UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to
Commission file number: 333-57212, 333-104539, 333-104546, 333-104547,
333-104548, 333-116137
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ING USA Annuity and Life Insurance Company
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(Exact name of registrant as specified in its charter)
Iowa 41-0991508
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(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
1475 Dunwoody Drive, West Chester, Pennsylvania 19380-1478
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (610) 425-3400
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Former name, former address and formal fiscal year, if changed since last report
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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: As of November 12, 2004,
250,000 shares of Common Stock, $10 Par Value, are authorized, issued, and
outstanding, all of which were directly owned by Lion Connecticut Holdings Inc.
NOTE: WHEREAS ING USA ANNUITY AND LIFE INSURANCE COMPANY MEETS THE CONDITIONS
SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10Q, THIS FORM IS BEING
FILED WITH THE REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION H(2).
1
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Form 10-Q for period ended September 30, 2004
INDEX
Page
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PART I. FINANCIAL INFORMATION (Unaudited)
Item 1. Financial Statements:
Condensed Statements of Income 3
Condensed Balance Sheets 4
Condensed Statements of Changes in
Shareholder's Equity 6
Condensed Statements of Cash Flows 7
Notes to Condensed Financial Statements 8
Item 2. Management's Narrative Analysis of the Results of
Operations and Financial Condition 47
Item 4. Controls and Procedures 60
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 61
Item 6. Exhibits 61
Signatures 64
2
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements
Condensed Statements of Income
(Unaudited)
(Millions)
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
----------------- ---------------- ----------------- ----------------
Revenue:
Premiums $ 6.6 $ $ 6.5 $ 19.0 $ 21.3
Fee income 148.7 108.7 417.8 285.8
Net investment income 266.0 272.2 829.9 838.2
Net realized capital gains 13.7 15.8 32.7 10.8
Other income 0.8 3.1 2.3 7.2
----------------- ---------------- ----------------- ----------------
Total revenue 435.8 406.3 1,301.7 1,163.3
----------------- ---------------- ----------------- ----------------
Benefits, losses and expenses:
Benefits:
Interest credited and other benefits to policyholders 276.4 272.4 852.6 809.9
Underwriting, acquisition, and insurance expenses:
General expenses 56.8 49.1 166.7 155.2
Commissions 140.1 91.2 383.0 236.3
Policy acquisition costs deferred (158.2) (132.6) (433.1) (345.1)
Amortization of deferred policy acquisition costs
and value of business acquired 76.6 88.5 178.0 236.1
Other:
Expense and charges reimbursed under modified
coinsurance agreements 0.8 0.3 1.5 0.5
Interest expense 3.0 4.8 10.3 12.3
----------------- ---------------- ----------------- ----------------
Total benefits, losses and expenses 395.5 373.7 1,159.0 1,105.2
----------------- ---------------- ----------------- ----------------
Income before income taxes and cumulative effect
of change in accounting principle 40.3 32.6 142.7 58.1
Income tax expense 37.2 3.8 70.4 10.7
----------------- ---------------- ----------------- ----------------
Income before cumulative effect of change
in accounting principle 3.1 28.8 72.3 47.4
Cumulative effect of change in accounting principle,
net of tax - - (2.3) -
----------------- ---------------- ----------------- ----------------
Net income $ 3.1 $ 28.8 $ 70.0 $ 47.4
================= ================ ================= ================
The accompanying notes are an integral part of these financial statements.
3
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Balance Sheets
(Unaudited)
(Millions, except share data)
September 30, December 31,
2004 2003
----------------- -----------------
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost of
$16,172.1 at 2004 and $15,025.0 at 2003) $ 16,628.5 $ 15,538.7
Equity securities available for sale, at fair value:
Common stock (cost of $16.4 at 2004 and $13.5 at 2003) 16.9 13.7
Preferred stock (cost of $6.4 at 2004 and $1.5 at 2003) 6.6 1.7
Investment in mutual funds (cost of $1.6 at 2004 and $100.5 at 2003) 1.7 104.8
Mortgage loans on real estate 3,706.2 3,388.7
Real estate 1.8 4.5
Policy loans 171.4 177.1
Short-term investments 28.5 0.3
Other investments 168.0 56.0
Securities pledged (amortized cost of $1,427.1 at 2004 and $555.5 at 2003) 1,454.3 559.1
----------------- -----------------
Total investments 22,183.9 19,844.6
Cash and cash equivalents 42.5 65.1
Short-term investments under securities loan agreement 825.9 22.9
Accrued investment income 209.3 185.7
Reinsurance recoverable 990.0 651.9
Receivable for securities sold 172.5 11.7
Deferred policy acquisition costs 1,534.4 1,826.7
Value of business acquired 105.3 111.5
Sales inducements to contractholders 487.6 -
Due from affiliates 199.5 117.7
Deferred income taxes - 28.6
Other assets 30.5 20.1
Assets held in separate accounts 21,708.7 18,220.1
----------------- -----------------
Total assets $ 48,490.1 $ 41,106.6
================= =================
The accompanying notes are an integral part of these financial statements.
4
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Balance Sheets
(Unaudited)
(Millions, except share data)
September 30, December 31,
2004 2003
----------------- ----------------
Liabilities and Shareholder's Equity
Policy liabilities and accruals:
Future policy benefits and claims reserves $ 22,092.5 $ 19,400.5
Notes to affiliates 35.0 35.0
Notes payable 14.0 -
Due to affiliates 30.7 60.7
Payables for securities purchased 253.6 -
Payables under securities loan agreement 825.9 22.9
Borrowed money 676.1 584.2
Current income taxes 16.0 19.4
Deferred income taxes 23.7 -
Other liabilities 263.9 226.6
Liabilities related to separate accounts 21,708.7 18,220.1
----------------- ----------------
Total liabilities 45,940.1 38,569.4
----------------- ----------------
Shareholder's equity
Common stock (250,000 shares authorized, issued and outstanding;
$10.00 per share value) 2.5 2.5
Additional paid-in capital 3,851.1 3,811.1
Accumulated other comprehensive income 92.8 190.0
Retained deficit (1,396.4) (1,466.4)
----------------- ----------------
Total shareholder's equity 2,550.0 2,537.2
----------------- ----------------
Total liabilities and shareholder's equity $ 48,490.1 $ 41,106.6
================= ================
The accompanying notes are an integral part of these financial statements.
5
ING USA Annuity and Life Insurance Company,
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Statements of Changes in Shareholder's Equity
(Unaudited)
(Millions)
Accumulated
Additional Other Total
Common Paid-In Comprehensive Retained Shareholder's
Stock Capital Income Deficit Equity
-------------- --------------- ---------------- -------------- ---------------
Balance at December 31, 2002 $ 2.5 $ 3,722.4 $ 135.1 $ (1,511.3) $ 2,348.7
Dividends paid - - (12.4) (12.4)
Contribution of capital - 88.7 - - 88.7
Comprehensive income:
Net income - - - 47.4 47.4
Other comprehensive income
net of tax:
Unrealized gain on securities
($164.0 pretax) - - 106.6 - 106.6
---------------
Comprehensive income - - - - 154.0
-------------- --------------- ---------------- -------------- ---------------
Balance at September 30, 2003 $ 2.5 $ 3,811.1 $ 241.7 $ (1,476.3) $ 2,579.0
============== =============== ================ ============== ===============
Balance at December 31, 2003 $ 2.5 $ 3,811.1 $ 190.0 $ (1,466.4) $ 2,537.2
Contribution of capital - 40.0 - - 40.0
Comprehensive loss:
Net income - - - 70.0 70.0
Other comprehensive loss
net of tax:
Unrealized loss on securities
(($149.5) pretax) - - (97.2) - (97.2)
---------------
Comprehensive loss (27.2)
-------------- --------------- ---------------- -------------- ---------------
Balance at September 30, 2004 $ 2.5 $ 3,851.1 $ $ 92.8 $ (1,396.4) $ 2,550.0
============== =============== ================ ============== ===============
The accompanying notes are an integral part of these financial statements.
6
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Statements of Cash Flows
(Unaudited)
(Millions)
Nine months ended September 30,
2004 2003
------------------ ------------------
Net cash provided by operating activities $ 989.1 $ 560.1
Cash Flows from Investing Activities:
Proceeds from the sale, maturity, or redemption of:
Fixed maturities, available for sale 15,034.9 15,961.6
Equity securities, available for sale 104.0 12.0
Mortgage loans on real estate originated 303.7 402.2
Short-term investments 2,798.1 10,171.8
Acquisition of investments:
Fixed maturities, available for sale (17,118.0) (16,966.9)
Equity securities (8.1) (16.2)
Mortgage loans on real estate (625.2) (789.7)
Short-term investments (2,826.3) (10,318.8)
Policy loans 5.7 2.2
Proceeds from sale of real estate 2.7 1.4
Purchase of real estate - (2.7)
Other investments (107.2) (59.3)
Other - (0.4)
------------------ ------------------
Net cash used in investing activities (2,435.7) (1,602.8)
------------------ ------------------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 3,190.8 2,693.1
Maturities and withdrawals from investment contracts (1,597.6) (1,257.0)
Reinsurance recapture - 134.5
Transfers to separate accounts (315.1) (883.1)
Short-term loans 105.9 175.9
Intercompany dividends - (12.4)
Contribution of capital from Parent 40.0 88.7
------------------ ------------------
Net cash provided by financing activities 1,424.0 939.7
------------------ ------------------
Net decrease in cash and cash equivalents (22.6) (103.0)
Cash and cash equivalents, beginning of period 65.1 199.1
------------------ ------------------
Cash and cash equivalents, end of period $ 42.5 $ 96.1
================== ==================
Supplemental cash flow information:
Income taxes paid (received), net $ 8.0 $ (2.2)
================== ==================
Interest paid $ 10.0 $ 8.5
================== ==================
The accompanying notes are an integral part of these financial statements.
7
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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1. Significant Accounting Policies
Basis of Presentation
ING USA Annuity and Life Insurance Company ("ING USA" or the "Company"), a
wholly-owned subsidiary of Lion Connecticut Holdings Inc. ("Lion" or
"Parent"), is a stock life insurance company organized under the laws of
the State of Iowa. ING USA was originally incorporated under the laws of
the State of Minnesota on January 2, 1973, in the name of St. Paul Life
Insurance Company. On December 21, 1993, the Company redomesticated from
Minnesota to Delaware.
On January 1, 2004, the Company redomesticated from Delaware to Iowa. In
addition, on January 1, 2004 (the "merger date"), Equitable Life Insurance
Company of Iowa ("Equitable Life"), USG Annuity & Life Company ("USG") and
United Life & Annuity Insurance Company ("ULA") (the "Merger Companies"),
merged with and into Golden American Life Insurance Company ("Golden
American"). Immediately after the merger, Golden American changed its name
to ING USA Annuity and Life Insurance Company. As of the merger date, the
Merger Companies ceased to exist and were merged into ING USA.
Lion is an indirect, wholly-owned subsidiary of ING Groep N.V. ("ING"), a
global financial services holding company based in The Netherlands. ING USA
is authorized to do business in the District of Columbia and all states
except New York. ING USA is licensed as a life insurance company under the
laws of the State of Delaware until December 31, 2003 and Iowa since
January 1, 2004.
Prior to the merger date, ING USA was a wholly-owned subsidiary of
Equitable Life from December 30, 2001 through December 31, 2003. Formerly,
from October 24, 1997, until December 30, 2001, Equitable of Iowa
Companies, Inc. ("EIC" or "Former Holding Company") directly owned 100% of
Golden American's stock.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("FAS 141"), excludes transfers of net assets or exchanges of
shares between entities under common control, and notes that certain
provisions under Accounting Principles Board Opinion No. 16, "Business
Combinations" ("APB 16"), provide a source of guidance for such
transactions. In accordance with APB 16, financial information of the
combined entity is presented as if the entities had been combined for the
full year, and all comparative financial statements are restated and
presented as if the entities had previously been combined, in a manner
similar to a pooling-of-interests.
The unaudited condensed financial statements have been prepared in a manner
similar to a pooling-of-interests, in accordance with the provisions of APB
16 in order to present the condensed financial position and results of
operations of the Company and the Merger Companies, as if the entities had
previously been combined. The unaudited condensed balance sheets and
statements of income give effect to the consolidation transaction as if it
had occurred on December 31, 2003 and January 1, 2003, respectively.
8
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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The condensed financial statements and notes as of September 30, 2004 and
December 31, 2003 and for the three and nine-month periods ended September
30, 2004 and 2003 ("interim periods"), have been prepared in accordance
with U.S. generally accepted accounting principles and are unaudited. The
condensed financial statements reflect all normal adjustments (consisting
only of normal recurring accruals) which are, in the opinion of management,
necessary for the fair presentation of the financial position, results of
operations and cash flows for the interim periods. The results of
operations for the interim periods may not be considered indicative of
results to be expected for the full year.
Description of Business
The Company offers various insurance products including deferred and
immediate annuities, variable annuities, interest sensitive and traditional
life insurance, and health insurance. All health insurance is ceded to
other insurers. The Company's products are marketed by broker/dealers,
financial institutions, insurance agents, and a career agency force. The
Company's primary customers are consumers and corporations.
Recently Adopted Accounting Standards
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts
The Company adopted Statement of Position ("SOP") 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts," on January 1, 2004. SOP 03-1
establishes several new accounting and disclosure requirements for certain
nontraditional long-duration contracts and for separate accounts including,
among other things, a requirement that assets and liabilities of separate
account arrangements that do not meet certain criteria be accounted for as
general account assets and liabilities, and that the revenue and expenses
related to such arrangements be consolidated within the respective line
items in the Condensed Statements of Income. In addition, the SOP requires
additional liabilities be established for certain guaranteed death and
other benefits and for products with certain patterns of cost of insurance
charges, and that sales inducements provided to contractholders be
recognized on the balance sheet separately from deferred acquisition costs
and amortized as a component of benefits expense using methodology and
assumptions consistent with those used for amortization of deferred policy
acquisition costs.
The Company evaluated all requirements of SOP 03-1 and determined that it
is affected by the SOP's requirements to establish additional liabilities
for certain guaranteed benefits and products with patterns of cost
insurance charges resulting in losses in later policy durations from the
insurance benefit function and to defer, amortize, and recognize
separately, sales inducements to contractholders. Requirements for certain
separate account arrangements that do not meet the established criteria for
separate asset and liability recognition are applicable to the Company,
however, the Company's policies on separate account assets and liabilities
have historically been, and continue to be, in conformity with the
9
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
requirements newly established. Upon adoption of the SOP, the Company
recognized a cumulative effect of a change in accounting principle of
$(3.6) million, before tax or $(2.3) million, net of $1.3 million of income
taxes, as of January 1, 2004.
The implementation of SOP 03-1 raised questions regarding the
interpretation of the requirements of Financial Accounting Standard ("FAS")
No. 97, concerning when it is appropriate to record an unearned revenue
liability related to the insurance benefit function. To clarify its
position, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position No. FAS 97-1 ("FSP FAS 97-1"), "Situations in Which
Paragraphs 17(b) and 20 of FASB Statement No. 97, `Accounting and Reporting
by Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments,' Permit or Require
Accrual of an Unearned Revenue Liability," effective for fiscal periods
beginning subsequent to the date the guidance was issued, June 18, 2004.
The Company adopted FSP FAS 97-1 on July 1, 2004 and has evaluated the
impact of the guidance on whether the Company is required to establish an
unearned revenue reserve on its existing and new business. The adoption of
FSP FAS 97-1 did not have an impact on the Company's financial position,
results of operations or cash flows.
The Meaning of Other Than Temporary Impairment and its Application to
Certain Investments
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF Issue No. 03-1 ("EITF 03-1"), "The Meaning of Other Than Temporary
Impairment and Its Application to Certain Investments," requiring that a
three-step impairment model be applied to securities within its scope. The
three-step model is to be applied on a security-by-security basis as
follows:
Step 1: Determine whether an investment is impaired. An investment is
impaired if the fair value of the investment is less than its
cost basis.
Step 2: Evaluate whether an impairment is other than temporary.
Step 3: If the impairment is other than temporary, recognize an
impairment loss equal to the difference between the investment's
cost and its fair value.
On September 30, 2004, the FASB issued FASB Staff Position No. EITF Issue
03-1-1 ("FSP EITF 03-1-1"), "Effective Date of Paragraphs 10-20 of EITF
Issue No. 03-1, `The Meaning of Other Than Temporary Impairment and Its
Application to Certain Investments,'" which delayed EITF 03-1's original
effective date of July 1, 2004 for the paragraphs of the guidance
surrounding steps two and three of the impairment model introduced. The
delay is in effect until a final consensus can be reached on such guidance.
Despite the delay of the implementation of steps two and three, other than
temporary impairments are still to be recognized as required by existing
guidance.
10
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Earlier consensus reached by the EITF on this issue required that certain
quantitative and qualitative disclosures be made for unrealized losses on
debt and equity securities that have not been recognized as other than
temporary impairments. These disclosures were adopted by the Company,
effective December 31, 2003, and included in the Investments footnote of
the Notes to Condensed Financial Statements included in the Company's
December 31, 2003 Form 10-K. In addition to the disclosure requirements
adopted by the Company effective December 31, 2003, the final consensus of
EITF 03-1 reached in March 2004 included additional disclosure requirements
that are effective for annual financial statements for fiscal years ending
after June 15, 2004.
Accounting for Derivative Instruments and Hedging Activities
In 2003, the Derivative Implementation Group ("DIG") responsible for
issuing guidance on behalf of the FASB for implementation of FAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" issued
Statement Implementation Issue No. B36, "Embedded Derivatives: Modified
Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk
Exposures That Are Unrelated or Only Partially Related to the Credit
Worthiness of the Obligor under Those Instruments" ("DIG B36"). Under this
interpretation, modified coinsurance and coinsurance with funds withheld
reinsurance agreements as well as other types of receivables and payables
where interest is determined by reference to a pool of fixed maturity
assets or total return debt index may be determined to contain embedded
derivatives that are required to be bifurcated. The Company adopted DIG B36
on October 1, 2003 and has modified coinsurance treaties that are
applicable to the guidance. The applicable contracts, however, were
determined to generate embedded derivatives with a fair value of zero.
Therefore, the guidance, while implemented, did not impact the Company's
financial position, results of operations, or cash flows.
Variable Interest Entities
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46). In December 2003, the FASB modified
FIN 46 to make certain technical corrections and address certain
implementation issues that had arisen. FIN 46 provides a new framework for
identifying variable interest entities (VIEs) and determining when a
company should include the assets, liabilities, noncontrolling interests
and results of activities of a VIE in its consolidated financial
statements.
In general, a VIE is a corporation, partnership, limited-liability
corporation, trust, or any other legal structure used to conduct activities
or hold assets that either (1) has an insufficient amount of equity to
carry out its principal activities without additional subordinated
financial support, (2) has a group of equity owners that are unable to make
significant decisions about its activities, or (3) has a group of equity
owners that do not have the obligation to absorb losses or the right to
receive returns generated by its operations.
11
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
FIN 46 requires a VIE to be consolidated if a party with an ownership,
contractual or other financial interest in the VIE (a variable interest
holder) is obligated to absorb a majority of the risk of loss from the
VIE's activities, is entitled to receive a majority of the VIE's residual
returns (if no party absorbs a majority of the VIE's losses), or both. A
variable interest holder that consolidates the VIE is called the primary
beneficiary. Upon consolidation, the primary beneficiary generally must
initially record all of the VIE's assets, liabilities and noncontrolling
interests at fair value and subsequently account for the VIE as if it were
consolidated based on majority voting interest. FIN 46 also requires
disclosures about VIEs that the variable interest holder is not required to
consolidate but in which it has a significant variable interest.
At September 30, 2004, the Company held the following investments that, for
purposes of FIN 46, were evaluated and determined that the investments do
not require consolidation in the Company's financial statements:
(Millions)
Asset Type Purpose Book Value (1) Market Value
--------------------------------------------------- -------------------------- ---------------- ----------------
Private Corporate Securities - synthetic leases;
project financings; credit tenant leases Investment Holdings $ 3,188.3 $ 3,321.1
Foreign Securities - US VIE subsidiaries of
foreign companies Investment Holdings 556.1 587.6
Commercial Mortgage Obligations (CMO) Investment Holdings 3,051.7 3,101.4
Collateralized Debt Obligations (CDO) Investment Holdings and/or
Collateral Manager 73.7 69.3
Asset-Backed Securities (ABS) Investment Holdings 153.2 152.8
Commercial Mortgage Backed Securities (CMBS) Investment Holdings 1,027.3 1,066.0
(1) Represents maximum exposure to loss except for those structures for
which the Company also receives asset management fees.
New Accounting Pronouncements
In September 2004, the AICPA issued Technical Practice Aid 6300.05 -
6300.08 "Q&As Related to the Implementation of SOP 03-1, Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" (the "TPA"). The TPA provides
additional guidance regarding certain implicit assessments that may be used
in testing of the base mortality function on contracts, which is performed
to determine whether additional liabilities are required in conjunction
with SOP 03-1. In addition, the TPA provides additional guidance
surrounding the allowed level of aggregation of additional liabilities
determined under the SOP. The Company is currently evaluating the impact of
the TPA on the cumulative effect of a change in accounting principle
recognized on January 1, 2004, and anticipates a potential decrease in the
net liability established as part of the accounting change. The TPA will be
fully implemented during the fourth quarter 2004 and will be reported as a
cumulative effect of a change in accounting principle applied retroactively
to January 1, 2004.
12
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from reported results using those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, money market instruments
and other debt issues with a maturity of 90 days or less when purchased.
Investments
All of the Company's fixed maturity and equity securities are currently
designated as available-for-sale. Available-for-sale securities are
reported at fair value and unrealized gains and losses on these securities
are included directly in shareholder's equity, after adjustment for related
charges in deferred policy acquisition costs, value of business acquired,
and deferred income taxes.
The Company analyzes the general account investments to determine whether
there has been an other than temporary decline in fair value below the
amortized cost basis in accordance with FAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." Management considers
the length of the time and the extent to which the market value has been
less than cost; the financial condition and near-term prospects of the
issuer; future economic conditions and market forecasts; and the Company's
intent and ability to retain the investment in the issuer for a period of
time sufficient to allow for recovery in market value. If it is probable
that all amounts due according to the contractual terms of a debt security
will not be collected, an other than temporary impairment is considered to
have occurred.
In addition, the Company invests in structured securities that meet the
criteria of Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets." Under EITF Issue No.
99-20, a determination of the required impairment is based on credit risk
and the possibility of significant prepayment risk that restricts the
Company's ability to recover the investment. An impairment is recognized if
the fair value of the security is less than amortized cost and there has
been an adverse change in cash flow since the remeasurement date. When a
decline in fair value is determined to be other than temporary, the
individual security is written down to fair value and the loss is accounted
for as a realized loss.
Realized capital gains and losses on all other investments are included in
the Condensed Statements of Income. Unrealized capital gains and losses on
all other investments are reflected in shareholder's equity, net of related
income taxes.
13
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Purchases and sales of fixed maturities and equity securities (excluding
private placements) are recorded on the trade date. Purchases and sales of
private placements and mortgage loans are recorded on the closing date.
Fair values for fixed maturities are obtained from independent pricing
services or broker/dealer quotations. Fair values for privately placed
bonds are determined using a matrix-based model. The matrix-based model
considers the level of risk-free interest rates, current corporate spreads,
the credit quality of the issuer and cash flow characteristics of the
security. The fair values for equity securities are based on quoted market
prices. For equity securities not actively traded, estimated fair values
are based upon values of issues of comparable yield and quality or
conversion value where applicable.
The Company engages in securities lending whereby certain securities from
its portfolio are loaned to other institutions for short periods of time.
Initial collateral, primarily cash, is required at a rate of 102% of the
market value of the loaned domestic securities. The collateral is deposited
by the borrower with a lending agent and retained and invested by the
lending agent according to the Company's guidelines to generate additional
income. The market value of the loaned securities is monitored on a daily
basis with additional collateral obtained or refunded as the market value
of the loaned securities fluctuates.
The Company engages in dollar repurchase agreements ("dollar rolls") and
repurchase agreements. These transactions involve a sale of securities and
an agreement to repurchase substantially the same securities as those sold.
Company policies require a minimum of 95% of the fair value of securities
pledged under dollar rolls and repurchase agreement transactions to be
maintained as collateral. Cash collateral received is invested in fixed
maturities and the offsetting collateral liability is included in borrowed
money on the Condensed Balance Sheets.
The Company enters into reverse repurchase agreements. These transactions
involve a purchase of securities and an agreement to sell substantially the
same securities as those purchased. Company policies require a minimum of
102% of the fair value of securities pledged under reverse repurchase
agreements to be pledged as collateral.
The investment in mutual funds represents an investment in mutual funds
managed by the Company, and is carried at fair value.
Mortgage loans on real estate are reported at amortized cost less
impairment writedowns. If the value of any mortgage loan is determined to
be impaired (i.e., when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement), the carrying value of the mortgage loan is reduced to the
present value of expected cash flows from the loan, discounted at the
loan's effective interest rate, or to the loan's observable market price,
or the fair value of the underlying collateral. The carrying value of the
impaired loans is reduced by establishing a permanent writedown charged to
realized loss.
14
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Investments in real estate are reported at historical cost, less
accumulated depreciation and impairment writedowns, with the exception of
land, which is not depreciated. If the value of any real estate is
determined to be impaired (i.e., when it is probable that the Company will
be unable to recover the carrying value of the real estate), the carrying
value of the real estate is reduced to the current fair value. The carrying
value of the impaired real estate is reduced by establishing a permanent
writedown charged to realized loss.
Policy loans are carried at unpaid principal balances, net of impairment
reserves.
Short-term investments, consisting primarily of money market instruments
and other fixed maturity issues purchased with an original maturity of 91
days to one year, are considered available for sale and are carried at fair
value, which approximates amortized cost.
The Company's use of derivatives is limited to hedging purposes which do
not qualify for hedge accounting treatment under FAS 133. The Company
enters into interest rate and currency contracts, including swaps, caps,
floors, options, futures, and embedded derivatives, to reduce and manage
risks associated with changes in value, yield, price, cash flow or exchange
rates of assets or liabilities held or intended to be held. Changes in the
fair value of open derivative contracts are recorded in net realized
capital gains and losses. Derivatives are included in Other investments on
the Condensed Balance Sheets.
On occasion, the Company sells call options written on underlying
securities that are carried at fair value. Changes in fair value of these
options are recorded in net realized capital gains or losses.
Deferred Policy Acquisition Costs and Value of Business Acquired
Deferred Policy Acquisition Costs ("DAC") is an asset, which represents
certain costs of acquiring certain insurance business, which are deferred
and amortized. These costs, all of which vary with and are primarily
related to the production of new and renewal business, consist principally
of commissions, certain underwriting and contract issuance expenses, and
certain agency expenses. Value of Business Acquired ("VOBA") is an asset,
which represents the present value of estimated net cash flows embedded in
the Company's contracts, which existed at the time the Company was acquired
by ING. DAC and VOBA are evaluated for recoverability at each balance sheet
date and these assets would be reduced to the extent that gross profits are
inadequate to recover the asset.
The amortization methodology varies by product type based upon two
accounting standards: FAS No. 60, "Accounting and Reporting by Insurance
Enterprises" ("FAS No. 60") and FAS No. 97, "Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and Realized
Gains and Losses from the Sale of Investments" ("FAS No. 97").
15
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Under FAS No. 60, acquisition costs for traditional life insurance
products, which primarily include whole life and term life insurance
contracts, are amortized over the premium payment period in proportion to
the premium revenue recognition.
Under FAS No. 97, acquisition costs for universal life and investment-type
products, which include universal life policies and fixed and variable
deferred annuities, are amortized over the life of the blocks of policies
(usually 25 years) in relation to the emergence of estimated gross profits
from surrender charges, investment margins, mortality and expense margins,
asset-based fee income, and actual realized gains (losses) on investments.
Amortization is adjusted retrospectively when estimates of current or
future gross profits to be realized from a group of products are revised.
DAC and VOBA are written off to the extent that it is determined that
future policy premiums and investment income or gross profits are not
adequate to cover related expenses.
Activity for the periods ended September 30, 2004 and 2003 within VOBA was
as follows:
(Millions)
Balance at December 31, 2002 $ 134.5
Adjustment for FAS No. 115 (0.2)
Interest accrued at 5% - 7% 5.0
Amortization (23.3)
--------------
Balance at September 30, 2003 $ 116.0
==============
Balance at December 31, 2003 $ 111.5
Adjustment for FAS No. 115 (5.8)
Interest accrued at 4% - 6% 5.2
Amortization (5.6)
--------------
Balance at September 30, 2004 $ 105.3
==============
The estimated amount of VOBA to be amortized, net of interest, over the
next five years is $2.7 million, $13.6 million, $13.4 million, $9.5 million
and $9.8 million for the years 2004, 2005, 2006, 2007 and 2008,
respectively. Actual amortization incurred during these years may vary as
assumptions are modified to incorporate actual results.
Separate Accounts
Separate Account assets and liabilities generally represent funds
maintained to meet specific investment objectives of contractholders who
bear the investment risk, subject, in limited cases, to certain minimum
guarantees. Investment income and investment gains and losses generally
accrue directly to such contractholders. The assets of each account are
legally segregated and are not subject to claims that arise out of any
other business of the Company.
16
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Separate Account assets supporting variable options under universal life
and annuity contracts are invested, as designated by the policyholder or
participant (who bears the investment risk subject, in limited cases, to
minimum guaranteed rates) under a contract in shares of mutual funds which
are managed by the Company, or in other selected mutual funds not managed
by the Company.
Separate Account assets and liabilities are carried at fair value and shown
as separate captions in the Condensed Balance Sheets. Deposits, investment
income and net realized and unrealized capital gains and losses of the
Separate Accounts are not reflected in the Condensed Financial Statements.
The Condensed Statements of Cash Flows do not reflect investment activity
of the Separate Accounts.
Assets and liabilities of separate account arrangements that do not meet
the criteria in SOP 03-1 for presentation in the separate caption in the
Condensed Balance Sheets (primarily guaranteed interest options), and
revenue and expenses related to such arrangements, are consolidated in the
financial statements with the general account. At September 30, 2004 and
2003, unrealized gains of $107.5 million and $143.4 million, respectively,
after taxes, on assets supporting a guaranteed interest option are
reflected in shareholder's equity.
Policy Liabilities and Accruals
Future policy benefits include reserves for universal life, immediate
annuities with life contingent payouts and traditional life insurance
contracts. Reserves for universal life products are equal to cumulative
deposits less withdrawals and charges plus credited interest thereon.
Reserves for traditional life insurance contracts represent the present
value of future benefits to be paid to or on behalf of policyholders and
related expenses less the present value of future net premiums.
Reserves for immediate annuities with life contingent payout contracts are
computed on the basis of assumed investment yield, mortality, and expenses,
including a margin for adverse deviations. Such assumptions generally vary
by plan, year of issue and policy duration. Reserve interest rates ranged
from 3.0% to 7.95% for all periods presented. Investment yield is based on
the Company's experience.
Mortality and withdrawal rate assumptions are based on relevant Company
experience and are periodically reviewed against both industry standards
and experience.
Other policyholders' fund include reserves for deferred annuity investment
contracts and immediate annuity without life contingent payouts. Reserves
on such contracts are equal to cumulative deposits less charges and
withdrawals plus credited interest thereon (rates range from 0.0% to 10.0%
for all periods presented) net of adjustments for investment experience
that the Company is entitled to reflect in future credited interest.
17
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts and are
higher than the contract's expected ongoing crediting rates for periods
after the inducement. As of January 1, 2004, such amounts are reported
separately on the balance sheet in accordance with SOP 03-1. Prior to 2004,
sales inducements were recorded as a component of DAC on the Condensed
Balance Sheet. Sales inducements are amortized as a component of benefit
expense using methodology and assumptions consistent with those used for
amortization of DAC.
Revenue Recognition
For universal life and certain annuity contracts, charges assessed against
policyholders' funds for the cost of insurance, surrender, expenses, and
other fees are recorded as revenue as charges are assessed against
policyholders. Other amounts received for these contracts are reflected as
deposits and are not recorded as revenue. Related policy benefits are
recorded in relation to the associated premiums or gross profit so that
profits are recognized over the expected lives of the contracts. When
annuity payments with life contingencies begin under contracts that were
initially investment contracts, the accumulated balance in the account is
treated as a single premium for the purchase of an annuity and reflected as
an offsetting amount in both premiums and current and future benefits in
the Condensed Statement of Income.
Reinsurance
The Company utilizes indemnity reinsurance agreements to reduce its
exposure to large losses in all aspects of its insurance business. Such
reinsurance permits recovery of a portion of losses from reinsurers,
although it does not discharge the primary liability of the Company as
direct insurer of the risks reinsured. The Company evaluates the financial
strength of potential reinsurers and continually monitors the financial
condition of reinsurers. Only those reinsurance recoverable balances deemed
probable of recovery are reflected as assets on the Company's Condensed
Balance Sheets.
Participating Insurance
Participating business approximates 10% of the Company's ordinary life
insurance in force and 27% of premium income. The amount of dividends to be
paid is determined annually by the Board of Directors. Amounts allocable to
participating policyholders are based on published dividend projections or
expected dividend scales. Dividends of $12.3 million and $12.8 million were
incurred during the nine months ended September 30, 2004 and 2003,
respectively.
18
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Income Taxes
The Company is taxed at regular corporate rates after adjusting income
reported for financial statement purposes for certain items. Deferred
income tax expenses/benefits result from changes during the year in
cumulative temporary differences between the tax basis and book basis of
assets and liabilities.
2. Investments
Fixed maturities and equity securities available for sale as of September
30, 2004 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- -------------- -------------- ---------------
Fixed maturities:
U.S. government and government
agencies and authorities $ 172.4 $ 1.5 $ 0.3 $ 173.6
State, municipalities and political
subdivisions 20.7 - 0.9 19.8
U.S. corporate securities:
Public utilities 1,794.6 78.2 8.6 1,864.2
Other corporate securities 7,309.4 298.4 27.9 7,579.9
--------------- -------------- -------------- ---------------
Total U.S. corporate securities 9,104.0 376.6 36.5 9,444.1
--------------- -------------- -------------- ---------------
Foreign securities:
Government 525.5 17.7 2.8 540.4
Other 2,423.4 95.2 11.5 2,507.1
--------------- -------------- -------------- ---------------
Total foreign securities 2,948.9 112.9 14.3 3,047.5
--------------- -------------- -------------- ---------------
Mortgage-backed securities 3,451.3 61.0 19.2 3,493.1
Other asset-backed securities 1,901.9 19.3 16.5 1,904.7
Total fixed maturities, including fixed
maturities pledged to creditors 17,599.2 571.3 87.7 18,082.8
Less: fixed maturities pledged to creditors 1,427.1 31.1 3.9 1,454.3
--------------- -------------- -------------- ---------------
Fixed maturities 16,172.1 540.2 83.8 16,628.5
Equity securities 24.4 0.9 0.1 25.2
--------------- -------------- -------------- ---------------
Total investments available for sale $ 16,196.5 $ 541.1 $ 83.9 $ 16,653.7
=============== ============== ============== ===============
19
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Fixed maturities and equity securities available for sale as of December
31, 2003 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- --------------- -------------- --------------
Fixed maturities:
U.S. government and government
agencies and authorities $ 195.5 $ 2.0 $ 0.1 $ 197.4
State, municipalities and political
subdivisions 31.7 - 2.5 29.2
U.S. corporate securities:
Public utilities 1,341.2 84.3 8.0 1,417.5
Other corporate securities 7,020.6 346.7 35.8 7,331.5
--------------- --------------- -------------- --------------
Total U.S. corporate securities 8,361.8 431.0 43.8 8,749.0
--------------- --------------- -------------- --------------
Foreign securities:
Government 487.1 21.7 3.9 504.9
Other 1,984.4 96.0 24.1 2,056.3
--------------- --------------- -------------- --------------
Total foreign securities 2,471.5 117.7 28.0 2,561.2
--------------- --------------- -------------- --------------
Mortgage-backed securities 3,247.0 66.7 21.8 3,291.9
Other asset-backed securities 1,273.0 17.2 21.1 1,269.1
Total fixed maturities, including fixed
maturities pledged to creditors 15,580.5 634.6 117.3 16,097.8
Less: fixed maturities pledged to creditors 555.5 6.4 2.8 559.1
--------------- --------------- -------------- --------------
Fixed maturities 15,025.0 628.2 114.5 15,538.7
Equity securities 115.5 4.7 - 120.2
--------------- --------------- -------------- --------------
Total investments available for sale $ 15,140.5 $ 632.9 $ 114.5 $ 15,658.9
=============== =============== ============== ==============
At September 30, 2004 and December 31, 2003, net unrealized appreciation is
$484.4 million and $522.0 million, respectively, on total fixed maturities,
including fixed maturities pledged to creditors, and equity securities.
20
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The aggregate unrealized losses and related fair values of total fixed
maturities, including fixed maturities pledged to creditors, and equity
securities with unrealized losses as of September 30, 2004, are shown below
by duration:
Unrealized Fair
Loss Value
------------ -------------
(Millions)
Duration category:
Less than six months below cost $ 13.2 $ 1,505.0
More than six months and less than
twelve months below cost 35.0 2,481.6
More than twelve months below cost 39.6 764.4
------------ -------------
Total $ 87.8 $ 4,751.0
============ =============
Of the unrealized losses less than 6 months in duration of $13.2 million,
there were $12.6 million in unrealized losses that are primarily related to
interest rate movement, or spread widening, for other than credit-related
reasons. Business and operating fundamentals are performing as expected.
The remaining losses of $0.6 million as of September 30, 2004, related to
securities under the guidance prescribed by EITF 99-20. This category
includes U.S. government-backed securities, principal protected securities,
and structured securities, which did not have an adverse change in cash
flows, for which the carrying amount was $259.2 million.
Of the unrealized losses more than 6 months and less than 12 months in
duration of $35.0 million, there were $30.1 million in unrealized losses
that are primarily related to interest rate movement, or spread widening,
for other than credit-related reasons. Business and operating fundamentals
are performing as expected. The remaining unrealized losses of $4.9 million
as of September 30, 2004, included the following significant items:
|X| $3.7 million of unrealized losses related to securities under the
guidance prescribed by EITF 99-20. This category includes U.S.
government-backed securities, principal protected securities, and
structured securities, which did not have an adverse change in cash
flows, for which the carrying amount was $243.1 million.
|X| $1.2 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $22.7 million.
Of the unrealized losses more than 12 months in duration of $39.6 million,
there were $33.7 million, in unrealized losses that are primarily related
to interest rate movement, or spread widening for other than credit-related
reasons. Business and operating fundamentals are performing as expected.
The remaining unrealized losses of $5.9 million as of September 30, 2004
included the following significant items:
|X| $3.4 million of unrealized losses related to securities under the
guidance prescribed by EITF 99-20. This category includes U.S.
government-backed securities, principal protected securities, and
structured securities, which did not have an adverse change in cash
flows, for which the carrying amount was $115.8 million.
21
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
|X| $1.1 million of unrealized losses relating to the airlines industry,
for which the carrying amount was $4.9 million.
|X| $1.4 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $5.6 million.
The amortized cost and fair value of total fixed maturities as of September
30, 2004 are shown below by contractual maturity. Actual maturities may
differ from contractual maturities because securities may be restructured,
called, or prepaid.
Amortized Fair
Cost Value
----------------- -----------------
(Millions)
Due to mature:
One year or less $ 303.6 $ 310.0
After one year through five years 3,772.7 3,880.5
After five years through ten years 3,954.5 4,146.5
After ten years 3,159.7 3,252.6
Mortgage-backed securities 4,506.8 4,588.5
Other asset-backed securities 1,901.9 1,904.7
Less: fixed maturities pledged
to creditors 1,427.1 1,454.3
----------------- -----------------
Fixed maturities $ 16,172.1 $ 16,628.5
================= =================
At September 30, 2004 and December 31, 2003, fixed maturities with fair
values of $13.4 million and $20.1 million, respectively, were on deposit as
required by regulatory authorities.
The Company did not have any investments in a single issuer, other than
obligations of the U.S. government, with a carrying value in excess of 10%
of the Company's shareholder's equity at September 30, 2004.
The Company enters into dollar repurchase agreement and repurchase
agreement transactions to increase its return on investments and improve
liquidity. At September 30, 2004 and December 31, 2003, the carrying value
of the securities pledged in dollar rolls and repurchase agreement
transactions was $663.0 million and $536.8 million, respectively. The
carrying value of the securities pledged in dollar rolls and repurchase
agreement transactions is included in pledged securities on the Condensed
Balance Sheets. The repurchase obligation totaled $691.2 million and $534.2
million at September 30, 2004 and December 31, 2003, respectively.
22
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The primary risk associated with short-term collateralized borrowings is
that the counterparty will be unable to perform under the terms of the
contract. The Company's exposure is limited to the excess of the net
replacement cost of the securities over the value of the short-term
investments, an amount that was not material at September 30, 2004. The
Company believes the counterparties to the dollar roll and reverse
repurchase agreements are financially responsible and that the counterparty
risk is immaterial.
During the three months ended September 30, 2004, the Company determined
that 47 fixed maturities had an other than temporary impairment. As a
result, for the three months ended September 30, 2004, the Company
recognized a pre-tax loss of $4.8 million to reduce the carrying value of
the fixed maturities to their fair value at the time of impairment. During
the three months ended September 30, 2003, the Company determined that 42
fixed maturities had other than temporary impairments. As a result, for the
three months ended September 30, 2003, the Company recognized a pre-tax
loss of $12.5 million to reduce the carrying value of the fixed maturities
to their fair value at the time of impairment.
During the nine months ended September 30, 2004, the Company determined
that 86 fixed maturities had an other than temporary impairment. As a
result, for the nine months ended September 30, 2004, the Company
recognized a pre-tax loss of $17.9 million to reduce the carrying value of
the fixed maturities to their fair value at the time of impairment. During
the nine months ended September 30, 2003, the Company determined that 188
fixed maturities had other than temporary impairments. As a result, for the
nine months ended September 30, 2003, the Company recognized a pre-tax loss
of $99.5 million to reduce the carrying value of the fixed maturities to
their fair value at the time of impairment.
The fair value of the remaining impaired fixed maturities at September 30,
2004 and 2003 is $173.4 million and $219.5 million, respectively.
3. Financial Instruments
Estimated Fair Value
The following disclosures are made in accordance with the requirements of
FAS No. 107, "Disclosures about Fair Value of Financial Instruments." FAS
No. 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it
is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value
or other valuation techniques.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In that
regard, the derived fair value estimates, in many cases, could not be
realized in immediate settlement of the instrument. FAS No. 107 excludes
certain financial instruments and all nonfinancial instruments from its
23
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
The following valuation methods and assumptions were used by the Company in
estimating the fair value of the above financial instruments:
Fixed maturities securities: The fair values for the actively traded
marketable bonds are determined based upon the quoted market prices. The
fair values for marketable bonds without an active market are obtained
through several commercial pricing services which provide the estimated
fair values. Fair values of privately placed bonds are determined using a
matrix-based pricing model. The model considers the current level of
risk-free interest rates, current corporate spreads, the credit quality of
the issuer and cash flow characteristics of the security. Also considered
are factors such as the net worth of the borrower, the value of collateral,
the capital structure of the borrower, the presence of guarantees and the
Company's evaluation of the borrower's ability to compete in their relevant
market. Using this data, the model generates estimated market values, which
the Company considers reflective of the fair value of each privately placed
bond.
Equity securities: Fair values of these securities are based upon quoted
market value.
Mortgage loans on real estate: The fair values for mortgage loans on real
estate are estimated using discounted cash flow analyses and rates
currently being offered in the marketplace for similar loans to borrowers
with similar credit ratings. Loans with similar characteristics are
aggregated for purposes of the calculations.
Real estate: The fair values for real estate are estimated using three
methods of review: a discounted cash flow analyses utilizing rates
currently being offered in the marketplace, market value/sales comparisons
of similar products in the subject property market, and cost to reproduce
the asset. These reviews are done periodically; however, a major event,
such as signing/loss of a tenant, physical change to the property, or local
governmental zoning or regulation changes, will trigger an immediate
valuation review.
Cash, short-term investments and policy loans: The carrying amounts for
these assets approximate the assets' fair values.
Assets held in separate accounts: Assets held in separate accounts are
reported at the quoted fair values of the individual securities in the
separate accounts.
Notes to affiliates: Estimated fair value of the Company's notes to
affiliates are based upon discounted future cash flows using a discount
rate approximating the current market value.
24
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Investment contract liabilities (included in future policy benefits and
claims' reserves):
With a fixed maturity: Fair value is estimated by discounting cash flows at
interest rates currently being offered by, or available to, the Company for
similar contracts.
Without a fixed maturity: Fair value is estimated as the amount payable to
the policyholder upon demand. However, the Company has the right under such
contracts to delay payment of withdrawals which may ultimately result in
paying an amount different than that determined to be payable on demand.
Liabilities related to separate accounts: Liabilities related to separate
accounts are reported at full account value in the Company's historical
balance sheet. Estimated fair values of separate account liabilities are
equal to their carrying amount.
The carrying values and estimated fair values of certain of the Company's
financial instruments at September 30, 2004 and December 31, 2003 were as
follows:
2004 2003
------------------------------- ------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------------- --------------- -------------- --------------
(Millions)
Assets:
Fixed maturity, including securities
pledged to creditors $ 18,082.8 $ 18,082.8 $ 16,097.8 $ 16,097.8
Equity securities 25.2 25.2 120.2 120.2
Mortgage loans on real estate 3,706.2 3,853.9 3,388.7 3,581.4
Real estate 1.8 2.0 4.5 4.8
Policy loans 171.4 171.4 177.1 177.1
Cash and short-term investments 896.9 896.9 88.3 88.3
Other investments 168.0 168.0 56.0 56.0
Assets held in separate accounts 21,708.7 21,708.7 18,220.1 18,220.1
Liabilities:
Notes to affiliates 35.0 49.7 35.0 57.3
Investment contract liabilities:
Deferred annuities 17,333.5 16,210.9 16,072.4 15,069.0
Supplementary contracts and
immediate annuities 865.9 865.9 840.1 840.1
Liabilities related to separate accounts 21,708.7 21,708.7 18,220.1 18,220.1
Fair value estimates are made at a specific point in time, based on
available market information and judgments about various financial
instruments, such as estimates of timing and amounts of future cash flows.
Such estimates do not reflect any premium or discount that could result
from offering for sale at one time the Company's entire holdings of a
particular financial instrument, nor do they consider the tax impact of the
realization of unrealized gains or losses. In many cases, the fair value
estimates cannot be substantiated by comparison to independent markets, nor
can the disclosed value be realized in immediate settlement of the
instruments. In evaluating the Company's management of interest rate, price
25
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
and liquidity risks, the fair values of all assets and liabilities should
be taken into consideration, not only those presented above.
Derivative Financial Instruments
Interest Rate Caps
Interest rate caps are used to manage the interest rate risk in the
Company's bond portfolio. Interest rate caps are purchased contracts that
provide the Company with an annuity in an increasing interest rate
environment. The notional amount of the Company's open interest rate caps
as of September 30, 2004 was $736.2 million. Carrying value and estimated
fair value of the open interest rate caps was minimal. The notional amount,
carrying value and estimated fair value (liabilities are denoted with
parentheses) of the Company's open interest rate caps as of December 31,
2003 were $1,036.2 million, $20.0 thousand and $20.0 thousand,
respectively.
Interest Rate Swaps
Interest rate swaps are used to manage the interest rate risk in the
Company's bond portfolio as well as the Company's liabilities. Interest
rate swaps represent contracts that require the exchange of cash flows at
regular interim periods, typically monthly or quarterly. The notional
amount, carrying value and estimated fair value of the Company's open
interest rate swaps as of September 30, 2004 were $2,263.1 million, $26.9
million and $26.9 million, respectively. The notional amount, carrying
value and estimated fair value of the Company's open interest rate swaps as
of December 31, 2003 were $1,266.5 million, $(91.2) million and $(91.2)
million, respectively.
Futures
Futures contracts are used to hedge against a decrease in certain indexes.
Such decrease results in increased reserve liabilities, and the futures
offset this increased expense. The underlying reserve liabilities are
carried at market value with the change in value running through the
statement of income, which is offset by the daily cash movement of the
futures. The notional amount, carrying value and estimated fair value of
the Company's open interest rate swaps as of September 30, 2004, were
$(1,165.2) million, $(1.9) million and $(1.9) million, respectively. The
notional amount, carrying value and estimated fair value of the Company's
open interest rate swaps as of December 31, 2003, were $491.3 million, $0.8
million and $0.8 million, respectively.
Foreign Exchange Swaps
Foreign exchange swaps are used to reduce the risk of a change in the
value, yield or cash flow with respect to invested assets. Foreign exchange
swaps represent contracts that require the exchange of foreign currency
cash flows for US dollar cash flows at regular interim periods, typically
quarterly or semi-annually. The notional amount, carrying value and
26
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
estimated fair value of the Company's open foreign exchange rate swaps as
of September 30, 2004 were $146.7 million, $(22.3) million and $(22.3)
million, respectively. The notional amount, carrying value and estimated
fair value of the Company's open foreign exchange rate swaps as of December
31, 2003 were $128.2 million, $(19.4) million and $(19.4) million,
respectively.
Options
S&P Options are used to hedge against an increase in the S&P Index. Such
increase results in increased reserve liabilities, and the options offset
this increased expense. The options are accounted for in a consistent
manner with the underlying reserve liabilities, both of which are carried
at fair value with the change in value running through the statement of
income. If the options mature in the money, the amount received is recorded
in income to offset the increased expense for the reserve liabilities. The
notional amount, carrying value and estimated fair value of the Company's
open options as of September 30, 2004 were $2,047.8 million, $109.7
million, and $109.7 million, respectively. The notional amount, carrying
value and estimated fair value of the Company's open options as of December
31, 2003 were $1,287.8 million, $100.9 million, and $100.9 million,
respectively.
Embedded Derivatives
The Company also had investments in certain fixed maturity instruments and
retail annuity products that contain embedded derivatives, including those
whose market value is at least partially determined by, among other things,
levels of or changes in domestic and/or foreign interest rates (short- or
long-term), exchange rates, prepayment rates, equity markets or credit
ratings/spreads. The estimated fair value of the embedded derivatives
within securities as of September 30, 2004 and December 31, 2003 was $(2.6)
thousand and $(1,055.9) thousand, respectively. The estimated fair value of
the embedded derivatives within retail annuity products as of September 30,
2004 and December 31, 2003, was $384.8 million and $238.9 million,
respectively.
27
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
4. Net Investment Income
Sources of net investment income were as follows:
Three months Three months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Fixed maturities $ 249.8 $ 239.3
Equity securities 0.1 0.1
Mortgage loans 54.0 50.9
Policy loans 1.2 3.5
Short-term investments and cash equivalents 0.5 0.7
Other (21.4) (5.3)
------------------ -----------------
Gross investment income 284.2 289.2
Less: investment expenses (18.2) (17.0)
------------------ -----------------
Net investment income $ 266.0 $ 272.2
================== =================
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Fixed maturities $ 722.5 $ 724.2
Equity securities 0.2 2.7
Mortgage loans 164.3 153.1
Real estate 0.2 0.5
Policy loans 6.1 7.3
Short-term investments and cash equivalents 1.1 2.0
Other (12.0) (4.8)
------------------ -----------------
Gross investment income 882.4 885.0
Less: investment expenses (52.5) (46.8)
------------------ -----------------
Net investment income $ 829.9 $ 838.2
================== =================
5. Dividend Restrictions and Shareholder's Equity
The Company's ability to pay dividends to its Parent is subject to the
prior approval of insurance regulatory authorities for payment of
dividends, which exceed an annual limit. The Company did not pay common
stock dividends during the period ended September 30, 2004 or the year
ended December 31, 2003.
28
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The Insurance Department of the State of Iowa (the "Department"), effective
January 1, 2004, recognizes as net income and capital and surplus those
amounts determined in conformity with statutory accounting practices
prescribed or permitted by the Department, which differ in certain respects
from accounting principles generally accepted in the United States.
Statutory net income was $68.0 million and $24.1 million, for the three
months ended September 30, 2004 and 2003, respectively. Statutory net
income (loss) was $55.4 million and $(36.3) million, for the nine months
ended September 30, 2004 and 2003, respectively. Statutory capital and
surplus was $1,224.8 million and $1,071.0 million as of September 30, 2004
and 2003, respectively.
As of September 30, 2004, the Company does not utilize any statutory
accounting practices, which are not prescribed by state regulatory
authorities that, individually or in the aggregate, materially affect
statutory capital and surplus.
6. Capital Gains and Losses
Realized capital gains and losses are comprised of the difference between
the carrying value of investments and proceeds from sale, maturity, and
redemption, as well as losses incurred due to the impairment of
investments. Net realized capital gains (losses) on investments were as
follows:
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
----------------- -----------------
Fixed maturities $ 30.7 $ 98.3
Equity securities 5.4 (1.0)
Derivatives (1.3) (83.5)
Real estate - (2.7)
Other (2.1) (0.3)
----------------- -----------------
Pretax realized capital gains 32.7 10.8
================= =================
After-tax realized capital gains $ 21.3 $ 7.0
================= =================
Proceeds from the sale of total fixed maturities and equity securities and
the related gross gains and losses were as follows:
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Proceeds on sales $ 8,536.5 $ 11,295.6
Gross gains 115.9 257.0
Gross losses 52.2 49.0
29
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Changes in shareholder's equity related to changes in accumulated other
comprehensive income were as follows:
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Fixed maturities $ (33.7) $ 35.5
Equity securities (4.4) 7.4
DAC/VOBA (67.1) 101.1
Derivatives 4.6 3.0
Sales inducements (8.7) -
Other 0.1 (0.1)
------------------ -----------------
Subtotal (109.2) 146.9
Decrease (increase) in deferred
income taxes 12.0 (40.3)
------------------ -----------------
Net changes in accumulated other
comprehensive income $ (97.2) $ 106.6
================== =================
Shareholder's equity included the following accumulated other comprehensive
income:
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Net unrealized capital gains (losses):
Fixed maturities $ 483.5 $ 643.3
Equity securities 0.9 4.0
DAC/VOBA (277.7) (260.8)
Derivatives (9.4) (24.7)
Sales inducements (8.7) -
Other 0.1 0.2
------------------ -----------------
Subtotal 188.7 362.0
Less: deferred income taxes 95.9 120.3
------------------ -----------------
Net accumulated other comprehensive income $ 92.8 $ 241.7
================== =================
30
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Changes in accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities, were as follows:
Nine months ended
September 30,
(Millions) 2004 2003
----------------- -----------------
Unrealized holding gains (losses) arising
during the year (1) $ (37.2) $ 197.9
Less: reclassification adjustment for gains
and other items included in net income (2) 60.0 91.3
----------------- -----------------
Net unrealized gains (losses) on securities $ (97.2) $ 106.6
================= =================
(1) Pretax unrealized holding gains (losses) arising during the period
were $(57.2) million and $304.5 million for the nine months ended
September 30, 2004 and 2003, respectively.
(2) Pretax reclassification adjustments for gains and other items included
in net income were $92.3 million and $140.5 million for the nine
months ended September 30, 2004 and 2003, respectively.
7. Additional Insurance Benefits and Minimum Guarantees
Under SOP 03-1, the Company calculates additional liabilities ("SOP
reserves") for certain guaranteed benefits and for Universal Life products
with certain patterns of cost of insurance charges. The SOP reserve
recognized for such products is in addition to the liability previously
held (the Account Value) and is to recognize the portion of contract
assessments received in early years used to compensate the insurer for
services provided in later years.
ING USA calculates a benefit ratio for each block of business subject to
the SOP, and calculates an SOP reserve by accumulating amounts equal to the
benefit ratio multiplied by the assessments for each period, reduced by
excess death benefits during the period. The SOP reserve is accumulated at
interest using the contract-credited rate for the period. The calculated
reserve includes a provision for universal life contracts with patterns of
cost of insurance charges that produce expected gains from the insurance
benefit function followed by losses from that function in later years.
31
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The SOP reserve for annuities with minimum guaranteed death benefits
("MGDB") is determined each period by estimating the expected value of
death benefits in excess of the projected account balance and recognizing
the excess ratably over the accumulation period based on total expected
assessments. The Company regularly evaluates estimates used to adjust the
additional liability balance, with a related charge or credit to benefit
expense, if actual experience or other evidence suggests that earlier
assumptions should be revised. The following assumptions and methodology
were used to determine the MGDB SOP reserve at September 30, 2004:
Area Assumptions/Basis for Assumptions
--------------------------- --------------------------------------
Data used Based on 101 investment performance
scenarios stratified based on 10,000
random generated scenarios
Mean investment performance 8.5%
Volatility 18.0%
Mortality 6.0%, 60.0%, 75.0%, 75.0% of the 90-95
ultimate mortality table for standard,
rachet, rolup and combination rollup
and rachet, respectively
Lapse rates Vary by contract type and duration;
range between 1.0% and 40.0%
Discount rates 6.5%, based on the portfolio earned
rate of the general account
The SOP reserve for annuities with guaranteed minimum accumulation benefits
("GMAB") and guaranteed minimum withdrawal benefits ("GMWB") are considered
to be derivatives under Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," and are recognized at fair value
through earnings.
The SOP reserve for the guaranteed minimum income benefits ("GMIB") is
determined each period by estimating the expected value of the annutization
benefits in excess of the projected account balance at the date of
annuitization and recognizing the excess ratably over the accumulation
period based on total expected assessments. The Company regularly evaluates
estimates used and adjusts the additional liability balance, with a related
charge or credit to benefit expense, if the actual experience or other
evidence suggests that earlier assumptions should be revised. The
assumptions used for calculating the additional GMIB liability at September
30, 2004, are consistent with those used for the calculating the additional
MGDB liability. In addition, the calculation of the GMIB liability assumes
dynamic surrenders and dynamic annuitization reflecting the extent to which
the benefit, at the time of payment, has a positive value.
32
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The separate account liabilities subject to SOP 03-1 for minimum guaranteed
benefits, and the additional liabilities recognized related to minimum
guarantees, by type, as of September 30, 2004, and the paid and incurred
amounts by type for the nine months ended September 30, 2004 are as
follows:
Minimum Guaranteed Guaranteed
Guaranteed Minimum Minimum
Death Accumulation/ Income
Benefit Withdrawal Benefit Benefit
(MGDB) (GMAB/GMWB) (GMIB)
-------------- --------------------- --------------
Separate account liability
balance $ 21,708.7 $ 1,544.6 $ 7,371.0
============== ===================== ==============
Additional liability balance:
Balance at January 1, 2004 $ 56.5 $ 14.5 $ 13.6
Incurred guaranteed benefits 39.8 5.5 17.1
Paid guaranteed benefits (24.8) - -
-------------- --------------------- --------------
Balance at September 30, 2004 $ 71.5 $ 20.0 $ 30.7
============== ===================== ==============
The net amount at risk (net of reinsurance) and the weighted average
attained age of contractholders by type of minimum guaranteed benefit, are
as follows as of September 30, 2004:
Minimum Guaranteed Guaranteed
Guaranteed Minimum Minimum
Death Accumulation/ Income
Benefit Withdrawal Benefit Benefit
(MGDB) (GMAB/GMWB) (GMIB)
-------------- --------------------- --------------
Net Amount at Risk (net of reinsurance) $ 1,811.4 $ 105.3 $ 352.7
Weighted Average Attained Age 64 59 59
The aggregate fair value of equity securities (including mutual funds),
supporting separate accounts with additional insurance benefits and minimum
investment return guarantees as of September 30, 2004 is $21,708.7 million.
8. Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts and are
higher than the contract's expected ongoing crediting rates for periods
after the inducement. Such amounts are reported separately on the balance
sheet as of January 1, 2004. Prior to 2004, these amounts were included in
DAC. Sales inducements are amortized as a component of benefit expense
using methodology and assumptions consistent with those used for
amortization of DAC. During the three months ended September 30, 2004, the
33
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Company capitalized and amortized $24.4 million and $24.5 million,
respectively, of sales inducements. During the nine months ended September
30, 2004, the Company capitalized and amortized $75.2 million and $64.7
million, respectively, of sales inducements. The unamortized balance of
capitalized sales inducements, net of unrealized gains and losses, is
$487.6 million as of September 30, 2004.
9. Income Taxes
Effective January 1, 2004, the Company files a stand-alone federal income
tax return. Prior to that date, the Company and each of the Merger
Companies, filed federal income tax returns with their respective filing
groups.
At September 30, 2004, the Company has operating loss carryforwards of
approximately $483.3 million net of a $42.9 million valuation allowance for
federal income tax purposes, which are available to offset future taxable
income. If not used, these carryforwards will expire between 2015 and 2019.
At September 30, 2004, the Company has capital loss carryforwards of
approximately $4.1 million for federal income tax purposes, which are
available to offset future capital gains. If not used, these carryforwards
will expire in 2009.
Income tax expense (benefit) from continuing operations included in the
condensed financial statements are as follows:
Three months Three months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Current tax (benefit):
Federal $ 4.7 $ 43.6
------------------ -----------------
Total current tax (benefit) 4.7 43.6
------------------ -----------------
Deferred tax (benefit):
Operations and capital loss carryforwards 19.5 -
Other federal deferred tax 13.0 (39.8)
------------------ -----------------
Total deferred tax (benefit) 32.5 (39.8)
------------------ -----------------
Total income tax expense (benefit) $ 37.2 $ 3.8
================== =================
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Current tax (benefit):
Federal $ 4.7 $ (0.9)
------------------ -----------------
Total current tax (benefit) 4.7 (0.9)
------------------ -----------------
Deferred tax:
Operations and capital loss carryforwards (17.1) -
Other federal deferred tax 82.8 11.6
------------------ -----------------
Total deferred tax 65.7 11.6
------------------ -----------------
Total income tax expense $ 70.4 $ 10.7
================== =================
34
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Income taxes were different from the amount computed by applying the
federal income tax rate to income from continuing operations before income
taxes for the following reasons:
Three months Three months
ended ended
September 30, September 30,
(Millions) 2004 2003
----------------- -----------------
Income before income taxes $ 40.3 $ 32.6
Tax rate 35% 35%
----------------- -----------------
Income tax at federal statutory rate 14.1 11.4
Tax effect of:
Meals and entertainment 0.2 0.2
Dividend received deduction 4.9 (7.8)
Valuation allowance for losses 15.0 -
Other 3.0 -
----------------- -----------------
Income taxes $ 37.2 $ 3.8
================= =================
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
----------------- -----------------
Income before income taxes $ 142.7 $ 58.1
Tax rate 35% 35%
----------------- -----------------
Income tax at federal statutory rate 50.0 20.3
Tax effect of:
Meals and entertainment 0.4 0.4
Dividend received deduction 2.0 (10.0)
Valuation allowance for losses 15.0 -
Other 3.0 -
----------------- -----------------
Income taxes $ 70.4 $ 10.7
================= =================
A valuation allowance has been provided for operating loss carryforwards
not expected to be utilized in the future as a result of publication of
clarifying tax guidance.
35
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at September 30, 2004 and December 31,
2003 are presented below:
(Millions) 2004 2003
----------------- -----------------
Deferred tax assets:
Operations and capital loss carryforwards $ 185.6 $ 168.5
Future policy benefits 303.7 470.7
Goodwill 9.6 9.8
Investments 14.2 20.5
Employee compensation and benefits 20.5 16.8
Other 31.0 33.4
----------------- -----------------
Total gross assets 564.6 719.7
Less valuation allowance 15.0 -
----------------- -----------------
Assets net of valuation allowance 549.9 719.7
----------------- -----------------
Deferred tax liabilities:
Unrealized gains on investments (111.4) (123.4)
Deferred policy acquisition cost (430.2) (529.1)
Value of purchased insurance in force (30.7) (38.3)
Other (1.0) (0.3)
----------------- -----------------
Total gross liabilities (573.3) (691.1)
----------------- -----------------
Net deferred income tax asset (liability) $ (23.7) $ 28.6
================= =================
The Internal Revenue Service has commenced examinations for the years 2000
and 2001. Management does not believe adverse consequences will result from
those examinations.
10. Benefit Plans
Defined Benefit Plan
ING North America Insurance Corporation ("ING North America") sponsors the
ING Americas Retirement Plan (the "Retirement Plan"), effective as of
December 31, 2001. Substantially all employees of ING North America and its
subsidiaries and affiliates (excluding certain employees) are eligible to
participate, including the Company's employees other than Company agents.
The Retirement Plan is a tax-qualified defined benefit plan, the benefits
of which are guaranteed (within certain specified legal limits) by the
Pension Benefit Guaranty Corporation ("PBGC"). As of January 1, 2002, each
participant in the Retirement Plan (except for certain specified employees)
earns a benefit under a final average compensation formula. Subsequent to
December 31, 2001, ING North America is responsible for all Retirement Plan
liabilities. The costs allocated to the Company for its employees'
participation in the Retirement Plan were $3.0 million and $2.2 million for
the three-month periods ended September 30, 2004 and 2003, respectively and
36
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
$8.5 million and $6.5 million for the nine-month periods ended September
30, 2004 and 2003, respectively.
Non-Qualified Retirement Plans
Through December 31, 2001, the Company, in conjunction with ING, offered
certain eligible employees a Supplemental Executive Retirement Plan and an
Excess Plan (collectively, the "SERPs"). The SERPs are non-qualified
defined benefit pension plans, which means all benefits are payable from
the general assets of the Company. SERP benefits are not guaranteed by the
PBGC. Benefit accruals under the SERPs ceased, effective as of December 31,
2001. Benefits under the SERPs are determined based on an eligible
employees years of service and such employee's average annual compensation
for the highest five years during the last ten years of employment. Pre-tax
charges of operations of the Company for the SERPs were $97.6 thousand and
$47.4 thousand for the three-month periods ended September 30, 2004 and
2003, respectively and $0.3 million and $0.1 million for the nine-month
periods ended September 30, 2004 and 2003, respectively.
The following tables summarize the benefit obligations and the funded
status for the SERP and the Excess Plan for the year ended December 31,
2003:
(Millions)
Change in Benefit Obligation:
Defined Benefit Obligation, January 1 $ 8.8
Interest cost 0.6
Benefits paid (0.4)
Actuarial (gain) loss on obligation 2.0
---------------
Defined Benefit Obligation, December 31 $ 11.0
===============
Funded status:
Funded status at December 31 $ (11.0)
Unrecognized past service cost (0.1)
Unrecognized net loss (1.8)
---------------
Net amount recognized $ (12.9)
===============
At December 31, 2003, the accumulated benefit obligation was $9.3 million.
The weighted-average assumptions used in the measurement of the benefit
obligation for the SERPs were as follows:
2004 2003
-------------- ---------------
Discount rate at beginning of period 6.25% 6.75%
Rate of compensation increase 3.75 3.75
37
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Net periodic benefit costs for the periods ended September 30, 2004 and
2003 were as follows:
Three months Three months
ended ended
September 30, September 30,
2004 2003
------------------- ------------------
(Millions)
Interest cost $ 0.2 $ 0.1
Unrecognized past service cost recognized in period (0.1) (0.1)
------------------- ------------------
Net periodic benefit cost $ 0.1 $ -
=================== ==================
Nine months Nine months
ended ended
September 30, September 30,
2004 2003
------------------- ------------------
(Millions)
Interest cost $ 0.5 $ 0.4
Unrecognized past service cost recognized in period (0.2) (0.3)
------------------- ------------------
Net periodic benefit cost $ 0.3 $ 0.1
=================== ==================
Contributions for the SERPs are expected to be $0.4 million during 2004.
Defined Contribution Plans
ING North America sponsors the ING Savings Plan and ESOP (the "Savings
Plan"). Substantially all employees of ING North America and its
subsidiaries and affiliates (excluding, among others, Career Agents) are
eligible to participate, including the Company's employees other than
Company agents. The Savings Plan is a tax-qualified profit sharing and
stock bonus plan, which includes an employee stock ownership plan ("ESOP")
component. Savings Plan benefits are not guaranteed by the PBGC. The
Savings Plan allows eligible participants to defer into the Savings Plan a
specified percentage of eligible compensation on a pre-tax basis. ING North
America matches such pre-tax contributions, up to a maximum of 6% of
eligible compensation. All matching contributions are subject to a 4-year
graded vesting schedule (although certain specified participants are
subject to a 5-year graded vesting schedule). All contributions made to the
Savings Plan are subject to certain limits imposed by applicable law.
Pre-tax charges to operations of the Company for the Savings Plan were $0.9
million and $0.7 million for the three-month periods ended September 30,
2004 and 2003, respectively and $2.8 million and $2.2 million for the
nine-month periods ended September 30, 2004 and 2003, respectively.
38
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Post-Retirement Benefits
In addition to providing pension benefits, the Company, in conjunction with
ING, provides certain health care and life insurance benefits for retired
employees and certain agents. Generally, retired employees and eligible
agents pay a portion of the cost of these post-retirement benefits, usually
based on their years of service with the Company. The amount a retiree or
eligible agent pays for such coverage is subject to change in the future.
The following tables summarize the benefit obligations and the funded
status for retired employees' and retired agents' post-retirement health
care benefits for the year ended December 31, 2003:
(Millions)
Change in Benefit Obligation:
Defined Benefit Obligation, January 1 $ 8.8
Service cost 0.5
Interest cost 0.6
Benefits paid (0.6)
Actuarial loss on obligation 0.7)
---------------
Defined Benefit Obligation, December 31 8.6
Funded status:
Funded status at December 31 (8.6)
Unrecognized losses (0.6)
Unrecognized past service cost 0.4
---------------
Net amount recognized $ (8.8)
===============
The medical health care trend rate was 10% for 2004, gradually decreasing
to 5.0% by 2009. Increasing the health care trend by 1% would increase the
benefit obligation by $0.5 million as of December 31, 2003. Decreasing the
health care trend rate by 1% would decrease the benefit obligation by $0.5
million as of December 31, 2003.
Net periodic benefit costs for the periods ended September 30, 2004 and
2003 were as follows:
Three months Three months
ended ended
September 30, September 30,
2004 2003
------------------- -------------------
(Millions)
Service cost $ 0.2 $ 0.1
Interest cost 0.1 0.1
Amortization of prior service costs (0.1) -
Curtailment gain or loss 0.3 -
------------------- -------------------
Net periodic benefit cost $ 0.5 $ 0.2
=================== ===================
39
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Nine months Nine months
ended ended
September 30, September 30,
2004 2003
------------------- -------------------
(Millions)
Service cost $ 0.5 $ 0.4
Interest cost 0.4 0.4
Amortization of prior service costs (0.1) -
Curtailment gain or loss 0.3 -
------------------- -------------------
Net periodic benefit cost $ 1.1 $ 0.8
=================== ===================
Contributions for retired employees' and retired agents' post-retirement
health care benefits are expected to be $0.5 million during 2004.
Substantive Change to Post Retirement Health and Welfare Plan
On August 1, 2004, the Post Retirement Health and Welfare Plan (the "Plan")
was amended to change the age and service required to qualify for benefits.
The Plan now requires five years of continuous service beginning on or
after age 50. Whereas previously service cost was attributed throughout the
employee's career with the Company, it will now be attributed beginning at
age 50. The change is accounted for as a negative plan amendment and
curtailment. A remeasurement was performed as of August 1, 2004, using best
estimate assumptions as of that date. The impact of the amendment and
subsequent remeasurement was as follows:
Accumulated post retirement benefit obligation $ 1.6
Unrecognized loss (gain) 0.6
Unrecognized past service cost (2.6)
--------------
Net (liability) asset $ (0.4)
==============
Net periodic cost for the quarter $ (0.2)
Net periodic cost year to date $ (0.2)
Effect of Recently Enacted Legislation
On December 8, 2003, President Bush signed into law the Medicare
Prescription Drug Improvement and Modernization Act of 2003 (the "Act").
The Act expands Medicare, primarily by including a prescription drug
benefit starting in 2006. Employers currently sponsoring such prescription
drug programs will have a range of options to potentially reduce program
costs. In May 2004, the FASB issued Staff Position No. 106-2, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003" (FSP FAS 106-2), which
superceded FSP FAS 106-1 and provides guidance on how companies should
account for the impact of the Act on postretirement health care plans. To
encourage employers to maintain postretirement drug benefits, beginning in
2006, the
40
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
federal government will provide non-taxable subsidy payments to employers
who sponsor retiree drug benefits that are "actuarially equivalent" to the
Medicare Part D benefits. The Company has determined that its
postretirement medical plan's prescription drug benefits are likely to
qualify as actuarially equivalent to Part D benefits. The resulting
subsidy, when received by the Company, will be passed through to the
retirees in the form of lower contributions on the part of plan
participants. The Company is currently in the process of amending the Plan
to reflect the reduction of participant contributions, and therefore, the
subsidy is not expected to have a significant impact on the Company's
financial position or results of operations.
11. Related Party Transactions
Operating Agreements
The Company has certain agreements whereby it generates revenues and incurs
expenses with affiliated entities. The agreements are as follows:
|X| Underwriting and distribution agreement with Directed Services, Inc.
("DSI"), for the variable insurance products issued by the Company.
DSI is authorized to enter into agreements with broker/dealers to
distribute the Company's variable products and appoint representatives
of the broker/dealers as agents. For the three months ended September
30, 2004 and 2003, commission expenses were incurred in the amounts of
$137.2 million and $89.8 million, respectively. For the nine months
ended September 30, 2004 and 2003, commission expenses were incurred
in the amounts of $374.4 million and $250.1 million, respectively.
|X| Asset management agreement with ING Investment Management LLC ("IIM"),
in which IIM provides asset management and accounting services. The
Company records a fee, which is paid quarterly, based on the value of
the assets under management. For the three months ended September 30,
2004 and 2003, expenses were incurred in the amounts of $18.1 million
and $16.6 million, respectively. For the nine months ended September
30, 2004 and 2003, expenses were incurred in the amounts of $51.5
million and $45.7 million, respectively.
|X| Expense sharing agreements with ING AIH for administrative,
management, financial, and information technology services, which were
approved in 2001. For the three months ended September 30, 2004 and
2003, ING USA incurred expenses of $15.3 million and $14.4 million,
respectively. For the nine months ended September 30, 2004 and 2003,
ING USA incurred expenses of $45.8 million and $46.8 million,
respectively.
|X| Services agreement with ING Financial Advisors, LLC ("ING FA") to
provide certain administrative, management, professional advisory,
consulting and other services to the Company for the benefit of its
customers. Charges for these services are to be determined in
accordance with fair and reasonable standards with neither party
realizing a profit nor incurring a loss as a result of the services
provided to the Company. The Company will reimburse ING FA for direct
and indirect costs incurred on behalf of the Company.
41
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Reinsurance Agreements
ING USA entered into a reinsurance agreement with Security Life of Denver
International, Ltd. ("SLDI"), an affiliate, covering variable annuity
minimum guaranteed death benefits and minimum guaranteed living benefits of
variable annuities issued after January 1, 2000. In March 2003, the Company
amended its reinsurance agreement with SLDI. Under this amendment, the
Company terminated the reinsurance agreement for all inforce and new
business and recaptured all inforce business reinsured under the
reinsurance agreement between the Company and SLDI retroactive to January
1, 2003 and the Company reduced its reinsurance recoverable related to
these liabilities by $150.1 million. On March 28, 2003, SLDI transferred
assets to the Company in the amount of $185.6 million. The difference in
amounts transferred on March 28, 2003 and the reduction of the reinsurance
recoverables as of January 1, 2003, reflects adjustments on the investment
of the reinsurance recoverable as of January 1, 2003. It also reflects
adjustments on the investment income on the assets and letter of credit
costs between January 1, 2003 and the date of the asset transfer. It also
encompasses the net effect of a recapture fee paid in the amount of $5.0
million offset by the receipt of a $24.1 million negative ceding
commission, the net impact of which was deferred in policy acquisition
costs and is being amortized over the period of estimated future profits.
Reciprocal Loan Agreement
On January 1, 2004, the Company entered into a new reciprocal loan
agreement with ING American Insurance Holdings, Inc. ("ING AIH"), a
Delaware corporation and affiliate, to facilitate the handling of unusual
and/or unanticipated short-term cash requirements. In accordance with this
agreement, the maximum outstanding amount to be borrowed or lent shall not
exceed 3% of ING USA's total admitted assets. This agreement supercedes the
previous reciprocal loan agreement with ING AIH, by which the Company and
ING AIH could borrow up to $499 million from one another.
Under the previous and current reciprocal loan agreements, interest on any
ING USA borrowings was charged at the rate of ING AIH's cost of funds for
the interest period plus 0.15%. Interest on any ING AIH borrowings was
charged at a rate based on the prevailing interest rate of U.S. commercial
paper available for purchase with a similar duration. Under this agreement,
ING USA incurred minimal interest expense for the three months ended
September 30, 2004 and 2003. Interest expense of $0.1 million and $0.2
million was incurred for the nine months ended September 30, 2004 and 2003,
respectively. ING USA earned interest of $0.5 million and $0.3 million for
the three months ended September 30, 2004 and 2003, respectively, and $1.6
million and $0.8 million for the nine months ended September 30, 2004 and
2003, respectively. At September 30, 2004 and December 31, 2003, ING USA
had $199.0 million and $120.4 million receivable from ING AIH under this
agreement included in due from affiliates.
42
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Notes to Affiliates
The Company's promissory note in the amount of $50 million payable to Lion
Connecticut Holdings Inc. was repaid on May 17, 2004. The note was issued
on April 15, 1997. Interest was charged at an annual rate of 8.75% and the
face amount was due on demand. The Company incurred no interest expense for
the three months ended September 30, 2004 and $1.1 million for the three
months ended September 30, 2003. For the nine months ended September 30,
2004 and 2003, the Company incurred interest expense of $1.7 million and
$3.3 million, respectively.
ING USA issued a 30-year surplus note for $35 million with its affiliate,
Security Life of Denver Insurance Company, which matures on December 7,
2029. Interest is charged at an annual rate of 7.98%. Payment of the notes
and related accrued interest is subordinate to payments due to
policyholders and claimant and beneficiary claims, as well as debts owed to
all other classes of debtors, other than surplus note holders, of ING USA.
Any payment of principal and/or interest made is subject to the prior
approval of the Iowa Insurance Commissioner. Interest expense was $0.7
million and $2.1 million for both the three months and nine months ended
September 30, 2004 and 2003, respectively.
Tax Sharing Agreements
The Company has entered into a state tax sharing agreement with ING AIH and
each of the specific subsidiaries that are parties to the agreement. The
state tax agreement applies to situations in which ING AIH and all or some
of the subsidiaries join in the filing of a state or local franchise,
income tax or other tax return on a consolidated, combined or unitary
basis.
Capital Transactions
During the nine months ended September 30, 2004, ING USA received capital
contributions of $40 million. During the nine months ended September 30,
2003, ING USA received capital contributions of $88.7 million.
12. Financing Agreements
The Company maintains a revolving loan agreement with SunTrust Bank,
Atlanta (the "Bank"). Under this agreement, which is due on demand, the
Company can borrow up to $125 million from the Bank. Interest on any
borrowing accrues at an annual rate equal to a rate quoted by the Bank to
the Company for the borrowing. Under the agreement, the Company incurred
minimal interest expense for the three and nine months ended September 30,
2004 and 2003. At September 30, 2004, the Company had a $14 million balance
payable to the Bank. At December 31, 2003, the Company did not have any
balances payable to the Bank.
43
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The Company also maintains a revolving loan agreement with Bank of New
York, New York ("BONY"). Under this agreement, the Company can borrow up to
$100 million from BONY. Interest on any of the Company borrowing accrues at
an annual rate equal to a rate quoted by BONY to the Company for the
borrowing. Under this agreement, the Company incurred no interest expense
for the three and nine months ended September 30, 2004. Minimal interest
expense was incurred for the three and nine months ended September 30,
2003. At September 30, 2004 and December 31, 2003, the Company did not have
any balances payable to BONY.
13. Reinsurance
At September 30, 2004, ING USA had reinsurance treaties with 18
unaffiliated reinsurers and 2 affiliated reinsurers covering a significant
portion of the mortality risks and guaranteed death and living benefits
under its variable contracts. ING USA remains liable to the extent its
reinsurers do not meet their obligations under the reinsurance agreements.
Reinsurance ceded in force for life mortality risks were $788.4 million and
$1,209.4 million at September 30, 2004 and December 31, 2003, respectively.
At September 30, 2004 and December 31, 2003, net receivables were comprised
of the following:
2004 2003
------------------ -----------------
Claims recoverable from reinsurers $ 14.0 $ 17.1
Payable for reinsurance premiums (2.9) (6.6)
Reserve credits 18.5 21.1
Reinsured amounts due to an unaffiliated reinsurer (1.9) (3.1)
Reinsurance ceded 958.8 619.4
Other 3.5 4.0
------------------ -----------------
Total $ 990.0 $ 651.9
================== =================
Included in the accompanying condensed financial statements are net policy
benefits recoveries of $11.9 million and $9.3 million for the three months
ended September 30, 2004 and 2003, respectively and $33.3 million and $31.7
million for the nine months ended September 30, 2004 and 2003,
respectively.
44
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Interest credited and other benefits to policyholders includes the
following premiums ceded and reinsurance recoveries:
Three months Three months
ended ended
September 30, September 30,
2004 2003
----------------- ----------------
Premiums ceded under reinsurance $ 2.1 $ 3.9
Reinsurance recoveries 2.3 0.4
Three months Three months
ended ended
September 30, September 30,
2004 2003
----------------- ----------------
Premiums ceded under reinsurance $ 9.1 $ 11.7
Reinsurance recoveries 0.1 0.3
ING USA participates in a modified coinsurance agreement with an
unaffiliated reinsurer. The accompanying condensed financial statements are
presented net of the effects of the treaty which decreased income by $0.1
million and $0.7 million for the three months ended September 30, 2004 and
2003, respectively and $1.1 million and $1.6 million for the nine months
ended September 30, 2004 and 2003, respectively.
14. Commitments and Contingent Liabilities
Leases
The Company leases its home office space and certain other equipment under
operating leases that expire through 2017.
For both the three months ended September 30, 2004 and 2003, rent expense
for leases was $1.9 million. For the nine months ended September 30, 2004
and 2003, rent expense for leases was $5.7 million and $5.5 million,
respectively. The future net minimum payments under noncancelable leases
for the years ended December 31, 2004 through 2008 are estimated to be $7.6
million, $7.8 million, $7.8 million, $7.7 million and $7.5 million,
respectively, and $46.9 million, thereafter. The Company pays substantially
all expenses associated with its leased and subleased office properties.
Expenses not paid directly by the Company are paid for by an affiliate and
allocated back to the Company.
45
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Commitments
Through the normal course of investment operations, the Company commits to
either purchase or sell securities, commercial mortgage loans or money
market instruments at a specified future date and at a specified price or
yield. The inability of counterparties to honor these commitments may
result in either higher or lower replacement cost. Also, there is likely to
be a change in the value of the securities underlying the commitments. At
September 30, 2004 and December 31, 2003, the Company had off-balance sheet
commitments to purchase investments equal to their fair value of $264.9
million and $154.0 million, respectively.
Litigation
The Company is a party to threatened or pending lawsuits/arbitrations
arising from the normal conduct of business. Due to the climate in
insurance and business litigation/arbitrations, suits against the Company
sometimes include claims for substantial compensatory, consequential or
punitive damages and other types of relief. Moreover, certain claims are
asserted as class actions, purporting to represent a group of similarly
situated individuals. While it is not possible to forecast the outcome of
such lawsuits/arbitrations, in light of existing insurance, reinsurance and
established reserves, it is the opinion of management that the disposition
of such lawsuits/arbitrations will not have a materially adverse effect on
the Company's operations or financial position.
46
Item 2. Management's Narrative Analysis of the Results of Operations
and Financial Condition
Overview
ING USA Annuity and Life Insurance Company ("ING USA" or the
"Company"), a wholly-owned subsidiary of Lion Connecticut Holdings
Inc. ("Lion" or "Parent"), is a stock life insurance company organized
under the laws of the State of Iowa. ING USA was originally
incorporated under the laws of the State of Minnesota on January 2,
1973, in the name of St. Paul Life Insurance Company. On December 21,
1993, the Company redomesticated from Minnesota to Delaware.
The following narrative analysis of the results of operations and
financial condition presents a review of the Company as of September
30, 2004 and December 31, 2003 and for the three and nine-month
periods ended September 30, 2004 and 2003. This review should be read
in conjunction with the condensed financial statements and other data
presented herein.
Basis of Presentation
On January 1, 2004, the Company redomesticated from Delaware to Iowa.
In addition, on January 1, 2004 (the "merger date"), Equitable Life
Insurance Company of Iowa ("Equitable Life"), USG Annuity & Life
Company ("USG") and United Life & Annuity Insurance Company ("ULA")
(the "Merger Companies"), merged with and into Golden American Life
Insurance Company ("Golden American"). Immediately after the merger,
Golden American changed its name to ING USA Annuity and Life Insurance
Company. As of the merger date, the Merger Companies ceased to exist
and were merged into ING USA. Lion is an indirect, wholly-owned
subsidiary of ING Groep N.V. ("ING"), a global financial services
holding company based in The Netherlands. ING USA is authorized to do
business in the District of Columbia and all states except New York.
ING USA is licensed as a life insurance company under the laws of the
State of Delaware until December 31, 2003 and Iowa since January 1,
2004.
Prior to the merger date, ING USA was a wholly-owned subsidiary of
Equitable Life from December 30, 2001 through December 31, 2003.
Formerly, from October 24, 1997, until December 30, 2001, Equitable of
Iowa Companies, Inc. ("EIC" or "Former Holding Company") directly
owned 100% of Golden American's stock.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("FAS 141"), excludes transfers of net assets or
exchanges of shares between entities under common control, and notes
that certain provisions under Accounting Principles Board Opinion No.
16, "Business Combinations" ("APB 16"), provide a source of guidance
for such transactions. In accordance with APB 16, financial
information of the combined entity is presented as if the entities had
been combined for the full year, and all comparative financial
statements are restated and presented as if the entities had
previously been combined, in a manner similar to a
pooling-of-interests.
47
The unaudited condensed financial statements have been prepared in a
manner similar to a pooling-of-interests, in accordance with the
provisions of APB 16 in order to present the condensed financial
position and results of operations of the Company and the Merger
Companies, as if the entities had previously been combined. The
unaudited condensed balance sheets and statements of income give
effect to the consolidation transaction as if it had occurred on
December 31, 2003 and January 1, 2003, respectively.
Results of Operations
Premiums for the three months ended September 30, 2004 are comparable
to that for the same period in 2003. Premiums decreased $2.3 million
for the nine months ended September 30, 2004 compared to the same
period in 2003. This decrease in premium is related to the closed
block of participating life business.
Fee income and other income increased by $37.7 million and $127.1
million for the three and nine months ended September 30, 2004,
respectively, compared to the same periods in 2003. The increase is
primarily due to an increase in the average variable assets under
management by the Company. The increase in average variable assets
under management reflects continued business growth in the Company's
variable annuity product lines. The rise in sales of products with
higher charges for living benefits during 2004 also contributed to the
increase.
Net investment income for the three and nine months ended September
30, 2004 decreased by $6.2 million and $8.3 million, respectively,
compared to the same period in 2003. This decrease in net investment
income is primarily attributed to an increase in derivative expense.
Net realized capital gains for the three months ended September 30,
2004 decreased by $2.1 million compared to the same period in 2003.
The decrease is primarily due to the interest rate environment. Rising
interest rates during third quarter 2004 resulted in lower net gains.
Net realized capital gains for the nine months ended September 30,
2004 increased by $21.9 million compared to the same period in 2003.
The increase is primarily due to the increase in the value of the
derivatives portfolio as interest rates have risen.
Interest credited and other benefits to the policyholders for the
three and nine months ended September 30, 2004 increased by $4.0
million and $42.7 million, respectively, compared to the same periods
in 2003. The increase is primarily due to the inclusion of deferred
sales inducement amortization as a component of benefit expense in
2004, as required with the adoption of SOP 03-1. In addition, lower
separate account benefit guarantees were recognized during the three
months ended September 30, 2004 as a result of improved separate
account market performance.
General expenses increased by $7.7 million and $11.5 million for the
three and nine months ended September 30, 2004, respectively, compared
48
to that for the same periods in 2003. The increase in general expenses
is largely due to growth of the business and higher assets under
management.
Commissions increased $48.9 million and $146.7 million for the three
and nine months ended September 30, 2004, respectively, compared to
the same periods in 2003. This increase is primarily due to additional
commissions on higher new sales of variable and fixed annuity
products. Also contributing to the nine months ended increase was a
$24.1 million ceded commission adjustment in the first quarter of 2003
related to the recapture of an affiliate reinsurance agreement.
Policy acquisition costs deferred for the three and nine months ended
September 30, 2004 increased by $25.6 million and $88.0 million,
respectively, compared to the same periods in 2003. This increase was
primarily due to the deferral of increased commissions and selling
expense on higher annuity product sales.
Amortization of deferred policy acquisition costs and value of
business acquired decreased $11.9 million and $58.1 million for the
three and nine months ended September 30, 2004, respectively, compared
to the same periods in 2003. Amortization of long-duration products is
reflected in proportion to actual and estimated future gross profits.
Estimated future gross profits are computed based on underlying
assumptions related to the underlying contracts, including but not
limited to interest margins, surrenders, withdrawals, expenses, and
asset growth. The decrease in the amortization of deferred policy
acquisition costs and value of insurance acquired reflects the impact
of these variables on the overall book of business.
Expense and charges reimbursed under modified coinsurance ("MODCO")
agreements for the three and nine months ended September 30, 2004,
increased by $0.5 million and $1.0 million, respectively, compared to
the same periods in 2003. This balance represents the net cash flows
from the Paine Webber MODCO agreements. As this MODCO agreement does
not cover new business, the run-off of the reserve credit and the
product charge reimbursement to Paine Webber exceed the commission and
expense allowances that accrue to the Company.
Interest expense for the three and nine months ended September 30,
2004 is comparable to that for the same periods in 2003.
The cumulative effect of the change in accounting principle for the
nine months ended September 30, 2004, was a loss of $2.3 million, net
of tax, due to the implementation of SOP 03-1. The change in
accounting principle was recorded during the first quarter of 2004.
Net income, excluding income tax expense and change in accounting
principle, increased by $7.7 million for the three months ended
September 30, 2004 compared to the three months ended September 30,
2003. The increase in net income is primarily related to increased fee
income and decreased amortization of deferred policy acquisition costs
and value of new business acquired, partially offset by the increase
49
in commission expense and policy acquisition costs deferred. Net
income, excluding income tax expense and change in accounting
principle, increased by $84.6 million for the nine months ended
September 30, 2004, as compared to the nine months ended September 30,
2003. The increase in net earnings is primarily the result of
increased fee income and decreased amortization of deferred policy
acquisition costs and value of new business acquired, partially offset
by higher interest credited and other guarantee benefits related to
expenses, increased commission expense, and policy acquisition costs
deferred.
Financial Condition
Investments
Fixed Maturities
Total fixed maturities reflected net unrealized capital gains of
$483.6 million and $517.3 million at September 30, 2004 and December
31, 2003, respectively.
It is management's objective that the portfolio of fixed maturities be
of high quality and be well diversified by market sector. The fixed
maturities in the Company's portfolio are generally rated by external
rating agencies and, if not externally rated, are rated by the Company
on a basis believed to be similar to that used by the rating agencies.
The average quality rating of the Company's fixed maturities portfolio
was A+ at September 30, 2004 and December 31, 2003.
Fixed maturities rated BB and below may have speculative
characteristics, and changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity of the
issuer to make principal and interest payments than is the case with
higher rated fixed maturities.
The percentage of total fixed maturities by quality rating category is
as follows:
September 30, December 31,
2004 2003
---------------- ----------------
AAA 34.7 % 35.3 %
AA 4.9 4.7
A 21.1 21.3
BBB 35.0 33.4
BB 3.6 4.0
B and below 0.7 1.3
---------------- ----------------
Total 100.0 % 100.0 %
================ ================
50
The percentage of total fixed maturities by market sector is as
follows:
September 30, December 31,
2004 2003
---------------- ----------------
U.S. Corporate 46.3 % 48.9 %
Residential Mortgaged-backed 19.3 20.8
Commercial/Multifamily
Mortgage-backed 6.0 5.0
Foreign (1) 16.9 15.9
U.S. Treasuries/Agencies 1.0 1.3
Asset-backed 10.5 8.1
---------------- ----------------
Total 100.0 % 100.0 %
================ ================
(1) Primarily U.S. dollar denominated
The Company analyzes the general account investments to determine
whether there has been an other than temporary decline in fair value
below the amortized cost basis in accordance with FAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities."
Management considers the length of the time and the extent to which
the market value has been less than cost; the financial condition and
near term prospects of the issuer; future economic conditions and
market forecasts; and the Company's intent and ability to retain the
investment in the issuer for a period of time sufficient to allow for
recovery in market value. If it is probable that all amounts due
according to the contractual terms of a debt security will not be
collected, an other than temporary impairment is considered to have
occurred.
In addition, the Company invests in structured securities that meet
the criteria of Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets." Under
EITF Issue No. 99-20, a determination of the required impairment is
based on credit risk and the possibility of significant prepayment
risk that restricts the Company's ability to recover the investment.
An impairment is recognized if the fair value of the security is less
than book value and there has been an adverse change in cash flow
since the last remeasurement date.
When a decline in fair value is determined to be other than temporary,
the individual security is written down to fair value and the loss is
accounted for as a realized loss.
Liquidity and Capital Resources
Liquidity is the ability of the Company to generate sufficient cash
flows to meet the cash requirements of operating, investing, and
financing activities. The Company's principal sources of liquidity are
annuity premiums and product charges, investment income, maturing
investments, proceeds from debt issuance, and capital contributions.
Primary uses of these funds are payments of commissions and operating
expenses, interest and premium credits, investment purchases,
repayment of debt, as well as withdrawals and surrenders.
51
The Company's liquidity position is managed by maintaining adequate
levels of liquid assets, such as cash or cash equivalents and
short-term investments. Additional sources of liquidity include
borrowing facilities to meet short-term cash requirements. The Company
maintains a $499 million revolving note facility with ING America
Insurance Holdings, Inc. ("ING AIH"), a perpetual $100 million
revolving note facility with Bank of New York and a $125 million
revolving note facility with SunTrust Bank which expires on July 30,
2005. Management believes that these sources of liquidity are adequate
to meet the Company's short-term cash obligations.
The National Association of Insurance Commissioners ("NAIC")
risk-based capital requirements require insurance companies to
calculate and report information under a risk-based capital formula.
These requirements are intended to allow insurance regulators to
monitor the capitalization of insurance companies based upon the type
and mixture of risks inherent in a Company's operations. The formula
includes components for asset risk, liability risk, interest rate
exposure, and other factors. The Company has complied with the NAIC's
risk-based capital reporting requirements. Amounts reported indicate
that the Company has total adjusted capital above all required capital
levels.
During the nine months ended September 30, 2004, ING USA received
capital contributions of $40 million. During the nine months ended
September 30, 2003, ING USA received capital contributions of $88.7
million.
Recently Adopted Accounting Standards
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts
The Company adopted Statement of Position ("SOP") 03-1, "Accounting
and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts," on January 1,
2004. SOP 03-1 establishes several new accounting and disclosure
requirements for certain nontraditional long-duration contracts and
for separate accounts including, among other things, a requirement
that assets and liabilities of separate account arrangements that do
not meet certain criteria be accounted for as general account assets
and liabilities, and that the revenue and expenses related to such
arrangements be consolidated with the respective line items in the
Condensed Statements of Income. In addition, the SOP requires
additional liabilities be established for certain guaranteed death
benefits and for products with certain patterns of cost of insurance
charges, and that sales inducements provided to contractholders be
recognized on the balance sheet separately from deferred acquisition
costs and amortized as a component of benefits expense using
methodology and assumptions consistent with those used for
amortization of deferred policy acquisition costs.
52
The Company evaluated all requirements of SOP 03-1 and determined that
it is affected by the SOP's requirements to establish additional
liabilities for certain guaranteed benefits and products with patterns
of cost insurance charges resulting in losses in later policy
durations from the insurance benefit function and to defer, amortize,
and recognize separately, sales inducements to contractholders.
Requirements for certain separate account arrangements that do not
meet the established criteria for separate asset and liability
recognition are applicable to the Company, however, the Company's
policies on separate account assets and liabilities have historically
been, and continue to be, in conformity with the requirements newly
established. Upon adoption of the SOP, the Company recognized a
cumulative effect of a change in accounting principle of $(3.6)
million, before tax or $(2.3) million, net of $1.3 million of income
taxes as of January 1, 2004.
The implementation of SOP 03-1 raised questions regarding the
interpretation of the requirements of Financial Accounting Standard
("FAS") No. 97, concerning when it is appropriate to record an
unearned revenue liability related to the insurance benefit function.
To clarify its position, the Financial Accounting Standards Board
("FASB") issued FASB Staff Position No. FAS 97-1 ("FSP FAS 97-1"),
"Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97,
`Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments,' Permit or Require Accrual of an Unearned Revenue
Liability," effective for fiscal periods beginning subsequent to the
date the guidance was issued, June 18, 2004. The Company adopted FSP
FAS 97-1 on July 1, 2004 and has evaluated the impact of the guidance
on whether the Company is required to establish an unearned revenue
reserve on its existing and new business. The adoption of FSP FAS 97-1
did not have an impact on the Company's financial position, results of
operations or cash flows.
The Meaning of Other Than Temporary Impairment and its Application to
Certain Investments
In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF Issue No. 03-1 ("EITF 03-1"), "The Meaning of Other
Than Temporary Impairment and Its Application to Certain Investments,"
requiring that a three-step impairment model be applied to securities
within its scope. The three-step model is to be applied on a
security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is
impaired if the fair value of the investment is less than its
cost basis.
Step 2: Evaluate whether an impairment is other than temporary.
Step 3: If the impairment is other than temporary, recognize an
impairment loss equal to the difference between the investment's
cost and its fair value.
53
On September 30, 2004, the FASB issued FASB Staff Position No. EITF
Issue 03-1-1 ("FSP EITF 03-1-1"), "Effective Date of Paragraphs 10-20
of EITF Issue No. 03-1, `The Meaning of Other Than Temporary
Impairment and Its Application to Certain Investments,'" which delayed
EITF 03-1's original effective date of July 1, 2004 for the paragraphs
of the guidance surrounding steps two and three of the impairment
model introduced. The delay is in effect until a final consensus can
be reached on such guidance. Despite the delay of the implementation
of steps two and three, other than temporary impairments are still to
be recognized as required by existing guidance.
Earlier consensus reached by the EITF on this issue required that
certain quantitative and qualitative disclosures be made for
unrealized losses on debt and equity securities that have not been
recognized as other than temporary impairments. These disclosures were
adopted by the Company, effective December 31, 2003, and included in
the Investments footnote of the Notes to Condensed Financial
Statements included in the Company's December 31, 2003 Form 10-K. In
addition to the disclosure requirements adopted by the Company
effective December 31, 2003, the final consensus of EITF 03-1 reached
in March 2004 included additional disclosure requirements that are
effective for annual financial statements for fiscal years ending
after June 15, 2004.
Accounting for Derivative Instruments and Hedging Activities
In 2003, the Derivative Implementation Group ("DIG") responsible for
issuing guidance on behalf of the FASB for implementation of FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities"
issued Statement Implementation Issue No. B36, "Embedded Derivatives:
Modified Coinsurance Arrangements and Debt Instruments That
Incorporate Credit Risk Exposures That Are Unrelated or Only Partially
Related to the Credit Worthiness of the Obligor under Those
Instruments" ("DIG B36"). Under this interpretation, modified
coinsurance and coinsurance with funds withheld reinsurance agreements
as well as other types of receivables and payables where interest is
determined by reference to a pool of fixed maturity assets or total
return debt index may be determined to contain embedded derivatives
that are required to be bifurcated. The Company adopted DIG B36 on
October 1, 2003 and has modified coinsurance treaties that are
applicable to the guidance. The applicable contracts, however, were
determined to generate embedded derivatives with a fair value of zero.
Therefore, the guidance, while implemented, did not impact the
Company's financial position, results of operations, or cash flows.
Off-Balance Sheet Arrangements
In January 2003, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB No.51" (FIN 46). In December 2003,
the FASB modified FIN 46 to make certain technical corrections and
address certain implementation issues that had arisen. FIN 46 provides
a new framework for identifying variable interest entities (VIEs) and
determining when a company should include the assets, liabilities,
54
noncontrolling interests and results of activities of a VIE in its
consolidated financial statements.
In general, a VIE is a corporation, partnership, limited-liability
corporation, trust, or any other legal structure used to conduct
activities or hold assets that either (1) has an insufficient amount
of equity to carry out its principal activities without additional
subordinated financial support, (2) has a group of equity owners that
are unable to make significant decisions about its activities, or (3)
has a group of equity owners that do not have the obligation to absorb
losses or the right to receive returns generated by its operations.
FIN 46 requires a VIE to be consolidated if a party with an ownership,
contractual or other financial interest in the VIE (a variable
interest holder) is obligated to absorb a majority of the risk of loss
from the VIE's activities, is entitled to receive a majority of the
VIE's residual returns (if no party absorbs a majority of the VIE's
losses), or both. A variable interest holder that consolidates the VIE
is called the primary beneficiary. Upon consolidation, the primary
beneficiary generally must initially record all of the VIE's assets,
liabilities and noncontrolling interests at fair value and
subsequently account for the VIE as if it were consolidated based on
majority voting interest. FIN 46 also requires disclosures about VIEs
that the variable interest holder is not required to consolidate but
in which it has a significant variable interest.
At September 30, 2004, the Company held the following investments
that, for purposes of FIN 46, were evaluated and determined that the
investments do not require consolidation in the Company's financial
statements:
(Millions)
Asset Type Purpose Book Value (1) Market Value
--------------------------------- -------------------------- --------------- ---------------
Private Corporate Securities - synthetic leases;
project financings; credit tenant leases Investment Holdings $ 3,188.3 $ 3,321.1
Foreign Securities - US VIE subsidiaries of
foreign companies Investment Holdings 556.1 587.6
Commercial Mortgage Obligations (CMO) Investment Holdings 3,051.7 3,101.4
Collateralized Debt Obligations (CDO) Investment Holdings and/or
Collateral Manager 73.7 69.3
Asset-Backed Securities (ABS) Investment Holdings 153.2 152.8
Commercial Mortgage Backed Securities (CMBS) Investment Holdings 1,027.3 1,066.0
(1) Represents maximum exposure to loss except for those structures
for which the Company also receives asset management fees.
New Accounting Pronouncements
In September 2004, the AICPA issued Technical Practice Aid ("TPA")
6300.05 - 6300.08 "Q&As Related to the Implementation of SOP 03-1,
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts" (the
"TPA"). The TPA provides additional guidance regarding certain
implicit assessments that may be used in testing of the base mortality
function on contracts, which is performed to determine whether
additional liabilities are required in conjunction with SOP 03-1. In
55
addition, the TPA provides additional guidance surrounding the allowed
level of aggregation of additional liabilities determined under the
SOP. The Company is currently evaluating the impact of the TPA on the
cumulative effect of a change in accounting principle recognized on
January 1, 2004 and anticipates a potential decrease in the net
liability established as part of the accounting change. The TPA will
be fully implemented during the fourth quarter 2004 and will be
reported as a cumulative effect of a change in accounting principle
applied retroactively to January 1, 2004.
Critical Accounting Policies
General
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires the use of estimates
and assumptions in certain circumstances that affect amounts reported
in the accompanying condensed financial statements and related
footnotes. These estimates and assumptions are evaluated on an
on-going basis based on historical developments, market conditions,
industry trends and other information that is reasonable under the
circumstances. There can be no assurance that actual results will
conform to estimates and assumptions, and that reported results of
operations will not be affected in a materially adverse manner by the
need to make future accounting adjustments to reflect changes in these
estimates and assumptions from time to time.
The Company has identified the following estimates as critical in that
they involve a higher degree of judgment and are subject to a
significant degree of variability: investment impairment testing,
amortization of deferred acquisition costs and value of business
acquired and goodwill impairment testing. In developing these
estimates, management makes subjective and complex judgments that are
inherently uncertain and subject to material changes as facts and
circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate
based upon the facts available upon compilation of the condensed
financial statements.
Investment Impairment Testing
The Company reviews the general account investments for impairments by
analyzing the amount and length of time amortized cost has exceeded
fair value, and by making certain estimates and assumptions regarding
the issuing companies' business prospects, future economic conditions
and market forecasts. Based on the facts and circumstances of each
case, management uses judgment in deciding whether any calculated
impairments are temporary or other than temporary. For those
impairments judged to be other than temporary, the Company reduces the
carrying value of those investments to the current fair value and
records impairment losses for the difference.
56
Amortization of Deferred Acquisition Costs and Value of Business
Acquired
Deferred policy acquisition costs ("DAC") and value of business
acquired ("VOBA") are amortized with interest over the life of the
contracts (usually 25 years) in relation to the present value of
estimated gross profits from projected interest and mortality margins,
asset-based fees, policy administration and surrender charges less
policy maintenance fees and non-capitalized commissions.
Changes in assumptions can have a significant impact on the
calculation of DAC/VOBA and its related amortization patterns. Due to
the relative size of DAC/VOBA balance and the sensitivity of the
calculation to minor changes in the underlying assumptions and the
related volatility that could result in the reported DAC/VOBA balance,
the Company performs a quarterly analysis of DAC/VOBA for the annuity
business (annually for the life business).
At each balance sheet date, actual historical gross profits are
reflected and expected future gross profits and related assumptions
are evaluated for continued reasonableness. Any adjustment in
estimated profit requires that the amortization rate be revised
retroactively to the date of policy or contract issuance
("unlocking"), which could be significant. The cumulative difference
related to prior periods is recognized as a component of current
period's amortization, along with amortization associated with the
actual gross profits of the period. In general, increases in estimated
returns result in increased expected future profitability and may
lower the rate of amortization, while increases in lapse/surrender and
mortality assumptions or decreases in returns reduce the expected
future profitability of the underlying business and may increase the
rate of amortization.
One of the most significant assumptions involved in the estimation of
future gross profits for variable universal life and variable deferred
annuity products is the assumed return associated with future variable
account performance. To reflect the near-term and long-term volatility
in the equity markets, this assumption involves a combination of
near-term expectations and a long-term assumption about market
performance. The overall return generated by the variable account is
dependent on several factors, including the relative mix of the
underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings.
Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts
and are higher than the contract's expected ongoing crediting rates
for periods after the inducement. Such amounts are reported separately
on the balance sheet and are amortized as a component of benefit
expense using methodology and assumptions consistent with those used
for amortization of DAC.
57
Contractual Obligations
As of September 30, 2004, the Company had certain contractual
obligations due over a period of time as summarized in the following
table:
Payments due by Period (in millions)
----------------------------------------------------------------------
Less than More than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years
--------------------------- ------------ ------------ -------------- ------------ ------------
Long-Term Debt $ 105.4 $ 2.8 $ 5.6 $ 5.6 $ 91.4
Operating Lease Obligations 85.3 7.6 15.6 15.2 46.9
Purchase Obligations 264.9 264.9 - - -
------------ ------------ -------------- ------------ ------------
Total $ 455.6 $ 275.3 $ 21.2 $ 20.8 $ 138.3
============ ============ ============== ============ ============
The Company's long-term debt consists of a surplus note and the
related interest payable, with Security Life of Denver Insurance
Company. As of September 30, 2004, the outstanding principal, interest
rate, and maturity date of the surplus note are $35 million, 7.98%,
and December 7, 2029, respectively.
Operating lease obligations relate to the rental of office space under
various non-cancelable operating lease agreements that expire through
May 2010.
Purchase obligations consist primarily of commitments to fund
additional limited partnerships and joint ventures and commitments to
enter into mortgage loan and private placement arrangements during
2004.
Legislative Initiatives
The Jobs and Growth Tax Relief Reconciliation Act of 2003, which was
enacted in second quarter 2003, may impact the Company. The Act's
provisions, which reduce the tax rates on long-term capital gains and
corporate dividends, impact the relative competitiveness of the
Company's products especially variable annuities.
On October 22, 2004, the President signed the American Jobs Creation
Act of 2004. The act allows tax-free distributions to be made from the
Policyholders' Surplus Account in 2005 and 2006. Under prior law, the
Company was allowed to defer from taxation a portion of statutory
income under certain circumstances. The deferred income was
accumulated in the Policyholders' Surplus Account and is taxable only
under conditions that management considers to be remote. Therefore, no
federal income taxes have been provided on the accumulated balance of
$14.4 million as of September 30, 2004. Based on currently available
information, the Company anticipates that the new law will permanently
eliminate any potential tax on the accumulated balance of $14.4
million.
Other legislative proposals under consideration include repealing the
estate tax, changing the taxation of products and changing life
insurance company taxation. Some of these proposals, if enacted, could
have a material effect on life insurance, annuity and other retirement
savings product sales. The impact on the Company's products cannot be
predicted.
58
Forward-Looking Information/Risk Factors
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, the Company cautions readers
regarding certain forward-looking statements contained in this report
and in any other statements made by, or on behalf of, the Company,
whether or not in future filings with the SEC. Forward-looking
statements are statements not based on historical information and
which relate to future operations, strategies, financial results, or
other developments. 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 levels of sales and redemptions of
the Company's products, investment spreads and yields, or the earnings
and profitability of the Company's activities.
Forward-looking statements are necessarily based on 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 are subject
to change. These uncertainties and contingencies 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
developments. Some may be national in scope, such as general economic
conditions, changes in tax law and changes in interest rates. Some may
be related to the insurance industry generally, such as pricing
competition, regulatory developments and industry consolidation.
Others may relate to the Company specifically, such as credit,
volatility and other risks associated with the Company's investment
portfolio. Investors are also directed to consider other risks and
uncertainties discussed in documents filed by the Company with the
SEC. The Company disclaims any obligation to update forward-looking
information.
59
Item 4. Controls and Procedures
a) The Company carried out an evaluation, under the supervision and
with the participation of its management, including its Chief
Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's disclosure controls and procedures
(as defined in Rule 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934) as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and
the Chief Financial Officer have concluded that the Company's
current disclosure controls and procedures are effective in
ensuring that material information relating to the Company
required to be disclosed in the Company's periodic SEC filings is
made known to them in a timely manner.
b) There has not been any change in the internal controls over
financial reporting of the Company that occurred during the
period covered by this report that has materially affected or is
reasonably likely to materially affect these internal controls.
60
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a party to threatened or pending
lawsuits/arbitrations arising from the normal conduct of
business. Due to the climate in insurance and business
litigation/arbitrations, suits against the Company sometimes
include claims for substantial compensatory, consequential or
punitive damages and other types of relief. Moreover, certain
claims are asserted as class actions, purporting to represent a
group of similarly situated individuals. While it is not possible
to forecast the outcome of such lawsuits/arbitrations, in light
of existing insurance, reinsurance and established reserves, it
is the opinion of management that the disposition of such
lawsuits/arbitrations will not have a materially adverse effect
on the Company's operations or financial position.
As with many financial services companies, the Company and its
affiliates have received informal and formal requests for
information from various governmental and self-regulatory
agencies in connection with investigations of the products and
business practices of the financial services industry. In each
case, full cooperation has been and is being provided. Reference
is made to "Other Regulatory Matters" in Note 12 to the Notes to
Consolidated Financial Statements in Part II, Item 8 of the
Company's Form 10-K Annual Report, filed on March 29, 2004 (SEC
File No. 033-87270); the Company's Form 8-K/A Current Report
filed on September 8, 2004 (SEC File No. 033-87270); and the
Company's Form 8-K Current Report filed on October 29, 2004 (SEC
File No. 033-87270).
Item 6. Exhibits
3.(i)Restated Articles of Incorporation Providing for the
Redomestication of Golden American Life Insurance Company
dated July 2 & 3, 2003, incorporated by reference to
Company's 10-K, as filed with the SEC on March 29, 2004
(File No. 033-87270).
Amendment to Articles of Incorporation Providing for the
Name Change of Golden American Life Insurance Company dated
November 20, 2003, incorporated by reference to the
Company's 10-K, as filed with the SEC on March 29, 2004
(File No. 033-87270).
Amendment to Articles of Incorporation Providing for the
Change in Purpose and Powers of ING USA Annuity and Life
Insurance Company dated March 3 & 4, 2004, incorporated by
reference to the Company's 10-Q, as filed with the SEC on
May17, 2004 (File No.033-87270).
(ii) Amended and Restated By-Laws of ING USA Annuity and Life
Insurance Company, adopted by the Board of Directors of the
Company on June 25, 2003, as amended November 11, 2003 and
February 25, 2004, incorporated by reference to the
Company's Form 10-Q, as filed with the SEC on May 17, 2004
(File No. 033-87270).
61
4. Instruments Defining the Rights of Security Holders,
Including Indentures (Annuity Contracts).
Single Premium Deferred Modified Guaranteed Annuity
Contract, Single Premium Deferred modified Guaranteed
Annuity Master Contract, and Single Premium Deferred
Modified Guaranteed Annuity Certificate - Incorporated
herein by reference to Pre-Effective Amendment No. 1 to
Registration Statement on Form S-1 for American Life
Insurance Company as filed with the SEC on February 8, 2002
(File No. 333-67660).
Single Premium Deferred Modified Guaranteed Annuity Contract
- Incorporated herein by reference to the initial
Registration Statement on Form S-1 for Golden American Life
Insurance Company, as filed with the SEC on June 30, 2000
(File No. 333-40596).
Single Premium Deferred Modified Guaranteed Annuity Master
Contract and Single Premium Deferred Modified guaranteed
Annuity Certificate - Incorporated by reference to
Post-Effective Amendment No. 1 to Registration Statement on
Form S-1 for Golden American Life Insurance Company, as
filed with the SEC on September 13, 2000 (File No.
333-40596).
Interest in Fixed Account I under Variable Annuity Contracts
- Incorporated herein by reference to: Post-Effective
Amendment No. 12 to Registration Statement on Form N-4 for
Golden American Life Insurance Company Separate Account B,
as filed with the Securities and Exchange Commission on
April 23, 1999 (File Nos. 333-59261, 811-5626); Incorporated
by reference to Post-Effective Amendment No. 3 to
Registration Statement on Form N-4 for Golden American life
Insurance Company, as filed with the SEC on April 23, 1999
(File Nos. 333-28769, 811-5626); and Incorporated by
reference to Pre-Effective Amendment No. 1 to Registration
statement on Form N-4 for Golden American Life Insurance
Company Separate Account B, as filed with the SEC on June
24, 2000 (File Nos. 333-33914, 811-5626).
Interests in Fixed Account II under Variable Annuity
Contracts - Incorporated herein by reference to
Post-Effective Amendment No. 7 to Registration Statement on
Form N-4 for Separate Account B of Golden American Life
Insurance Company as filed with the SEC on October 2, 2000
(File No. 333-28679, 811-5626), Incorporated herein by
reference to Post-Effective Amendment No. 2 to Registration
Statement on Form N-4 for Separate Account B of Golden
American Life Insurance Company as filed with the SEC on
October 2, 2000 (File No. 333-30180, 811-5626), Incorporated
herein by reference to Post-Effective Amendment No. 5 to
Registration Statement on Form N-4 for Separate Account B of
Golden American Life Insurance Company as filed with the SEC
62
on April 23, 1999 (File No. 333-28755, 811-5626),
Incorporated herein by reference to Post-Effective Amendment
No. 1 to Registration Statement on Form N-4 for Separate
Account B of Golden American Life Insurance Company as filed
with the SEC on April 23, 1999 (File No. 333-66757,
811-5626), Incorporated herein by reference to Pre-Effective
Amendment No. 1 to Registration Statement on Form N-4 for
Separate Account B of Golden American Life Insurance Company
as filed with the SEC on October 26, 2001 (File No.
333-63692, 811-5626), Incorporated herein by reference to
Pre-Effective Amendment No. 1 to Registration Statement on
Form N-4 for Separate Account B of Golden American Life
Insurance Company as filed with the SEC on December 11, 2001
(File No.333-70600, 811-5626), and Incorporated by reference
to Post-Effective Amendment No. 1 to Registration Statement
on Form N-4 for Golden American Life Insurance Company
Separate Account B, as filed with the SEC on April 16, 2003
(File No. 333-90516, 811-5626).
Interest in the Guaranteed Account under Variable Annuity
Contracts - Incorporated herein by reference to
Pre-Effective Amendment No. 1 to Registration Statement on
Form S-2 for Golden American Life Insurance Company, as
filed with the SEC on June 29, 2001 (File No. 333-57212).
Single Premium Deferred Equity Indexed Modified Guaranteed
Annuity Contract, Single Premium Deferred Modified
Guaranteed Annuity Group Master Contract, Single Premium
Deferred Equity Indexed Modified Guaranteed Annuity
Certificate - Incorporated herein by reference to
Pre-Effective Amendment No. 1 to Registration Statement on
Form S-2 for ING USA Annuity and Life Insurance Company, as
filed with the SEC on August 13, 2004 (File No. 333-116137).
31.1 Certificate of David A. Wheat pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of Jacques de Vaucleroy pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certificate of David A. Wheat pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certificate of Jacques de Vaucleroy pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
63
SIGNATURES
Pursuant to the requirements 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.
ING USA ANNUITY AND LIFE INSURANCE COMPANY
(Registrant)
By: /s/ David A. Wheat
November 12, 2004 -----------------------------------------
----------------- David A. Wheat
(Date) Director, Senior Vice President and
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
64
Exhibit 31.1
CERTIFICATION
I, David A. Wheat, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ING USA Annuity
and Life Insurance Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 12, 2004
-----------------
By /s/ David A. Wheat
-------------------------------------------
David A. Wheat
Director, Senior Vice President and
Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
Exhibit 31.2
CERTIFICATION
I, Jacques de Vaucleroy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ING USA Annuity
and Life Insurance Company;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date November 12, 2004
-----------------
By /s/ Jacques de Vaucleroy
-----------------------------------------
Jacques de Vaucleroy
Director and President
(Duly Authorized Officer and Principal Executive Officer)