-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Aan8QI0IzrwDIsc+gpRQotjROgwgKTqgJezKIwTqJ6xkgIRh9f0cBRy7MdBJwjea V82X0SxOpmQEEms81+05lQ== 0000744455-99-000008.txt : 19990428 0000744455-99-000008.hdr.sgml : 19990428 ACCESSION NUMBER: 0000744455-99-000008 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990427 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GREAT WEST LIFE & ANNUITY INSURANCE CO CENTRAL INDEX KEY: 0000744455 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 840467907 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 333-01173 FILM NUMBER: 99601336 BUSINESS ADDRESS: STREET 1: 8515 E ORCHARD RD CITY: ENGLEWOOD STATE: CO ZIP: 80111 BUSINESS PHONE: 3036893831 MAIL ADDRESS: STREET 1: 8515 E ORCHARD RD CITY: ENGLEWOOD STATE: CO ZIP: 80111 10-K/A 1 GWLA 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 [FEE REQUIRED] For The Fiscal Year Ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition 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 No.) 8515 East Orchard Road, Englewood, Colorado 80111 (Address of principal executive offices) (Zip Code) (303) 689-3000 (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. [ ] As of March 1, 1999, the aggregate market value of the registrant's voting stock held by non-affiliates of the registrant was $0. As of March 1, 1999, 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 is filed by the registrant only as a consequence of the sale by the registrant of a market value adjusted annuity product. EXPLANATORY NOTE This amendment No. 1 on Form 10-K/A amends Great-West Life & Annuity Insurance Company's Annual Report on Form 10-K for the year ended December 31, 1998, in its entirety. This amendment is being filed in order to amend the disclosure contained under Item 7A Quantitative and Qualitative Disclosures About Market Risk. TABLE OF CONTENTS Page PART I Item 1. Business........................................................................1 A. Organization and Corporate Structure...................................1 B. Business of the Company ...............................................1 C. Employee Benefits .....................................................3 D. Financial Services ....................................................7 E. Investment Operations..................................................12 F. Regulation.............................................................13 G. Ratings................................................................15 H. Miscellaneous..........................................................16 Item 2. Properties......................................................................16 Item 3. Legal Proceedings...............................................................16 Item 4. Submission of Matters to a Vote of Security Holders.............................16 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................................................16 A. Equity Security Holders and Market Information.........................16 B. Dividends..............................................................16 Item 6. Selected Financial Data.........................................................17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................................................17 A. Company Results of Operations..........................................18 B. Employee Benefits Results of Operations................................22 C. Financial Services Results of Operations...............................25 D. Investment Operations .................................................28 E. Liquidity and Capital Resources........................................30 F. Accounting Pronouncements..............................................31 G. Year 2000 Issue .......................................................31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk......................33 Item 8. Financial Statements and Supplementary Data.....................................34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............................................65 PART III Item 10. Directors and Executive Officers of the Registrant..............................65 A. Identification of Directors............................................65 B. Identification of Executive Officers...................................68 Item 11. Executive Compensation..........................................................71 A. Summary Compensation Table.............................................71 B. Options................................................................72 C. Pension Plan Table.....................................................73 D. Compensation of Directors..............................................74 E. Compensation Committee Interlocks and Insider Participation............75 Item 12. Security Ownership of Certain Beneficial Owners and Management..................75 A. Security Ownership of Certain Beneficial Owners........................75 B. Security Ownership of Management.......................................76 Item 13. Certain Relationships and Related Transactions..................................78 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................78 A. Index to Financial Statements..........................................78 B. Index to Exhibits......................................................79 C. Reports on Form 8-K....................................................80 Signatures................................................................................81
16 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 in 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. GWL&A Financial is an indirect wholly-owned subsidiary of The Great-West Life Assurance Company ("Great-West Life"), a Canadian life insurance company. Great-West Life is a subsidiary of Great-West Lifeco Inc. ("Great-West Lifeco"), a Canadian holding company. Great-West Lifeco is a subsidiary of Power Financial Corporation ("Power Financial"), a Canadian holding company with substantial interests in the financial services industry. Power Financial Corporation is a subsidiary of Power Corporation of Canada ("Power Corporation"), a Canadian holding and management company. Mr. Paul Desmarais, through a group of private holding companies, which he controls, has voting control of Power Corporation. Common and preferred shares of Great-West Life, Great-West 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 subsidiary, First Great-West Life & Annuity Insurance Company. The Company is also a licensed reinsurer in the State of New York. As of December 31, 1997, the Company ranked among the top 25 of all U.S. life insurance companies in terms of total admitted assets. The Company operates in the following two business segments: Employee Benefits -life, health and 401(k) products for group clients Financial Services -savings products for both public and non-profit employers and individuals, and life insurance products for individuals and businesses 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) 1998 1997 1996 ------------- ------------- ------------- Premium Income Employee Benefits Group Life & Health $ 747 $ 465 $ 486 ------------- ------------- ------------- Total Employee Benefits 747 465 486 ------------- ------------- ------------- Financial Services Savings 17 23 27 Individual Insurance 231 (3) 345 (2) 316 (2) ------------- ------------- ------------- Total Financial Services 248 368 343 ------------- ------------- ------------- Premium income $ 995 $ 833 $ 829 ============= ============= ============= Fee Income Employee Benefits Group Life & Health $ 367 $ 305 $ 277 401(k) 78 53 44 ------------- ------------- ------------- ------------- ------------- ------------- Total Employee Benefits 445 358 321 ------------- ------------- ------------- ------------- ------------- ------------- Financial Services Savings 71 62 26 ------------- ------------- ------------- Total Financial Services 71 62 26 ------------- ------------- ------------- ============= ============= ============= Fee income $ 516 $ 420 $ 347 ============= ============= ============= ============= ============= ============= Deposits for Investment-type Contracts: Employee Benefits $ 37 $ 25 $ 34 Financial Services 1,307 (3) 633 781 ------------- ------------- ------------- Total investment-type deposits $ 1,344 $ 658 $ 815 ============= ============= ============= Deposits to Separate Accounts Employee Benefits $ 1,568 $ 1,403 $ 1,109 Financial Services 640 742 329 ------------- ------------- ------------- Total separate accounts deposits $ 2,208 $ 2,145 $ 1,438 ============= ============= ============= Self-funded equivalents (4) $ 2,606 $ 2,039 $ 1,940 ============= ============= =============
(1) All information in the above table and other tables herein is derived from information that has been prepared in conformity with generally accepted accounting principles, unless otherwise indicated. (2) These amounts include the recapture of $156 million and $164 million for the years ended December 31, 1997 and 1996, respectively, of participating policy reserves previously coinsured with Great-West Life under a participating life coinsurance agreement. (3) These amounts include $46 million in premium income for non-participating life insurance policies and $520 million in deposits for investment-type contracts which Great-West Life coinsured with the Company in 1998 under two indemnity reinsurance agreements. (4) Self-funded equivalents generally represent paid claims under minimum premium and administrative services only contracts, which amounts approximate the additional premiums that would have been earned under such contracts if they had been written as traditional indemnity or HMO programs. C. EMPLOYEE BENEFITS 1. Principal Products The Employee Benefits segment of the Company provides a full range of employee benefits products to more than 11,300 employers across the United States. This includes approximately 1,200 employers covered by Anthem Health & Life Insurance Company ("AH&L"), which the Company acquired in July 1998. The Company offers customers a variety of health plan options to help them maximize the value of their employee benefits package. The majority of the Company's health care business is 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 savings. The Company offers employers a total benefits solution - an integrated package of group life and disability insurance, managed care programs, 401(k) savings plans and flexible spending accounts. Through integrated pricing, administration, funding and service, the Company helps employers provide cost-effective benefits that will attract and retain quality employees, and at the same time, helps employees reach their personal goals by offering benefit choices, along with information needed to make appropriate choices. Many customers also find this integrated approach appealing because their benefit plans are administered through a single company with linked systems that provide on-line administration and account access, for enhanced efficiency and simplified plan administration. The Company offers a choice of managed care products including Health Maintenance Organization ("HMO") plans, which provide a high degree of managed care, and Preferred Provider Organization ("PPO") plans and Point of Service ("POS") plans which offer more flexibility in provider choice than HMO plans. Under HMO plans, health care for the member is coordinated by a primary care physician who is responsible for managing all aspects of the member's health care. HMO plans offer a broad scope of benefits coverage including routine office visits and preventive care, as well as lower premiums and low copayments which minimize out-of-pocket costs. Services for care not coordinated with the primary care physician are not covered, with the exception of emergency care. There are no claims to file when services are received through a primary care physician. Physicians are reimbursed on a monthly capitated rate per HMO patient for most services. POS plans also require that a member enroll with a primary care physician who is responsible for coordinating the member's health care. Similar to an HMO, members receive the highest benefit coverage and the lowest out-of-pocket costs when they use their primary care physician to coordinate their heath care. In contrast to an HMO, members can seek care outside of the primary physician's direction, at a reduced level of benefits. Some benefits may not be covered outside the in-network POS plan. PPO plans offer members a greater choice of physicians and hospitals. Members do not need to enroll with a primary care physician - they simply select a contracted PPO provider at the time of the service to receive the highest level of benefits. If members seek care outside of the PPO network, they receive a lower level of benefits. The Company continues to offer fully insured indemnity plans. A traditional indemnity plan allows complete freedom of choice for covered services. After meeting an annual deductible, insureds pay their share of coinsurance for all covered services. These plans are not typically considered managed care, although they may include some medical management features, such as inpatient certification, reasonable and customary charges, and some benefits for preventive care. The Company continues to develop its One Health Plan HMO subsidiary organization. In 1998, it licensed four One Health Plan HMOs (Arizona, Florida, Indiana and New Jersey). This brings the total number of licensed HMO subsidiaries to 14. In addition to day-to-day HMO operation, the One Health Plans also administer provider networks and provide medical management, member services and quality assurance for the other managed care products of the Company, AH&L and New England Life Insurance Company ("New England"). In addition to creating economies of scale, this "pooling" of PPO, POS and HMO membership benefits the Company by improving its position in negotiating provider reimbursement arrangements, which leads to more competitive pricing. The Company offers Internal Revenue Code Section 125 plans which enable participants to set aside pre-tax dollars to pay for unreimbursed medical expenses and dependent care expenses. This creates tax efficiencies for both the employer and its employees. The Company offers group life insurance. 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 years indicated: [Millions] Years Ended December 31, --------------------------------------------------------------- 1998 1997 1996 1995 1994 -------------- ---------- --------- ---------- --------- In force, end of year $ 84,121(1) $ 53,211 $ 49,500 $ 50,370 $ 51,051 (1) Includes $25,597 of in force group life insurance obtained from the acquisition of AH&L.
The Company's 401(k) product is offered by way of a group fixed and variable deferred annuity contract. The product provides a variety of funding and distribution options for employer-approved retirement plans that qualify under Internal Revenue Code Section 401(k). The 401(k) product investment options for the employer include guaranteed interest rates for various lengths of time and variable investment options. For the fully guaranteed option, the difference between the income earned on investments in the Company's general account and the interest credited to the participant's account balance flows through to operating income. Variable investment options utilize separate accounts to provide participants with a vehicle to assume the investment risks. Assets held under these options are invested, as designated by the participant, in separate accounts which in turn invest in shares of underlying funds managed by a subsidiary of the Company or by selected external fund managers. The participant currently has up to 32 different variable investment options. Of the total 401(k) assets under administration in 1998, 96% were allocated to variable investment options versus 94% in 1997. The Company is compensated by the separate accounts for bearing expense risks pertaining to the variable annuity contract, and for providing administrative services. A subsidiary of the Company also receives fees for serving as an investment advisor for those underlying funds which are managed by the subsidiary. Customer retention is a key factor for the profitability of the Company's 401(k) product. The annuity contract imposes a charge for termination during a designated period of time after the contract's inception. The charge is determined in accordance with a formula in the contract. Existing federal tax penalties on distributions prior to age 59 1/2 provide an additional disincentive to premature surrenders of account balances, but do not impact rollovers to products of competitors. The Company offers a rollover Individual Retirement Annuity, which allows individuals to move retirement funds from a 401(k) plan to a qualified Individual Retirement Account. The Company offers a Non-Qualified Deferred Compensation ("NQDC") supplement to its 401(k) product. NQDC allows highly compensated employees to defer compensation on a pre-tax basis beyond 401(k) limits until retirement. In the following table, the amount of 401(k) business in force is measured by the total of individual account balances: [Millions] Year Ended December 31, Fixed Annuities Variable Annuities ----------------------- ------------------- ----------------------- 1994 345 1,324 1995 358 2,227 1996 347 3,229 1997 328 4,568 1998 299 5,770 2. Method of Distribution The Company distributes its products and services through field sales staff of the Company, AH&L and New England located in 80 sales offices throughout the United States. Although each sales organization markets some common products, they also sell products under distinctive brand identities. This enables each distribution system to capitalize on existing market strengths and business relationships. Each sales office works with insurance brokers, agents and consultants in their local market. 3. Competition The employee benefits industry is highly competitive. Over the past year, the United States health care industry has experienced a number of mergers and consolidations. A number of larger carriers dropped out of the group health market entirely. Although there are still many different carriers in the marketplace, it has become dominated by an increasingly smaller number of carriers, including the Company. The highly competitive marketplace creates pricing pressures, which encourage employers to seek competitive bids each year. Although most employers are looking for affordably priced employee benefits products, they 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, which offers multiple product lines and centralized administration. In addition to price, there are a number of other factors which 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 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, the policy reserves equal the present value of future benefits and expenses using best estimate assumptions for interest, mortality and expenses (including margins for adverse deviation). For group universal life, the policy reserves equal the accumulated fund balance (which reflects cumulative deposits plus credited interest less charges thereon). Reserves for long-term disability products are established for lives currently in payment status using industry and Company morbidity factors, and interest rates based on Company experience. In addition, reserves are held for lives that have not satisfied their waiting period and for claims that have been incurred but not reported. For medical, dental and vision 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 retrospective experience rating that is done on certain types of business. Reserves for investment contracts (401(k) deferred annuities) are equal to cumulative deposits, less withdrawals and charges, plus credited interest thereon. 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 at their maturities, and pay expected death or retirement benefits or surrender requests. 5. Reinsurance The Company has a marketing and administrative services arrangement with New England. Under reinsurance agreements, New England issues group life and health and 401(k) products and then immediately reinsures 50% of its group life and health business, and nearly 100% of its guaranteed 401(k) business, with the Company. 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 coinsurance contracts. The maximum amount of group life insurance retained on any one life is $1.0 million. The maximum amount of group monthly disability income benefit at risk on any one life is $6,000 per month. D. FINANCIAL SERVICES 1. Principal Products The Financial Services segment of the Company develops, administers and sells retirement savings and life insurance products and services for individuals, and for employees of state and local governments, hospitals, non-profit organizations and public school districts. The Company's core savings business is in the public/non-profit pension market. The Company provides investment products, and administrative and communication services, to employees of state and local governments (Internal Revenue Code Section 457 plans), as well as employees of hospitals, non-profit organizations and public school districts (Internal Revenue Code Section 401, 403(b) and 408 plans). The Company provides pension plan administrative services through a subsidiary company, Financial Administrative Services Corporation ("FASCorp"). The Company provides marketing and communication services through another subsidiary company, Benefits Communication Corporation, and BenefitsCorp Equities, Inc., a broker-dealer subsidiary of Benefits Communication Corporation (collectively, "BenefitsCorp"). The Company's primary marketing emphasis in the public/non-profit pension market is group fixed and variable annuity contracts for defined contribution retirement savings plans. Defined contribution plans provide for participant accounts with 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 Company has a marketing agreement with Charles Schwab & Co., Inc. to sell individual fixed and variable qualified and non-qualified deferred annuities. The variable annuity product offers several investment options. The fixed product is a Guarantee Period Fund, which 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. Guarantee period durations of one to ten years are currently being offered by the Company. Distributions from the amounts allocated to a Guarantee Period Fund more than six months prior to the maturity date results 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. The Company's variable annuity products provide the opportunity for contractholders to assume the risks of, and receive all the benefits from, the investment of retirement assets. The variable product assets are invested, as designated by the participant, in separate accounts which in turn invest in shares of underlying funds managed by a subsidiary of the Company or by selected external fund managers. Demand for investment diversification for customers and their participants continued to grow during 1998. The Company continues to expand the annuity products available through Maxim Series Fund, Inc., a subsidiary of the Company which is an insurance products fund company, and through arrangements with external fund managers. This array of funds allows customers to diversify their investments across a wide range of investment products, including fixed income, stock and international equity fund offerings. On a very limited basis the Company offers single premium annuities and guaranteed certificates, which provide guarantees of principal and interest with a fixed maturity date. Customer retention is a key factor for the profitability of 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. Annuity products generate earnings from the investment spreads on the guaranteed investment options and from the fees collected for mortality and expense risks associated with the variable options. The Company also receives fees for providing administration services to contractholders. A subsidiary of the Company receives fees for serving as an investment advisor for underlying funds which are managed by the subsidiary. The Company's annuity products are supported by the general account assets of the Company for guaranteed investment options, and the separate accounts for the variable investment options. The amount of annuity products in force is measured by account balances. The following table shows guaranteed investment contract and group and individual annuity account balances for the years indicated: [Millions] Guaranteed Year Ended Investment Fixed Variable December 31, Contracts Annuities Annuities ----------------------- ---------------- -------------- ------------ 1994 930 5,672 1,231 1995 664 5,722 1,772 1996 525 5,531 2,256 1997 409 5,227 3,280 1998 275 4,849 4,330 In addition to providing administrative services to customers of the Company's annuities, FASCorp also provides comprehensive third-party administrative and recordkeeping services for other financial institutions and employer-sponsored retirement plans. Assets under administration with unaffiliated organizations totaled $12.6 billion at December 31, 1998 and $8.5 billion at December 31, 1997. Life insurance products in force include participating and non-participating term life, whole life and 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. Participating products are no longer actively marketed by the Company but continue to produce renewal premium ($283.8 million in 1998). Participating dividends for 1998 and 1997 were $71.4 million and $63.8 million, respectively. The provision for participating policyholder earnings is reflected in liabilities under 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. At December 31, 1998 and 1997, the Company had $3.5 billion and $3.3 billion, respectively, of policy reserves on individual insurance products sold to corporations to provide coverage on the lives of certain employees - so-called Corporate-Owned Life Insurance ("COLI"). Due to legislation enacted during 1996 which phases out the interest deductions on COLI policy loans over a two-year period ending 1998, COLI sales have ceased. The Company continues to work closely with existing COLI customers to determine the options available to them and is confident that the effect of the legislative changes will not be material to the Company's operations. The Company has shifted its emphasis to the Bank-Owned Life Insurance ("BOLI") market. BOLI was not affected by the 1996 legislation. This interest-sensitive whole life product funds post-retirement benefits for bank employees. At December 31, 1998 and 1997, the Company had $1.0 billion and $0.5 billion, respectively, of BOLI policy reserves. Sales of life insurance products typically have high initial marketing expenses. Retention, an important factor in profitability, 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 credit rates may be offered after policies have been in force for a period of time. Certain of the Company's life insurance and group annuity products allow policy owners to borrow against their policies. At December 31, 1998, approximately 5% of outstanding policy loans were on individual life policies that had fixed interest rates ranging from 5% to 8%. The remaining 95% of outstanding policy loans had variable interest rates averaging 6.5% at December 31, 1998. Investment income from policy loans was $180.9 million for the year ended December 31, 1998. The following table summarizes changes in individual life insurance in force prior to reinsurance ceded for the years indicated: Years Ended December 31, --------------------------------------------------------- [Millions] 1998 1997 1996 1995 1994 ----------- ---------- ---------- --------- ---------- In force, begin- ning of year 28,266 $ 26,892 25,865 24,877 20,259 Sales and additions 16,215 3,119 2,695 2,520 6,302 (1) Terminations 1,515 1,745 1,668 1,532 1,684 ----------- ---------- ---------- --------- ---------- Net 14,700 1,374 1,027 988 4,618 ----------- ---------- ---------- --------- ---------- In force, end of year 42,966 28,266 26,892 25,865 24,877 (1) Includes approximately $8.5 billion in adjustments related to COLI policyholders exercising non-forfeiture options to increase the face value of their policies, and $5.2 billion related to the reinsurance transactions referred to in footnote (3) on page 2. In 1998, the Company obtained membership in the Insurance Marketplace Standards Association, which is granted in recognition of high standards of ethical company behavior in advertising, sales and service for individually sold life insurance and annuity products. 2. Method of Distribution Financial Services primarily uses BenefitsCorp to distribute pension products and to provide communication and enrollment services to employers in the public/non-profit market. Pension products are also distributed through independent marketing agencies. The Company distributes universal and joint survivor life insurance, as well as individual fixed and variable qualified and non-qualified deferred annuities, through Charles Schwab & Co., Inc. Individual life products are also sold through large banks and other financial institutions. BOLI products are currently marketed through one broker, Clark/Bardes, Inc. 3. Competition The life insurance, savings and investments marketplace is highly competitive. The Company's competitors include mutual fund companies, insurance companies, banks, investment advisors and certain service and professional organizations. No one competitor or small number of competitors is dominant. Competition focuses on service, technology, cost, 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 universal life 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 (including universal life insurance), 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 with life contingent payouts) are computed on the basis of assumed investment yield, mortality, morbidity and expenses. These assumptions generally vary by plan, year of issue and policy duration. Reserves for investment contracts (deferred annuities and immediate annuities without life contingent payouts) are equal to cumulative deposits plus credited interest less withdrawals and other charges. 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 at their maturities, and pay expected death or retirement benefits or surrender requests. 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 coinsurance contracts. The Company retains a maximum of $1.5 million of coverage per individual life. E. INVESTMENT OPERATIONS The Company's investment division manages the Company's general and separate accounts in support of cash and liquidity requirements of the Company's insurance and investment products. Investments under management at December 31, 1998 totaled $23.8 billion, comprised of general account assets of $13.7 billion and separate account assets of $10.1 billion. The Company invests in a broad range of asset classes, including domestic and international fixed maturities, common stocks, mortgage loans, real estate and short-term investments. Fixed maturity investments include public and privately placed corporate bonds, public and privately placed structured assets, government bonds and redeemable preferred stocks. The Company's portfolio of structured assets consists of mortgage-backed securities and other 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, which vary among the Company's principal product lines. The Company observes strict asset and liability matching guidelines, which are 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 uses derivative instruments in hedging applications to manage market risk. Derivative instruments are not used for speculative purposes. For more information on derivatives, see Notes 1 and 6 to the consolidated financial statements of the Company (the "Consolidated Financial Statements"), which 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 industry and other diversification considerations for fixed maturity investments. The Company's fixed maturity investments constituted 67% of investment assets as of December 31, 1998. The Company reduces credit risk for the portfolio as a whole by investing primarily in investment grade fixed maturities rated by either third-party rating agencies, or in the case of securities which may not be rated by third-parties, by the Company (for private investments). The Company's mortgage portfolio constituted 8% of investment assets as of December 31, 1998. The Company's mortgage investment policy emphasizes a broadly diversified portfolio of commercial and industrial mortgages. Mortgage loans are subject to underwriting criteria addressing loan-to-value ratios, debt service coverage, cash flow, tenant quality, leasing, market, location and financial strength of borrower. Since 1986, the Company has reduced the overall weighting of its mortgage portfolio with a greater emphasis in bond investments. At December 31, 1998 only 0.5% of investment assets were invested in real estate. 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 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- in Millions] Debt Securities: Bonds U.S. Government Securities and obligations of U.S. Government Agencies 1,951 2,091 1,947 1,990 1,672 Corporate bonds 7,117 6,544 6,133 6,168 5,079 Foreign Governments 69 146 119 159 368 --------- --------- --------- --------- --------- Total 9,137 8,781 8,199 8,317 7,119 Common Stock 49 39 20 9 5 Mortgage loans 1,133 1,236 1,488 1,713 2,011 Real estate 73 94 68 61 44 Policy loans 2,859 2,657 2,523 2,238 1,905 Short-term investments 420 399 419 135 707 --------- --------- --------- --------- --------- Total investments 13,671 13,206 12,717 12,473 11,791 ========= ========= ========= ========= ========= Cash 176 126 125 91 132 Accrued investment income 158 166 198 212 196 The following table summarizes general account investment results of the Company's operations: Net Earned Net [Millions] Investment Investment Income Income Rate ----------------- ----------------- For the year: 1998 897 7.03 % 1997 882 7.21 1996 835 7.05 1995 835 7.36 1994 768 7.23 F. REGULATION 1. Insurance Regulation The business of the Company is subject to comprehensive state and federal regulation and supervision throughout the United States, which primarily provides safeguards for policyholders rather than investors. 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 Insurance Division and other regulators at specified intervals. The latest financial examination by the Colorado Insurance Division was completed in 1997, and covered the five year period ending December 31, 1995. This examination produced no significant adverse findings regarding the Company. The National Association of Insurance Commissioners has adopted risk-based capital rules and other financial ratios for life insurance companies. Based on the Company's December 31, 1998 statutory financial reports, the Company has risk-based capital well in excess of that required and was within the usual ranges of all ratios. 2. Insurance Holding Company Regulations The Company is subject to and complies with insurance holding company regulations in Colorado. These regulations contain certain restrictions and reporting requirements for transactions between an insurer and its affiliates, including the payments 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 advisor subsidiary and transfer agent subsidiary are regulated by the SEC. Certain of the Company's separate accounts, mutual funds and variable insurance and annuity products are registered under the Investment Company Act of 1940 and 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 $6.6 million as of December 31, 1998 to cover future assessments of known insolvencies. 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 $4.5 million at December 31, 1998. 5. Canadian Regulation Because the Company is a subsidiary of Great-West Life, which is a Canadian company, the Office of the Superintendent of Financial Institutions Canada conducts periodic examinations of the Company and approves certain investments in subsidiary companies. 6. Potential Legislation United States legislation and administrative developments in various areas, including pension regulation, financial services regulation, health care legislation and the insurance industry could significantly and adversely affect the Company in the future. For example, Congress is currently considering legislation relating to health care reform and managed care issues (including patients' rights, privacy of medical records and managed care plan or enterprise liability), and legislation relating to the taxation of policyholder surplus accounts and the capitalization of deferred acquisition costs. Congress has from time to time also considered the deferral of taxation on the accretion of value within certain annuities and life insurance products, financial services reform legislation establishing frameworks for banks engaging in the insurance business, changes in regulation for the Employee Retirement Income Security Act of 1974, as amended, and the availability of Section 401(k) for individual retirement accounts. 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 on the financial strength of the Company and its ability to meet the obligations of its insurance policies. Rating Agency Measurement Rating - ------------------------------ ------------------------------------------ ------------ A.M. Best Company Financial Condition and Operating A++ * Performance Duff & Phelps Corporation Claims Paying Ability AAA * Standard & Poor's Corporation Claims Paying Ability AA+ ** Moody's Investors Service Insurance Financial Strength Aa2 ***
* Highest ratings available. ** Second highest rating out of 19 rating categories. *** Third highest rating out of 19 rating categories. H. MISCELLANEOUS No customer accounted for 10% or more of the Company's consolidated revenues in 1998. 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 6,500 employees at December 31, 1998. ITEM 2. PROPERTIES The Head Office of the Company consists of a 517,633 square foot office complex located in Englewood, Colorado. The office complex is owned by a subsidiary of the Company. The Company leases sales and claims 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 1998 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. B. DIVIDENDS In the two most recent fiscal years, the Company has paid quarterly dividends on its common shares. Dividends on common stock totaled $73.3 million in 1998 and $62.5 million in 1997. Dividends on preferred stock totaled $6.7 million and $8.9 million in 1998 and 1997, respectively. 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 at the preceding December 31; or (ii) the Company's statutory net gain from operations as at the preceding December 31. 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. [Millions] Years Ended December 31, ----------------------------------------------------------- INCOME STATEMENT 1998 1997 1996 1995 1994 ---------- ----------- ---------- ---------- ---------- DATA Premiums $ 995 $ 833 $ 829 $ 732 $ 706 Fee income 516 420 347 335 294 Net investment income 897 882 835 835 768 Realized investment gains (losses) 38 10 (21) 8 (72) ---------- ----------- ---------- ---------- ---------- Total Revenues 2,446 2,145 1,990 1,910 1,696 Policyholder benefits 1,462 1,385 1,356 1,269 1,184 Operating expenses 688 552 469 464 409 ---------- ----------- ---------- ---------- ---------- Total benefits and expenses 2,150 1,937 1,825 1,733 1,593 ---------- ----------- ---------- ---------- ---------- Income from operations 296 208 165 177 103 Income tax expense 99 49 30 49 29 ========== =========== ========== ========== ========== Net Income $ 197 $ 159 $ 135 $ 128 $ 74 ========== =========== ========== ========== ========== Deposits for investment- type contracts $ 1,344 $ 658 $ 815 $ 868 $ 1,006 Deposits to separate accounts 2,208 2,145 1,438 1,165 1,013 Self-funded premium equivalents 2,606 2,039 1,940 2,140 1,907 December 31, ----------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ----------- ---------- ---------- ---------- BALANCE SHEET DATA Investment assets $ 13,671 $ 13,206 $ 12,717 $ 12,473 $ 11,791 Separate account assets 10,100 7,847 5,485 3,999 2,555 Total assets 25,123 22,078 19,351 17,682 15,616 Total policyholder liabilities 12,583 11,706 11,600 11,408 10,859 Total long-term obligations (1) 35 118 120 122 124 Total stockholder's 1,199 1,186 1,034 993 777 equity
(1)Represents long-term portion of "Due to Parent Corporation" amounts disclosed in the Consolidated Financial Statements. 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 which relate to future operations, strategies, financial results or other developments. In particular, statements using verbs such as "expect," "anticipate," "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which 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 risks and uncertainties discussed in documents filed by the Company and certain of its subsidiaries with the Securities and Exchange Commission. Management's discussion and analysis of financial condition and results of operations of the Company for the three years ended December 31, 1998 follows. A. COMPANY RESULTS OF OPERATIONS 1. Consolidated Results The Company's consolidated net income increased $38.1 million or 24% in 1998 when compared to the year ended December 31, 1997, reflecting improved results in both the Employee Benefits segment and the Financial Services segment. The Employee Benefits segment contributed $8.8 million or 23% to the improved consolidated results compared to the Financial Services segment which contributed $29.3 million or 77% to the overall improvement. Of total consolidated net income in 1998 and 1997, the Employee Benefits segment contributed 54% and 62%, respectively, while the Financial Services segment contributed 46% and 38%, respectively. The Company's consolidated net income increased $24.2 million or 18% in 1997 when compared to the year ended December 31, 1996. In 1997, the Employee Benefits segment contributed $3.0 million or 12% to the overall growth and the Financial Services segment contributed $21.2 million or 88% to the overall growth. The Company's 1997 and 1996 consolidated net income increased by $21.1 million and $25.6 million, respectively, due to changes in income tax provisions for these years. The current income tax provisions were decreased by $42.2 million and $31.2 million for 1997 and 1996, respectively, due to the release of a contingent liability relating to taxes of Great-West Life's U.S. branch associated with the blocks of business that had been transferred from Great-West Life's U.S. branch to the Company, as discussed below. Of the amount released in 1997, $15.1 million was attributable to participating policyholders and, therefore, had no effect on the net income of the Company. In 1989, Great-West Life began a series of transactions to transfer its U.S. business from its U.S. branch to the Company; this process was essentially completed in 1993. The objective of these transactions was to transfer to the Company all of the risks and rewards of Great-West Life's U.S.-related business. The transfers of insurance contracts and related assets were accomplished through several reinsurance agreements executed by the Company and Great-West Life's U.S. branch during these years. As part of this transfer of Great-West Life's U.S. business, the Company in 1993 entered into a tax agreement with Great-West Life in order to transfer the tax liabilities associated with the insurance contracts and related assets that had been transferred. In addition to the contingent tax liability release described above, the Company's income tax provisions for 1997 and 1996 also reflect increases for additional contingent items related to open tax years where it was determined to be probable that additional tax liabilities could be owed based on changes in facts and circumstances. The increase in 1997 was $16.0 million, of which $10.1 million was attributable to participating policyholders and, therefore, had no effect on the net income of the Company. The increase in 1996 was $5.6 million. Certain reclassifications, primarily related to the classification of the release of the contingent liability described above (see Note 10 to the Consolidated Financial Statements), have been made to the 1997 and 1996 financial statements. In 1998 total revenues increased $301.1 million or 14% to $2.4 billion when compared to the year ended December 31, 1997. The growth in revenues in 1998 was comprised of increased premium income of $161.7 million, increased fee income of $95.3 million, increased net investment income of $15.7 million and increased realized gains on investments of $28.4 million. In 1997 total revenues increased $154.8 million or 8% to $2.1 billion when compared to the year ended December 31, 1996. The growth in revenues in 1997 was comprised of increased premium income of $3.7 million, increased fee income of $73.2 million, increased net investment income of $47.0 million and realized gains on investments of $9.8 million in 1997 versus realized losses in 1996 of $21.1 million. The increased premium income in 1998 was comprised of growth in Employee Benefits premium income of $281.8 million, offset by a decrease in Financial Services premium income of $120.1 million. The growth in premium income in the Employee Benefits segment primarily reflected $209.5 million of premium income derived from the acquisition of Anthem Health & Life Insurance Company ("AH&L") in July 1998 (see Other Matters below). The decrease of $120.1 million in Financial Services premium income was due primarily to reinsurance transactions in 1997 of $155.8 million versus only $46.2 million in premiums due to reinsurance transactions in 1998. The increased premium income in 1997 was comprised of a decrease in Employee Benefits premium income of $21.4 million, offset by growth in Financial Services premium income of $25.1 million. The decrease in Employee Benefits was attributable to terminations in 1996 which impacted 1997 premiums (see Item 7(B) - Employee Benefits Results of Operations). The increase in Financial Services premium income was attributable to participating individual insurance. The increased fee income in 1998 was comprised of growth in Employee Benefits fee income and Financial Services fee income of $86.6 million and $8.7 million, respectively. The growth in Employee Benefits fee income reflected $31.6 million of fee income derived from the acquisition of AH&L. The remaining increase was the result of new sales and increased fees on variable funds related to growth in equity markets. The increase in fee income in 1997 was comprised of Employee Benefits fee income and Financial Services fee income of $36.9 million and $36.3 million, respectively. The increase in both segments was attributable to new sales and increased fees on variable funds related to growth in equity markets. Realized investment gains increased in recent years from a realized investment loss of $21.1 million in 1996 to realized investment gains of $9.8 million and $38.2 million in 1997 and 1998, respectively. The decrease in interest rates in 1998 and 1997 resulted in gains on sales of fixed maturities totaling $38.4 million and $16.0 million in 1998 and 1997, respectively, while higher interest rates contributed to $11.6 million of fixed maturity losses in 1996. Increases in the provision for asset losses of $0.6 million and $7.6 million, respectively, were recognized in 1998 and 1997. Total benefits and expenses increased $213.9 million or 11% in 1998 when compared to the year ended December 31, 1997. The increase in 1998 was due to a combination of the acquisition of AH&L which resulted in benefits and expenses of $258.3 million and overall growth in the group health business, partially offset by a decrease in policyholder benefits related to reinsurance transactions of $109.4 million. Excluding these items, benefits and expenses would have increased $64.6 million or 3% in 1998. The increase from 1996 to 1997 was the result of increased operating expenses associated with the cost of developing HMOs and FASCorp's business, and system enhancements. In October 1996, the Company recaptured certain pieces of an individual participating block of business previously reinsured to Great-West Life. In June 1997, the Company recaptured all remaining pieces of that block of business. The Company recorded various assets and liabilities related to the recaptures as discussed in Note 3 to the Consolidated Financial Statements. In recording the recaptures, both life insurance premiums and benefits were increased by the amounts recaptured ($155.8 million and $164.8 million in 1997 and 1996, respectively). Consequently, the net income of the Company was not impacted by the reinsurance transactions. Income tax expense increased $49.0 million or 98% in 1998 when compared to the year ended December 31, 1997. Income tax expense increased $19.5 million or 64% in 1997 when compared to the year ended December 31, 1996. The increase in income tax expense in 1998 reflects higher earnings in 1998, as well as the fact that the 1997 income tax provision includes a net $26.2 million release of contingent tax liabilities relating to prior open tax years, as discussed above. The increase in income tax expense from 1996 to 1997 was partially attributable to a growth in earnings in 1997, but also reflects net releases in 1997 and 1996 of $26.2 million and $25.6 million of contingent tax liabilities relating to prior open tax years, as discussed above. Excluding these contingent tax releases, the Company's income tax expense increased 30% and 27% in 1998 and 1997. See Note 10 to the Consolidated Financial Statements for a discussion of the Company's effective tax rates. 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, which amounts approximate the additional premiums that would have been earned under such contracts if they had been written as traditional indemnity or HMO programs. Deposits for investment-type contracts increased $686.0 million or 104% in 1998 when compared to the year ended December 31, 1997. Deposits for investment-type contracts decreased $157.4 million or 19% in 1997 when compared to the year ended December 31, 1996. The increase in 1998 was primarily due to two indemnity reinsurance agreements with Great-West Life whereby the Company reinsured by coinsurance certain Great-West Life individual non-participating life insurance policies. This transaction increased deposits by $519.6 million in 1998 and accounted for 78% of the growth. The 19% decrease in 1997 was the result of decreased deposits related to COLI sales (see Item 7(C) - Financial Services Results of Operations). Deposits for separate accounts increased $63.7 million or 3% in 1998 when compared to the year ended December 31, 1997. The increase in 1998 reflected a continuing movement toward variable funds and away from fixed options. Deposits for separate accounts increased $706.9 million or 49% in 1997 when compared to the year ended December 31, 1996. The increase in 1997 was primarily due to increased deposits in the Financial Services segment (see Item 7(C) - Financial Services Results of Operations). Self-funded premium equivalents increased $567.1 million or 28% in 1998 when compared to the year ended December 31, 1997. Self-funded premium equivalents increased $98.6 million or 5% in 1997 when compared to the year ended December 31, 1996. Approximately half of the 1998 increase ($281.3 million) was due to the acquisition of AH&L, with the remainder coming from the growth in business. Total assets increased $3.0 billion or 14% in 1998 when compared to the year ended December 31, 1997. Separate account assets increased $2.3 billion primarily due to the strength of the equity markets in the United States. Invested assets increased $464.5 million, of which $258.6 million was attributable to AH&L. The remaining growth of $205.9 million represents a 2% increase in invested assets over 1997, which was primarily attributable to the consideration received in connection with the reinsurance agreements discussed previously. 2. Other Matters On July 8, 1998, the Company acquired the outstanding common stock of AH&L, a subsidiary of Anthem, Inc. (the Blue Cross and Blue Shield licensee for Indiana, Kentucky, Ohio, and Connecticut). This acquisition strengthened the Employee Benefits segment by providing nearly $975.0 million of annualized health and life premium income and self-funded premium equivalents, and approximately 450,000 additional health care members and approximately 75 group sales representatives. The cost of the acquisition was $82.7 million. The purchase price was based on adjusted book value and is subject to further minor adjustments. The acquisition was accounted for as a purchase and was financed through internally generated funds. The fair value of tangible assets acquired and liabilities assumed was $379.9 million and $317.4 million, respectively. Goodwill of $20.2 million was recorded at the time of the acquisition. The majority of AH&L's customers are in the Company's target market of small to mid-size employers who prefer to self-fund their benefit plans. As of November 1, 1998, the Company began integrating the AH&L business to a common systems platform with a scheduled completion date of July 1999. New and existing customers are being migrated to the Company's One Health Plan network, which will provide substantial new growth for the One Health Plan subsidiary organization. Life and health premium and fee income for AH&L since the date of acquisition totaled $241.1 million, while self-funded premium equivalents were $281.3 million. The Company recorded a small loss associated with AH&L operations in 1998. The results of AH&L since the date of acquisition are included in the Employee Benefits segment. B. EMPLOYEE BENEFITS RESULTS OF OPERATIONS The following is a summary of certain financial data of the Employee Benefits segment: (Millions) Years Ended December 31, ---------------------------------- INCOME STATEMENT 1998 1997 1996 ---------- ---------- ---------- DATA Premiums 747 465 486 Fee income 445 358 321 Net investment income 95 100 88 Realized investment gains (losses) 8 3 (3) ---------- ---------- ---------- Total Revenues 1,295 926 892 Policyholder benefits 590 371 406 Operating expenses 547 428 368 ---------- ---------- ---------- ---------- ---------- ---------- Total benefits and expenses 1,137 799 774 ---------- ---------- ---------- Income from operations 158 127 118 Income tax expense 51 29 22 ========== ========== ========== Net Income 107 98 96 ========== ========== ========== Deposits for investment-type contracts 37 25 34 Deposits to separate accounts 1,568 1,403 1,109 Self-funded premium equivalents 2,606 2,039 1,940 During 1998, the Employee Benefits segment experienced: o significant growth in 401(k) assets under administration, o increased sales and improved customer retention in group life and health, o favorable mortality results, and o license approval for four HMO subsidiaries, for a total of 14 fully operational HMOs. Net income for Employee Benefits increased 9% in 1998 and 2% in 1997. The improvement in earnings in 1998 and 1997 reflects increased fee income from the variable 401(k) assets and improved group life mortality experience which more than offset unfavorable morbidity experience and the increased level of operating expenses associated with building the HMO network in 1998 and 1997. The changes in income tax provisions discussed above under "Company Results of Operations" resulted in increases in net income for the Employee Benefits segment of $17.6 million and $18.2 million in 1997 and 1996, respectively. 401(k) premiums and deposits for 1998 and 1997 increased 14% and 25%, respectively, as the result of higher recurring deposits from existing customers and sales in 1997. Assets under administration (including third-party administration) in 401(k) increased 26% over 1997 to $6.7 billion and 38% from 1996 to 1997, primarily due to strong equity markets. Equivalent premium revenue and fee income for group life and health increased 32% from 1997 levels as the result of a combination of increased sales (41%) and the AH&L acquisition (59%). From 1996 to 1997, equivalent premium revenue and fee income had increased 4% as growth was constrained by competitive pressures. 1. Group Life and Health The Employee Benefits segment experienced strong sales growth during 1998 with a net increase of 593 group health care customers (versus 440 in 1997), which added 143,699 new individual health care members, excluding the AH&L acquisition. Much of the health care growth can be attributed to the introduction of new HMOs in markets with high sales potential, and the Company's ability to offer a choice of managed care products. To position itself for the future, the Employee Benefits segment is focused on putting in place the products, strategies and processes that will strengthen its competitive position in the evolving managed care environment. With a heightened sensitivity to price comes the demand for more tightly managed health plans, which is why HMO development remains Employee Benefits' most important product development initiative. In 1998, the Company licensed HMOs in Arizona, Florida, Indiana and New Jersey and applied for licenses in North Carolina and Pennsylvania. The Company also entered into agreements with another insurance carrier which will exclusively market the HMO product in various states. This type of arrangement will augment growth in the Company's HMO programs in the future. The Company experienced a 35% increase in total health care membership, including the AH&L acquisition, from 1,675,800 at the end of 1997 to 2,266,700 at year-end 1998. Excluding the AH&L acquisition, which added 450,000 members, total health care membership increased 8%. Gatekeeper (i.e., POS and HMO) members grew 34% from 414,500 in 1997 to 556,800 in 1998 including 61,800 AH&L members. Excluding the AH&L acquisition, gatekeeper members increased 19%. The Company expects this segment of the business to grow as additional HMO licenses are obtained. Total health care membership increased from 1996 to 1997 by 8% (1996 was the first year the Company offered HMO plans). Gatekeeper members grew 18% from 1996 to 1997. 2. 401(k) The number of new 401(k) case sales (employer groups), including third-party administration business generated through the Company's marketing and administration arrangement with New England, decreased 33% to 800 in 1998 from 1,200 in 1997 (1,200 in 1996). The decrease in 1998 was the result of a shift in emphasis to group life and health sales. The 401(k) block of business under administration total 6,100 employer groups and more than 475,000 individual participants, compared to 5,700 employer groups and 430,000 individual participants in 1997, and 4,900 employer groups and 355,000 individual participants in 1996. During 1998, the in-force block of 401(k) business continued to perform well, with customer retention of 93% versus 94% in 1997. This, combined with strong equity markets, resulted in a 26% and 39% increase in assets under management during 1998 and 1997, respectively. In addition to the Company's internally-managed funds, the Company offers externally-managed funds from recognized mutual funds companies such as AIM, Fidelity, Putnam, American Century, Founders and T. Rowe Price. This strategy, supported by participant education efforts, is validated by the fact that 99% of assets contributed in 1998 were allocated to variable funds. To promote long-term asset retention, the Company enhanced a number of products and services including prepackaged "lifestyle" funds (The Profile Series), expense reductions for high-balance accounts, a rollover IRA product, more effective enrollment communications, one-on-one retirement planning assistance and personal plan illustrations. 3. Outlook In 1999, the Company will continue to enhance managed care programs and services, further HMO development, seek National Committee for Quality Assurance accreditation for its HMOs, refine quality assurance programs and introduce member communications directed at health improvements. Management intends to enhance the health claims payment system in 1999 to provide medical auto-adjudication capabilities to reduce administrative expenses and improve claims processing time. The Company will enhance the 401(k) product for large cases by adding additional investment fund options, reviewing and replacing current funds, as well as offering funds outside the annuity contract. The Company plans to add the 401(k) product to AH&L's product portfolio in the latter part of 1999. C. FINANCIAL SERVICES RESULTS OF OPERATIONS The following is a summary of certain financial data of the Financial Services segment: (Millions) Years Ended December 31, --------------------------------------- INCOME STATEMENT 1998 1997 1996 ------------ ----------- ---------- DATA Premiums 248 368 343 Fee income 71 62 26 Net investment income 802 782 747 Realized investment gains 30 7 (18) (losses) ------------ ----------- ---------- Total Revenues 1,151 1,219 1,098 Policyholder benefits 872 1,014 950 Operating expenses 141 124 101 ------------ ----------- ---------- Total benefits and expenses 1,013 1,138 1,051 ------------ ----------- ---------- Income from operations 138 81 47 Income tax expense 48 20 8 ============ =========== ========== Net Income 90 61 39 ============ =========== ========== Deposits for investment-type contracts 1,307 633 781 Deposits to separate accounts 640 742 329 During 1998, the Financial Services segment experienced: o significant growth in participants and separate account funds primarily attributable to the public/non-profit business, o very good persistency in all lines of business, and o strong sales of BOLI. Net income for Financial Services increased 48% in 1998 and 56% in 1997. The improvement in earnings in 1998 reflects higher earnings from an increased asset base, an increase in investment margins, and larger capital gains on fixed maturities. The 1997 earnings improvement was the result of a reduction of the mortgage provision for asset impairments, increased fee income on a larger asset base, capital gains on fixed maturities and an increase in investment margins. The changes in income tax provisions discussed above under "Company Results of Operations" resulted in increases in net income for the Financial Services segment of $3.6 million and $7.4 million in 1997 and 1996, respectively. 1. Savings Premiums decreased $5.9 million or 26%, from $22.6 million in 1997 to $16.8 million in 1998. Premiums decreased $4.0 million or 15%, from $26.7 million in 1996 to $22.6 million in 1997. The decrease in both years is attributable to the continuing trend of policyholders selecting variable annuity options (separate accounts) as opposed to the more traditional fixed annuity products. Fee income increased $8.6 million or 14%, from $62.4 million in 1997 to $71.0 million in 1998. Fee income increased $36.1 million or 137%, from $26.3 million in 1996 to $62.4 million in 1997. The growth in fee income in 1998 and 1997 was the result of new sales and increased fees on variable funds related to growth in equity markets. Deposits for investment-type contracts increased $20.4 million or 9%, from $218.6 million in 1997 to $239.0 million in 1998. Deposits for investment-type contracts increased $4.3 million or 2%, from $214.3 million in 1996 to $218.6 million in 1997. Deposits to separate accounts decreased $101.5 million or 14%, from $742.1 million in 1997 to $640.6 million in 1998. Deposits to separate accounts increased $413.6 million or 126% from $328.5 million in 1996 to $742.1 million in 1997. The decrease in 1998 was the result of 1997 being inflated by the receipt of a large single deposit in the amount of $120.0 million. The increase in 1997 was due to a combination of the $120.0 million deposit and the commencement of marketing a new fixed and variable qualified and non-qualified annuity product through Charles Schwab & Co., Inc., which resulted in $239.9 million in deposits to separate accounts (the amount of such deposits from Schwab in 1998 was $204.7 million). The Financial Services segment's core savings business is in the public/non-profit pension market. The assets of the public/non-profit business, including separate accounts but excluding Guaranteed Investment Contracts ("GICs"), increased 9% and 8% during 1998 and 1997 to $7.8 billion and $7.2 billion, respectively. Much of the growth came from the variable annuity business, which was driven by premiums and deposits and strong investment returns in the equity markets. The Financial Services segment's savings business experienced strong growth in 1998. The number of new participants in 1998 was 151,300 compared to 129,200 in 1997 (51,900 in 1996), bringing the total lives under administration to 643,200 in 1998 and 536,200 in 1997. BenefitsCorp sold 21 new large employer cases compared to 13 in 1997 and increased the penetration of existing cases by enrolling new employees. The Financial Services segment again experienced a very high retention rate in public/non-profit contract renewals in 1998, renewing 100% of its own large case state contracts. Part of this customer loyalty comes from initiatives to provide high-quality service while controlling expenses. The Company continued to limit sales of GICs and to allow this block of business to contract in response to the highly competitive GIC market. As a result, GIC assets decreased 33% in 1998, to $274.8 million. In 1997, GIC assets decreased 22% from 1996, to $409.1 million. Customer demand for investment diversification continued to grow during 1998. New contributions to variable business represented 63% of the total 1998 premiums versus 69% in 1997. The Company continues to expand the investment products available through Maxim Series Fund, Inc., and through partnership arrangements with external fund managers. Externally-managed funds offered to participants in 1998 included American Century, Ariel, Fidelity, Founders, INVESCO, Janus, Loomis Sayles, Templeton, T. Rowe Price and Vista. Customer participation in guaranteed separate accounts increased, as many customers prefer the security of fixed income securities and separate account assets. Assets under management for guaranteed separate account funds were $562.3 million in 1998, compared to $466.2 million in 1997 and $392.8 million in 1996. FASCorp administered records for approximately 1,304,000 participants in 1998 versus 1,000,000 in 1997. 2. Life Insurance The Company continued its conservative approach to the manufacture and distribution of traditional life insurance products, while focusing on customer retention and expense management. Individual life insurance revenue premiums and deposits of $1.3 billion in 1998 increased 71% from 1997 primarily due to reinsurance transactions with Great-West Life, which resulted in $565.8 million of premiums and deposits in 1998 versus $155.8 million in 1997. Excluding these reinsurance transactions, individual life insurance revenue premiums and deposits increased 14% from 1997 to 1998. The Company also experienced strong BOLI sales in 1998 which more than offset reductions in COLI premiums. Individual life insurance premiums and deposits decreased 14% from 1996 to 1997 due to the reduction of COLI premiums associated with 1996 legislative changes. During 1996, the U.S. Congress enacted legislation to phase out during 1997 and 1998 the tax deductibility of interest on policy loans on COLI products. Since then, renewal premiums and deposits for COLI products have decreased to $179.8 million in 1998 from $299.8 million in 1997 and $384.2 million in 1996, and the Company expects this decline to continue. As a result of these legislative changes, the Company has shifted its emphasis from COLI to new sales in the BOLI market. This product provides long-term benefits for bank employees and was not affected by the 1996 legislative changes. BOLI premiums and deposits were $430.7 million during 1998, compared to $179.3 million in 1997. The Company continues working closely with existing COLI customers to determine the options available to them and is confident that the effect of the legislative changes will not be material to the Company's operations. 3. Outlook During 1999, the Company expects to continue its growth in the third party administration area through FASCorp. Emphasis will also be placed on developing the institutional insurance and annuity markets. During 1997, communications were provided to policyholders in the public/non-profit market through the use of the internet. Increased emphasis will be placed on improving internet functionality during the upcoming year to improve this service for our customers. d. INVESTMENT OPERATIONS The Company's primary investment objective is to acquire assets whose durations and cash flows reflect the characteristics 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. Through dynamic modeling, using state-of-the-art software to analyze the effects of a wide range of possible market changes upon investments and policyholder benefits, the Company ensures 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] 1998 1997 --------------------- Fixed maturities, available for sale, at fair value 6,937 6,698 Fixed maturities, held-to-maturity, at amortized cost 2,200 2,083 Mortgage loans 1,133 1,236 Real estate and common stock 122 133 Short-term investments 420 399 Policy loans 2,859 2,657 ========== ========== Total invested assets 13,671 13,206 ========== ========== 1. Fixed Maturities Fixed maturity investments include public and privately placed corporate bonds, public and privately placed structured assets and government bonds. This latter category contains both asset-backed and mortgage-backed securities, including collateralized mortgage obligations ("CMOs"). The Company's strategy related to structured assets is to focus on those with lower volatility and minimal credit risk. The Company does not invest in higher risk CMOs such as interest-only and principal-only strips, and currently has no plans to invest in such securities. Private placement investments, which are primarily in the held-to-maturity category, are generally less marketable than publicly traded assets, yet they typically offer covenant protection which 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. The distribution of the fixed maturity portfolio (both available for sale and held to maturity) by credit rating is summarized as: Credit Rating 1998 1997 ------------- -------------- --------------- AAA 45.6% 45.7% AA 9.4 8.8 A 23.8 23.8 BBB 20.7 20.7 BB and Below (non-investment grade) 0.5 1.0 -------------- --------------- TOTAL 100.0% 100.0% At December 31, 1998 and 1997, the Company owned no bonds in default. 2. Mortgage Loans During 1998, the mortgage portfolio declined 8% to $1.1 billion, net of impairment reserves. The Company has not actively sought new loan opportunities since 1989 and, as such, has experienced an ongoing reduction in this portfolio's balance. The Company follows a comprehensive approach to the management of mortgage loans which 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 which, 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 continued to remain low at $31.2 million in 1998, compared with $37.9 million in 1997, and foreclosures totaled $3.0 million and $14.1 million in 1998 and 1997, respectively. The low levels of problematic mortgages relative to the Company's overall balance sheet are due to the ongoing decrease in the size of the mortgage portfolio, the Company's active loan management program and overall strength in market conditions. Occasionally, the Company elects to restructure certain loans if the economic benefits to the Company are believed to be more advantageous than those achieved by acquiring the collateral through foreclosure. At December 31, 1998 and 1997, the Company's loan portfolio included $52.9 million and $64.4 million, respectively, of non-impaired restructured loans. 3. Real Estate and Common Stock The Company's real estate portfolio is composed primarily of the Head Office property ($54.2 million) and properties acquired through the foreclosure of troubled mortgages ($16.3 million). The Company operates a wholly-owned real estate subsidiary, which attempts to maximize the value of these properties through rehabilitation, leasing and sale. The Company is currently adding a third tower to its Head Office complex, which it anticipates completing in the year 2000. The common stock portfolio is composed of mutual fund seed money and some private equity investments. The Company anticipates a limited participation in the stock markets in 1999. 4. Derivatives The Company uses certain derivatives, such as futures, options and swaps, for purposes of hedging interest rate and foreign exchange risk. 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 credit approvals, limits and monitoring procedures. The Company has also developed controls within its operations to ensure that only Board authorized transactions are executed. Note 6 to the Consolidated Financial Statements contains a summary of the Company's outstanding financial hedging derivatives. 5. Outlook General economic conditions continued to remain strong during 1998. The Company does not expect to recognize any asset writedowns or restructurings in 1999 that would result in a material adverse effect upon the Company's financial condition. E. LIQUIDITY AND CAPITAL RESOURCES The Company's operations have liquidity requirements that vary among the 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. The Company has a commitment to fund an addition to its Head Office complex over the next 18 months, totaling approximately $30.0 million. Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio and utilizing positive cash flows from operations. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash, which totaled $596.3 million and $525.4 million as of December 31, 1998 and 1997, respectively. Funds provided from 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 Company's capital resources represent funds available for long-term business commitments and primarily consist of retained earnings and proceeds from the issuance of commercial paper and equity securities. Capital resources provide protection for policyholders and the 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. 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 $39.7 million of commercial paper outstanding at December 31, 1998, compared with $54.1 million at December 31, 1997. The commercial paper has been given a rating of A-1+ by Standard & Poor's Corporation and a rating of P-1 by Moody's Investors Service, each being the highest rating available. F. ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and for Hedging Activities". This Statement provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. This Statement is effective for the Company beginning January 1, 2000, and earlier adoption is encouraged. The Company has not adopted this Statement as of December 31, 1998. Management has not determined the impact of the Statement on the Company's financial position or results of operations. See the Note 1 to the Consolidated Financial Statements for additional information regarding accounting pronouncements. G. YEAR 2000 ISSUE The Year 2000 ("Y2K") problem arises when a computer performing date-based computations or operations produces erroneous results due to the historical practice of using two digit years within computer hardware and software. This causes errors or misinterpretations of the century in date calculations. Virtually all businesses, including the Company, are required to determine the extent of their Y2K problems. Systems that have a Y2K problem must then be converted or replaced by systems that will operate correctly with respect to the year 2000 and beyond. The Company has a written plan that encompasses all computer hardware, software, networks, facilities (embedded systems) and telephone systems. The plan also includes provisions for identifying and verifying that major vendors and business partners are Y2K compliant. The Company is developing contingency plans to address the possibility of both internal and external failures as well. The plan calls for full Y2K compliance for core systems by June 30, 1999 and full Y2K compliance for all Company systems by October 31, 1999. The Company's plan establishes five phases for becoming Y2K compliant. Phase 1 is "impact analysis" which includes initial inventory and preliminary assessment of Y2K impact. Phase 2 is "solution planning" which includes system by system planning to outline the approach and timing for reaching compliance. Phase 3 is "conversion/renovation" which means the actual process of replacing or repairing non-compliant systems. Phase 4 is "testing" to ensure that the systems function correctly under a variety of different date scenarios including current dates, year 2000 and leap year dates. Phase 5 is "implementation" which means putting Y2K compliant systems back into production. As of December 31, 1998, the Company had completed impact analysis (phase 1) and solution planning (phase 2) for all of its core systems and was more than 95% complete for phases 1 and 2 with respect to its systems as a whole. In addition, the Company was approximately 87% complete with respect to conversion and renovation (phase 3), 79% complete with respect to testing (phase 4), and 78% complete with respect to implementation (phase 5). In addition to ensuring that the Company's own systems are Y2K compliant, the Company has identified third parties with which the Company has significant business relationships in order to assess the potential impact on the Company of the third parties' Y2K issues and plans. The Company expects to complete this process during the first quarter of 1999 and will conduct system testing with third parties throughout 1999. The Company does not have control over these third parties and cannot make any representations as to what extent the Company's future operating results may be adversely affected by the failure of any third party to address successfully its own Y2K issues. On the basis of currently available information, the expense incurred by the Company, including anticipated future expenses, related to the Y2K issue has not and is not expected to be material to the Company's financial condition or results of operations. The Company has spent approximately $9.7 million on its Y2K project through the end of December 1998 and expects to spend up to approximately $15.3 million on its Y2K project. All of these funds will come from the Company's cash flow from operations. The Company has continued other scheduled non-Y2K information systems changes and upgrades. Although work on Y2K issues may have resulted in minor delays on the other projects, the delays are not expected to have a material adverse effect on the Company's consolidated financial condition or results of operations. The most reasonably likely worst case Y2K scenario is that the Company will experience isolated internal or third party computer failures and will be temporarily unable to process insurance and annuity benefit transactions. All of the Company's Y2K efforts have been designed to prevent such an occurrence. However, if the Company identifies internal or third party Y2K issues which cannot be timely corrected, there can be no assurance that the Company can avoid Y2K problems or that the cost of curing the problem will not be material. In an effort to mitigate risks associated with Y2K failures, the Company is in the process of developing contingency plans to address core functions, including relations with third parties. It is the Company's expectation that contingency plans will address possible failures generated internally, by vendors or business partners, and by customers. Possible general approaches include manual processing, payments on an estimated basis and use of disaster recovery facilities. 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 can then react to changing interest rates sooner as these assets mature for reinvestment. The Company also manages risk with interest rate derivatives such as interest rate caps that pay when interest rates rise. 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 the 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 of interest rate changes at December 31, 1998. If interest rates increased by 100 basis points (1%), the fair value of the fixed income assets would decrease by approximately $351 million. This calculation uses projected asset cash flows, discounted back to December 31, 1998. The cash flow projections are shown in the table below. The table shows cash flows rather than expected maturity dates because many of the Company's assets have substantial expected principal payments prior to the final maturity date. The fair value shown in the table below was calculated using spot discount interest rates that varied by the year in which the cash flow was expected to be received. These spot rates in the benchmark calculation ranged from 5.27% to 7.16%. Projected Cash Flows by Calendar Year ($millions) 1999 2000 2001 2002 2003 Thereafter Undiscounted Fair Total Value ---- ----- ---- ---- ---- ---------- ----- ---- Benchmark 1,916 1,791 1,575 1,370 1,129 3,824 11,605 10,074 Interest Rates up 1% 1,835 1,696 1,536 1,402 1,082 4,439 11,990 9,723
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 $10 million per year. The Company is managing this risk for 1999 with a derivative swap that pays the Company a fixed return in exchange for the performance of a combination of equity and bond indexes. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following are the Company's Consolidated Financial Statements for the Years Ended December 31, 1998, 1997, and 1996 and the Independent Auditors' Report thereon. GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY (An indirect wholly-owned subsidiary of The Great-West Life Assurance Company) Consolidated Financial Statements for the Years Ended December 31, 1998, 1997, and 1996 and Independent Auditors' Report INDEPENDENT AUDITORS' REPORT 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 (an indirect wholly-owned subsidiary of The Great-West Life Assurance Company) and subsidiaries as of December 31, 1998 and 1997, 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, 1998. 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 generally accepted auditing standards. 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, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Denver, Colorado January 25, 1999 GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (Dollars in Thousands) 1998 1997 -------------------- ------------------ ASSETS INVESTMENTS: Fixed Maturities: Held-to-maturity, at amortized cost (fair value $2,298,936 and $2,151,476) $ 2,199,818 $ 2,082,716 Available-for-sale, at fair value (amortized cost $6,752,532 and $6,541,422) 6,936,726 6,698,629 Common stock, at fair value (cost $41,932 and 48,640 39,021 $34,414) Mortgage loans on real estate, net 1,133,468 1,235,594 Real estate, net 73,042 93,775 Policy loans 2,858,673 2,657,116 Short-term investments, available-for-sale (cost approximates fair value) 420,169 399,131 -------------------- ------------------ Total Investments 13,670,536 13,205,982 Cash 176,119 126,278 Reinsurance receivable Related party 5,006 1,950 Other 187,952 82,414 Deferred policy acquisition costs 238,901 255,442 Investment income due and accrued 157,587 165,827 Other assets 311,078 121,543 Premiums in course of collection 84,940 77,008 Deferred income taxes 191,483 193,820 Separate account assets 10,099,543 7,847,451 -------------------- ------------------ TOTAL ASSETS $ 25,123,145 $ 22,077,715 ==================== ==================
See notes to consolidated financial statements. 1998 1997 ------------- ------------ LIABILITIES AND STOCKHOLDER'S EQUITY POLICY BENEFIT LIABILITIES: Policy reserves Related party 555,300 17,774 Other 11,284,414 11,084,945 Policy and contract claims 491,932 375,499 Policyholders' funds 181,779 165,106 Provision for policyholders' dividends 69,530 62,937 GENERAL LIABILITIES: Due to Parent Corporation 52,877 126,656 Repurchase agreements 244,258 325,538 Commercial paper 39,731 54,058 Other liabilities 761,505 689,967 Undistributed earnings on participating business 143,717 141,865 Separate account liabilities 10,099,543 7,847,451 ------------- ------------ Total Liabilities 23,924,586 20,891,796 ------------- ------------ COMMITMENTS AND CONTINGENCIES 1998 1997 STOCKHOLDER'S EQUITY: ------------- ------------ Preferred stock, $1 par value, 50,000,000 shares authorized Series A, cumulative, 1,500 shares authorized, liquidation value of $100,000 per share, 0 and 600 shares issued and outstanding 60,000 Series B, cumulative, 1,500 shares authorized, liquidation value of $100,000 per share, 0 and 200 shares issued and outstanding 20,000 Series C, cumulative, 1,500 shares authorized, none outstanding Series D, cumulative, 1,500 shares authorized, none outstanding Series E, non-cumulative, 2,000,000 shares authorized, liquidation value of $20.90 per share, 0 and 2,000,000 shares issued and outstanding 41,800 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 699,556 690,748 Accumulated other comprehensive income 61,560 52,807 Retained earnings 430,411 313,532 ------------- -------------- Total Stockholder's Equity 1,198,559 1,185,919 ------------- -------------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY 25,123,145 $ 22,077,715 ============= ==============
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands) 1998 1997 1996 ------------- ------------- ------------- REVENUES: Premiums Related party (net of premiums recaptured totaling $0, $155,798, and $164,839) $ 46,191 $ 155,798 $ 164,839 Other (net of premiums ceded totaling $86,409, $61,152, and $60,589) 948,672 677,381 664,610 Fee income 516,052 420,730 347,519 Net investment income Related party (9,416) (8,957) (26,082) Other 906,776 890,630 860,719 Net realized gains (losses) on investments 38,173 9,800 (21,078) ------------- ------------- ------------- 2,446,448 2,145,382 1,990,527 ------------- ------------- ------------- BENEFITS AND EXPENSES: Life and other policy benefits (net of reinsurance recoveries totaling $81,205, $44,871 and $52,675) 768,474 543,903 515,750 Increase in reserves Related party 46,191 155,798 164,839 Other 78,851 90,013 64,359 Interest paid or credited to contractholders 491,616 527,784 561,786 Provision for policyholders' share of earnings (losses) on participating business 5,908 3,753 (7) Dividends to policyholders 71,429 63,799 49,237 ------------- ------------- ------------- 1,462,469 1,385,050 1,355,964 Commissions 144,246 102,150 106,561 Operating expenses (income): Related party (4,542) (6,292) 304,599 Other 517,676 431,714 33,435 Premium taxes 30,848 24,153 25,021 ------------- ------------- ------------- 2,150,697 1,936,775 1,825,580 INCOME BEFORE INCOME TAXES 295,751 208,607 164,947 ------------- ------------- ------------- PROVISION FOR INCOME TAXES: Current 81,770 61,644 45,934 Deferred 17,066 (11,797) (15,562) ------------- ------------- ------------- 98,836 49,847 30,372 ------------- ------------- ------------- NET INCOME $ 196,915 $ 158,760 $ 134,575 ============= ============= =============
See notes to consolidated financial statements. GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands) Accumulated Additional Other Preferred Stock Common Stock Paid-in Comprehensive Retained -------------------------- ----------------------- Shares Amount Shares Amount Capital Income Earnings Total ------------ ----------- ----------- --------- ------------- ------------- ---------- ------------ BALANCE, JANUARY 1, 1996 2,000,800 121,800 7,032,000 7,032 657,265 58,763 148,261 993,121 Net income 134,575 134,575 Other comprehensive loss (43,812) (43,812) ------------ Total comprehensive income 90,763 ------------ Capital contributions 7,000 7,000 Dividends (56,670) (56,670) ------------ ----------- ----------- --------- -------------------------------------- ------------ BALANCE, DECEMBER 31, 1996 2,000,800 121,800 7,032,000 7,032 664,265 14,951 226,166 1,034,214 Net income 158,760 158,760 Other comprehensive income 37,856 37,856 ------------ Total comprehensive income 196,616 ------------ Capital contributions 26,483 26,483 Dividends (71,394) (71,394) ------------ ----------- ----------- --------- ------------- ------------- ---------- ------------ BALANCE, DECEMBER 31, 1997 2,000,800 121,800 7,032,000 7,032 690,748 52,807 313,532 1,185,919 Net income 196,915 196,915 Other comprehensive income 8,753 8,753 ------------ Total comprehensive income 205,668 ------------ Capital contributions 8,808 8,808 Dividends (80,036) (80,036) Purchase of preferred shares (2,000,800) (121,800) (121,800) ------------ ----------- ----------- --------- ------------ -------------- ---------- ------------ BALANCE, DECEMBER 31, 1998 0 0 7,032,000 7,032 699,556 61,560 430,411 1,198,559 ============ =========== =========== ========= =========== =============== ========== ============
See notes to consolidated financial statements. 87 GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands) 1998 1997 1996 ------------- ------------- ------------ OPERATING ACTIVITIES: Net income $ 196,915 $ 158,760 $ 134,575 Adjustments to reconcile net income to net cash provided by operating activities: Gain (loss) allocated to participating policyholders 5,908 3,753 (7) Amortization of investments (15,068) 409 15,518 Realized losses (gains) on disposal of investments and provisions for mortgage loans and real estate (38,173) (9,800) 21,078 Amortization 55,550 46,929 49,454 Deferred income taxes 17,066 (11,824) (14,658) Changes in assets and liabilities: Policy benefit liabilities 938,444 498,114 358,393 Reinsurance receivable (43,643) 112,594 136,966 Accrued interest and other receivables 28,467 30,299 24,778 Other, net (184,536) 64,465 (13,676) ------------- ------------- ------------ Net cash provided by operating activities 960,930 893,699 712,421 ------------- ------------- ------------ INVESTING ACTIVITIES: Proceeds from sales, maturities, and redemptions of investments: Fixed maturities Held-to maturity Sales 9,920 Maturities and redemptions 471,432 359,021 516,838 Available-for-sale Sales 6,169,678 3,174,246 3,569,608 Maturities and redemptions 1,268,323 771,737 803,369 Mortgage loans 211,026 248,170 235,907 Real estate 16,456 36,624 2,607 Common stock 3,814 17,211 1,888 Purchases of investments: Fixed maturities Held-to-maturity (584,092) (439,269) (453,787) Available-for-sale (7,410,485) (4,314,722) (4,753,154) Mortgage loans (100,240) (2,532) (23,237) Real estate (4,581) (64,205) (15,588) Common stock (10,020) (29,608) (12,113) ------------- ------------- ------------ Net cash provided by (used in) investing activities $ 41,231 $ (243,327) $ (127,662) ============= ============= ============
(Continued) GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands) 1998 1997 1996 -------------- -------------- ------------- FINANCING ACTIVITIES: Contract withdrawals, net of deposits $ (507,237) $ (577,538) $ (413,568) Due to Parent Corporation (73,779) (19,522) 1,457 Dividends paid (80,036) (71,394) (56,670) Net commercial paper repayments (14,327) (30,624) (172) Net repurchase agreements (repayments) borrowings (81,280) 38,802 (88,563) Capital contributions 8,808 11,000 7,000 Purchase of preferred shares (121,800) Acquisition of subsidiary (82,669) -------------- -------------- ------------- -------------- -------------- ------------- Net cash used in financing activities (952,320) (649,276) (550,516) -------------- -------------- ------------- NET INCREASE IN CASH 49,841 1,096 34,243 CASH, BEGINNING OF YEAR 126,278 125,182 90,939 -------------- -------------- ------------- CASH, END OF YEAR $ 176,119 $ 126,278 $ 125,182 ============== ============== ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Income taxes $ 111,493 $ 86,829 $ 103,700 Interest 13,849 15,124 15,414
See notes to consolidated financial statements. (Concluded) GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Amounts in Thousands, except Share Amounts) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Organization - Great-West Life & Annuity Insurance Company (the Company) is an indirect wholly-owned subsidiary of The Great-West Life Assurance Company (the Parent Corporation). The Company is an insurance company domiciled in the State of Colorado. 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. Basis of Presentation - The preparation of financial statements in conformity with generally accepted accounting principles 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. Actual results could differ from those estimates. The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. Certain reclassifications, primarily related to the presentation of related party transactions and the classification of the release of a contingent liability (see Note 10) have been made to the 1997 and 1996 financial statements. Investments - Investments are reported as follows: 1. Management determines the classification of fixed maturities at the time of purchase. Fixed maturities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost unless fair value is less than cost and the decline is deemed to be other than temporary, in which case they are written down to fair value and a new cost basis is established. Fixed maturities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the net unrealized gains and losses reported as accumulated other comprehensive income in stockholder's equity. The net unrealized gains and losses on derivative financial instruments used to hedge available-for-sale securities are also included in other comprehensive income. The amortized cost of fixed maturities classified as held-to-maturity or available-for-sale is adjusted for amortization of premiums and accretion of discounts using the effective interest method over the estimated life of the related bonds. Such amortization is included in net investment income. 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 valuation reserves. 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 possible credit losses on its impaired loans and to provide adequate provision for any possible losses inherent in the loan portfolio. 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. Investments in common stock are carried at fair value. 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 amortized cost. The Company considers short-term investments to be available-for-sale and amortized cost approximates fair value. 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. Deferred Policy Acquisition Costs - Policy acquisition costs, which primarily consist of sales commissions related to the production of new and renewal business, have been deferred to the extent recoverable. Other costs capitalized include expenses associated with the Company's group sales representatives. 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 $51,724, $44,298, and $47,089 in 1998, 1997, and 1996, 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, Inc., both diversified, open-end management investment companies which are affiliates of the Company, shares of other external mutual funds, or government or corporate bonds. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contractholders and, therefore, are not included in the Company's statements of income. Revenues to the Company from the separate accounts consist of contract maintenance fees, administrative fees, and mortality and expense risk charges. Life Insurance and Annuity Reserves - Life insurance and annuity policy reserves with life contingencies of $6,866,478 and $5,741,596 at December 31, 1998 and 1997, 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 $4,908,964 and $5,346,516 at December 31, 1998 and 1997, respectively, 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 (see Note 3). 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. 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 $4,108,314 and $3,901,297 at December 31, 1998 and 1997, respectively. Participating business approximates 32.7% and 50.5% of the Company's ordinary life insurance in force and 71.9% and 91.1% of ordinary life insurance premium income at December 31, 1998 and 1997, respectively. The amount of dividends to be paid from undistributed earnings on participating business is determined annually by the Board of Directors. Amounts 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 sheet. 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 Parent 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 acquired participating policyholders. Recognition of Premium and Fee Income and Benefits and Expenses - Life insurance premiums are recognized when due. Annuity premiums with life contingencies are recognized as received. Accident and health premiums are earned on a monthly pro rata basis. Revenues for annuity and other contracts without significant life contingencies consist of contract charges for the cost of insurance, contract administration, and surrender fees that have been assessed against the contract account balance during the period. Fee income is derived primarily from contracts for claim processing or other administrative services and from assets under management. Fees from contracts for claim processing or other administrative services are recorded as the services are provided. Fees from assets under management, which consist of contract maintenance fees, administration fees and mortality and expense risk changes, are recognized when due. Benefits and expenses on policies with life contingencies impact premium income by means of the provision for future policy benefit reserves, resulting in recognition of profits over the life of the contracts. The average crediting rate on annuity products was approximately 6.3%, 6.6%, and 6.8% in 1998, 1997, and 1996. Income Taxes - Income taxes are recorded using the asset and liability approach, which requires, among other provisions, the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events (other than the enactments or changes in the tax laws or rules) are considered. Although realization is not assured, management believes it is more likely than not that the deferred tax asset, net of a valuation allowance, will be realized. Repurchase Agreements and Securities Lending - The Company enters into repurchase agreements with third-party broker/dealers in which the Company 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 received or paid is amortized over the term of the related agreement and recognized as an adjustment to investment income. The Company requires collateral in an amount greater than or equal to 102% of the borrowing for all securities lending transactions. The Company implemented Statement of Financial Accounting Standards (SFAS) No. 125 "Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities" in 1998 as it relates to repurchase agreements and securities lending arrangements. The implementation of this statement had no material effect on the Company's financial statements. Derivatives - The Company makes limited use of derivative financial instruments to manage interest rate, market, and foreign exchange risk. Such hedging activity consists of interest rate swap agreements, interest rate floors and caps, foreign currency exchange contracts and equity swaps. The differential paid or received under the terms of these contracts is recognized as an adjustment to net investment income on the accrual method. Gains and losses on foreign exchange contracts are deferred and recognized in net investment income when the hedged transactions are realized. Interest rate swap agreements are used to convert the interest rate on certain fixed maturities from a floating rate to a fixed rate. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amount. Interest rate floors and caps are interest rate protection instruments that require the payment by a counter-party to the Company of an interest rate differential. The differential represents the difference between current interest rates and an agreed-upon rate, the strike rate, applied to a notional principal amount. Foreign currency exchange contracts are used to hedge the foreign exchange rate risk associated with bonds denominated in other than U.S. dollars. Equity swap transactions generally involve the exchange of variable market performance of a basket of securities for a fixed interest rate. Although derivative financial instruments taken alone may expose the Company to varying degrees of market and credit risk when used solely for hedging purposes, these instruments typically reduce overall market and interest rate risk. The Company controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures. As the Company generally enters into transactions only with high quality institutions, no losses associated with non-performance on derivative financial instruments have occurred or are expected to occur. In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for Derivative Instruments and for Hedging Activities". This Statement provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. This Statement is effective for the Company beginning January 1, 2000, and earlier adoption is encouraged. The Company has not adopted this Statement as of December 31, 1998. Management has not determined the impact of the Statement on the Company's financial position or results of operations. Stock Options - In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", which was effective for the Company beginning January 1, 1996. This Statement requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company has continued to apply APB Opinion No. 25 to stock-based compensation awards to employees and has disclosed the required pro forma effect on net income (see Note 13). 2. ACQUISITION On July 8, 1998, the Company paid $82,669 in cash to acquire all of the outstanding shares of Anthem Health & Life Insurance Company (AH&L). The purchase price was based on AH&L's adjusted book value, and is subject to further minor adjustments. The results of AH&L's operations, which had an insignificant effect on net income, have been combined with those of the Company since the date of acquisition. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the net assets acquired based on their estimated fair values. The fair value of tangible assets acquired and liabilities assumed was $379,934 and $317,440, respectively. The balance of the purchase price, $20,175, was recorded as excess cost over net assets acquired (goodwill) and is being amortized over 30 years on a straight-line basis. Management intends to finalize its allocation of the purchase price within a year of the transaction, which will likely result in a reallocation of the purchase price, which is not expected to be material. 3. RELATED-PARTY TRANSACTIONS On December 31, 1998, the Company and the Parent Corporation entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured by coinsurance certain Parent Corporation individual non-participating life insurance policies. The Company recorded $859 in premium income and an increase in reserves, associated with certain policies, as a result of this transaction. Of the $137,638 in reserves that were recorded as a result of this transaction, $136,779 was recorded under 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" ("SFAS No. 97"), accounting principles. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at December 31, 1998 as a result of this transaction: Assets Liabilities and Stockholder's Equity Cash 24,600 Policy reserves 137,638 Deferred income taxes 3,816 Policy loans 82,649 Due from Parent Corporation 19,753 Other 6,820 ----------- ----------- 137,638 137,638 In connection with this transaction, the Parent Corporation made a capital contribution of $5,608 to the Company. On September 30, 1998, the Company and the Parent Corporation entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured by coinsurance certain Parent Corporation individual non-participating life insurance policies. The Company recorded $45,332 in premium income and an increase in reserves as a result of this transaction. Of the $428,152 in reserves that were recorded as a result of this transaction, $382,820 was recorded under SFAS No. 97 accounting principles. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at September 30, 1998 as a result of this transaction: Assets Liabilities and Stockholder's Equity Bonds $ 147,475 Policy reserves $ 428,152 Mortgages 82,637 Due to Parent Corporation 20,820 Cash 134,900 Deferred policy acquisition 9,724 costs Deferred income taxes 15,762 Policy loans 56,209 Other 2,265 ---------- ----------- $ 448,972 $ 448,972
In connection with this transaction, the Parent Corporation made a capital contribution of $3,200 to the Company. On September 30, 1998, the Company purchased furniture, fixtures and equipment from the Parent Corporation for $25,184. In February 1997, the Company purchased the corporate headquarters properties from the Parent Corporation for $63,700. On June 30, 1997, the Company recaptured all remaining pieces of an individual participating insurance block of business previously reinsured to the Parent Corporation on December 31, 1992. The Company recorded $155,798 in premium income and an increase in reserves as a result of this transaction. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at June 30, 1997 as a result of this transaction: Assets Liabilities and Stockholder's Equity Cash 160,000 Policy reserves 155,798 Bonds 17,975 Due to Parent Corporation 20,373 Other 60 Deferred income taxes 2,719 Undistributed earnings on participating business (855) ----------- --------------- 178,035 178,035 In connection with this transaction, the Parent Corporation made a capital contribution of $11,000 to the Company. On October 31, 1996, the Company recaptured certain pieces of an individual participating insurance block of business previously reinsured to the Parent Corporation on December 31, 1992. The Company recorded $164,839 in premium income and an increase in reserves as a result of this transaction. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at October 31, 1996 as a result of this transaction: Assets Liabilities and Stockholder's Equity Cash 162,000 Policy reserves 164,839 Mortgages 19,753 Due to Parent Corporation 16,180 Other 118 Deferred income taxes 1,283 Undistributed earnings on participating business (431) ------------ -------------- 181,871 181,871 In connection with this transaction, the Parent Corporation made a capital contribution of $7,000 to the Company. Effective January 1, 1997, all employees of the U.S. operations of the Parent Corporation and the related benefit plans were transferred to the Company. All related employee benefit plan assets and liabilities were also transferred to the Company (see Note 9). The transfer did not have a material effect on the Company's operating expenses as the actual costs associated with the employees and the benefit plans were charged previously to the Company under administrative service agreements between the Company and the Parent Corporation. Prior to January 1997, the Parent Corporation administered, distributed, and underwrote business for the Company and administered the Company's investment portfolio under various administrative agreements. Since January 1, 1997, the Company has performed these services for the U.S. operations of the Parent Corporation. The following represents revenue from or payments made to the Parent Corporation for services provided pursuant to these service agreements. The amounts recorded are based upon management's best estimate of actual costs incurred and resources expended based upon number of policies and/or certificates in force. Years Ended December 31, ------------------------------------------ 1998 1997 1996 ------------ ------------ ------------ Investment management revenue (expense) $ 475 $ 801 $ (14,800) Administrative and underwriting revenue (payments) 4,542 6,292 (304,599)
At December 31, 1998 and 1997, due to Parent Corporation includes $17,930 and $8,957 due on demand and $34,947 and $117,699 of notes payable which bear interest and mature at various dates through June 15, 2008. These notes 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 the Parent Corporation bear interest at the public bond rate (6.1% and 7.1% at December 31, 1998 and 1997, respectively) while the remainder bear interest at various rates ranging from 5.4% to 6.6%. Interest expense attributable to these payables was $9,891, $9,758, and $11,282 for the years ended December 31, 1998, 1997 and 1996, respectively. 4. 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 of $1.5 million of coverage per individual life. 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, 1998 and 1997, the reinsurance receivable had a carrying value of $192,958 and $84,364, respectively. The following schedule details life insurance in force and life and accident/health premiums: Ceded Assumed Percentage Primarily to Primarily of Amount Gross the Parent from Other Net Assumed Amount Corporation Companies Amount to Net ------------- ------------- ------------- ------------- ------------ December 31, 1998: Life insurance in force: Individual $ 34,017,379 $ 4,785,079 $ 8,948,442 $ 38,180,742 23.44% Group 81,907,539 2,213,372 84,120,911 2.63% ============= ============= ============= ============= Total $ 115,924,918 $ 4,785,079 $ 11,161,814 $ 122,301,653 ============= ============= ============= ============= Premium Income: Life $ 352,710 $ 24,720 $ 65,452 $ 393,442 16.6% insurance 571,992 61,689 74,284 584,587 12.7% Accident/health ============= ============= ============= ============= Total $ 924,702 $ 86,409 $ 139,736 $ 978,029 ============= ============= ============= ============= December 31, 1997: Life insurance in force: Individual $ 24,598,679 $ 4,040,398 $ 3,667,235 $ 24,225,516 15.1% Group 51,179,343 2,031,477 53,210,820 3.8% ============= ============= ============= ============= Total $ 75,778,022 $ 4,040,398 $ 5,698,712 $ 77,436,336 ============= ============= ============= ============= Premium Income: Life $ 320,456 $ (127,388) $ 19,923 $ 467,767 4.1% insurance 341,837 32,645 34,994 344,186 10.0% Accident/health ============= ============= ============= ============= Total $ 662,293 $ (94,743) $ 54,917 $ 811,953 ============= ============= ============= ============= December 31, 1996: Life insurance in force: Individual $ 23,409,823 $ 5,246,079 $ 3,482,118 $ 21,645,862 16.1% Group 47,682,237 1,817,511 49,499,748 3.7% ============= ============= ============= ============= Total $ 71,092,060 $ 5,246,079 $ 5,299,629 $ 71,145,610 ============= ============= ============= ============= Premium Income: Life $ 307,516 $ (111,743) $ 19,633 $ 438,892 4.2% insurance 339,284 7,493 34,242 366,033 9.4% Accident/health ============= ============= ============= ============= Total $ 646,800 $ (104,250) $ 53,875 $ 804,925 ============= ============= ============= =============
5. NET INVESTMENT INCOME AND NET REALIZED GAINS (LOSSES) ON INVESTMENTS Net investment income is summarized as follows: Years Ended December 31, --------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Investment income: Fixed maturities and short-term $ 638,079 $ 633,975 $ 601,913 investments Mortgage loans on real estate 110,170 118,274 140,823 Real estate 20,019 20,990 5,292 Policy loans 180,933 194,826 175,746 Other 285 18 1,316 ------------- ------------- ------------- 949,486 968,083 925,090 Investment expenses, including interest on amounts charged by the Parent 52,126 86,410 90,453 Corporation of $9,891, $9,758, and $11,282 ------------- ------------- ------------- Net investment income $ 897,360 $ 881,673 $ 834,637 ============= ============= ============= Net realized gains (losses) on investments are as follows: Years Ended December 31, ------------------------------------------- 1998 1997 1996 ------------- ------------ -------------- Realized gains (losses): Fixed maturities $ 38,391 $ 15,966 $ (11,624) Mortgage loans on real estate 424 1,081 1,143 Real estate 363 Provisions (642) (7,610) (10,597) ============= ============ ============== Net realized gains (losses) on investment $ 38,173 $ 9,800 $ (21,078) ============= ============ ============== 6. SUMMARY OF INVESTMENTS Fixed maturities owned at December 31, 1998 are summarized as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value ----------- ------------ ----------- ----------- ----------- Held-to-Maturity: U.S. Treasury Securities and obligations of $ 34,374 $ 1,822 $ $ 36,196 $ 34,374 U.S. Government Agencies Collateralized mortgage obligations 194 10,135 9,941 10,135 Public utilities 213,256 12,999 460 225,795 213,256 Corporate bonds 1,809,957 78,854 3,983 1,884,828 1,809,957 Foreign governments 782 10,133 10,915 10,133 State and 121,963 9,298 131,261 121,963 municipalities ----------- ------------ ----------- ----------- ----------- $ 2,199,818 $ 103,755 $ 4,637 $ 2,298,936 $ 2,199,818 =========== ============ ========= =========== =========== Available-for-Sale: U.S. Treasury Securities and obligations of U.S. Government Agencies: Collateralized mortgage obligations $ 863,479 $ 39,855 $ 1,704 $ 901,630 $ 901,630 Direct mortgage pass- through 467,100 4,344 692 470,752 470,752 certificates Other 191,138 1,765 788 192,115 192,115 Collateralized mortgage obligations 926,797 16,260 1,949 941,108 941,108 Public utilities 464,096 14,929 36 478,989 478,989 Corporate bonds 3,557,209 123,318 17,420 3,663,107 3,663,107 Foreign governments 2,732 56,505 59,237 59,237 State and 226,208 4,588 1,008 229,788 229,788 municipalities ----------- ------------ ----------- ----------- ----------- $ 6,752,532 $ 207,791 $ 23,597 $ 6,936,726 $ 6,936,726 =========== ============ =========== =========== =========== Fixed maturities owned at December 31, 1997 are summarized as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value ----------- ------------ ------------ ----------- ----------- Held-to-Maturity: U.S. Treasury Securities and obligations of U.S. Government Agencies $ $ 1,186 $ 25 $ $ 25,883 27,044 25,883 Collateralized mortgage obligations 174 5,006 5,180 5,006 Public utilities 11,214 3 256,605 245,394 245,394 Corporate bonds 1,668,710 57,036 3,069 1,722,677 1,668,710 Foreign governments 659 10,268 10,927 10,268 State and 1,588 129,043 127,455 municipalities 127,455 ----------- ------------ ------------ ----------- ----------- $ 2,082,716 $ 71,857 $ 3,097 $ 2,151,476 $ 2,082,716 =========== ============ ============ =========== ===========
Gross Gross Estimated Amortized Unrealized Unrealized Fair Carrying Cost Gains Losses Value Value ------------ ----------- ----------- ----------- ----------- Available-for-Sale: U.S. Treasury Securities and obligations of U.S. Government Agencies: Collateralized mortgage obligations $ $ 17,339 $ 310 $ 670,004 $ 670,004 652,975 Direct mortgage pass- through 7,911 2,668 922,459 922,459 certificates 917,216 Other 1,794 244 298,887 298,887 297,337 Collateralized mortgage obligations 19,494 1,453 700,199 700,199 682,158 Public utilities 8,716 1,320 556,831 556,831 549,435 Corporate bonds 3,265,039 107,740 4,350 3,368,429 3,368,429 Foreign governments 4,115 60 135,641 135,641 131,586 State and municipalities 503 46,179 46,179 45,676 ------------ ----------- ----------- ----------- ----------- $ 6,541,422 $ 167,612 $ 10,405 $ 6,698,629 $ 6,698,629 ============ =========== =========== =========== ===========
The collateralized mortgage obligations consist primarily of sequential and planned amortization classes with final stated maturities of two to thirty years and 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 is adjusted by such prepayments. See Note 8 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, 1998, 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. Held-to-Maturity Available-for-Sale ------------------------------ --------- -------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value ------------- -------------- ------------ -------------- Due in one year or less 316,174 321,228 235,842 252,067 Due after one year through five years 925,016 961,592 1,279,123 1,309,202 Due after five years through ten years 675,444 722,685 769,278 803,498 Due after ten years 130,480 138,119 449,273 457,785 Mortgage-backed securities 10,135 9,941 2,257,376 2,313,490 Asset-backed securities 142,569 145,371 1,761,640 1,800,684 ============= ============== ============= ============= 2,199,818 2,298,936 6,752,532 6,936,726 ============= ============== ============= ============= Proceeds from sales of securities available-for-sale were $6,169,678, $3,174,246, and $3,569,608 during 1998, 1997, and 1996, respectively. The realized gains on such sales totaled $41,136, $20,543, and $24,919 for 1998, 1997, and 1996, respectively. The realized losses totaled $8,643, $10,643, and $40,748 for 1998, 1997, and 1996, respectively. During the years 1998, 1997, and 1996 held-to-maturity securities with an amortized cost of $9,920, $0, and $0 were sold due to credit deterioration with insignificant gains and losses. At December 31, 1998 and 1997, pursuant to fully collateralized securities lending arrangements, the Company had loaned $115,168 and $162,817 of fixed maturities, respectively. The Company engages in hedging activities to manage interest rate and exchange risk. The following table summarizes the 1998 financial hedge instruments: Notional Strike/Swap December 31, 1998 Amount Rate Maturity ------------------------ -------------- ------------------------- --------------------- Interest Rate Floor $ 100,000 4.50% (LIBOR) 11/99 Interest Rate Caps 1,070,000 6.75% - 11.82% (CMT) 12/99 - 10/03 Interest Rate Swaps 242,451 4.95% - 9.35% 08/99 - 02/03 Foreign Currency Exchange Contracts 34,123 N/A 05/99 - 07/06 Equity Swap 95,652 4.00% 12/99 The following table summarizes the 1997 financial hedge instruments: Notional Strike/Swap December 31, 1997 Amount Rate Maturity ------------------------ -------------- -------------------------- --------------------- Interest Rate Floor $ 100,000 4.5% (LIBOR) 1999 Interest Rate Caps 565,000 6.75% - 11.82% (CMT) 1999 - 2002 Interest Rate Swaps 212,139 6.20% - 9.35% 01/98 - 02/03 Foreign Currency Exchange Contracts 57,168 N/A 09/98 - 07/06 Equity Swap 100,000 5.64% 12/98
LIBOR - London Interbank Offered Rate CMT - Constant Maturity Treasury Rate The Company has established specific investment guidelines designed to emphasize a diversified and geographically dispersed portfolio of mortgages collateralized by commercial and industrial properties located in the United States. The Company's policy is to obtain collateral sufficient to provide loan-to-value ratios of not greater than 75% at the inception of the mortgages. At December 31, 1998, approximately 33% of the Company's mortgage loans were collateralized by real estate located in California. The following represents impairments and other information with respect to impaired loans: 1998 1997 --------------- ------------- Loans with related allowance for credit losses of $2,492 and $2,493 $ 13,192 $ 13,193 Loans with no related allowance for credit losses 10,420 20,013 Average balance of impaired loans during the year 31,193 37,890 Interest income recognized (while impaired) 2,308 2,428 Interest income received and recorded (while impaired) using the cash basis method of recognition 2,309 2,484
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 that are not impaired, aggregated $52,913 and $64,406 at December 31, 1998 and 1997, respectively. The following table presents changes in allowance for credit losses: 1998 1997 1996 ------------- ------------- -------------- Balance, beginning of year 67,242 65,242 63,994 Provision for loan losses 642 4,521 4,470 Chargeoffs (787) (2,521) (3,468) Recoveries 145 246 ============= ============= ============== Balance, end of year 67,242 67,242 65,242 ============= ============= ============== 7. COMMERCIAL PAPER The Company has a commercial paper program that is partially supported by a $50,000 standby letter-of-credit. At December 31, 1998, commercial paper outstanding had maturities ranging from 69 to 118 days and interest rates ranging from 5.10% to 5.22%. At December 31, 1997, maturities ranged from 41 to 99 days and interest rates ranged from 5.6% to 5.8%. 8. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS December 31, ---------------------------------------------------------- 1998 1997 ---------------------------- ---------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------------ ------------- ------------- ------------- ASSETS: Fixed maturities and short-term investments $ 9,556,713 $ 9,655,831 $ 9,180,476 $ 9,249,235 Mortgage loans on real estate 1,133,468 1,160,568 1,235,594 1,261,949 Policy loans 2,858,673 2,858,673 2,657,116 2,657,116 Common stock 48,640 48,640 39,021 39,021 LIABILITIES: Annuity contract reserves without life contingencies 4,908,964 4,928,800 5,346,516 5,373,818 Policyholders' funds 181,779 181,779 165,106 165,106 Due to Parent Corporation 52,877 52,877 126,656 124,776 Repurchase agreements 244,258 244,258 325,538 325,538 Commercial paper 39,731 39,731 54,058 54,058 HEDGE CONTRACTS: Interest rate floor 17 17 25 25 Interest rate caps 971 971 130 130 Interest rate swaps 6,125 6,125 4,265 4,265 Foreign currency exchange contracts 689 689 3,381 3,381 Equity swap (8,150) (8,150) 856 856
The estimated fair value of financial instruments have been determined using available information and appropriate valuation methodologies. However, considerable judgement is necessarily 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 that are publicly traded are obtained from an independent pricing service. To determine fair value for fixed maturities not actively traded, the Company utilized discounted cash flows calculated at current market rates on investments of similar quality and term. Mortgage loans fair value estimates generally are based on a discounted cash flow basis. A discount rate "matrix" is incorporated whereby the discount rate used in valuing a specific mortgage generally corresponds to that mortgage's remaining term. 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 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 Parent Corporation is based on discounted cash flows at current market spread rates on high quality investments. 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 financial hedge instruments, all of which are held for other than trading purposes, is the estimated amount the Company would receive or pay to terminate the agreement at each year-end, taking into consideration current interest rates and other relevant factors. Included in the net gain position for interest rates swaps are $0 of unrealized losses in 1998 and 1997. Included in the net gain position for foreign currency exchange contracts are $932 and $0 of loss exposures in 1998 and 1997, respectively. 9. EMPLOYEE BENEFIT PLANS Effective January 1, 1997, all employees of the U.S. operations of the Parent Corporation and the related benefit plans were transferred to the Company. See Note 3 for further discussion. The Company's Parent had previously accounted for the pension plan under the Canadian Institute of Chartered Accountants (CICA) guidelines and had recorded a prepaid pension asset of $19,091. As U.S. generally accepted accounting principles do not materially differ from these CICA guidelines and the transfer was between related parties, the prepaid pension asset was transferred at carrying value. As a result, the Company recorded the following effective January 1, 1997: Prepaid pension cost 19,091 Undistributed earnings on 3,608 participating business Stockholder's equity 15,483 ------------ ----------- 19,091 19,091 The following table summarizes changes from 1997 to 1998 and from 1996 to 1997, in the benefit obligations and in plan assets for the Company's defined benefit pension plan and post-retirement medical plan. There is no additional minimum pension liability required to be recognized. There were no amendments to the plans due to the acquisition of AH&L. Post-Retirement Pension Benefits Medical Plan ------------------------- ------------------------ 1998 1997 1998 1997 ----------- ------------ ----------- ----------- Change in benefit obligation Benefit obligation at beginning of $ 115,057 $ 96,417 $ 19,454 $ 16,160 year Service cost 6,834 5,491 1,365 1,158 Interest cost 7,927 7,103 1,341 1,191 Actuarial gain (loss) 5,117 9,470 (1,613) 1,500 Benefits paid (3,630) (3,424) (603) (555) ----------- ------------ ----------- ----------- Benefit obligation at end of year 131,305 115,057 19,944 19,454 ----------- ------------ ----------- ----------- Change in plan assets Fair value of plan assets at beginning of year 162,879 138,221 Actual return on plan assets 23,887 28,082 Benefits paid (3,630) (3,424) ----------- ------------ ----------- ----------- Fair value of plan assets at end of year 183,136 162,879 ----------- ------------ ----------- ----------- Funded status 51,831 47,822 (19,944) (19,454) Unrecognized net actuarial loss (11,405) (6,326) (113) 1,500 Unrecognized net obligation or (asset) at transition (19,684) (21,198) 14,544 15,352 =========== ============ =========== =========== Prepaid (accrued) benefit cost $ 20,742 $ 20,298 $ (5,513) $ (2,602) =========== ============ =========== =========== Weighted-average assumptions as of December 31 Discount rate 6.50% 7.00% 6.50% 7.00% Expected return on plan assets 8.50% 8.50% 8.50% 8.50% Rate of compensation increase 4.00% 4.50% 4.00% 4.50% Components of net periodic benefit cost Service cost $ 6,834 $ 5,491 $ 1,365 $ 1,158 Interest cost 7,927 7,103 1,341 1,191 Expected return on plan assets (13,691) (12,286) Amortization of transition (1,514) (1,514) 808 808 obligation ----------- ----------- ---------- ---------- =========== =========== ========== ========== Net periodic (benefit) cost $ (444) $ (1,206) $ 3,514 $ 3,157 =========== =========== ========== ==========
The Company-sponsored post-retirement medical plan (medical plan) provides health benefits to 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 will be to fund the cost of the medical plan benefits in amounts determined at the discretion of management. Assumed health care cost trend rates have a significant effect on the amounts reported for the medical plan. For measurement purposes, a 6.5% annual rate of increase in the per capita cost of covered health care benefits was assumed. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage 1-Percentage Point Point Increase Decrease -------------- ---------------- Effect on total of service and interest cost on components 649 1,140 Effect on post-retirement benefit obligation 4,129 3,098 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. Company contributions for the years ended December 31, 1998 and 1997 totaled $3,915 and $3,475, 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 their deferred amounts. The program is not qualified under Section 401 of the Internal Revenue Code. The total of participant deferrals, which is reflected in other liabilities, was $16,102 and $13,952 at December 31, 1998 and 1997, respectively. The participant deferrals earn interest at a rate based on the average 10-year composite government securities rate plus 1.5%. The interest expense related to this plan was $1,185 and $1,019 in 1998 and 1997, respectively. The Company also provides a supplemental executive retirement plan (SERP) 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 incremental expense for this plan for 1998 and 1997 was $2,840 and $2,531, respectively. The total liability of $9,349 and $6,509 as of December 31, 1998 and 1997 is included in other liabilities. 10. FEDERAL INCOME TAXES The following is a reconciliation between the federal income tax rate and the Company's effective rate after giving effect to the reclassifications discussed below: 1998 1997 1996 ----------- ----------- --------- Federal tax rate 35.0 % 35.0 % 35.0 % Change in tax rate resulting from: Settlement of Parent tax exposures (20.2) (18.9) Provision for contingencies 7.7 3.4 Prior year tax adjustment (1.5) 0.5 (1.4) Other, net (0.1) 0.9 0.3 =========== =========== ========= Total 33.4 % 23.9 % 18.4 % =========== =========== ========= The Company's income tax provision was favorably impacted in 1997 and 1996 by releases of contingent liabilities relating to taxes of the Parent Corporation's U.S. branch associated with blocks of business that were transferred from the Parent Corporation's U.S. branch to the Company from 1989 to 1993; the Company had agreed to the transfer of these tax liabilities as part of the transfer of this business. The releases recorded in 1997 and 1996 reflected the resolution of certain tax issues with the Internal Revenue Service (IRS) relating to the 1990-1991 and 1988-1989 audit years, respectively. The releases totaled $42,150 for 1997 and $31,200 for 1996; however, $15,100 of the release in 1997 was attributable to participating policyholders and therefore had no effect on the net income of the Company since that amount was credited to the provision for policyholders' share of earnings (losses). The 1997 and 1996 releases were recorded in revenues in the Company's prior financial statements, but have been reclassified in the accompanying consolidated financial statements as a component of the current income tax provisions for those years. In addition to these releases of contingent tax liabilities, the Company's income tax provisions for 1997 and 1996 also reflect increases for other contingent items relating to open tax years where the Company determined it was probable that additional taxes could be owed based on changes in facts and circumstances. The increase in 1997 was $16,000, of which $10,100 was attributable to participating policyholders and therefore had no effect on the net income of the Company. The increase in 1996 was $5,600. These increases in contingent tax liabilities have been reflected as a component of the deferred income tax provisions for 1997 and 1996 as the Company does not expect near term resolution of these contingencies. Excluding the effect of the 1997 and 1996 tax items discussed above, the effective tax rates for 1997 and 1996 were 34.1% and 33.9%, respectively. Temporary differences which give rise to the deferred tax assets and liabilities as of December 31, 1998 and 1997 are as follows: 1998 1997 --------------------------- ------------------------- Deferred Deferred Deferred Deferred Tax Tax Tax Tax Asset Liability Asset Liability ------------- ------------ ------------ ----------- Policyholder reserves 143,244 159,767 Deferred policy acquisition costs 39,933 47,463 Deferred acquisition cost proxy tax 100,387 79,954 Investment assets 19,870 5,574 Net operating loss carryforwards 2,867 9,427 Other 6,566 1,279 ------------- ------------ ------------ ----------- Subtotal 253,064 59,803 250,427 53,037 Valuation allowance (1,778) (3,570) ============= ============ ============ =========== Total Deferred Taxes 251,286 59,803 246,857 53,037 ============= ============ ============ ===========
Amounts included in investment assets above include $34,556 and $30,085 related to the unrealized gains on the Company's fixed maturities available-for-sale at December 31, 1998 and 1997, respectively. The Company files a separate tax return and, therefore, losses incurred by subsidiaries cannot be offset against operating income of the Company. At December 31, 1998, the Company's subsidiaries had approximately $8,193 of net operating loss carryforwards, expiring through the year 2011. The tax benefit of subsidiaries' net operating loss carryforwards, net of a valuation allowance of $0 and $1,809 are included in the deferred tax assets at December 31, 1998 and 1997, respectively. The Company's valuation allowance was increased (decreased) in 1998, 1997, and 1996 by $(1,792), $34, and $1,463, respectively, as a result of the re-evaluation by management of future estimated taxable income in its subsidiaries. Under pre-1984 life insurance company income tax laws, a portion of life insurance company 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. 11. COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income". This Statement establishes new rules for reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or stockholders' equity. This Statement requires unrealized gains or losses on the Company's available-for-sale securities and related offsets for reserves and deferred policy acquisition costs, which prior to adoption were reported separately in stockholder's equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement No. 130. Other comprehensive income at December 31, 1998 is summarized as follows: Before-Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount -------------- ------------------------------ Unrealized gains on available-for-sale securities: Unrealized holding gains arising during the period $ 39,430 $ (13,800) $ 25,630 Less: reclassification adjustment for (gains) losses realized in net (14,350) 5,022 (9,328) income -------------- ---------------- ------------ Net unrealized gains 25,080 (8,778) 16,302 Reserve and DAC adjustment (11,614) 4,065 (7,549) -------------- ---------------- ------------ ============== ================ ============ Other comprehensive income $ 13,466 $ (4,713) $ 8,753 ============== ================ ============ Other comprehensive income at December 31, 1997 is summarized as follows: Before-Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount -------------- ---------------- -------------- Unrealized gains on available-for-sale securities: Unrealized holding gains arising during the period $ 80,821 $ (28,313) $ 52,508 Less: reclassification adjustment for (gains) losses realized in net 2,012 (704) 1,308 income -------------- ---------------- -------------- Net unrealized gains 82,833 (29,017) 53,816 Reserve and DAC adjustment (24,554) 8,594 (15,960) ============== ================ ============== Other comprehensive income $ 58,279 $ (20,423) $ 37,856 ============== ================ ============== Other comprehensive loss at December 31, 1996 is summarized as follows: Before-Tax Tax (Expense) Net-of-Tax Amount or Benefit Amount -------------- ---------------- -------------- Unrealized gains on available-for-sale securities: Unrealized holding gains (losses) arising during the period $ (125,559) $ 43,971 $ (81,588) Less: reclassification adjustment for (gains) losses realized in net 19,381 (6,783) 12,598 income -------------- ---------------- -------------- Net unrealized gains (losses) (106,178) 37,188 (68,990) -------------- Reserve and DAC adjustment 38,736 (13,558) 25,178 ============== ================ ============== Other comprehensive loss $ (67,442) $ 23,630 $ (43,812) ============== ================ ==============
12. STOCKHOLDER'S EQUITY, DIVIDEND RESTRICTIONS, AND OTHER MATTERS Effective September 30, 1998, the Company purchased all of its outstanding series of preferred stock, which were owned by the Parent Corporation, for $121,800. 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: 1998 1997 1996 --------------- ------------- ------------- (Unaudited) Net income 225,863 $ 181,312 $ 180,634 Capital and surplus 727,124 759,429 713,324 The maximum amount of dividends which can be paid to stockholders by insurance companies domiciled in the State of Colorado are subject to restrictions relating to statutory surplus and statutory net gain from operations. Statutory surplus and net gains from operations at December 31, 1998 were $727,124 and $225,586 (unaudited), respectively. The Company should be able to pay up to $225,586 (unaudited) of dividends in 1999. Dividends of $6,692, $8,854, and $8,587 were paid on preferred stock in 1998, 1997, and 1996, respectively. In addition, dividends of $73,344, $62,540, and $48,083 were paid on common stock in 1998, 1997, and 1996, respectively. Dividends are paid as determined by the Board of Directors. 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 its financial position or results of operations. 13. STOCK OPTIONS The Company is an indirect subsidiary of Great-West Lifeco Inc. (Lifeco). Lifeco has a stock option plan (the Lifeco plan) that provides for the granting of options for common shares of Lifeco to certain officers and employees of Lifeco and its subsidiaries, including the Company. Options may be awarded at no less than the market price on the date of the grant. Termination of employment prior to vesting results in forfeiture of the options, unless otherwise determined by a committee that administers the Lifeco plan. As of December 31, 1998, 1997 and 1996, stock available for award under the Lifeco plan aggregated 1,424,400, 3,440,000 and 6,244,000 shares. The plan provides for the granting of options with varying terms and vesting requirements. The basic options under the plan become exercisable twenty percent per year commencing on the first anniversary of the grant and expire ten years from the date of grant. Options granted in 1997 and 1998 totaling 1,832,000 and 278,000, respectively, become exercisable if certain long-term cumulative financial targets are attained. If exercisable, the exercise period runs from April 1, 2002 to June 26, 2007. Additional options granted in 1998 totaling 380,000 become exercisable if certain sales or financial targets are attained. During 1998, 30,000 of these options vested and accordingly, the Company recognized compensation expense of $116. If exercisable, the exercise period runs from the date that the particular options become exercisable until January 27, 2008. The following table summarizes the status of, and changes in, Lifeco options outstanding and the weighted-average exercise price (WAEP) for the years ended December 31. 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: 1998 1997 1996 ---------------------- ---------------------- ---------------------- Options WAEP Options WAEP Options WAEP ------------ -------- ----------- -------- ----------- --------- Outstanding, Jan. 1, 5,736,000 $ 7.71 4,104,000 $ 6.22 0 $ .00 Granted 988,000 13.90 1,932,000 10.82 4,104,000 6.62 Exercised 99,176 6.33 16,000 5.95 0 .00 Expired or canceled 80,000 13.05 284,000 6.12 0 .00 ============ ======== =========== ======== =========== ========= Outstanding, Dec. 31, 6,544,824 8.07 5,736,000 7.71 4,104,000 6.22 ============ ======== =========== ======== =========== ========= Options exercisable at year-end 1,652,424 $ 5.72 760,800 $ 5.96 0 $ .00 ============ ======== =========== ======== =========== ========= Weighted average fair value of options granted during year $ 1.18 $ 2.65 $ 4.46 ============ =========== =========== The following table summarizes the range of exercise prices for outstanding Lifeco common stock options at December 31, 1998: Outstanding Exercisable ---------------------------------------- ---------------------------- Average Average Exercise Average Exercise Exercise Price Range Options Life Price Options Price ------------------- -------------- ---------- ----------- ------------- ------------ $ 5.54 - $ 7.36 3,804,824 7.62 $ 5.61 1,622,424 $ 5.58 $10.61 - $13.23 2,740,000 8.70 $ 11.48 30,000 $ 13.23
Of the exercisable Lifeco options, 1,622,424 relate to basic option grants and 30,000 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 April 1996, certain officers of the Company participated in the PFC plan. Under the PFC plan, options may be awarded at no less than the market price on the date of the grant. Termination of employment prior to vesting results in forfeiture of the options, unless otherwise determined by a committee that administers the PFC plan. As of December 31, 1998, 1997 and 1996, stock available for award under the PFC plan aggregated 4,400,800, 4,400,800 and 5,440,800 shares. Options granted to officers of the Company under the PFC plan become exercisable twenty percent per year commencing on the date of the grant and expire ten years from the date of grant. The following table summarizes the status of, and changes in, PFC options outstanding and the weighted-average exercise price (WAEP) for the years ended December 31. 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: 1998 1997 1996 ---------------------- ---------------------- --------------------- Options WAEP Options WAEP Options WAEP ----------- --------- ----------- -------- ----------- -------- Outstanding, Jan. 1, 1,076,000 $ 3.05 1,329,200 $ 3.14 1,436,000 $ 3.17 Exercised 720,946 3.60 253,200 2.68 106,800 2.95 =========== ========= =========== ======== =========== ======== Outstanding, Dec. 31, 355,054 2.89 1,076,000 3.05 1,329,200 3.14 =========== ========= =========== ======== =========== ======== Options exercisable at year-end 355,054 $ 2.89 1,076,000 $ 3.05 1,301,200 $ 3.15 =========== ========= =========== ======== =========== ========
As of December 31, 1998, the PFC options outstanding have exercise prices between $2.25 and $3.44 and a weighted-average remaining contractual life of 2.99 years. The Company accounts for stock-based compensation using the intrinsic value method prescribed by APB No. 25, "Accounting for Stock Issued to Employees", 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 values 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 $727, $608, and $257, in 1998, 1997, and 1996, 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 assumption used for those options granted in 1998, 1997, and 1996, respectively: dividend yield of 3.00%, expected volatility of 34.05%, 24.04%, and 15.61%, risk-free interest rates of 4.79%, 4.72%, and 4.67%, and expected lives of 7.5 years. 14. SEGMENT INFORMATION The Company has two reportable segments: Employee Benefits and Financial Services. The Employee Benefits segment markets group life and health and 401(k) products to small and mid-sized corporate employers. The Financial Services segment markets and administers savings products to public and not-for-profit employers and individuals and offers life insurance products to individuals and businesses. 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 reportable segments are strategic business units that offer different products and services. They are managed separately as each segment has unique distribution channels. 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, 1998 Operations: Employee Financial Total Benefits Services U.S. -------------- -------------- ------------- Revenue: Premium income $ 746,898 $ 247,965 $ 994,863 Fee income 444,649 71,403 516,052 Net investment income 95,118 802,242 897,360 Realized investment gains (losses) 8,145 30,028 38,173 -------------- -------------- ------------- Total revenue 1,294,810 1,151,638 2,446,448 Benefits and Expenses: Benefits 590,058 872,411 1,462,469 Operating expenses 546,959 141,269 688,228 -------------- -------------- ------------- Total benefits and expenses 1,137,017 1,013,680 2,150,697 Net operating income before income taxes 157,793 137,958 295,751 Income taxes 50,678 48,158 98,836 ============== ============== ============= Net income $ 107,115 $ 89,800 $ 196,915 ============== ============== =============
Assets: Employee Financial Total Benefits Services U.S. --------------- -------------- -------------- Investment assets $ 1,434,691 $ 12,235,845 $ 13,670,536 Separate account assets 5,704,313 4,395,230 10,099,543 Other assets 567,126 785,940 1,353,066 =============== ============== ============== Total assets $ 7,706,130 $ 17,417,015 $ 25,123,145 =============== ============== ============== Year ended December 31, 1997 Operations: Employee Financial Total Benefits Services U.S. -------------- ------------- ------------- Revenue: Premium income $ 465,143 $ 368,036 $ 833,179 Fee income 358,005 62,725 420,730 Net investment income 100,067 781,606 881,673 Realized investment gains (losses) 3,059 6,741 9,800 -------------- ------------- ------------- Total revenue 926,274 1,219,108 2,145,382 Benefits and Expenses: Benefits 371,333 1,013,717 1,385,050 Operating expenses 427,969 123,756 551,725 -------------- ------------- ------------- Total benefits and expenses 799,302 1,137,473 1,936,775 Net operating income before income taxes 126,972 81,635 208,607 Income taxes 28,726 21,121 49,847 ------------- ============== ============= Net income $ 98,246 $ 60,514 $ 158,760 ============== ============= =============================================================================================================== Assets: Employee Financial Total Benefits Services U.S. --------------- -------------- -------------- Investment assets $ 1,346,944 $ 11,859,038 $ 13,205,982 Separate account assets 4,533,516 3,313,935 7,847,451 Other assets 355,764 668,518 1,024,282 =============== ============== ============== Total assets $ 6,236,224 $ 15,841,491 $ 22,077,715 =============== ============== ==============
Year ended December 31, 1996 Operations: Employee Financial Total Benefits Services U.S. --------------- -------------- ------------- Revenue: Premium income $ 486,565 $ 342,884 $ 829,449 Fee income 321,074 26,445 347,519 Net investment income 87,511 747,126 834,637 Realized investment gains (losses) (2,661) (18,417) (21,078) --------------- -------------- ------------- Total revenue 892,489 1,098,038 1,990,527 Benefits and Expenses: Benefits 406,143 949,821 1,355,964 Operating expenses 368,258 101,358 469,616 --------------- -------------- ------------- Total benefits and expenses 774,401 1,051,179 1,825,580 Net operating income before income taxes 118,088 46,859 164,947 Income taxes 22,874 7,498 30,372 =============== ============== ============= Net income $ 95,214 $ 39,361 $ 134,575 =============== ============== ============= The following table, which summarizes premium and fee income by segment, represents supplemental information: 1998 1997 1996 ------------- ------------- ------------- Premium Income Employee Benefits Group Life & Health $ 746,898 $ 465,143 $ 486,565 ------------- ------------- ------------- Total Employee Benefits 746,898 465,143 486,565 ------------- ------------- ------------- Financial Services Savings 16,765 22,634 26,655 Individual Insurance 231,200 345,402 316,229 ------------- ------------- ------------- Total Financial Services 247,965 368,036 342,884 ------------- ------------- ------------- Premium income $ 994,863 $ 833,179 $ 829,449 ============= ============= ============= Fee Income Employee Benefits Group Life & Health $ 366,805 $ 305,302 $ 276,688 401(k) 77,844 52,703 44,386 ------------- ------------- ------------- ------------- ------------- ------------- Total Employee Benefits 444,649 358,005 321,074 ------------- ------------- ------------- ------------- ------------- ------------- Financial Services Savings 71,403 62,725 26,445 ------------- ------------- ------------- Total Financial Services 71,403 62,725 26,445 ------------- ------------- ------------- ============= ============= ============= Fee income $ 516,052 $ 420,730 $ 347,519 ============= ============= =============
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE In the two most recent fiscal years or any subsequent interim period, there has been no change in the Company's independent accountants or resulting disagreements on accounting and financial disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT A. IDENTIFICATION OF DIRECTORS Director Age Served as Principal Occupation(s) For Director From Last Five Years James Balog 70 1993 Company Director (1)(2) James W. Burns, O.C. 69 1991 Chairman of the Boards of (1)(2)(4) Great-West Lifeco, Great-West Life, London Insurance Group Inc. and London Life Insurance Company; Deputy Chairman, Power Corporation Orest T. Dackow 62 1991 President and Chief Executive (1)(2)(4) Officer, Great-West Lifeco Andre Desmarais 42 1997 President and Co-Chief (1)(2)(4)(5) Executive Officer, Power Corporation; Deputy Chairman, Power Financial Paul Desmarais, Jr. 44 1991 Chairman and Co-Chief (1)(2)(4)(5) Executive Officer, Power Corporation; Chairman, Power Financial Robert G. Graham 67 1991 Company Director since January (1)(2)(4) 1996; previously Chairman and Chief Executive Officer, Inter-City Products Corporation (a company engaged in the manufacture and distribution of air conditioning, heating and related products) Robert Gratton 55 1991 Chairman of the Board of the (1)(2)(4) Company; President and Chief Executive Officer, Power Financial N. Berne Hart 69 1991 Company Director (1)(2)(3) Kevin P. Kavanagh 66 1986 Company Director; Chancellor, (1)(3)(4) Brandon University William Mackness 60 1991 Company Director since July (1)(2) 1995; previously Dean, Faculty of Management, University of Manitoba William T. McCallum 56 1990 President and Chief Executive (1)(2)(4) Officer of the Company; President and Chief Executive Officer, United States Operations, Great-West Life Jerry E.A. Nickerson 62 1994 Chairman of the Board, H.B. (3)(4) Nickerson & Sons Limited (a management and holding company) The Honourable 61 1991 Vice-Chairman, Power P. Michael Pitfield, P.C., Q.C. Corporation; Member of the (1)(2)(4) Senate of Canada Michel Plessis-Belair, F.C.A. 56 1991 Vice-Chairman and Chief (1)(2)(3)(4) Financial Officer, Power Corporation; Executive Vice-President and Chief Financial Officer, Power Financial Brian E. Walsh 45 1995 Co-Founder and Managing (1)(2) Partner, Veritas Capital Management, LLC (a merchant banking company) since September 1997; previously Partner, Trinity L.P. (an investment company) from January 1996; previously Managing Director and Co-Head, Global Investment Bank, Bankers Trust Company (an investment/commercial bank)
(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 lists 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. J. Balog Elan plc ........ Euclid Mutual Fund ........ Transatlantic Holdings ........ Zweig-Glaser Mutual Fund A. Desmarais The Seagram Company Limited P. Desmarais, Jr. Petrofina S.A. J.E.A. Nickerson Bank of Montreal B.......IDENTIFICATION OF EXECUTIVE OFFICERS Executive Officer Age Served as Executive Principal Occupation(s) For Officer From Last Five Years William T. McCallum 56 1984 President and Chief Executive President and Chief Officer of the Company; President Executive Officer and Chief Executive Officer, United States Operations, Great-West Life Mitchell T.G. Graye 43 1997 Executive Vice President and Chief Executive Vice President and Financial Officer of the Company; Chief Financial Officer Executive Vice President and Chief Financial Officer, United States, Great-West Life James D. Motz 49 1992 Executive Vice President, Employee Executive Vice President, Benefits of the Company and Employee Benefits Great-West Life Douglas L. Wooden 42 1991 Executive Vice President, Financial Executive Vice President, Services of the Company and Financial Services Great-West Life John A. Brown 51 1992 Senior Vice President, Sales, Senior Vice President, Financial Services of the Company Sales, Financial Services and Great-West Life Donna A. Goldin 51 1996 Executive Vice President and Chief Executive Vice President and Operating Officer, One Corporation Chief Operating Officer, since June 1996; previously One Corporation Executive Vice President and Chief Operating Officer, Harris Methodist Health Plan (a health maintenance organization) from March 1995; previously Executive Vice President and Chief Operating Officer, Private Healthcare Systems, Inc. (a managed care company) John T. Hughes 62 1989 Senior Vice President, Chief Senior Vice President, Investment Officer of the Company; Chief Investment Officer Senior Vice President, Chief Investment Officer, United States, Great-West Life D. Craig Lennox 51 1984 Senior Vice President, General Senior Vice President, Counsel and Secretary of the General Counsel and Secretary Company; Senior Vice President and Chief U.S. Legal Officer, Great-West Life Steve H. Miller 46 1997 Senior Vice President, Employee Senior Vice President, Benefits Sales of the Company and Employee Benefits Sales Great-West Life Charles P. Nelson 38 1998 Senior Vice President, Senior Vice President, Public Non-Profit Markets of the Public Non-Profit Markets Company and Great-West Life Martin Rosenbaum 46 1997 Senior Vice President, Employee Senior Vice President, Benefits Operations of the Company Employee Benefits Operations and Great-West Life Gregory E. Seller 45 1999 Senior Vice President, Major Senior Vice President, Major Accounts of the Company and Accounts Great-West Life Robert K. Shaw 43 1998 Senior Vice President, Individual Senior Vice President, Markets of the Company and Individual Markets Great-West Life 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. ITEM 11. EXECUTIVE COMPENSATION A. SUMMARY COMPENSATION TABLE The following table sets out all compensation paid to the individuals who were, at December 31, 1998, the Chief Executive Officer and the other four most highly compensated executive officers of the Company (collectively the "Named Executive Officers") for services rendered to the Company and its subsidiaries, and Great-West Life, in all capacities for fiscal years ended 1996, 1997 and 1998, respectively. SUMMARY COMPENSATION TABLE - ----------------------------------------------------------------------- ========================= Annual compensation Long-term compensation awards - ----------------------------------------------------------------------- ========================= - -------------------------- ------------- ------------- ---------------- ========================= Name and Year Salary Bonus Options (1) principal position ($) ($) (#) - -------------------------- ------------- ------------- ---------------- ========================= - -------------------------- ------------- ------------- ---------------- ========================= W.T. McCallum 1998 651,667 432,250 - President and 1997 608,708 406,250 600,000 (3) Chief Executive Officer 1996 561,818 370,500 600,000 (2) - -------------------------- ------------- ------------- ---------------- ========================= - -------------------------- ------------- ------------- ---------------- ========================= D.L. Wooden 1998 330,000 198,000 - Executive Vice 1997 300,000 150,000 300,000 (3) President, Financial 1996 287,000 143,500 200,000 (2) Services - -------------------------- ------------- ------------- ---------------- ========================= - -------------------------- ------------- ------------- ---------------- ========================= J.T. Hughes 1998 338,000 185,900 - Senior Vice President, 1997 324,000 162,000 - Chief Investment Officer 1996 312,000 136,968 160,000 (2) - -------------------------- ------------- ------------- ---------------- ========================= - -------------------------- ------------- ------------- ---------------- ========================= J.D. Motz 1998 350,000 157,500 - Executive Vice 1997 300,000 151,300 100,000 (2) President, Employee 300,000 (3) Benefits 1996 250,000 89,750 200,000 (2) - -------------------------- ------------- ------------- ---------------- ========================= - -------------------------- ------------- ------------- ---------------- ========================= M.T.G. Graye Executive 1998 275,000 151,250 18,000 (2) Vice President and Chief 18,000 (3) Financial Officer 1997 219,469 117,958 132,000 (3) 1996 183,824 73,810 132,000 (2) - -------------------------- ------------- ------------- ---------------- =========================
(1) The options set out are options for common shares of Great-West Lifeco which are granted by Great-West Lifeco pursuant to the Great-West Lifeco Stock Option Plan ("Lifeco Options"). (2) These Lifeco Options become exercisable 20% per year commencing on the first anniversary of the grant and expire ten years after the date of the grant. (3) All or portions of these Lifeco Options become exercisable if certain financial targets are attained. If exercisable, the exercise period runs from April 1, 2002 to June 26, 2007. 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 Great-West 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 1/1.53. OPTION GRANTS IN LAST FISCAL YEAR - ----------------------------------------------------------------------------- ======================== Potential realizable value at assumed Individual grants annual rates of stock price appreciation for option term - ----------------------------------------------------------------------------- ======================== Percent of total Options options Exercise Name granted granted to or base Expiration date 5% 10% (#) employees price ($) ($) in fiscal ($/share) year - ------------------- ------------ ------------- ------------ ----------------- ----------- ============ M.T.G. Graye 18,000 .85 13.23 January 27, 2008 150,028 378,642 - ------------------- ------------ ------------- ------------ ----------------- ----------- ============ - ------------------- ------------ ------------- ------------ ----------------- ----------- ============ M.T.G. Graye 18,000 .85 13.23 June 26, 2007 138,121 350,066 - ------------------- ------------ ------------- ------------ ----------------- ----------- ============
Prior to April 24,1996, the Named Executive Officers participated in the Power Financial Employee Share Option Plan pursuant to which options to acquire common shares of Power Financial ("PFC Options") were granted. The following table describes all PFC Options exercised in 1998, and all unexercised PFC Options held as of December 31, 1998, by the Named Executive Officers. PFC Options are issued with an exercise price in Canadian dollars. Canadian dollar amounts have been translated to U.S. dollars at a rate of 1/1.53. AGGREGATED PFC OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES - --------------------------------------------------- --------------------------- ============================ Unexercised options at Value of unexercised fiscal year-end in-the-money options at (#) fiscal year-end ($) - --------------------------------------------------- --------------------------- ============================ Shares acquired Value Name on exercise realized Exercisable Exercisable (#) ($) Unexercisable Unexercisable ==================== ---------------- ------------- ------------- ------------- ------------- ============== W.T. McCallum 80,000 1,064,134 - - - - ------------- ============== ==================== ---------------- ------------- ------------- ------------- ------------- ============== D.L. Wooden - - 176,000 - 3,232,239 - ------------- ============== - -------------------- ---------------- ------------- ------------- ------------- ------------- ============== J.T. Hughes 240,000 3,115,195 - - - - - -------------------- ---------------- ------------- ------------- ------------- ------------- ============== ==================== ================ ============= ============= ============= ============= ============== M.T.G. Graye - - 140,000 - 2,573,243 - ==================== ================ ============= ============= ============= ============= ==============
Commencing April 24,1996, the Named Executive Officers began participating in the Great-West Lifeco Stock Option Plan. The following table describes all Lifeco Options exercised in 1998, and all unexercised Lifeco Options held as of December 31, 1998, by the Named Executive Officers. Lifeco Options are issued with an exercise price in Canadian dollars. Canadian dollar amounts have been translated to U.S. dollars at a rate of 1/1.53. AGGREGATED LIFECO OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES - --------------------------------------------------- --------------------------- ============================ Unexercised options at Value of unexercised fiscal year-end in-the-money options at (#) fiscal year-end ($) - --------------------------------------------------- --------------------------- ============================ Shares acquired Value Name on exercise realized Exercisable Exercisable (#) ($) Unexercisable Unexercisable ==================== ---------------- ------------- ------------- ------------- ------------- ============== W.T. McCallum - - 240,000 960,000 2,748,543 7,952,872 ------------- ============== ==================== ---------------- ------------- ------------- ------------- ------------- ============== D.L. Wooden - - 80,000 420,000 916,181 3,289,300 ------------- ============== ==================== ---------------- ------------- ------------- ------------- ------------- ============== J.T. Hughes - - 64,000 96,000 732,945 1,099,417 ------------- ============== - -------------------- ---------------- ------------- ------------- ------------- ------------- ============== J.D. Motz - - 100,000 500,000 1,108,898 4,060,166 - -------------------- ---------------- ------------- ------------- ------------- ------------- ============== ==================== ================ ============= ============= ============= ============= ============== M.T.G. Graye - - 56,400 243,600 618,226 1,871,554 ==================== ================ ============= ============= ============= ============= ============== C. PENSION PLAN TABLE The following table sets out the pension benefits payable to the Named Executive Officers by Great-West Life or the Company. PENSION PLAN TABLE ========================= ============================================================= Years of service ============================================================= Remuneration ($) 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. Name Years of Service W.T. McCallum 33 D.L. Wooden 8 J.T. Hughes 9 J.D. Motz 28 M.T.G. Graye 5 For W.T. McCallum, the benefits shown are payable commencing December 31, 2000, and remuneration is the average of the highest 36 consecutive months of compensation during the last 84 months of employment. For M.T.G. Graye, J.T. Hughes, J.D. Motz and D.L. Wooden, 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 1. Great-West Life Directors As indicated above, 11 directors of the Company are also directors of Great-West Life. The following sets out remuneration paid by Great-West Life to its directors. Great-West Life pays an annual fee of $17,500 to each director. Great-West Life pays an annual fee of $10,000 to the Chairman of each of the Audit Committee, the Conduct Review Committee and the Corporate Management Committee, $20,000 to the Chairman of each of the Canadian Investment and Credit Committee and the United States Investment and Credit Committee, $25,000 to the Chairman of each of the Canadian Executive Committee and the United States Executive Committee, and $25,000 to the Chairman of the Board. Great-West Life pays a meeting fee of $1,000 to each director for each meeting of the Board of Directors or a committee thereof attended. 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. 2. Directors of the Company The following sets out remuneration paid by the Company to its directors. For each director of the Company who is not also a director of Great-West Life, the Company pays an annual fee of $17,500, and a meeting fee of $1,000 for each meeting of the Board of Directors or a committee thereof attended. For each director of the Company who is also a director of Great-West Life, the Company pays a meeting fee of $1,000 for each meeting of the Board of Directors or a committee thereof attended which is not coincident with a Great-West Life meeting. 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 February 1, 1999, 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, Englewood, 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 The Great-West Life Assurance Company, 100 Osborne Street North, Winnipeg, Manitoba, Canada R3C 3A5. (4) 99.6% of the outstanding common shares of The Great-West Life Assurance Company are owned by Great-West Lifeco Inc., 100 Osborne Street North, Winnipeg, Manitoba, Canada R3C 3A5. (5) 81.1% of the outstanding common shares of Great-West Lifeco Inc. are controlled by Power Financial Corporation, 751 Victoria Square, Montreal, Quebec, Canada H2Y 2J3. (6) 67.5% 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 which will become exercisable within 60 days) for equity securities, of the Company or any of its parents or subsidiaries, beneficially owned, as of February 1, 1999, 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. - ------------------------- ------------------------------------------------------------------------ Company ------------------------------------------------------------------------ ----------------- ---------------- ------------------ ------------------ The Great-West Great-West Power Financial Power Life Assurance Lifeco Inc. Corporation Corporation of Company Canada (1) (2) (3) (4) ----------------- ---------------- ------------------ ------------------ Directors - -------------------------------------------------------------------------------------------------- - ------------------------- ----------------- ---------------- ------------------ ------------------ J. Balog - - - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ J. W. Burns 50 112,000 8,000 400,640 200,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ O.T. Dackow 16 72,837 - - 200,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ A. Desmarais 50 40,000 21,600 40,800 1,100,500 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ P. Desmarais, Jr. 50 32,000 - 890,500 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ R.G. Graham - - - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ R. Gratton - 330,000 310,000 5,000 5,280,000 options 300,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ N.B. Hart - - - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ K. P. Kavanagh - 20,000 - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ W. Mackness - - - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ W.T. McCallum 17 71,362 80,000 - 240,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ J.E.A. Nickerson - - - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ P.M. Pitfield - 100,000 80,000 100,000 309,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ M. Plessis-Belair - 20,000 2,000 15,800 53,300 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ B.E. Walsh - - - - - ------------------------- ----------------- ---------------- ------------------ ------------------ - -------------------------------------------------------------------------------------------------- Named Executive Officers - -------------------------------------------------------------------------------------------------- - ------------------------- ----------------- ---------------- ------------------ ------------------ W.T. McCallum 17 71,362 80,000 - 240,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ D.L. Wooden - 80,000 options 176,000 options - - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ J.T. Hughes - 9,989 - - 64,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ J.D. Motz - 14,033 - - 100,000 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - ------------------------- ----------------- ---------------- ------------------ ------------------ M.T.G. Graye - 506 140,000 options - 56,400 options - ------------------------- ----------------- ---------------- ------------------ ------------------ - -------------------------------------------------------------------------------------------------- Directors and Executive Officers as a Group - -------------------------------------------------------------------------------------------------- - ------------------------- ----------------- ---------------- ------------------ ------------------ 183 862,822 622,546 563,040 998,000 options 5,635,054 options 2,853,300 options - ------------------------- ----------------- ---------------- ------------------ ------------------
(1) All holdings are common shares of The Great-West Life Assurance Company. (2) All holdings are common shares, or where indicated, exercisable options for common shares, of Great-West Lifeco Inc. (3) All holdings are common shares, or where indicated, exercisable options for common shares, of Power Financial Corporation. (4) 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 1.6% 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 1.8% 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 the directors and executive officers as a group represents 1.7% 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 exceed 1% of the total number of shares and exercisable options for shares of the class outstanding. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The documents identified below are filed as a part of this report: Page A. INDEX TO FINANCIAL STATEMENTS Independent Auditors' Report on Consolidated Financial Statements for the Years Ended December 31, 1998, 1997, and 1996 36 Consolidated Balance Sheets as of December 31, 1998 and 1997 37 Consolidated Statements of Income for the Years Ended December 31, 1998, 1997, and 1996 39 Consolidated Statements of Stockholder's Equity for the Years Ended December 31, 1998, 1997, and 1996 40 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997, and 1996 41 Notes to Consolidated Financial Statements for the Years Ended December 31, 1998, 1997, and 1996 43
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. 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. 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. 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. 21 Subsidiaries of Great-West Life & Annuity 84 Insurance Company 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. 27 Financial Data Schedule 86 C. REPORTS ON FORM 8-K No reports on Form 8-K were filed during the fourth quarter of 1998.
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/ W.T. McCallum William T. McCallum President and Chief Executive Officer Date: April 26, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature and Title Date /s/ William T. McCallum April 26, 1999 William T. McCallum President and Chief Executive Officer and a Director /s/ Mitchell T.G. Graye April 26, 1999 Mitchell T.G. Graye Executive Vice President and Chief Financial Officer /s/ Glen R. Derback April 26, 1999 Glen R. Derback Vice President and Controller Signature and Title Date /s/ James Balog * April 26, 1999 James Balog, Director /s/ James W. Burns * April 26, 1999 - -------------------- James W. Burns, Director /s/ Orest T. Dackow * April 26, 1999 - --------------------- Orest T. Dackow, Director /s/ Andre Desmarais* April 26, 1999 Andre Desmarais, Director /s/ Paul Desmarais, Jr. * April 26, 1999 - ------------------------- Paul Desmarais, Jr., Director /s/ Robert G. Graham * April 26, 1999 - ------------------------ Robert G. Graham, Director /s/ Robert Gratton * April 26, 1999 Robert Gratton, Director /s/ N. Berne Hart * April 26, 1999 - ------------------- N. Berne Hart, Director /s/ Kevin P. Kavanagh * April 26, 1999 - ----------------------- Kevin P. Kavanagh, Director /s/ William Mackness * April 26, 1999 William Mackness, Director /s/ Jerry E.A. Nickerson * April 26, 1999 - -------------------------- Jerry E.A. Nickerson, Director Signature and Title Date /s/ P. Michael Pitfield * April 26, 1999 - ------------------------- P. Michael Pitfield, Director /s/ Michel Plessis-Belair * April 26, 1999 Michel Plessis-Belair, Director /s/ Brian E. Walsh * April 26, 1999 - -------------------- Brian E. Walsh, Director * By: /s/ D. Craig Lennox April 26, 1999 --------------------- D. Craig Lennox Attorney-in-fact pursuant to filed Powers of Attorney. EXHIBIT 21 SUBSIDIARIES OF GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY SUBSIDIARIES OF GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY JURISDICTION OF INCORPORATION OR ORGANIZATION SUBSIDIARY Anthem Health & Life Insurance Company Indiana Benefits Communication Corporation (1) Delaware BenefitsCorp Equities, Inc. Delaware Financial Administrative Services Corporation (2) Colorado First Great-West Life & Annuity Insurance Company New York Great-West Benefit Services, Inc. Delaware Great-West Realty Investments, Inc. Delaware Greenwood Investments, Inc. Colorado Greenwood Property Corporation Colorado GW Capital Management, LLC Colorado GWL Properties, Inc. Colorado Maxim Series Fund, Inc. Maryland One Corporation Colorado One Health Plan, Inc. Vermont One Health Plan of Alaska, Inc. Alaska One Health Plan of Arizona, Inc. Arizona One Health Plan of California, Inc. California One Health Plan of Colorado, Inc. Colorado One Health Plan of Florida, Inc. Florida One Health Plan of Georgia, Inc. Georgia One Health Plan of Illinois, Inc. Illinois One Health Plan of Indiana, Inc. Indiana One Health Plan of Maine, Inc. Maine One Health Plan of Massachusetts, Inc. Massachusetts One Health Plan of Nevada, Inc. Nevada One Health Plan of New Hampshire, Inc. New Hampshire One Health Plan of New Jersey, Inc. New Jersey One Health Plan of North Carolina, Inc. North Carolina One Health Plan of Ohio, Inc. Ohio One Health Plan of Oregon, Inc. Oregon One Health Plan of South Carolina, Inc. South Carolina One Health Plan of Tennessee, Inc. Tennessee One Health Plan of Texas, Inc. Texas One Health Plan of Washington, Inc. Washington One Health Plan of Wyoming, Inc. Wyoming One of Arizona, Inc. Arizona One Orchard Equities, Inc. Colorado Orchard Capital Management, LLC Colorado Orchard Series Fund Delaware Orchard Trust Company Colorado (1) Also doing business as Benefits Insurance Services, Inc. (2) Also doing business as Financial Administrative Services Corporation of Colorado. EX-27 2 FDS --
7 EXHIBIT 27 FINANCIAL DATA SCHEDULE 0000744455 Great-West Life & Annuity Insurance Company 1,000 U.S. 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 1.000 6936726 2199818 2298936 48640 1133468 0 13670536 176119 192958 238901 25123145 12331646 0 0 395026 39731 0 0 7032 1191527 25123145 994863 897360 38173 516052 1462469 0 51724 636504 295751 98836 196915 0 0 0 196915 0 0 0 0 0 0 0 0
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