UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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 June 30, 2002
---------------------------------------------
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transaction period from to
-------------- --------------
Commission file number 333-64473
----------
GWL&A FINANCIAL INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
- --------------------------------------------------------------------------------
Colorado 84-1474245
- --------------------------------------------------------- --------------------
(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification Number)
8515 East Orchard Road, Greenwood Village, CO 80111
--------------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(303) 737-4128
--------------------------------------------------------------
(Registrant's telephone number, including area code)
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
-------------- --------------
As of June 30, 2002, 50,025 shares of the registrant's common stock were
outstanding, all of which were owned by the registrant's parent company.
NOTE: This Form 10-Q is filed by the registrant only as a consequence of
the sale by the registrant of a market value adjusted annuity product.
22
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION Page
---------
Item 1 Financial Statements 3
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 6
Consolidated Statement of Stockholder's Equity 8
Notes to Consolidated Financial Statements 9
Item 2 Management's Discussion and Analysis of Financial Condition and
Results
of Operations 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk 20
Part II OTHER INFORMATION 21
Item 1 Legal Proceedings 21
Item 6 Exhibits and Reports on Form 8-K 21
Signature 21
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
GWL&A FINANCIAL INC.
CONSOLIDATED STATEMENTS OF INCOME
[Dollars in Thousands]
=================================================================================================
[Unaudited]
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
REVENUES:
Premium income $ 259,488 $ 262,900 $ 549,009 $ 597,330
Fee income 233,264 231,601 460,008 482,850
Net investment income 234,585 243,013 462,505 482,042
Net realized gains on
Investments 1,667 1,264 7,908 8,932
------------ ------------ ------------ ------------
729,004 738,778 1,479,430 1,571,154
------------ ------------ ------------ ------------
BENEFITS AND EXPENSES:
Life and other policy 240,856 246,676 451,184 531,916
benefits
(Decrease) increase
in reserves (14,367) (12,656) 25,227 29,315
Interest paid or credited
to contractholders 125,129 133,038 251,029 266,822
Provision for policyholders'
share of earnings on
Participating business (7) 723 922 2,311
Dividends to policyholders 16,088 16,165 40,290 39,526
------------ ------------ ------------ ------------
367,699 383,946 768,652 869,890
------------ ------------ ------------ ------------
Commissions 59,102 46,951 98,539 94,230
Operating expenses 175,083 212,321 371,070 412,809
Premium taxes 9,547 6,449 15,348 13,593
Special charges 127,040 127,040
------------ ------------ ------------ ------------
611,431 776,707 1,253,609 1,517,562
------------ ------------ ------------ ------------
INCOME BEFORE
INCOME TAXES 117,573 (37,929) 225,821 53,592
PROVISION FOR
INCOME TAXES:
Current 37,307 44,685 44,165 57,725
Deferred 80 (60,941) 28,592 (41,911)
------------ ------------ ------------ ------------
37,387 (16,256) 72,757 15,814
------------ ------------ ------------ ------------
NET INCOME $ 80,186 $ (21,673) $ 153,064 $ 37,778
============ ============ ============ ============
See notes to consolidated financial statements.
GWL&A FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
[Dollars in Thousands]
=================================================================================================
June 30, December 31,
ASSETS 2002 2001
- ------
----------------- ----------------
[unaudited]
INVESTMENTS:
Fixed Maturities available-for-sale, at fair value
(amortized cost $9,423,071 and $9,904,453) $ 10,178,902 $ 10,116,175
Mortgage loans on real estate (net of allowances
of $57,654 and $57,654) 522,105 613,453
Common stock, at fair value (cost $89,225, and 91,119 73,344
$74,107)
Real estate, net 3,852 11,838
Policy loans 3,090,399 3,000,441
Short-term investments, available-for-sale
(amortized cost $504,951 and $427,866) 504,803 425,198
----------------- ----------------
Total investments 14,391,180 14,240,449
Cash 361,403 216,209
Reinsurance receivable 312,501 282,352
Deferred policy acquisition costs 268,027 275,570
Investment income due and accrued 115,628 130,775
Amounts receivable related to uninsured accident
and health plan claims (net of allowances
of $41,200 and $53,431) 79,592 89,533
Other assets 725,498 745,617
Premiums in course of collection (net of allowances
of $14,495 and $22,217) 72,007 99,811
Deferred income taxes 103,991 149,168
Separate account assets 11,916,664 12,584,661
----------------- ----------------
TOTAL ASSETS $ 28,346,491 $ 28,814,145
================= ================
(continued)
GWL&A FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
[Dollars in Thousands]
=================================================================================================
June 30, December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2002 2001
- ------------------------------------
----------------- ----------------
[unaudited]
POLICY BENEFIT LIABILITIES:
Policy reserves $ 12,273,499 $ 12,211,496
Policy and contract claims 396,431 401,389
Policyholders' funds 280,253 242,916
Provision for policyholders' dividends 75,744 74,740
Undistributed earnings on participating business 165,927 163,086
GENERAL LIABILITIES:
Due to GWL 40,129 41,874
Repurchase agreements 315,698 250,889
Commercial paper 98,521 97,046
Other liabilities 1,036,847 1,099,963
Separate account liabilities 11,916,664 12,584,661
----------------- ----------------
Total liabilities 26,599,713 27,168,060
----------------- ----------------
GUARANTEED PREFERRED BENEFICIAL INTERESTS
IN THE COMPANY'S JUNIOR SUBORDINATE
DEBENTURES 175,000 175,000
STOCKHOLDER'S EQUITY:
Preferred stock, $1 par value, 50,000,000 shares
authorized; 0 shares issued and outstanding
Common stock, $0 par value; 500,000 shares
authorized; 50,025 shares issued and outstanding 250 250
Additional paid-in capital 723,540 719,833
Accumulated other comprehensive income 110,787 76,507
Retained earnings 737,201 674,495
----------------- ----------------
Total stockholder's equity 1,571,778 1,471,085
----------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 28,346,491 $ 28,814,145
================= ================
See notes to consolidated financial statements. (Concluded)
GWL&A FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
[Dollars in Thousands]
=================================================================================================
[Unaudited]
Six Months Ended
June 30,
-------------------------------------
2002 2001
----------------- ----------------
OPERATING ACTIVITIES:
Net income $ 153,064 $ 37,778
Adjustments to reconcile net income to net cash
Provided by operating activities:
Earnings allocated to participating policyholders 922 2,312
Amortization of investments (37,991) (38,330)
Realized gains on disposal of investments
And write-downs of mortgage loans and real (7,908) (8,932)
estate
Amortization 19,834 24,519
Deferred income taxes 28,592 (41,911)
Changes in assets and liabilities:
Policy benefit liabilities 197,437 111,766
Reinsurance receivable (30,149) 7,398
Accrued interest and other receivables 52,892 202,793
Other, net (62,190) (244,934)
----------------- ----------------
Net cash provided by operating activities 314,503 52,459
----------------- ----------------
INVESTING ACTIVITIES:
Proceeds from sales, maturities, and redemptions
of investments:
Fixed maturities available-for-sale
Sales 3,013,838 2,747,351
Maturities and redemptions 699,609 629,040
Mortgage loans 102,047 76,757
Real estate 1,800 103,038
Common stock 7,347 19,600
Purchases of investments:
Fixed maturities available-for-sale (3,701,476) (3,534,634)
Mortgage loans
Real estate (2,243) (104,407)
Common stock (15,372) (24,769)
----------------- ----------------
Net cash provided by (used in) investing 105,550 (88,024)
activities
----------------- ----------------
(continued)
GWL&A FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
[Dollars in Thousands]
=================================================================================================
[Unaudited]
Six Months Ended
June 30,
-----------------------------------
2002 2001
--------------- ----------------
FINANCING ACTIVITIES:
Contract withdrawals, net of deposits $ (249,040) $ (86,787)
Net GWL repayments (1,745) (11,542)
Dividends paid (90,358) (94,461)
Net commercial paper borrowings, net 1,475 1,070
Net repurchase agreements borrowings, net 64,809 231,402
--------------- ----------------
Net cash (used in) provided by financing activities (274,859) 39,682
--------------- ----------------
NET INCREASE IN CASH 145,194 4,117
CASH, BEGINNING OF YEAR 216,209 156,388
--------------- ----------------
CASH, END OF PERIOD $ 361,403 $ 160,505
=============== ================
See notes to consolidated financial statements. (Concluded)
GWL&A FINANCIAL INC.
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2002 [Dollars in Thousands]
=================================================================================================
[Unaudited]
Accumulated
Additional Other
Preferred Stock Common Stock Paid-in Comprehensive Retained
---------------------- -----------------------
Shares Amount Shares Amount Capital Income Earnings Total
---------- --------- ---------- ---------- ---------- -------------- ---------- ----------
BALANCES, JANUARY 1, 2002 0 $ 0 50,025 $ 250 $ 719,833 $ 76,507 $ 674,495 $ 1,471,085
Net income 153,064 153,064
Other comprehensive income 34,280 34,280
----------
Total comprehensive income 187,344
----------
Dividends (90,358) (90,358)
Income tax benefit on stock
compensation 3,707 3,707
---------- --------- ---------- ---------- ---------- -------------- ---------- ----------
BALANCES, JUNE 30, 2002 0 $ 0 50,025 $ 250 $ 723,540 $ 110,787 $ 737,201 $ 1,571,778
========== ========= ========== ========== ========== ============== ========== ==========
See notes to consolidated financial statements.
GWL&A FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
[Amounts in Thousands]
================================================================================
[Unaudited]
1. BASIS OF PRESENTATION
The consolidated financial statements and related notes of GWL&A
Financial Inc. (the Company) have been prepared in accordance with
accounting principles generally accepted in the United States of America
applicable to interim financial reporting and do not include all of the
information and footnotes required for complete financial statements.
However, in the opinion of management, these statements include all
normal recurring adjustments necessary for a fair presentation of the
results. These financial statements should be read in conjunction with
the audited consolidated financial statements and the accompanying notes
included in the Company's latest annual report on Form 10-K for the year
ended December 31, 2001.
Operating results for the six months ended June 30, 2002 are not
necessarily indicative of the results that may be expected for the full
year ending December 31, 2002.
2. NEW ACCOUNTING PRONOUNCEMENTS
On June 29, 2001, Statement No. 142, "Goodwill and Other Intangible
Assets" (SFAS No. 142) was approved by the FASB. SFAS No. 142 changes
the accounting for goodwill and certain other intangibles from an
amortization method to an impairment-only approach. Amortization of
goodwill, including goodwill recorded in past business combinations,
will cease upon adoption of this statement. The Company implemented
SFAS No. 142 on January 1, 2002. Adoption of this statement did not
have a material impact on the Company's financial position or results
of operations.
In August 2001, the FASB issued Statement No.144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS No.144). SFAS No.144
supercedes current accounting guidance relating to impairment of
long-lived assets and provides a single accounting methodology for
long-lived assets to be disposed of, and also supercedes existing
guidance with respect to reporting the effects of the disposal of a
business. SFAS No.144 was adopted January 1, 2002 without a material
impact on the Company's financial position or results of operations.
In April 2002, the FASB issued Statement No. 145 "Rescission of FASB No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). FASB No. 4 required all gains or losses
from extinguishment of debt to be classified as extraordinary items net
of income taxes. SFAS No. 145 requires that gains and losses from
extinguishment of debt be evaluated under the provision of Accounting
Principles Board Opinion No. 30, and be classified as ordinary items
unless they are unusual or infrequent or meet the specific criteria for
treatment as an extraordinary item. This statement is effective January
1, 2003. The Company does not expect this statement to have a material
effect on the Company's financial position or results of operations.
In July 2002, the FASB issued Statement No. 146 " Accounting for Costs
Associated With Exit or Disposal Activities" (SFAS No. 146). This
statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies EITF Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in
a Restructuring)." This statement requires recognition of a liability
for a cost associated with an exit or disposal activity when the
liability is incurred, as opposed to when the entity commits to an exit
plan under EITF 94-3. SFAS No. 146 is to be applied prospectively to
exit or disposal activities initiated after December 31, 2002. The
Company does not expect this statement to have a material impact on the
Company's financial position or results of operations.
3. OTHER
In the second quarter of 2001, the Company recorded a $127 million
special charge, ($80.9 million, net of tax) related to Alta Health &
Life Insurance Company (Alta). The principal components of the charge
include a $46 million premium deficiency reserve related to
under-pricing on the block of business, a $29 million reserve for
doubtful premium receivables, a $28 million reserve for doubtful
accident and health plan claim receivables, and $24 million decrease in
goodwill and other. Alta was acquired by the Company on July 8, 1998.
During 1999 and 2000 the Alta business continued to be run as a
free-standing unit but was converted to the Company's system and
accounting processes. This conversion program resulted in significant
issues related to pricing, underwriting, and administration of the
business. The Company has decided to transition Alta business to other
Company products. All Alta sales and administration staff have become
employees of the Company and the underwriting functions will be
conducted by the underwriting staff of the Company.
The Company is involved in various legal proceedings that arise in the
ordinary course of its business. In the opinion of management, after
consultation with counsel, the resolution of these proceedings should
not have a material adverse effect on its financial position or results
of operations.
Certain reclassifications have been made to the 2001 financial
statements to conform to the 2002 presentation.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Three Months Ended Six Months Ended
Operating Summary June 30, June 30,
---------------------- ----------------------------
[Millions] 2002 2001 2002 2001
----------------------------- --------- --------- ---------- -- --------------
Premium income $ 260 $ 263 $ 549 $ 597
Fee income 233 232 460 483
Net investment income 234 243 462 482
Net realized gains on
investments 2 1 8 9
--------- --------- ---------- --------------
Total revenues 729 739 1,479 1,571
Total benefits and expenses 611 649 1,253 1,390
Income tax expenses 38 30 73 62
Net income before
special charges 80 60 153 119
Special charges (net) 81 81
--------- --------- ---------- --------------
Net income (loss) $ 80 $ (21) $ 153 $ 38
========= ========= ========== ==============
Deposits for investment-type
contracts $ 162 $ 176 $ 312 $ 374
Deposits to
separate accounts 589 686 1,388 1,642
Self-funded
premium equivalents 1,294 1,426 2,642 2,976
Balance Sheet June 30, December 31,
[Millions] 2002 2001
----------------------------- ---------- --------------
Investment assets $ 14,391 $ 14,240
Separate account assets 11,917 12,585
Total assets 28,346 28,814
Total policy benefit 13,026 12,931
liabilities
Due to GWL 40 42
Guaranteed preferred
beneficial interests in
the
Company's junior
subordinated debentures 175 175
Total stockholder's equity 1,572 1,471
GENERAL
This Form 10-Q contains forward-looking statements. Forward-looking
statements are statements not based on historical information and that
relate to future operations, strategies, financial results, or other
developments. In particular, statements using verbs such as "expect",
"anticipate", "believe", or words of similar import generally involve
forward-looking statements. Without limiting the foregoing,
forward-looking statements include statements which represent the
Company's beliefs concerning future or projected levels of sales of the
Company's products, investment spreads or yields, or the earnings or
profitability of the Company's activities. Forward-looking statements
are necessarily based upon estimates and assumptions that are inherently
subject to significant business, economic, and competitive uncertainties
and contingencies, many of which are beyond the Company's control and
many of which, with respect to future business decisions, are subject to
change. These uncertainties and contingencies can affect actual results
and could cause actual results to differ materially from those expressed
in any forward-looking statements made by, or on behalf of, the Company.
Whether or not actual results differ materially from forward-looking
statements may depend on numerous foreseeable and unforeseeable events
or developments, some of which may be national in scope, such as general
economic conditions and interest rates, some of which may be related to
the insurance industry generally, such as pricing competition,
regulatory developments, and industry consolidation, and others of which
may relate to the Company specifically, such as credit, volatility, and
other risks associated with the Company's investment portfolio, and
other factors. Readers are also directed to consider other risks and
uncertainties discussed in documents filed by the Company and certain of
its subsidiaries with the Securities and Exchange Commission.
The following discussion addresses the financial condition of the
Company as of June 30, 2002, compared with December 31, 2001, and its
results of operations for the quarter and six months ended June 30,
2002, compared with the same period last year. The discussion should be
read in conjunction with the Management's Discussion and Analysis
section included in the Company's report on Form 10-K for the year ended
December 31, 2001 to which the reader is directed for additional
information.
CONSOLIDATED RESULTS
The Company's consolidated net income increased $1.3 million or 2% and
$15.3 million or 11% for the second quarter and first six months of 2002
when compared to the second quarter and first six months of 2001, before
one-time charges of $80.9 million and operating losses of $18.7 million,
net of tax, related to the Alta Health & Life Insurance Company (Alta)
business. Alta was acquired by the Company on July 8, 1998. During 2001
and 2000, the Alta business continued to be run as a free-standing unit
but was converted to the Company's systems and accounting processes.
This conversion program resulted in significant issues related to
pricing, underwriting, and administration of the business. The Company
has decided to transition Alta business to other Company products. All
Alta sales and administration staff have become employees of the Company
and the underwriting functions will be conducted by the underwriting
staff of the Company. The net income increases reflect $16 million and
$31 million for the second quarter and first six months of 2002 in the
Employee Benefits segment. The net income increases reflect $4 million
and $3 million for the second quarter and first six months of 2002 in
the Financial Services segment.
Total revenues decreased $10 million or 1% and $92 million or 6% for the
second quarter and first six months of 2002 when compared to the second
quarter and first six months of 2001. The decrease in the second quarter
was primarily due to a $9 million decrease in net investment income.
The decrease in total revenues for the first six months of 2002 was due
to a $48 million decrease in premium income, a $23 million decrease in
fee income, a $20 million decrease in net investment income, and a $1
million decrease in realized investment gains.
The decrease in premium income for the first six months of 2002 is
primarily in the Employee Benefits segment reflecting a higher level of
terminations in the latter part of 2001 and the first six months of
2002.
The decreases in net investment income in the second quarter and first
six months of 2002 were primarily the result of decreasing interest
rates in 2001. The actual earned rate at June 30, 2002 was 6.87%
compared to 7.38% at June 30, 2001. The earned rate is expected to trend
lower in the next few quarters reflecting the interest rate environment.
Benefits and expenses decreased $38 million or 6% and $137 million or
10% for the second quarter and the first six months of 2002 when
compared to the second quarter and the first six months of 2001. The
decrease in benefits and expenses was a combination of lower group life
and health claims and effective cost management.
Income tax expense before special charges increased $8 million or 27%
and $11 million or 18% for the second quarter and first six months of
2002 when compared to the same periods in 2001. The increase reflects
the increase in pretax income.
In evaluating its results of operations, the Company also considers net
changes in deposits received for investment-type contracts, deposits to
separate accounts and self-funded equivalents. Self-funded equivalents
represent paid claims under minimum premium and administrative services
only contracts, which amounts approximate the additional premiums that
would have been earned under such contracts if they had been written as
traditional indemnity or HMO programs.
Deposits for separate accounts decreased $254 million or 15% for the
first six months of 2002 when compared to the first six months of 2001.
The decrease is due primarily to lower 401(k) single premium deposits.
Self-funded premium equivalents decreased $334 million or 11% for the
first six months of 2002 when compared to the first six months of 2001.
The decrease was due to the decrease in membership and improved
morbidity.
Historically, the 401(k) business unit had been included with the
Employee Benefits segment. In order to capitalize on administrative
system efficiencies and group pension expertise, 401(k) is now
administered by the Financial Services segment. As a result, prior
period segment results have been reclassified to conform with this
change.
SEGMENT RESULTS
Employee Benefits
The following is a summary of certain financial data of the Employee
Benefits segment:
Three Months Ended Six Months Ended
Operating Summary June 30, June 30,
------------------------- -------------------------
[Millions] 2002 2001 2002 2001
----------------------------- ----------- ---------- ----------- ----------
Premium income $ 222 $ 225 $ 465 $ 508
Fee income 175 176 346 364
Net investment income 17 16 34 34
Realized investment gains 1 1 2
----------- ---------- ----------- ----------
Total revenues 415 417 846 908
Total benefits and expenses 352 378 728 835
Income tax expenses 21 13 39 25
----------- ---------- ----------- ----------
Net income before special
Charges 42 26 79 48
Special charges (net) 81 81
----------- ---------- ----------- ----------
Net income $ 42 $ (55) $ 79 $ (33)
=========== ========== =========== ==========
Self-funded premium $ 1,294 $ 1,426 $ 2,642 $ 2,976
equivalents
The increase in earnings for the second quarter and the first six months
of 2002 compared to a year ago, before one-time charges of $80.9 million
and operating losses of $18.7 million, net of tax, related to the Alta
Health & Life Insurance Company (Alta) business, is primarily related to
improved mortality and morbidity results, as well as effective expense
management.
Premium and fee income decreased $4 million or 1% for the second quarter
of 2002 and decreased $61 million or 7% for the first six months of
2002, when compared to the same periods of 2001. The decreases are
primarily due to lower membership levels associated with higher
termination rates. There was a 3% decrease in total health care
membership from 2,386,200 at March 31, 2002 to 2,321,400 at June 30,
2002. There was a 19% decrease in total health care membership from
2,876,200 at June 30, 2001 to 2,321,400 at June 30, 2002. Much of the
health care decline can be attributed to terminations resulting from
aggressive pricing related to target margins. The decline in membership
was also, in part, due to difficulties with the implementation of a
systems enhancement, which was resolved by the end of 2001; a decrease
in the employee base for existing group health care customers; and the
general decline in the economy. The Company anticipates that membership
will stabilize at the current level as the decline was reduced in the
second quarter.
Total benefits and expenses decreased $26 million or 7% and $107 million
or 13% for the second quarter and first six months of 2002 when compared
to the second quarter and first six months of 2001. The decreases are
due primarily to a combination of lower group life and health claims and
effective cost management.
Self-funded premium equivalents decreased $132 million and $334 million
for the second quarter and first six months of 2002 compared to the
second quarter and first six months of 2001. The decrease was due to the
decrease in membership and improved morbidity.
The Company recorded $14.0 million ($9.1 million, net of tax) and $4.5
million ($2.9 million, net of tax) of restructuring costs in the first
quarter of 2002 and in the second quarter of 2002 related to the costs
associated with the consolidation of benefit payment offices and sales
offices throughout the United States. The charges relate to severance of
$2.8 million and $1.5 million, disposal of furniture and equipment of
$4.4 million and $0.5 million, and termination of leasing agreements of
$6.8 million and $2.5 million. During the first quarter of 2002, 304
employees were terminated, of which 250 employees were from the Employee
Benefits division. During the second quarter of 2002, 252 employees were
terminated, all of which were from the Employee Benefits division.
The Company established a premium deficiency reserve on the Alta block
of business in 2001. Releases of $18.7 million in 2001, $6.2 million in
the first quarter of 2002, and $2.1 million in the second quarter of
2002 were made to offset the underwriting losses incurred on the
under-priced block of business. During the first quarter of 2002 the
reserve was reduced by $15.0 million ($9.8 million net of tax) and
during the second quarter of 2002 the reserve was reduced by $4.0
million ($2.6 million, net of tax) based on an analysis of emerging
experience which was more favorable than originally estimated. The
balance of the premium deficiency reserve at June 30, 2002 was zero.
Financial Services
The following is a summary of certain financial data of the Financial
Services segment.
Three Months Ended Six Months Ended
Operating Summary June 30, June 30,
------------------------- -------------------------
[Millions] 2002 2001 2002 2001
----------------------------- ----------- ---------- ----------- ----------
Premium income $ 38 $ 38 $ 84 $ 90
Fee income 58 56 114 118
Net investment income 217 227 428 448
Realized investment gains 1 1 7 7
----------- ---------- ----------- ----------
Total revenues 314 322 633 663
Total benefits and expenses 259 271 525 555
Income tax expenses 17 17 34 37
----------- ---------- ----------- ----------
Net income $ 38 $ 34 $ 74 $ 71
=========== ========== =========== ==========
Deposits for investment-type
contracts $ 162 $ 176 $ 312 $ 374
Deposits to separate 589 686 1,388 1,642
accounts
Net income for Financial Services increased $4 million and $3 million
for the second quarter and first six months ended June 30, 2002 when
compared to the same periods last year. The increase reflects an
improvement in interest margins on guaranteed public nonprofit business.
Savings
Savings premiums and deposits and fees decreased $64 million (from $368
million to $304 million) or 17% for the second quarter of 2002 when
compared to the same period last year, and decreased $69 million (from
$882 million to $813 million) or 8% for the first six months of 2002
when compared to the first six months of 2001. The decreases primarily
reflect decreases in the deposits to separate accounts.
The Financial Services segment's core savings business is in the
public/non-profit pension market. The assets of the public/non-profit
pension business including separate accounts but excluding Guaranteed
Investment Contracts decreased $31.8 million or 0.4% from December 31,
2001.
The Financial Services segment's savings business experienced growth
during the first six months of 2002. The total lives under
administration increased 3.4% from 1,268,549 at December 31, 2001 to
1,312,304 at June 30, 2002.
Customer participation in guaranteed separate accounts increased during
2002, as many customers prefer the security of fixed income securities
in separate account assets. Assets under management for guaranteed
separate account funds were $1,516.9 million at June 30, 2002 compared
to $1,207.9 million at December 31, 2001.
Life Insurance
Individual life insurance deposits and premiums and fees of $141.0
million and $245.4 million for the second quarter and first six months
of 2002 represent an increase of $15 million or 12% and a decrease of
$8.2 million or 3% from the same periods last year. The second quarter
increase when compared to the prior year is primarily due to an increase
in Business Owned Life Insurance (BOLI) separate account deposits. ____
The decrease in the first six months of 2002 compared to the first six
months of 2001 is primarily due to significant decrease in deposits for
investment type contracts offset by a significant increase in deposits
to separate accounts. Specifically, the small case BOLI products have
not sold as well in 2002 due to lower fixed interest rates.
401(k)
401(k) premiums and deposits decreased 13% for the second quarter of
2002 when compared to the second quarter of 2001 (from $462.4 million to
$402.7 million). 401(k) premiums and deposits decreased 23% for the six
months of 2002 (from $1,087.9 million to $839.8 million) when compared
to the six months of 2001. Assets under administration (including
third-party administration) in 401(k) decreased 7.5% during the six
months of 2002 due to the impact of lower U.S. equity markets and
decreasing number of participants. The number of participants decreased
from 562,800 at June 30, 2001 to 517,057 at June 30, 2002, reflecting
higher termination rates.
The number of 401(k) case sales (employer groups), including third-party
administration business generated by the Company's marketing and
administration arrangement with New England, decreased 21% to 181 for
the first six months of 2002 as compared to 230 for the same period in
2001.
GENERAL ACCOUNT INVESTMENTS
The Company's primary investment objective is to acquire assets whose
duration and cash flow reflect the characteristics of the Company's
liabilities, while meeting industry, size, issuer, and geographic
diversification standards. Formal liquidity and credit quality
parameters have also been established.
The Company follows rigorous procedures to control interest rate risk
and observes strict asset and liability matching guidelines. These
guidelines are designed to ensure that even in changing market
conditions, the Company's assets will meet the cash flow and income
requirements of its liabilities. Using dynamic modeling to analyze the
effects of a wide range of possible market changes upon investments and
policyholder benefits, the Company ensures that its investment portfolio
is appropriately structured to fulfill financial obligations to its
policyholders.
Fixed Maturities
Fixed maturities investments include public and privately placed
corporate bonds, public and privately placed structured assets and
government bonds. This latter category contains both asset-backed and
mortgage-backed securities, including collateralized mortgage
obligations (CMOs). The Company's strategy related to structured assets
is to focus on those with lower volatility and minimal credit risk. The
Company does not invest in higher risk CMOs such as interest-only and
principal-only strips, and currently has no plans to invest in such
securities.
Private placement investments are generally less marketable than
publicly traded assets, yet they typically offer covenant protection
that allows the Company, if necessary, to take appropriate action to
protect its investment. The Company believes that the cost of the
additional monitoring and analysis required by private placements is
more than offset by their enhanced yield.
One of the Company's primary objectives is to ensure that its fixed
maturity portfolio is maintained at a high average quality, so as to
limit credit risk. If not externally rated, the securities are rated by
the Company on a basis intended to be similar to that of rating
agencies.
The distribution of the fixed maturity portfolio by credit rating is
summarized as follows:
June 30, December 31,
2002 2001
------------------ -------------------
AAA 59 % 58 %
AA 9 % 9 %
A 14 % 14 %
BBB 16 % 16 %
BB and Below (non-investment grade) 2 % 3 %
-------------- --- --------------- ---
TOTAL 100.0 % 100.0 %
============== === =============== ===
During the first six months of 2002, net unrealized gains on fixed
maturities included in stockholder's equity, which is net of
policyholder-related amounts and deferred income taxes, increased
stockholder's equity by $34.3 million.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
the Company's management to make a variety of estimates and assumptions.
These estimates and assumptions affect, among other things, the reported
amounts of assets and liabilities, the disclosure of contingent
liabilities and the reported amounts of revenues and expenses. Actual
results can differ from the amounts previously estimated, which were
based on the information available at the time the estimates were made.
The critical accounting policies described below are those that the
Company believes are important to the portrayal of the Company's
financial condition and results, and which require management to make
difficult, subjective and/or complex judgments. Critical accounting
policies cover accounting matters that are inherently uncertain because
the future resolution of such matters is unknown. The Company believes
that critical accounting policies include policy reserves, allowances
for credit losses, deferred policy acquisition costs, and valuation of
privately placed fixed maturities.
Policy Reserves
Life Insurance and Annuity Reserves - Life insurance and annuity policy
reserves with life contingencies are computed on the basis of estimated
mortality, investment yield, withdrawals, future maintenance and
settlement expenses, and retrospective experience rating premium
refunds. Annuity contract reserves without life contingencies are
established at the contractholder's account value.
Reinsurance - Policy reserves ceded to other insurance companies are
carried as a reinsurance receivable on the balance sheet. The cost of
reinsurance related to long-duration contracts is accounted for over the
life of the underlying reinsured policies using assumptions consistent
with those used to account for the underlying policies. Reinsurance
contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could
result in losses to the Company. The Company evaluates the financial
condition of its reinsurers and monitors concentrations of credit risk
arising from similar geographic regions, activities, or economic
characteristics of the reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. In the normal course of
business, the Company seeks to limit its exposure to loss on any single
insured and to recover a portion of benefits paid by ceding risks to
other insurance enterprises under excess coverage and co-insurance
contracts. The Company retains a maximum of $1.5 million of coverage per
individual life.
Policy and Contract Claims - Policy and contract claims include
provisions for reported life and health claims in process of settlement,
valued in accordance with the terms of the related policies and
contracts, as well as provisions for claims incurred and unreported
based primarily on prior experience of the Company.
Allowance For Credit Losses
The Company maintains an allowance for credit losses at a level that, in
management's opinion, is sufficient to absorb credit losses on its
amounts receivable related to uninsured accident and health plan claims
paid on behalf of policyholders and premiums in course of collection,
and to absorb credit losses on its impaired loans. Management's
judgement is based on past loss experience and current and projected
economic conditions, and extensive situational analysis of each
individual loan. The measurement of impaired loans is based on the fair
value of the collateral.
Deferred Policy Acquisition Costs
Policy acquisition costs, which primarily consist of sales commissions
and costs associated with the Company's group sales representatives
related to the production of new business, have been deferred to the
extent recoverable. These costs are variable in nature and are dependent
upon sales volume. Deferred costs associated with the annuity products
are being amortized over the life of the contracts in proportion to the
emergence of gross profits. Retrospective adjustments of these amounts
are made when the Company revises its estimates of current or future
gross profits. Deferred costs associated with traditional life insurance
are amortized over the premium paying period of the related policies in
proportion to premium revenues recognized.
Valuation Of Privately Placed Fixed Maturities
The estimated fair values of financial instruments have been determined
using available information and appropriate valuation methodologies.
However, considerable judgement is required to interpret market data to
develop estimates of fair value. Accordingly, the estimates presented
are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
To determine fair value for fixed maturities not actively traded, the
Company utilizes discounted cash flows calculated at current market
rates on investments of similar quality and term.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations have liquidity requirements that vary among the
principal product lines. Life insurance and pension plan reserves are
primarily long-term liabilities. Accident and health reserves, including
long-term disability, consist of both short-term and long-term
liabilities. Life insurance and pension plan reserve requirements are
usually stable and predictable, and are supported primarily by
long-term, fixed income investments. Accident and health claim demands
are stable and predictable but generally shorter term, requiring greater
liquidity.
Generally, the Company has met its operating requirements by maintaining
appropriate levels of liquidity in its investment portfolio. Liquidity
for the Company has remained strong, as evidenced by significant amounts
of short-term investments and cash that totaled $866.2 million and
$641.4 million as of June 30, 2002 and December 31, 2001, respectively.
Funds provided from premiums and fees, investment income and maturities
of investment assets are reasonably predictable and normally exceed
liquidity requirements for payment of claims, benefits, and expenses.
However, since the timing of available funds cannot always be matched
precisely to commitments, imbalances may arise when demands for funds
exceed those on hand. Also, a demand for funds may arise as a result of
the Company taking advantage of current investment opportunities. The
Company's capital resources represent funds available for long-term
business commitments and primarily consist of retained earnings and
proceeds from the issuance of equity securities. Capital resources
provide protection for policyholders and the financial strength to
support the underwriting of insurance risks, and allow for continued
business growth. The amount of capital resources that may be needed is
determined by the Company's senior management and Board of Directors, as
well as by regulatory requirements. The allocation of resources to new
long-term business commitments is designed to achieve an attractive
return, tempered by considerations of risk and the need to support the
Company's existing business.
Additional liquidity is available through the Company's participation in
repurchase agreements with third party brokers and the issuance of
commercial paper. The Company had $315.7 million of repurchase
agreements at June 30, 2002, compared to $250.9 at December 31, 2001.
The Company's participation in repurchase agreements depends on current
market conditions, and as a result, fluctuations may occur.
The Company's financial strength provides the capacity and flexibility
to enable it to raise funds in the capital markets through the issuance
of commercial paper. The Company continues to be well capitalized, with
sufficient borrowing capacity to meet the anticipated needs of its
business. The Company had $98.5 million and $97.0 million of commercial
paper outstanding at June 30, 2002, and December 31, 2001, respectively.
The commercial paper has been given a rating of A-1 + by Standard &
Poor's Corporation and a rating of P-1 by Moody's Investors Service,
each being the highest rating available.
OBLIGATIONS RELATING TO DEBT AND LEASES FOR THE FULL YEAR ARE AS
FOLLOWS:
2002 2003 2004 2005 2006 Thereafter
-------- -------- -------- -------- -------- -----------
Related party $ $ $ $ $ 25.0 $
note
Operating leases 15.4 26.5 22.7 19.6 16.7 35.6
-------- -------- -------- -------- -------- -----------
Total contractual
obligations $ 15.4 $ 26.5 $ 22.7 $ 19.6 $ 41.7 $ 35.6
======== ======== ======== ======== ======== ===========
Item 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's assets are purchased to fund future benefit payments to
its policyholders and contractholders. The primary risk of these assets
is exposure to rising interest rates. The Company's exposure to foreign
currency exchange rate fluctuations is minimal as only nominal foreign
investments are held.
To manage interest rate risk, the Company invests in assets that are
suited to the products that it sells. For products with fixed and highly
predictable benefit payments such as certificate annuities and payout
annuities, the Company invests in fixed income assets with cash flows
that closely match the liability product cash flows. The Company is then
protected against interest rate changes, as any change in the fair value
of the assets will be offset by a similar change in the fair value of
the liabilities. For products with uncertain timing of benefit payments
such as portfolio annuities and life insurance, the Company invests in
fixed income assets with expected cash flows that are earlier than the
expected timing of the benefit payments. The Company can then react to
changing interest rates sooner as these assets mature for reinvestment.
The Company also manages risk with interest rate derivatives such as
interest rate caps that would pay the Company investment income if
interest rates rise above the level specified in the cap. The Company
also uses interest rate swaps to convert cash flow from variable-rate
investments to fixed amounts to match such cash flows to expected cash
flows on its liabilities to policyholders. These derivatives are only
used to reduce risk and are not used for speculative purposes.
To manage foreign currency exchange risk, the Company uses currency
swaps to convert foreign currency back to United States dollars. These
swaps are purchased each time a foreign currency denominated asset is
purchased.
There are no significant changes to the Company's risk from December 31,
2001.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or
any of its subsidiaries is a party or of which any of their property is
the subject.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
None
(b) Reports on Form 8-K
A report on Form 8-K, dated April 25, 2002, was filed disclosing
the Company's first quarter results as of March 31, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
GWL&A FINANCIAL INC.
BY: /s/ Glen R. Derback DATE: August 14, 2002
--------------------------------------- ----------------------
Glen R. Derback, Vice President and Controller
(Duly authorized officer and chief accounting officer)