversion program resulted in significant issues related to pricing, underwriting and administration of the Alta business. The Company decided to discontinue writing new Alta business and that all Alta customers will be moved to its contracts over time. All Alta sales and administration staff have become employees of the Company and the underwriting functions are being conducted by its underwriting staff. In the second quarter of 2001, the Company recorded a $127 million special charge ($80.9 million, net of tax) related to its decision to cease marketing the Alta products. The principal components of the charge included $46 million for premium deficiency reserves, $29 million for premium receivables, $28 million for uninsured accident and health plan claim receivables and $24 million for goodwill and other. 3. RELATED-PARTY TRANSACTIONS The Company performs administrative services for the U.S. operations of GWL and, beginning in 2003, the U.S. operations of Canada Life. Beginning in 2002, the Company performs investment services for London Reinsurance Group, an indirect subsidiary of GWL. The Company also manages the U.S. businesses of Canada Life, providing administrative and operational services. The following represents revenue 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 management's best estimate of actual costs incurred and resources expended based upon the number of policies, certificates in force and/or administered assets. Years Ended December 31, ---------------------------------------------------- 2003 2002 2001 --------------- --------------- --------------- Investment management revenue $ 3,355 $ 892 $ 186 Administrative and underwriting revenue 1,859 860 1,043 --------------- --------------- --------------- Total $ 5,214 $ 1,752 $ 1,229 =============== =============== ===============
At December 31, 2003 and 2002, due to GWL includes $5,612 and $8,503 due on demand and, at each date, $25,338 of a note payable which matures on October 1, 2006. The note may be prepaid in whole or in part at any time without penalty. The issuer may not demand payment before the maturity date. The amounts due on demand to GWL bear interest at the public bond rate (4.59% and 4.75% at December 31, 2003 and 2002, respectively). The note payable bears interest at 5.4%. At December 31, 2003 and 2002, due to GWL&A Financial includes $656 and $(3,619) due on demand and, at each date, $175,035 of a subordinated note payable. The note, which was issued in 1999, bear interest and mature on June 30, 2048. Payments of principal and interest under this subordinated note shall be made only with prior written approval of the Commissioner of Insurance of the State of Colorado. Payments of principal and interest on this subordinated note are payable only out of surplus funds of the Company and only at such time as its financial condition is such that at the time of payment of principal or interest, its statutory surplus after the making of any such payment would exceed the greater of $1,500 or 1.25 times the company action level amount as required by the most recent risk based capital calculations. The amounts due on demand to GWL&A Financial bear interest at the public bond rate (4.59% and 4.75% at December 31, 2003 and 2002, respectively). The note payable bears interest at 7.25%. Interest expense attributable to these related party obligations was $14,345, $14,976 and $14,732 for the years ended December 31, 2003, 2002 and 2001, respectively. 4. ALLOWANCES ON POLICYHOLDER RECEIVABLES Amounts receivable for accident and health plan claims and premiums in the course of collection are generally uncollateralized. Such receivables are from a large number of policyholders dispersed throughout the United States and throughout many industry groups. The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on amounts receivable related to uninsured accident and health plan claims and premiums in course of collection. Management's judgment is based on past loss experience and current and projected economic conditions. Activity in the allowance for amounts receivable related to uninsured accident and health plan claims is as follows: 2003 2002 2001 -------------- --------------- --------------- Balance, beginning of year $ 42,144 $ 53,431 $ 34,700 Amounts acquired by reinsurance 6,207 Provisions charged (reversed) to operations 1,460 (7,544) 50,500 Amounts written off - net (11,275) (9,950) (31,769) -------------- --------------- --------------- Balance, end of year $ 32,329 $ 42,144 $ 53,431 ============== =============== =============== Activity in the allowance for premiums in course of collection is as follows: 2003 2002 2001 -------------- --------------- --------------- Balance, beginning of year $ 12,011 $ 22,217 $ 18,700 Amounts acquired by reinsurance 1,600 Provisions charged (reversed) to operations 1,889 (5,729) 29,642 Amounts written off - net (4,132) (6,077) (26,125) -------------- --------------- --------------- Balance, end of year $ 9,768 $ 12,011 $ 22,217 ============== =============== ===============
5. REINSURANCE In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The Company retains a maximum liability of $1,500 of coverage per individual life. In addition to the Indemnity Reinsurance Agreement entered into with CLAC (see Note 2), the Great-West Healthcare division of the Company entered into a reinsurance agreement during 2003 with Allianz Risk Transfer (Bermuda) Limited (Allianz) to cede 90% of direct written group health stop-loss and excess loss activity. This Allianz agreement was retroactive to January 1, 2003. The net cost of the Allianz agreement was charged to the Financial Services division. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 2003 and 2002, the reinsurance receivables had carrying values of $1,574,824 and $241,153, respectively. The following schedule details life insurance in force and life and accident/health premiums: Percentage of Amount Reinsurance Reinsurance Assumed Direct Ceded Assumed Net To Net --------------- ---------------- ---------------- --------------- ------------- December 31, 2003: Life insurance in force: Individual $ 49,590,015 $ 16,483,477 $ 18,054,587 $ 51,161,125 35.3% Group 49,150,866 18,941 53,570,393 102,702,318 52.2% --------------- ---------------- ---------------- ---------------- Total $ 98,740,881 $ 16,502,418 $ 71,624,979 $ 153,863,442 =============== ================ ================ ================ Premium Income: Life insurance $ 459,039 $ 30,138 $ 1,184,332 $ 1,613,233 73.4% Accident/health 678,516 423,592 321,996 576,920 55.8% --------------- ---------------- ---------------- ---------------- Total $ 1,137,555 $ 453,730 $ 1,506,328 $ 2,190,153 =============== ================ ================ ================ December 31, 2002: Life insurance in force: Individual $ 43,324,059 $ 12,786,783 $ 7,280,731 $ 37,818,007 19.3% Group 51,385,610 7,186,698 58,572,308 12.3% --------------- ---------------- ---------------- ---------------- Total $ 94,709,669 $ 12,786,783 $ 14,467,429 $ 96,390,315 =============== ================ ================ ================ Premium Income: Life insurance $ 312,388 $ 40,582 $ 41,245 $ 313,051 13.2% Accident/health 728,972 43,047 128,820 814,745 15.8% --------------- ---------------- ---------------- ---------------- Total $ 1,041,360 $ 83,629 $ 170,065 $ 1,127,796 =============== ================ ================ ================ December 31, 2001: Life insurance in force: Individual $ 43,370,006 $ 8,330,282 $ 7,399,250 $ 42,438,974 17.4% Group 56,650,090 9,888,796 66,538,886 14.9% --------------- ---------------- ---------------- ---------------- Total $ 100,020,096 $ 8,330,282 $ 17,288,046 $ 108,977,860 =============== ================ ================ ================ Premium Income: Life insurance $ 384,688 $ 32,820 $ 37,442 $ 389,310 9.6% Accident/health 830,970 49,001 42,750 824,719 5.2% --------------- ---------------- ---------------- ---------------- Total $ 1,215,658 $ 81,821 $ 80,192 $ 1,214,029 =============== ================ ================ ================
6. NET INVESTMENT INCOME AND NET REALIZED GAINS (LOSSES) ON INVESTMENTS Net investment income is summarized as follows: Years Ended December 31, ---------------------------------------------------- 2003 2002 2001 --------------- --------------- --------------- Investment income: Fixed maturities and short-term investments $ 697,209 $ 673,825 $ 693,573 Equity investments 4,703 3,272 4,882 Mortgage loans on real estate 84,532 48,625 69,237 Real estate 1,434 2,815 1,113 Policy loans 195,633 209,608 200,533 Other 37,254 5,236 3,766 --------------- --------------- --------------- 1,020,765 943,381 973,104 Investment expenses, including interest on amounts charged by the related parties of $14,345, $14,976 and $14,732 32,365 24,016 38,348 --------------- --------------- --------------- Net investment income $ 988,400 $ 919,365 $ 934,756 =============== =============== =============== Net realized gains (losses) on investments are as follows: Years Ended December 31, ---------------------------------------------------- 2003 2002 2001 --------------- --------------- --------------- Realized gains (losses): Fixed maturities $ 26,621 $ 33,455 $ 32,116 Equity investments 1,013 1,639 13,052 Mortgage loans on real estate 3,159 1,493 1,657 Real estate (248) Provisions for impairments 9,015 5,039 --------------- --------------- --------------- Net realized gains on investments $ 39,560 $ 41,626 $ 46,825 =============== =============== ===============
7. SUMMARY OF INVESTMENTS Subsequent to the issuance of its consolidated financial statements for the year ended December 31, 2003, the Company determined that certain disclosures required by EITF 03-1, "The Meaning of Other - Than - Temporary Impairment and Its Application to Certain Investments" were omitted. As a result, this Note 7 has been restated to provide the required disclosures. Fixed maturities owned at December 31, 2003 are summarized as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value ----------------------------- ------------ ------------ ------------ ------------ ------------ U.S. Government CMO $ 1,112,972 $ 27,273 $ 1,992 $ 1,138,253 $ 1,138,253 U.S. Government ABS 461,185 21,490 232 482,443 482,443 U.S. Government MBS 520,629 5,521 123 526,027 526,027 U.S. Government Other 1,052,061 17,747 17,981 1,051,827 1,051,827 Credit tenant loans 128,931 11,717 265 140,383 140,383 State and municipalities 1,133,234 79,323 4,204 1,208,353 1,208,353 Foreign government 58,211 1,191 940 58,462 58,462 Corporate bonds 4,107,100 238,908 84,306 4,261,702 4,261,702 Mortgage backed securities - CMO 353,750 15,914 1,315 368,349 368,349 Public utilities 1,156,156 61,015 20,248 1,196,923 1,196,923 Asset backed securities 2,272,648 64,538 33,751 2,303,435 2,303,435 Derivatives 1,838 3,805 (1,967) (1,967) Collateralized mortgage obligation 398,899 3,605 130 402,374 402,374 ------------ ------------ ------------ ------------ ------------ $ 12,757,614 $ 548,242 $ 169,292 $ 13,136,564 $ 13,136,564 ============ ============ ============ ============ ============ Fixed maturities owned at December 31, 2002 are summarized as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value ----------------------------- ------------ ------------ ------------ ------------ ------------ U.S. Government CMO $ 1,304,614 $ 43,929 $ $ 1,348,543 $ 1,348,543 U.S. Government ABS 491,183 16,310 1,785 505,708 505,708 U.S. Government MBS 385,764 5,957 149 391,572 391,572 U.S. Government Other 445,281 19,589 4 464,866 464,866 Credit tenant loans 104,648 11,081 115,729 115,729 State and municipalities 1,019,049 100,256 194 1,119,111 1,119,111 Foreign government 42,182 1,038 61 43,159 43,159 Corporate bonds 2,771,977 182,787 53,534 2,901,230 2,901,230 Mortgage backed Securities - CMO 96,776 16,170 18 112,928 112,928 Public utilities 698,365 44,334 11,369 731,330 731,330 Asset backed securities 2,138,025 86,261 27,089 2,197,197 2,197,197 Derivatives (3,422) 15,343 11,921 11,921 Collateralized mortgage obligation 416,220 11,638 427,858 427,858 ------------ ------------ ------------ ------------ ------------ $ 9,910,662 $ 554,693 $ 94,203 $ 10,371,152 $ 10,371,152 ============ ============ ============ ============ ============
The collateralized mortgage obligations consist primarily of sequential and planned amortization classes with final stated maturities of two to thirty years and expected average lives of less than one to fifteen years. Prepayments on all mortgage-backed securities are monitored monthly and amortization of the premium and/or the accretion of the discount associated with the purchase of such securities are adjusted by such prepayments. See Note 9 for additional information on policies regarding estimated fair value of fixed maturities. The amortized cost and estimated fair value of fixed maturity investments at December 31, 2003, by projected maturity, are shown below. Actual maturities will likely differ from these projections because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Estimated Cost Fair Value ---------------- ---------------- Due in one year or less $ 684,947 $ 710,287 Due after one year through five years 3,351,405 3,495,805 Due after five years through ten years 1,660,758 1,743,056 Due after ten years 1,940,424 1,966,535 Mortgage backed securities 2,386,248 2,435,003 Asset backed securities 2,733,832 2,785,878 ---------------- ---------------- $ 12,757,614 $ 13,136,564 ================ ================
Proceeds from sales of securities available-for-sale were $7,852,152, $5,729,919, and $5,201,692 during 2003, 2002 and 2001, respectively. The realized gains on such sales totaled $72,815, $45,315 and $42,299 for 2003, 2002 and 2001, respectively. The realized losses totaled $43,214, $10,410, and $10,186 for 2003, 2002 and 2001, respectively. At December 31, 2003 and 2002, pursuant to fully collateralized securities lending arrangements, the Company had loaned $193,200 and $284,990 of fixed maturities, respectively. The Company makes limited use of derivative financial instruments to manage interest rate, market, credit and foreign exchange risk. The following tables summarize the derivative financial instruments: Notional Strike/Swap December 31, 2003 Amount Rate Maturity ------------------------------- --------------- -------------------------------- -------------------- Interest Rate Caps $ 617,000 7.91% - 11.65% 02/04 - 01/05 Interest Rate Swaps 331,334 1.03% - 4.50% 01/04 - 11/09 Credit Default Swaps 171,310 N/A 10/05 - 11/07 Foreign Currency Exchange Contracts 27,585 N/A 06/05 - 11/06 Options Calls 92,700 Various 05/04 - 03/07 Puts 15,000 Various 03/07 - 03/07 Total Return Swap - Receivable for Coinsurance with Funds Withheld 1,309,160 Variable Indeterminate Notional Strike/Swap December 31, 2002 Amount Rate Maturity ------------------------------- --------------- ------------------------------ -------------------- Interest Rate Caps $ 1,122,000 7.64% - 11.65% 02/03 - 01/05 Interest Rate Swaps 400,188 1.26% - 4.75% 02/03 - 11/09 Credit Default Swaps 128,157 N/A 02/03 - 11/07 Foreign Currency Exchange Contracts 27,585 N/A 06/05 - 11/06 Options Calls 191,200 Various 05/04 - 06/07 Puts 15,000 Various 03/07 - 03/07
The following is information with respect to impaired mortgage loans: 2003 2002 ---------------- ---------------- Loans, net of related allowance for credit losses of $19,542 and $20,917 $ 7,680 $ 8,200 Loans with no related allowance for credit losses 2,638 Average balance of impaired loans during the year 29,633 31,243 Interest income recognized (while impaired) 1,350 2,007 Interest income received and recorded (while impaired) using the cash basis method of recognition 1,405 2,249
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 $34,880 and $40,302 at December 31, 2003 and 2002, respectively. The following table presents changes in the allowance for credit losses: 2003 2002 2001 --------------- --------------- --------------- Balance, beginning of year $ 55,654 $ 57,654 $ 61,242 Provision (credits) (9,817) (3,588) Charge-offs (15,766) (139) (3,588) Recoveries 1,818 1,727 --------------- --------------- --------------- Balance, end of year $ 31,889 $ 55,654 $ 57,654 =============== =============== -- ===============
The carrying value of the Company's equity investments was $427,810 and $90,188 at December 31, 2003 and 2002, respectively. At December 31, 2003, the Company has invested $130,473 in an exchange-traded fund which invests in corporate debt securities. Upon redemption of the equity ownership, the Company has the option of receiving the debt securities or the redemption value of the investment. At December 31, 2003, the Company has invested $216,610 in limited partnerships and limited liability corporations. The Company makes commitments to fund partnership interests in the normal course of its business. The amounts of unfunded commitments at December 31, 2003 and 2002 were $128,341 and $16,689, respectively. Impairment of Fixed Maturities. The Company classifies all of its fixed maturities as available-for-sale and marks them to market through other comprehensive income. All securities with gross unrealized losses at the consolidated balance sheet date are subjected to the Company's process for identifying other-than-temporary impairments. The Company's portfolio of fixed maturities fluctuates in value based on interest rates in financial markets and other economic factors. These fluctuations caused by market rate changes have little bearing on whether or not the investment will be ultimately recoverable. Therefore, the Company considers these declines in value as temporary even in periods exceeding one year. The Company writes down to fair value securities that it deems to be other-than-temporarily impaired in the period the securities are deemed to be so impaired. The Company records writedowns as investment losses and adjusts the cost basis of the fixed maturities accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. The assessment of whether an other-than-temporary impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors, as described below, about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to, the following: o Fair value is significantly below cost. o The decline in fair value is attributable to specific adverse conditions affecting a particular instrument, its issuer, an industry or a geographic area. The decline in fair value has existed for an extended period of time. o A debt security has been downgraded by a rating agency. o The financial condition of the issuer has deteriorated. o Dividends have been reduced/eliminated or scheduled interest payments have not been made. While all available information is taken into account, it is difficult to predict the ultimately recoverable amount of a distressed or impaired security. The following table summarizes unrealized investment losses by class of investment at December 31, 2003. The Company considers these investments to be only temporarily impaired. Less than twelve months Twelve months or longer Total ------------------------ ------------------------ ------------------------ Estimated Unrealized Estimated Unrealized Estimated Unrealized fair value loss fair value loss fair value loss ----------- ---------- ---------- ---------- ----------- ---------- U.S. Government CMO $ 135,414 $ 1,992 $ $ $ 135,414 $ 1,992 U.S. Government ABS 1,878 54 30,720 178 32,598 232 U.S. Government MBS 6,323 122 71 1 6,394 123 U.S. Government Other 329,005 17,981 329,005 17,981 Credit tenant loans 15,505 265 15,505 265 State and municipalities 160,668 3,947 16,679 257 177,347 4,204 Foreign government 26,133 940 26,133 940 Corporate bonds 852,763 62,037 262,986 22,269 1,115,749 84,306 Mortgage backed securities - CMO 48,203 1,315 48,203 1,315 Public utilities 359,218 18,417 17,161 1,831 376,379 20,248 Asset backed securities 326,602 5,705 247,056 28,046 573,658 33,751 Derivatives (1,967) 3,805 (1,967) 3,805 Collateralized mortgage 29,957 130 29,957 130 obligations ----------- ---------- ---------- ---------- ----------- ---------- $ 2,291,669 $ 112,905 $ 572,706 $ 56,387 $ 2,864,375 $ 169,292 =========== ========== ========== ========== =========== ==========
The Company's gross unrealized loss related to fixed maturities was $169,292 at December 31, 2003. Within the corporate bond investments, approximately 43% of the unrealized loss older than 12 months was related to foreign bank debt and 33% was related to the airline industry. All airline exposure is collateralized by aircraft. Within the asset backed securities investments, approximately 63% of the unrealized loss older than 12 months was related to the manufactured housing industry. As of December 31, 2003, the Company has no information available to cause it to believe that any of these investments are other-than-temporarily impaired. 8. COMMERCIAL PAPER The Company has a commercial paper program that is partially supported by a $50,000 standby letter-of-credit. At December 31, 2003, commercial paper outstanding in the amount of $96,432 had maturities ranging from 9 to 86 days and interest rates ranging from 1.18% to 1.2%. At December 31, 2002, commercial paper outstanding in the amount of $96,645 had maturities from 3 to 66 days and interest rates ranging from 1.40% to 1.88%. 9. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS December 31, ----------------------------------------------------------------------- 2003 2002 ---------------------------------- --------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value --------------- --------------- -------------- --------------- ASSETS: Fixed maturities and short-term investments $ 13,988,762 $ 13,988,762 $ 11,080,956 $ 11,080,956 Mortgage loans on real estate 1,885,812 1,871,373 417,412 429,907 Policy loans 3,389,534 3,389,534 2,964,030 2,964,030 Equity investments 427,810 427,810 90,188 90,188 Reinsurance receivables 1,574,824 1,574,824 241,153 241,153 LIABILITIES: Annuity contract reserves without life contingencies 6,552,507 6,640,677 4,152,594 4,228,080 Policyholders' funds 368,076 368,076 299,730 299,730 Due to GWL 30,950 32,591 33,841 35,316 Due to GWL&A Financial 175,691 178,421 171,416 173,376 Commercial paper 96,432 96,432 96,645 96,645 Repurchase agreements 389,715 389,715 323,200 323,200
The estimated fair values of financial instruments have been determined using available information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair value of fixed maturities and equity investments that are publicly traded are obtained from an independent pricing service. To determine fair value for fixed maturities and equity investments not actively traded, the Company utilizes discounted cash flows calculated at current market rates on investments of similar quality and term. Fair values of derivatives in the amounts of $(1,967) and $11,921 at December 31, 2003 and 2002, respectively, consisting principally of interest rate swaps, are included in fixed maturities. Mortgage loan fair value estimates generally are based on discounted cash flows. A discount rate "matrix" is incorporated whereby the discount rate used in valuing a specific mortgage generally corresponds to that mortgage's remaining term and credit quality. The rates selected for inclusion in the discount rate "matrix" reflect rates that the Company would quote if placing loans representative in size and quality to those currently in the portfolio. Policy loans accrue interest generally at variable rates with no fixed maturity dates and therefore, estimated fair value approximates carrying value. The estimated fair value and carrying amount of reinsurance receivables includes $20,416 representing the estimated fair value of the total return swap, which is an embedded derivative associated with the Company's reinsurance receivable under its coinsurance with funds withheld agreement with the U.S. branch of CLAC. Valuation of the total return swap is based on the estimated fair value of the segregated pool of assets from which the Company derives its return on the reinsurance receivable. The estimated fair value of annuity contract reserves without life contingencies is estimated by discounting the cash flows to maturity of the contracts utilizing current crediting rates for similar products. The estimated fair value of policyholders' funds is the same as the carrying amount as the Company can change the crediting rates with 30 days notice. The estimated fair value of due to GWL is based on discounted cash flows at current market rates on high quality investments. The fair value of due to GWL&A Financial reflects the last trading price of the subordinated notes in the public market at December 31, 2003. The carrying value of repurchase agreements and commercial paper is a reasonable estimate of fair value due to the short-term nature of the liabilities. The estimated fair value of over-the-counter derivatives, primarily consisting of interest rate swaps 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 fixed maturities are derivative financial instruments with a net liability position of $1,967 in 2003 and a net asset position of $11,921 in 2002. Included in the net asset position for foreign currency exchange contracts are $7,464 and $2,518 of liabilities in 2003 and 2002, respectively. 10. EMPLOYEE BENEFIT PLANS The following table summarizes changes for the years ended December 31, 2003, 2002 and 2001 in the benefit obligations and in plan assets for the Company's defined benefit pension plan and post-retirement medical plan. Post-Retirement Pension Benefits Medical Plan ---------------------------------- --------------------------------- 2003 2002 2001 2003 2002 2001 --------- --------- --------- --------- --------- -------- Change in projected benefit obligation Benefit obligation at beginning $ 186,047 $ 150,521 $ 140,563 $ 31,242 $ 57,861 $ 33,018 of year Service cost 8,269 8,977 8,093 2,046 3,516 3,331 Interest cost 12,275 11,407 9,718 2,269 3,138 3,303 Acquisition of new employees 7,823 Amendments 827 (22,529) Actuarial (gain) loss 12,746 20,679 (2,640) 9,614 (9,814) 11,401 Benefits paid (6,374) (6,364) (5,213) (1,066) (930) (1,015) --------- --------- --------- --------- --------- -------- Benefit obligation at end of year $ 212,963 $ 186,047 $ 150,521 $ 44,105 $ 31,242 $ 57,861 ========= ========= ========= ========= ========= ======== Change in plan assets Fair value of plan assets at Beginning of year $ 163,316 $ 187,661 $ 193,511 $ $ $ Actual return on plan assets 32,377 (17,981) (637) Benefits paid (6,374) (6,364) (5,213) --------- --------- --------- --------- --------- -------- Fair value of plan assets at end 189,319 163,316 187,661 of year --------- --------- --------- --------- --------- -------- Funded (unfunded) status (23,643) (22,730) 37,140 (44,105) (31,242) (57,861) Unrecognized net actuarial (gain) 41,777 51,943 (1,499) 13,715 4,361 14,659 loss Unrecognized prior service cost 2,095 2,727 2,533 (8,679) (9,392) 9,326 Unrecognized net obligation or (asset) at transition (12,113) (13,627) (15,142) 12,120 Acquisition of GenAm employees (7,823) --------- --------- --------- --------- --------- -------- Prepaid (accrued) benefit cost 8,116 18,313 23,032 (39,069) (36,273) (29,579) Additional minimum liability (16,419) (22,549) --------- --------- --------- --------- --------- -------- Prepaid benefit cost/ (accrued benefit liability) (8,303) (4,236) 23,032 (39,069) (36,273) (29,579) Intangible asset 2,095 2,727 Accumulated other comprehensive income adjustments 14,324 19,822 --------- --------- --------- --------- --------- -------- Net amount recognized $ 8,116 $ 18,313 $ 23,032 $ (39,069) $ (36,273) $ (29,579) ========= ========= ========= ========= ========= ======== Increase (decrease) in minimum liability included in other Comprehensive income $ 3,573 $ (12,884) $ $ $ $
Late last year Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 which made significant changes to the federal Medicare Program. The Act provides for drug benefits under a new Medicare Part D program. Employers such as the Company who provide drug benefits for post-65 retirees are expected to make use of the subsidies inherent in this new program. The measurement of the accumulated post-retirement benefit obligation (APBO) and the net post-retirement benefit cost included these financial statements do not reflect the effects that this legislation may have on the plan. Authoritative guidance on the accounting for this issue is currently pending and when issued, could require the Company to revise previously reported information. The accumulated benefit obligation for all defined benefit pension plans was $197.6 million and $167.5 million at December 31, 2003 and 2002, respectively. Post-Retirement Pension Benefits Medical Plan ---------------------------------- --------------------------------- 2003 2002 2001 2003 2002 2001 --------- --------- --------- --------- --------- -------- Components of net periodic benefit cost Service cost $ 8,269 8,977 $ 8,093 $ 2,046 $ 3,516 $ 3,331 Interest cost 12,275 11,406 9,718 2,269 3,138 3,303 Expected return on plan assets (12,954) (14,782) (15,276) Amortization of transition (1,514) (1,514) (1,514) 808 808 obligation Amortization of unrecognized prior service cost 632 632 541 (713) 161 645 Amortization of unrecognized prior service cost - GenAm (484) Amortization of gain from earlier periods 3,489 (467) 261 172 --------- --------- --------- --------- --------- -------- Net periodic (benefit) cost $ 10,197 4,719 $ 1,095 $ 3,863 $ 7,623 $ 7,775 ========= ========= ========= ========= ========= ======== Weighted-average assumptions as of December 31 Discount rate 6.25% 6.75% 7.25% 6.25% 6.75% 7.25% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 3.44% 3.92% 4.00% 3.44% 3.92% 4.00%
The Company-sponsored post-retirement medical plan (medical plan) provides health benefits to retired employees. The medical plan is contributory and contains other cost sharing features, which may be adjusted annually for the expected general inflation rate. The Company's policy is to fund the cost of the medical plan benefits in amounts determined at the discretion of management. The Company made no contributions to this plan in 2003, 2002 or 2001. Assumed health care cost trend rates have a significant effect on the amounts reported for the medical plan. For measurement purposes, a 10% annual rate of increase in the per capita cost of covered health care benefits was assumed and that the rate would gradually decrease to a level of 5.25% by 2014. Additionally, it was assumed that the Company's cost for retirees eligible for health care benefits under Medicare would be limited to an increase of 3% starting in 2003, due to a plan change. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage 1-Percentage Point Increase Point Decrease -------------------- -------------------- Increase (decrease) on total of service and interest cost on components $ 428 $ (367) Increase (decrease) on post-retirement benefit obligation 3,157 (2,612) The Company's pension plan assets are invested as follows: Plan Assets at December 31 --------------------------------------------- 2003 2002 -------------------- -------------------- Asset Category Equity securities 61% 55% Debt securities 25% 36% Real estate 0% 0% Other 14% 9% -------------------- -------------------- Total 100% 100% ==================== ==================== The Company's target allocation for invested plan assets at December 31, 2004 is as follows: Asset Category Equity securities 60% Debt securities 30% Real estate 0% Other 10% -------------------- Total 100% ====================
The Company expects to contribute $4,800 to its pension plan and $1,300 to its other post-retirement benefit plan in 2004. The discount rate has been set based on the rates of return on high-quality fixed-income investments currently available and expected to be available during the period the benefits will be paid. In particular, the yields on bonds rated AA or better on the measurement date have been used to set the discount rate. The investment objective is to provide an attractive risk-adjusted return that will ensure the payment of benefits while protecting against the risk of substantial investment losses. Correlations among the asset classes are used to identify an asset mix that the Company believes will provide the most attractive returns. Long-term return forecasts for each asset class using historical data and other qualitative considerations to adjust for projected economic forecasts are used to set the expected rate of return for the entire portfolio. The Company sponsors a defined contribution 401(k) retirement plan which provides eligible participants with the opportunity to defer up to 15% of base compensation. The Company matches 50% of the first 5% of participant pre-tax contributions for employees hired before January 1, 1999. For all other employees the Company matches 50% of the first 8% of participant pre-tax contributions. Company contributions for the years ended December 31, 2003, 2002 and 2001 totaled $6,646, $7,257 and $7,773, respectively. The Company has a 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 deferrals, which are reflected in other liabilities, are $21,926 and $20,606 as of December 31, 2003 and 2002, respectively. The participant deferrals earned interest at 6.87% at December 31, 2003, based on the average ten-year composite government securities rate plus 1.5%. The interest expense related to the plan for the years ending December 31, 2003, 2002 and 2001 was $1,449, $1,459 and $1,434, respectively. The Company also provides a supplemental executive retirement plan to certain key executives. This plan provides key executives with certain benefits upon retirement, disability, or death based upon total compensation. The Company has purchased individual life insurance policies with respect to each employee covered by this plan. The Company is the owner and beneficiary of the insurance contracts. The expense for this plan for 2003, 2002 and 2001 was $3,123, $2,527 and $2,726, respectively. The total liability of $24,942 and $20,037 as of December 31, 2003 and 2002 is included in other liabilities. 11. FEDERAL INCOME TAXES The following is a reconciliation between the federal income tax rate and the Company's effective income tax rate: 2003 2002 2001 ------------ ------------ ------------ Federal tax rate 35.0 % 35.0 % 35.0 % Reduction in tax contingency (2.1) (3.3) Investment income not subject to federal tax (2.1) (1.3) (1.7) Other, net 1.8 1.1 (0.3) ------------ ------------ ------------ Total 32.6 % 31.5 % 33.0 % ============ ============ ============
During 2003, the Company reduced its liability for tax contingencies due to the completion of Internal Revenue Service examinations. The amount released was $9,600; however, $5,000 of the release was attributable to participating policyholders and therefore, had no affect on the net income of the Company since that amount was credited to the provision for policyholders' share of earnings on participating business in the accompanying 2003 statement of income. The tax effect of temporary differences, which give rise to the deferred tax assets and liabilities, as of December 31, 2003 and 2002 are as follows: 2003 2002 ------------------------------- ------------------------------ Deferred Deferred Deferred Deferred Tax Tax Tax Tax Asset Liability Asset Liability ------------- -------------- ------------- ------------- Policyholder reserves $ 219,490 $ 231,679 $ Deferred policy acquisition costs 96,207 94,018 Deferred acquisition cost proxy tax 124,498 109,779 Investment assets 130,090 149,958 Other 2,280 28,466 ------------- -------------- ------------- ------------- Total deferred taxes $ 346,268 226,297 $ 341,458 $ 272,442 ============= ============== ============= =============
Amounts included for investment assets above include $74,326 and $86,907 related to the unrealized gains on the Company's fixed maturities available-for-sale at December 31, 2003 and 2002, respectively. Under pre-1984 life insurance company income tax laws, a portion of a life insurance company's gain from operations was not subject to current income taxation but was accumulated, for tax purposes, in a memorandum account designated as "policyholders' surplus account." The aggregate accumulation in the account is $7,742 and the Company does not anticipate any transactions, which would cause any part of the amount to become taxable. Accordingly, no provision has been made for possible future federal income taxes on this accumulation. 12. OTHER COMPREHENSIVE INCOME Other comprehensive income for the year ended December 31, 2003 is summarized as follows: Before-Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount ----------------- ---------------- ----------------- Unrealized gains on available-for-sale securities: Net changes during the year related to cash flow hedges $ (18,159) $ 6,356 $ (11,803) Unrealized holding gains (losses) arising during the period 12,967 (4,538) 8,429 Less: reclassification adjustment for (gains) losses realized in net income (22,824) 7,989 (14,835) ----------------- ---------------- ----------------- (28,016) 9,807 (18,209) Reserve and DAC adjustment (12,553) 4,393 (8,160) ----------------- ---------------- ----------------- Net unrealized gains (losses) (40,569) 14,200 (26,369) Minimum pension liability adjustment 5,498 (1,925) 3,573 ----------------- ---------------- ----------------- Other comprehensive income (loss) $ (35,071) $ 12,275 $ (22,796) ================= ================ ================= Other comprehensive income for the year ended December 31, 2002 is summarized as follows: Before-Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount ----------------- ---------------- ----------------- Unrealized gains on available-for-sale securities: Net changes during the year related to cash flow hedges $ (7,486) $ 2,620 $ (4,866) Unrealized holding gains (losses) arising during the period 192,079 (67,290) 124,789 Less: reclassification adjustment for (gains) losses realized in net income (8,004) 2,802 (5,202) ----------------- ---------------- ----------------- Net unrealized gains 176,589 (61,868) 114,721 Reserve and DAC adjustment (42,681) 14,953 (27,728) ----------------- ---------------- ----------------- Net unrealized gains (losses) 133,908 (46,915) 86,993 Minimum pension liability adjustment (19,822) 6,938 (12,884) ----------------- ---------------- ----------------- Other comprehensive income $ 114,086 $ (39,977) $ 74,109 ================= ================ ================= Other comprehensive income for the year ended December 31, 2001 is summarized as follows: Before-Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount ----------------- ---------------- ----------------- Unrealized gains on available-for-sale securities: Net changes during the year related to cash flow hedges $ 12,637 $ (4,423) $ 8,214 Unrealized holding gains (losses) arising during the period 112,544 (39,397) 73,147 Less: reclassification adjustment for (gains) losses realized in net income (15,912) 5,569 (10,343) ----------------- ---------------- ----------------- Net unrealized gains 109,269 (38,251) 71,018 Reserve and DAC adjustment (43,358) 15,175 (28,183) ----------------- ---------------- ----------------- Other comprehensive income $ 65,911 $ (23,076) $ 42,835 ================= ================ =================
13. STOCKHOLDER'S EQUITY, DIVIDEND RESTRICTIONS AND OTHER MATTERS At December 31, 2003 and 2002, the Company has 1,500 authorized shares each of Series A, Series B, Series C and Series D cumulative preferred stock; and 2,000,000 authorized shares of non-cumulative preferred stock. No dividends were paid on preferred stock in 2003, 2002 and 2001. Dividends of $75,711, $170,572 and $187,633, were paid on common stock in 2003, 2002 and 2001, respectively. Dividends are paid as determined by the Board of Directors, subject to restrictions as discussed below. The Company's net income and capital and surplus, as determined in accordance with statutory accounting principles and practices, for December 31 are as follows: 2003 2002 2001 ---------------- ---------------- --------------- (Unaudited) Net income (loss) $ (75,627) $ 205,749 $ 266,398 Capital and surplus 1,212,548 1,292,292 1,200,372
In March 1998, the National Association of Insurance Commissioners adopted the Codification of Statutory Accounting Principles (Codification). The Codification, which is intended to standardize accounting and reporting to state insurance departments, was effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. The Colorado Division of Insurance required adoption of Codification with certain modifications for the preparation of statutory financial statements effective January 1, 2001. The adoption of Codification, as modified by the Colorado Division of Insurance, increased statutory net worth as of January 1, 2001, by approximately $105,760. The modifications adopted by the Colorado Division of Insurance had no effect on statutory net worth. The maximum amount of dividends which can be paid to stockholders by insurance companies domiciled in the State of Colorado is subject to restrictions relating to statutory surplus and statutory net gain from operations. Statutory surplus and net losses from operations at December 31, 2003 were $1,212,548 and ($77,158)[Unaudited], respectively. The Company should be able to pay up to $121,255 [Unaudited] of dividends in 2004. 14. STOCK OPTIONS The Parent has a stock option plan (the Lifeco plan) that provides for the granting of options on common shares of Lifeco to certain officers and employees of Lifeco and its subsidiaries, including the Company. Options may be awarded with exercise prices not less than the market price on the date of the grant. Termination of employment prior to vesting results in forfeiture of the options. As of December 31, 2003, 2002 and 2001, stock available for award to Company employees under the Lifeco plan aggregated 3,034,344, 3,917,344 and 3,278,331 shares, respectively. The Lifeco plan provides for the granting of options with varying terms and vesting requirements. The majority of basic options under the Lifeco plan vest and become exercisable twenty percent per year commencing on the first anniversary of the grant and expire ten years from the date of grant. Other basic options vest and become exercisable one-third per year commencing on various dates from December 31, 2000 to September 30, 2004 and expire ten years from the date of grant. Variable options granted to Company employees totaling 278,000 and 1,832,000 in 1998 and 1997, respectively, became exercisable if certain cumulative financial targets were attained by the end of 2001. A total of 175,511 options vested and became exercisable. The exercise period runs from June 26, 2007. During 2000, the Company determined that it was probable that certain of these options would become exercisable and, accordingly, accrued compensation expense of $15,052 with a corresponding credit to additional paid-in capital as prescribed by AIN-APB 25. During 2001, the Company released $12,098 of this accrual when certain financial targets were not attained. Additional variable options granted in 2003, 2001, 2000 and 1998 totaling 100,000, 80,000, 120,000 and 380,000 respectively, become exercisable if certain sales or financial targets are attained. During 2003, 2002 and 2001, 0, 0, and 7,750 of these options vested and accordingly, the Company recognized compensation expense of $0, $0, and $48, respectively. If exercisable, the exercise period expires ten years from the date of grant. The following table summarizes the status of, and changes in, Lifeco options granted to Company employees which are outstanding and the weighted-average exercise price (WAEP) for 2003, 2002 and 2001. As the options granted relate to Canadian stock, the values, which are presented in U.S. dollars, will fluctuate as a result of exchange rate fluctuations: 2003 2002 2001 ------------------------- ------------------------- ------------------------- Options WAEP Options WAEP Options WAEP ------------------------ ------------ ---------- ------------ ---------- ----------- ---------- Outstanding, Jan. 1 4,447,145 $ 13.66 6,398,149 $ 11.66 7,675,551 $ 9.91 ------------------------ Granted 1,336,000 27.28 174,500 22.16 947,500 22.28 Exercised 486,176 10.85 1,359,491 7.16 1,534,568 5.87 Expired or Canceled 980,000 14.07 766,013 11.02 690,334 11.24 ------------ ---------- ------------ ---------- --------- ---------- Outstanding, Dec 31 4,316,969 $ 21.63 4,447,145 $ 13.66 6,398,149 $ 11.66 ============ ========== ============ ========== ========= ========== Options Exercisable at year-end 2,237,810 $ 16.08 2,121,638 $ 11.67 2,602,480 $ 8.08 ============ ========== ============ ========== =========== ========== Weighted average Fair value of Options granted During year $ 7.05 $ 7.46 $ 7.10 ============ ============ ===========
The following table summarizes the range of exercise prices for outstanding Lifeco common stock options granted to Company employees at December 31, 2003: Outstanding Exercisable ------------------------------------------------- --------------------------------- Average Average Exercise Average Exercise Exercise Price Range Options Life Price Options Price --------------------- ---------------- ------------ ------------- ---------------- ------------- $6.57 - 8.73 437,500 2.56 6.57 437,500 6.57 $12.58 - 20.87 1,736,469 5.50 16.62 1,471,436 16.50 $26.57 - 32.29 2,143,000 8.74 28.77 328,874 26.86
Of the exercisable Lifeco options, 1,838,810 relate to fixed option grants and 399,000 relate to variable grants. Power Financial Corporation (PFC), which is the parent corporation of Lifeco, has a stock option plan (the PFC plan) that provides for the granting of options for common shares of PFC to key employees of PFC and its affiliates. Prior to the creation of the Lifeco plan in 1996, certain officers of the Company participated in the PFC plan in Canada. The following table summarizes the status of, and changes in, PFC options granted to Company officers, which remain outstanding and WAEP for 2003, 2002 and 2001. As the options granted relate to Canadian stock, the values, which are presented in U.S. dollars, will fluctuate as a result of exchange rate fluctuations: 2003 2002 2001 -------------------------- -------------------------- -------------------------- Options WAEP Options WAEP Options WAEP ------------- --------- ------------- --------- ------------- ---------- Outstanding, Jan.1, 0 $ 0.00 70,000 $ 2.16 70,000 $ 2.29 Exercised 0 0.00 70,000 2.21 ------------- --------- ------------- --------- ------------- ---------- Outstanding, Dec 31, 0 $ 0.00 0 $ 0.00 70,000 $ 2.16 ============= ========= ============= ========= ============= ========== Options exercisable at year-end 0 $ 0.00 0 $ 0.00 70,000 $ 2.16 ============= ========= ============= ========= ============= ==========
The Company accounts for stock-based compensation using the intrinsic value method prescribed by APB No. 25 under which compensation expenses for stock options are generally not recognized for stock option awards granted at or above fair market value. Had compensation expense for the Company's stock option plan been determined based upon fair value at the grant dates for awards under the plan in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's net income would have been reduced by $3,315, $2,364, and $2,092, in 2003, 2002 and 2001, respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for those options granted in 2003, 2002, and 2001, respectively: dividend yields of 2.81%, 2.453%, and 2.27%, expected volatility of 26.21%, 31.67%, and 28.56%, risk-free interest rates of 4.48%, 5.125%, and 5.30%, and expected lives of 7 years. 15. SEGMENT INFORMATION The Company has two reportable segments: Great-West Healthcare (formerly Employee Benefits) and Financial Services. The Great-West Healthcare segment markets group life and health insurance to small and mid-sized corporate employers. The Financial Services segment markets and administers savings products to public and not-for-profit employers, corporations, and individuals and offers life insurance products to individuals and businesses. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately as each segment has unique distribution channels. Prior to 2002, the Great-West Healthcare segment marketed and administered corporate savings products (401(k) plans). In 2002 the Financial Services segment assumed responsibility for these products. The 2001 and 2000 segment information has been reclassified to account for this change. The accounting policies of the segments are the same as those described in Note 1. The Company evaluates performance based on profit or loss from operations after income taxes. The Company's operations are not materially dependent on one or a few customers, brokers or agents. Summarized segment financial information for the year ended and as of December 31 was as follows: Year ended December 31, 2003 Operations: Great-West Financial Healthcare Services Total ----------------- ----------------- ----------------- Revenue: Premium income $ 838,194 $ 1,414,703 $ 2,252,897 Fee income 607,369 232,703 840,072 Net investment income 72,191 916,209 988,400 Realized investment gains 10,340 29,220 39,560 ----------------- ----------------- ----------------- Total revenue 1,528,094 2,592,835 4,120,929 ----------------- ----------------- ----------------- Benefits and Expenses: Benefits 567,603 2,116,001 2,683,604 Operating expenses 699,146 266,538 965,684 ----------------- ----------------- ----------------- Total benefits and expenses 1,266,749 2,382,539 3,649,288 ----------------- ----------------- ----------------- Net operating income before income taxes 261,345 210,296 471,641 Income taxes 88,104 65,516 153,620 ----------------- ----------------- ----------------- Net income $ 173,241 $ 144,780 $ 318,021 ================= ================= ================= Assets: Great-West Financial Healthcare Services Total ----------------- ----------------- ----------------- Investment assets $ 1,351,871 $ 18,347,959 $ 19,699,830 Other assets 244,100 3,333,472 3,577,572 Separate account assets 13,175,480 13,175,480 ----------------- ----------------- ----------------- Total assets $ 1,595,971 $ 34,856,911 $ 36,452,882 ================= ================= ================= Year ended December 31, 2002 Operations: Great-West Financial Healthcare Services Total ----------------- ----------------- ----------------- Revenue: Premium income $ 960,191 $ 159,904 $ 1,120,095 Fee income 660,423 223,139 883,562 Net investment income 67,923 851,442 919,365 Realized investment gains 8,918 32,708 41,626 ----------------- ----------------- - ----------------- Total revenue 1,697,455 1,267,193 2,964,648 ----------------- ----------------- - ----------------- Benefits and Expenses: Benefits 761,481 831,272 1,592,753 Operating expenses 732,472 225,671 958,143 ----------------- ----------------- ----------------- Total benefits and expenses 1,493,953 1,056,943 2,550,896 ----------------- ----------------- ----------------- Net operating income before income taxes 203,502 210,250 413,752 Income taxes 67,198 63,017 130,215 ----------------- ----------------- ----------------- Net income $ 136,304 $ 147,233 $ 283,537 ================= ================= ================= Assets: Great-West Financial Healthcare Services Total ----------------- ----------------- ----------------- Investment assets $ 1,491,857 $ 13,064,464 $ 14,556,321 Other assets 605,029 1,156,343 1,761,372 Separate account assets 11,338,376 11,338,376 ----------------- ----------------- ----------------- Total assets $ 2,096,886 $ 25,559,183 $ 27,656,069 ================= ================= ================= Year ended December 31, 2001 Operations: Great-West Financial Healthcare Services Total ----------------- ----------------- ----------------- Revenue: Premium income $ 1,033,886 $ 169,753 $ 1,203,639 Fee income 713,297 233,958 947,255 Net investment income 65,474 869,282 934,756 Realized investment gains 15,638 31,187 46,825 ----------------- ----------------- ----------------- Total revenue 1,828,295 1,304,180 3,132,475 ----------------- ----------------- ----------------- Benefits and Expenses: Benefits 858,945 837,652 1,696,597 Operating expenses 775,018 246,102 1,021,120 ----------------- ----------------- ----------------- Total benefits and expenses 1,633,963 1,083,754 2,717,717 Income taxes 67,771 73,341 141,112 ----------------- ----------------- ----------------- Net income before special charges 126,561 147,085 273,646 Special charges (net of tax) 80,900 80,900 ----------------- ----------------- ----------------- Net income $ 45,661 $ 147,085 $ 192,746 ================= ================= ================= Assets: Great-West Financial Healthcare Services Total ----------------- ----------------- ----------------- Investment assets $ 1,080,974 $ 13,159,007 $ 14,239,981 Other assets 792,383 1,201,373 1,993,756 Separate account assets 12,584,661 12,584,661 ----------------- ----------------- ----------------- Total assets $ 1,873,357 $ 26,945,041 $ 28,818,398 ================= ================= ================= The following table, which summarizes premium and fee income by segment, represents supplemental information. 2003 2002 2001 ----------------- ---------------- ---------------- Premium Income: Great-West Healthcare: Group Life & Health $ 838,194 $ 960,191 $ 1,033,886 ----------------- ---------------- ---------------- Total Great-West Healthcare 838,194 960,191 1,033,886 ----------------- ---------------- ---------------- Financial Services: Retirement Services 824 15 3,533 Individual Markets 1,413,879 159,889 166,220 ---------------- ---------------- ----------------- Total Financial Services 1,414,703 159,904 169,753 ----------------- ---------------- ---------------- Total premium income $ 2,252,897 $ 1,120,095 $ 1,203,639 ================= ================ ================ Fee Income: Great-West Healthcare: Group Life & Health (uninsured plans) $ 607,369 $ 660,423 $ 713,297 ----------------- ---------------- ---------------- Total Great-West Healthcare 607,369 660,423 713,297 ----------------- ---------------- ---------------- Financial Services: Retirement Services 199,374 196,972 207,677 Individual Markets 33,329 26,167 26,281 ----------------- ---------------- ---------------- Total Financial Services 232,703 223,139 233,958 ----------------- ---------------- ---------------- Total fee income $ 840,072 $ 883,562 $ 947,255 ================= ================ ================
16. OBLIGATIONS RELATING TO DEBT AND LEASES The Company enters into operating leases primarily for office space. As of December 31, 2003, minimum annual rental commitments on operating leases having initial or remaining non-cancelable lease terms in excess of one year during the years 2004 through 2008 are $25,586, $23,564, $20,469, $18,426 and $17,616, respectively, with $23,502 in minimum commitments thereafter. 2004 2005 2006 2007 2008 Thereafter ---------- ----------- ---------- ---------- ----------- ------------- Related party notes $ $ $ 25,000 $ $ $ 175,000 Operating leases 25,586 23,564 20,469 18,426 17,616 23,502 ---------- ----------- ---------- ---------- ----------- ------------- Total contractual obligations $ 25,586 $ 23,564 $ 45,469 $ 18,426 $ 17,616 $ 198,502 ========== =========== ========== ========== =========== =============
17. COMMITMENTS AND CONTINGENCIES The Company is involved in various legal proceedings, which arise in the ordinary course of its business. In the opinion of management, after consultation with counsel, the resolution of these proceedings should not have a material adverse effect on the Company's financial position or the results of its operations. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has been no change in the Company's independent accountants or resulting disagreements on accounting and financial disclosure. ITEM 9A. CONTROLS AND PROCEDURES Based on their evaluation as of December 31, 2003, and after consideration of the omitted disclosure required by EITF 03-1 that resulted in this Form 10-K/A, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's Disclosure Controls and Procedures are effective at the reasonable assurance level in ensuring that information relating to the Company which is required to be disclosed in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms; and is (ii) accumulated and communicated to the Company's senior management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, as appropriate so that timely decisions may be made regarding disclosure. The Chief Executive Officer and Chief Financial Officer hereby confirm that there were no changes in the Company's internal control over financial reporting during the fourth quarter of 2003 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT A. IDENTIFICATION OF DIRECTORS Served as Director Principal Occupation(s) Director Age from: for last Five Years ------------------------------ ------- ------------- ---------------------------------------------- James Balog 75 1993 Company Director (1)(2) James W. Burns, O.C. 74 1991 Director Emeritus, Power Corporation and (1)(2)(4) Power Financial Orest T. Dackow 67 1991 Company Director since April 2000; (1)(2)(4) previously President and Chief Executive Officer, Lifeco Andre Desmarais, O.C. 47 1997 President and Co-Chief Executive (1)(2)(4)(5) Officer, Power Corporation; Deputy Chairman, Power Financial Paul Desmarais, Jr. 49 1991 Chairman and Co-Chief Executive (1)(2)(4)(5) Officer, Power Corporation; Chairman, Power Financial Robert Gratton 60 1991 Chairman of the Board of the Company; (1)(2)(4) President and Chief Executive Officer, Power Financial; Chairman of the Boards of Lifeco, Great-West Life, Canada Life and London Life Insurance Company Kevin P. Kavanagh 71 1986 Company Director; Chancellor Emeritus, (1)(3)(4) Brandon University William Mackness 65 1991 Company Director (1)(2)(4) William T. McCallum 61 1990 President and Chief Executive Officer of (1)(2)(4) the Company; Co-President and Chief Executive Officer, Lifeco Jerry E.A. Nickerson 67 1994 Chairman of the Board, H.B. Nickerson & (3)(4) Sons Limited (a management and holding company) David A. Nield 65 2003 Company Director; previously Chairman and (1)(2)(4) Chief Executive Officer, Canada Life Michel Plessis-Belair, 61 1991 Vice Chairman and Chief Financial F.C.A.(1)(2)(3)(4) Officer, Power Corporation; Executive Vice President and Chief Financial Officer, Power Financial Brian E. Walsh 50 1995 Managing Partner, QVan Capital, (1)(2)(3) LLC (a merchant banking company)
(1) Member of the Executive Committee (2) Member of the Investment and Credit Committee (3) Member of the Audit Committee (4) Also a director of Great-West Life (5) Mr. Andre Desmarais and Mr. Paul Desmarais, Jr. are brothers. Unless otherwise indicated, all of the directors have been engaged for not less than five years in their present principal occupations or in another executive capacity with the companies or firms identified. Directors are elected annually to serve until the following annual meeting of shareholders. The following is a list of directorships held by the directors of the Company, on companies whose securities are traded publicly in the United States or that are investment companies registered under the Investment Company Act of 1940. In addition, all directors of the Company currently serve on the board of directors of GWL&A Financial. J.Balog Transatlantic Holdings, Inc. P.Desmarais, Jr. SUEZ TOTAL S.A. W.T. McCallum Maxim Series Fund, Inc. Orchard Series Fund Great-West Variable Annuity Account A B. IDENTIFICATION OF EXECUTIVE OFFICERS Served as Executive Officer Principal Occupation(s) Executive Officer Age from: for last Five Years ------------------------------- ------ ------------- ---------------------------------------------- William T. McCallum 61 1984 President and Chief Executive Officer President and Chief of the Company; Co-President Executive Officer and Chief Executive Officer, Lifeco Mitchell T.G. Graye 48 1997 Executive Vice President and Chief Executive Vice Financial Officer of the Company President and Chief Financial Officer Richard F. Rivers 50 2002 Executive Vice-President, Healthcare Executive Vice President of the Company since August Healthcare 2002; previously Senior Vice President, PacifiCare Health System from August 2002; previously Chief Operating Officer, Blue Cross/Blue Shield Georgia Douglas L. Wooden 47 1991 Executive Vice President, Financial Executive Vice Services of the Company President, Financial Services John A. Brown 56 1992 Senior Vice President, Healthcare Markets Senior Vice President, of the Company Healthcare Markets Charles B. Childs, Jr. 48 2003 Senior Vice President and Chief Technology Senior Vice President and Officer of the Company; previously Associate Chief Technology Officer Partner, Accenture S. Mark Corbett 44 2001 Senior Vice President, Senior Vice President, Investments of the Company Investments Glen R. Derback 52 2003 Senior Vice President and Controller of the Senior Vice President Company and Controller Terry L. Fouts 60 2003 Senior Vice President and Chief Medical Senior Vice President and Officer of the Company since May 2003; Chief Medical Officer previously National Medical Director for Clinical Cost Management, Aetna U.S. Healthcare from May 2001; previously Global Medical Director for Cigna International John R. Gabbert 49 2000 Senior Vice President and Chief Senior Vice President Information Officer, Healthcare and Chief Information of the Company since April 2000; Officer, Healthcare previously Vice President, Information Technology, AT&T Broadband Donna A. Goldin 56 1996 Senior Vice President, Healthcare Senior Vice President, Operations of the Company Healthcare Operations Wayne T. Hoffmann 48 2001 Senior Vice President, Senior Vice President, Investments of the Company Investments D. Craig Lennox 56 1984 Senior Vice President, General Counsel Senior Vice President, and Secretary of the Company General Counsel and Secretary James L. McCallen 53 2003 Senior Vice President and Actuary of the Senior Vice President and Company Actuary Graham R. McDonald 57 2003 Senior Vice President, Corporate Senior Vice President, Administration of the Company Corporate Administration Charles P. Nelson 43 1998 Senior Vice President, Retirement Services Senior Vice President, of the Company Retirement Services Deborah L. Origer 47 2002 Senior Vice President, Healthcare Senior Vice President, Management of the Company since Healthcare Management November 2002; previously Chief Strategy Officer, Providence Health System Martin Rosenbaum 51 1997 Senior Vice President, Healthcare Finance Senior Vice President, of the Company Healthcare Finance Gregory E. Seller 50 1999 Senior Vice President, Senior Vice President, Government Markets of the Company Government Markets Robert K. Shaw 48 1998 Senior Vice President, Senior Vice President, Individual Markets of the Company Individual Markets Mark L. Stadler 50 2003 Senior Vice President, U.S. Markets of the Senior Vice President, Company since March 2003; previously U.S. Markets Principal, Mercer Human Resource Consulting Douglas J. Stefanson 48 2003 Senior Vice President, Healthcare Senior Vice President, Underwriting of the Company Healthcare Underwriting George D. Webb 60 1999 Senior Vice President, P/NP Operations of Senior Vice-President, the Company since July 1999; previously P/NP Operations Principal, William M. Mercer Investment Consulting Inc.
Unless otherwise indicated, all of the executive officers have been engaged for not less than five years in their present principal occupations or in another executive capacity with the companies or firms identified. The appointments of executive officers are confirmed annually. C. CODE OF ETHICS The Company has adopted a Code of Business Conduct (the Code) that is applicable to its senior financial officers, as well as to other officers and employees. All of the items identified as elements of a "code of ethics" as defined in SEC regulations adopted pursuant to the Sarbanes-Oxley Act of 2002 are substantively covered by the Code. A copy of the Code is available without charge upon written request to David C. Aspinwall, Chief Compliance Officer, 8515 East Orchard Road, Greenwood Village, Colorado 80111. D. AUDIT COMMITTEE FINANCIAL EXPERT The Board of Directors has reviewed the qualifications and backgrounds of the members of the Audit Committee and determined that, although no one member of the Audit Committee is an "audit committee financial expert" within the meaning of the Rules under the Securities Exchange Act of 1934, the combined qualifications and experience of the members of the Audit Committee give the Committee collectively the financial expertise necessary to discharge its responsibilities. ITEM 11. EXECUTIVE COMPENSATION A. SUMMARY COMPENSATION TABLE The following table sets out all compensation paid by the Company to the individuals who were, at December 31, 2003, the Chief Executive Officer and the other four most highly compensated executive officers of the Company (collectively the Named Executive Officers) for the three most recently completed fiscal years. Annual Compensation Long-term Awards -------------------------------- ---------- -------------------- ------------------- ------------------------ Name and Year Salary Bonus Options(1) Principal Position ($) ($) (#) -------------------------------- ---------- -------------------- ------------------- ------------------------ W.T. McCallum 2003 903,333 915,000 --- President and Chief Executive 400,000(2) Officer 2002 880,000 --- --- 2001 880,000 --- --- -------------------------------- ---------- -------------------- ------------------- ------------------------ R.F. Rivers(3) 2003 530,600 515,000 --- Executive Vice President, 2002 185,600(4) 225,000 120,000 Healthcare 2001 N/A N/A N/A -------------------------------- ---------- -------------------- ------------------- ------------------------ M.T.G. Graye 2003 490,000 371,250 50,000(5) Executive Vice President, 200,000(2) Chief Financial Officer 2002 457,000 237,500 --- 2001 415,000 75,000 40,000 -------------------------------- ---------- -------------------- ------------------- ------------------------ D.L. Wooden 2003 568,750 200,000(2) 50,000(5) Executive Vice President, 2002 550,000 343,750 --- Financial Services 2001 525,000 393,750 --- -------------------------------- ---------- -------------------- ------------------- ------------------------ Donna A. Goldin 2003 322,125 217,400 60,000 Senior Vice President, 2002 315,000 155,000 --- Healthcare Operations 2001 315,000 36,500 --- -------------------------------- ---------- -------------------- ------------------- ------------------------
(1) The options set out are options for common shares of Lifeco that are granted by Lifeco pursuant to the Lifeco Stock Option Plan (Lifeco Options). Lifeco Options become exercisable on specified dates and expire ten years after the date of the grant. (2) Special bonus paid in respect of the acquisition of Canada Life. (3) Mr. Rivers joined the Company in August 2002. (4) Mr. Rivers' annualized salary for 2002 was $500,000. (5) These Lifeco Options are contingent upon the attainment of certain financial targets. B. OPTIONS The following table describes options granted to the Named Executive Officers during the most recently completed fiscal year. All options are Lifeco Options granted pursuant to the Lifeco Stock Option Plan. Lifeco Options are issued with an exercise price in Canadian dollars. Canadian dollar amounts have been translated to U.S. dollars at a rate of 1/1.29. OPTION GRANTS IN LAST FISCAL YEAR ------------------- --------------- -------------- ----------- ------------------ ----------------------------- Potential realized value at assumed annual rates Individual Grants of stock price appreciation for option term ------------------- ------------ -------------- -------------- ------------------ ----------------------------- Percentage of total options Granted to Exercise Options employees or base Granted in fiscal price Expiration 5% 10% Name (#) Year ($/share) date ($) ($) ------------------- ------------ -------------- -------------- ------------------ ------------- --------------- M.T.G. Graye 50,000 2.6 30.11 July 9, 2013 946,794 2,399,315 D.L. Wooden 50,000 2.6 30.11 July 9, 2013 946,794 2,399,315 D.A. Goldin 60,000 3.1 29.21 January 29, 2013 1,102,193 2,793,119 ------------------- ------------ -------------- -------------- ------------------ ------------- ---------------
The Great-West Lifeco Stock Option Plan was created effective April 24, 1996. The following table describes all Lifeco Options exercised in 2003, and all unexercised Lifeco Options held as of December 31, 2003, by the Named Executive Officers. Lifeco Options are issued with an exercise price in Canadian dollars. Canadian dollar amounts have been translated to U.S. dollars at a rate of 1/1.29. AGGREGATED LIFECO OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES -------------------- ----------- ------------- ------------------------------ ------------------------------ Value of unexercised in-the- Unexercised options at Money options at fiscal fiscal year-end year-end (#) ($) -------------------- ----------- ------------- ------------------------------ ------------------------------ Shares acquired on Value exercise Realized Exercisable Unexercisable Exercisable Unexercisable Name (#) ($) -------------------- ----------- ------------- ------------- ---------------- ------------- ---------------- W.T. McCallum 100,000 2,312,330 549,200 20,000 10,103,549 362,380 -------------------- ----------- ------------- ------------- ---------------- ------------- ---------------- R.F. Rivers --- --- 24,000 96,000 175,556 826,255 -------------------- ----------- ------------- ------------- ---------------- ------------- ---------------- M.T.G. Graye --- --- 249,334 115,667 5,770,743 1,200,278 -------------------- ----------- ------------- ------------- ---------------- ------------- ---------------- D.L. Wooden --- --- 313,334 116,667 6,484,635 1,458,610 -------------------- ----------- ------------- ------------- ---------------- ------------- ---------------- D.A. Goldin 36,000 666,847 30,000 60,000 860,976 363,385 -------------------- ----------- ------------- ------------- ---------------- ------------- ----------------
C. PENSION PLAN TABLE The following table sets out the pension benefits payable to the Named Executive Officers. PENSION PLAN TABLE -------------------------------------------------------------------------------------- Years of Service -------------------------------------------------------------------------------------- Remuneration ($) 15 20 25 30 35 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 400,000 120,000 160,000 200,000 240,000 240,000 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 500,000 150,000 200,000 250,000 300,000 300,000 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 600,000 180,000 240,000 300,000 360,000 360,000 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 700,000 210,000 280,000 350,000 420,000 420,000 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 800,000 240,000 320,000 400,000 480,000 480,000 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 900,000 270,000 360,000 450,000 540,000 540,000 -------------------- ---------------- ----------------- ---------------- ----------------- ---------------- 1,000,000 300,000 400,000 500,000 600,000 600,000 -------------------- ---------------- ----------------- ---------------- ----------------- ----------------
The Named Executive Officers have the following years of service, as of December 31, 2003. ------------------------------------------------------ ---------------------------------------------------- Name Years of Service ------------------------------------------------------ ---------------------------------------------------- W.T. McCallum 38 ------------------------------------------------------ ---------------------------------------------------- R.F. Rivers 1 ------------------------------------------------------ ---------------------------------------------------- M.T.G. Graye 10 ------------------------------------------------------ ---------------------------------------------------- D.L. Wooden 13 ------------------------------------------------------ ---------------------------------------------------- D.A. Goldin 20 ------------------------------------------------------ ----------------------------------------------------
W.T. McCallum is entitled, upon election, to receive the benefits shown, with remuneration based on the average of the highest 36 consecutive months of compensation during the last 84 months of employment. For R.F. Rivers, M.T.G. Graye, D.L. Wooden, and D.A. Goldin, the benefits shown are payable upon the attainment of age 62, and remuneration is the average of the highest 60 consecutive months of compensation during the last 84 months of employment. Compensation includes salary and bonuses prior to any deferrals. The normal form of pension is a life only annuity. Other optional forms of pension payment are available on an actuarially equivalent basis. The benefits listed in the table are subject to deduction for social security and other retirement benefits. D. COMPENSATION OF DIRECTORS For each director of the Company who is not also a director of Great-West Life, the Company pays an annual fee of $22,500. The Company pays all directors a meeting fee of $1,500 for each meeting of the Board of Directors or a committee thereof attended. At their option, in lieu of cash payments, directors may receive deferred share units under The Great-West Life Assurance Company Deferred Share Unit Plan. In addition, all directors are reimbursed for incidental expenses. The above amounts are paid in the currency of the country of residence of the director. E. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Executive compensation is determined by the Company's Board of Directors. W.T. McCallum, President and Chief Executive Officer of the Company, is a member of the Board of Directors. Mr. McCallum participated in executive compensation matters generally but was not present when his own compensation was discussed or determined. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT A. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS Set forth below is certain information, as of March 1, 2004, concerning beneficial ownership of the voting securities of the Company by entities and persons who beneficially own more than 5% of the voting securities of the Company. The determinations of "beneficial ownership" of voting securities are based upon Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the Exchange Act). This rule provides that securities will be deemed to be "beneficially owned" where a person has, either solely or in conjunction with others, (1) the power to vote or to direct the voting of securities and/or the power to dispose or to direct the disposition of the securities or (2) the right to acquire any such power within 60 days after the date such "beneficial ownership" is determined. (1) 100% of the Company's 7,032,000 outstanding common shares are owned by GWL&A Financial Inc., 8515 East Orchard Road, Greenwood Village, Colorado 80111. (2) 100% of the outstanding common shares of GWL&A Financial Inc. are owned by GWL&A Financial (Nova Scotia) Co., Suite 800, 1959 Upper Water Street, Halifax, Nova Scotia, Canada B3J 2X2. (3) 100% of the outstanding common shares of GWL&A Financial (Nova Scotia) Co. are owned by GWL&A Financial (Canada) Inc., 100 Osborne Street North, Winnipeg, Manitoba, Canada R3C 3A5. (4) 100% of the outstanding common shares of GWL&A Financial (Canada) Inc. are owned by Great-West Lifeco Inc., 100 Osborne Street North, Winnipeg, Manitoba, Canada R3C 3A5. (5) 70.4% of the outstanding common shares of Great-West Lifeco Inc. are controlled by Power Financial Corporation, 751 Victoria Square, Montreal, Quebec, Canada H2Y 2J3, representing approximately 65% of the voting rights attached to all outstanding voting shares of Great-West Lifeco Inc. (6) 67.1% of the outstanding common shares of Power Financial Corporation are owned by 171263 Canada Inc., 751 Victoria Square, Montreal, Quebec, Canada H2Y 2J3. (7) 100% of the outstanding common shares of 171263 Canada Inc. are owned by 2795957 Canada Inc., 751 Victoria Square, Montreal, Quebec, Canada H2Y 2J3. (8) 100% of the outstanding common shares of 2795957 Canada Inc. are owned by Power Corporation of Canada, 751 Victoria Square, Montreal, Quebec, Canada H2Y 2J3. (9) Mr. Paul Desmarais, 751 Victoria Square, Montreal, Quebec, Canada H2Y 2J3, through a group of private holding companies, which he controls, has voting control of Power Corporation of Canada. As a result of the chain of ownership described in paragraphs (1) through (9) above, each of the entities and persons listed in paragraphs (1) through (9) would be considered under Rule 13d-3 of the Exchange Act to be a "beneficial owner" of 100% of the outstanding voting securities of the Company. B. SECURITY OWNERSHIP OF MANAGEMENT The following table sets out the number of equity securities, and exercisable options (including options that will become exercisable within 60 days) for equity securities, of the Company or any of its parents or subsidiaries, beneficially owned, as of December 31, 2003, by (i) the directors of the Company; (ii) the Named Executive Officers; and (iii) the directors and executive officers of the Company as a group. Power Financial Power Corporation Great-West Lifeco Inc. Corporation of Canada -------------------------- ---------------------------- -------------------------- ------------------------ Directors (1) (2) (3) -------------------------- ---------------------------- -------------------------- ------------------------ J. Balog - - - -------------------------- ---------------------------- -------------------------- ------------------------ J.W. Burns 153,659 8,000 385,640 200,000 options -------------------------- ---------------------------- -------------------------- ------------------------ O.T. Dackow 81,642 - - 50,000 options -------------------------- ---------------------------- -------------------------- ------------------------ A. Desmarais 51,659 21,600 149,000 2,129,000 options -------------------------- ---------------------------- -------------------------- ------------------------ P. Desmarais, Jr. 43,659 - 17,702 2,040,000 options -------------------------- ---------------------------- -------------------------- ------------------------ R. Gratton 332,496 1,710,000 10,318 5,080,000 options -------------------------- ---------------------------- -------------------------- ------------------------ K.P. Kavanagh 10,052 - - 4,000 Preferred (Series D) -------------------------- ---------------------------- -------------------------- ------------------------ W. Mackness - - - -------------------------- ---------------------------- -------------------------- ------------------------ W.T. McCallum 184,768 - - 569,200 options -------------------------- ---------------------------- -------------------------- ------------------------ J.E.A. Nickerson - 5,100 5,479 -------------------------- ---------------------------- -------------------------- ------------------------ D.A. Nield 28,424 - - 2,777 Preferred (Series E) 38,553 Preferred (Series F) -------------------------- ---------------------------- -------------------------- ------------------------ M. Plessis-Belair 20,000 3,000 201,246 176,250 options -------------------------- ---------------------------- -------------------------- ------------------------ B.E. Walsh - - - -------------------------- ---------------------------- -------------------------- ------------------------ Power Financial Power Corporation Great-West Lifeco Inc. Corporation of Canada -------------------------- ---------------------------- -------------------------- ------------------------ Named Executive (1) (2) (3) Officers -------------------------- ---------------------------- -------------------------- ------------------------ W.T. McCallum 184,768 - - 569,200 options -------------------------- ---------------------------- -------------------------- ------------------------ D.L. Wooden 113,000 - 430,001 options -------------------------- ---------------------------- -------------------------- ------------------------ M.T.G. Graye 1,754 50,000 - 365,001 options -------------------------- ---------------------------- -------------------------- ------------------------ R.F. Rivers - - 120,000 options -------------------------- ---------------------------- -------------------------- ------------------------ D.A. Goldin 30 - - 90,000 options -------------------------- ---------------------------- -------------------------- ------------------------ Power Financial Power Corporation Great-West Lifeco Inc. Corporation of Canada -------------------------- ---------------------------- -------------------------- ------------------------ Directors and Executive Officers (1) (2) (3) as a Group -------------------------- ---------------------------- -------------------------- ------------------------ 1,058,194 2,281,900 770,185 2,639,808 options 5,080,000 options 4,545,250 options 4,000 Preferred (Series D) 2,777 Preferred (Series E) 38,553 Preferred (Series F) -------------------------- ---------------------------- -------------------------- ------------------------
(1) All holdings are common shares, or where indicated, preferred shares or exercisable options for common shares, of Great-West Lifeco Inc. (2) All holdings are common shares, or where indicated, exercisable options for common shares, of Power Financial Corporation. (3) All holdings are subordinate voting shares, or where indicated, exercisable options for subordinate voting shares, of Power Corporation of Canada. The number of common shares and exercisable options for common shares of Power Financial Corporation held by R. Gratton represents 1.9% of the total number of common shares and exercisable options for common shares of Power Financial Corporation outstanding. The number of common shares and exercisable options for common shares of Power Financial Corporation held by the directors and executive officers as a group represents 2% of the total number of common shares and exercisable options for common shares of Power Financial Corporation outstanding. The number of subordinate voting shares and exercisable options for subordinate voting shares of Power Corporation of Canada held by A. Desmarais represents 1.1% of the total number of subordinate voting shares and exercisable options for subordinate voting shares of Power Corporation of Canada outstanding. The number of subordinate voting shares and exercisable options for subordinate voting shares of Power Corporation of Canada held by the directors and executive officers as a group represents 2.6% of the total number of subordinate voting shares and exercisable options for subordinate voting shares of Power Corporation of Canada outstanding. None of the remaining holdings set out above exceeds 1% of the total number of shares and exercisable options for shares of the class outstanding. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES A. PRINCIPAL ACCOUNTING FEES For the years ended December 31, 2003 and 2002, professional services were performed by Deloitte & Touche LLP (Deloitte). The total fees for these services were $4,400,850 and $3,055,400 for the years ended December 31, 2003 and 2002, respectively, and were composed of the following: Audit Fees The aggregate fees billed for the audit of the Company's and its subsidiaries' annual financial statements for the fiscal years ended December 31, 2003 and 2002, and for the review of the financial statements included in the Company's quarterly reports on Form 10-Q, were $3,153,000 and $2,348,400, respectively. Audit Related Fees The aggregate fees billed for audit related services for the fiscal years ended December 31, 2003 and 2002 were $335,750 and $296,750, respectively. These services included "SAS 70" internal control reports and audits of the Company's employee benefit plans. Tax Fees The aggregate fees billed for tax services for the fiscal years ended December 31, 2003 and 2002 were $284,000 and $328,000, respectively. These services included tax compliance services for the Company's affiliated mutual funds, Maxim Series Fund, Inc. and Orchard Series Fund, as well as tax planning and compliance services for the Company and its subsidiaries. All Other Fees The aggregate fees for services not included above were $628,100 and $82,250, respectively, for the fiscal years ended December 31, 2003 and 2002. The fees for 2003 primarily relate to a market and other analysis in support of strategic planning by the Great-West Healthcare division, and for both 2003 and 2002 included audits of employee benefit plans for customers of the Company. B. PRE-APPROVAL POLICIES AND PROCEDURES The Audit Committee pre-approves all services, including both audit and non-audit services, provided by Deloitte. Each year, the Committee receives a schedule of the audit, audit-related and tax services that it is asked to approve for the year before Deloitte may be engaged. The Committee has authorized its Chairman, in his discretion, to approve additional services between meetings of the Committee. Such discretion may only be exercised by the Chairman so long as he remains "independent" for purposes of Section 301 of the Sarbanes-Oxley Act of 2002. Any approval by the Chairman must be reviewed by the Committee at its next meeting. None of the services described in this Item 14 were approved by the Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X. The amount of hours expended on Deloitte's audit of the Company's financial statements for 2003 attributable to work performed by persons other than Deloitte's full-time, permanent employees was less than 50%. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The documents identified below are filed as a part of this report: A. INDEX TO FINANCIAL STATEMENTS Page --------------- Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements for the Years Ended December 31, 2003, 2002, and 2001............................................ 32 Consolidated Balance Sheets as of December 31, 2003 and 2002....................... 33 Consolidated Statements of Income for the Years Ended December 31, 2003, 2002, and 2001................................................ 35 Consolidated Statements of Stockholder's Equity for the Years Ended December 31, 2003, 2002, and 2001................................................ 36 Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002, and 2001................................................ 37 Notes to Consolidated Financial Statements for the Years Ended December 31, 2003, 2002, and 2001................................................ 40
All schedules and separate financial statements of the Registrant are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto. B. INDEX TO EXHIBITS Exhibit Number Title Page ------------------------ ----------------------------------------------------- -------------------- 3(i) Articles of Redomestication of Great-West Life & Annuity Insurance Company Filed as Exhibit 3(i) to Registrant's Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. 3(ii) Bylaws of Great-West Life & Annuity Insurance Company Filed as Exhibit 3(ii) to Registrant's Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. 10 Material Contracts 10.1 Description of Executive Officer Annual Incentive Bonus Program Filed as Exhibit 10.1 to Registrant's Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. 10.2 Great-West Lifeco Inc. Stock Option Plan Filed as Exhibit 10.2 to Registrant's Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. Description of amendment to the Great-West Lifeco Inc. Stock Option Plan Filed as Exhibit 10.2 to Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. 10.3 Supplemental Executive Retirement Plan Filed as Exhibit 10.3 to Registrant's Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. Amendment No. 3 to Supplemental Executive Retirement Plan. Filed as Exhibit 10.3 to Registrant's Form 10-K for the year ended December 31, 2000 and incorporated herein by reference. 10.4 Executive Deferred Compensation Plan Filed as Exhibit 10.4 to Registrant's Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. 10.5 Deferred Share Unit Plan. Filed as Exhibit 10.5 to Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. 10.6 Executive Long Term Disability Plan. Filed as Exhibit 10.6 to Registrant's Form 10-K for the year ended December 31, 2002 and incorporated herein by reference. 10.7 Nonqualified Deferred Compensation Plan. Filed as Exhibit 10.7 to Registrant's Form 10-K for the year ended December 31, 2002 and incorporated herein by reference. 21 Subsidiaries of Great-West Life & Annuity Insurance Company filed herewith. 24 Directors' Powers of Attorney Directors' Powers of Attorney filed as Exhibit 24 to Registrant's Form 10-K for the year ended December 31, 1996, and Exhibit 24 to Registrant's Form 10-K for the year ended December 31, 1997, and incorporated herein by reference. Director's Power of Attorney for D.A. Nield filed herewith. 31.1 Section 302 Certification of the Chief Executive Officer filed herewith. 31.2 Section 302 Certification of the Chief Financial Officer filed herewith. 32 Section 906 Certification of the Chief Executive Officer and Chief Financial Officer filed herewith.
C. REPORTS ON FORM 8-K A report on Form 8-K, dated October 29, 2003, was filed disclosing Lifeco's third quarter results. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY By: /s/ Mitchell T.G. Graye ------------------------------------------------------------ Mitchell T.G. Graye, Executive Vice President and Chief Financial Officer Date: October 26, 2004