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EX-31.2 - EX-31.2 - GREAT WEST LIFE & ANNUITY INSURANCE COa11-11768_1ex31d2.htm

Table of Contents

 

 

 

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 March 31, 2011

 

OR

 

o

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 333-1173

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

(Exact name of registrant as specified in its charter)

 

COLORADO

 

84-0467907

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

8515 EAST ORCHARD ROAD, GREENWOOD VILLAGE, CO 80111

(Address of principal executive offices)

 

(303) 737-3000

(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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company as defined in Rule 12b-2 of the Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Act.  Yes o  No x

 

As of May 1, 2011, 7,032,000 shares of the registrant’s common stock were outstanding, all of which were owned by the registrant’s parent company.

 

 

 



Table of Contents

 

Table of Contents

 

 

 

 

Page

 

 

 

Number

 

 

 

 

Part I

Financial Information

3

 

 

 

 

 

Item 1

Interim Financial Statements

3

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at March 31, 2011 (Unaudited) and December 31, 2010

3

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2011 and 2010 (Unaudited)

5

 

 

 

 

 

 

Condensed Consolidated Statements of Stockholder’s Equity for the Year Ended December 31, 2010 and for the Three Months Ended March 31, 2011 (Unaudited)

6

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (Unaudited)

7

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

9

 

 

 

 

 

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

42

 

 

 

 

 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

53

 

 

 

 

 

Item 4

Controls and Procedures

54

 

 

 

 

Part II

Other Information

54

 

 

 

 

 

Item 1

Legal Proceedings

54

 

 

 

 

 

Item 1A

Risk Factors

54

 

 

 

 

 

Item 6

Exhibits

55

 

 

 

 

 

 

Signature

55

 

2



Table of Contents

 

Part I                             Financial Information

Item 1.                       Interim Financial Statements

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Condensed Consolidated Balance Sheets

March 31, 2011 (Unaudited) and December 31, 2010

(In Thousands, Except Share Amounts)

 

 

 

March 31, 2011

 

December 31, 2010

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities, available-for-sale, at fair value (amortized cost $15,042,668 and $15,382,402)

 

$

15,580,749

 

$

15,943,057

 

Fixed maturities, held for trading, at fair value (amortized cost $172,095 and $134,587)

 

180,611

 

144,174

 

Mortgage loans on real estate (net of allowances of $16,300 and $16,300)

 

1,973,770

 

1,722,422

 

Equity investments, available-for-sale, at fair value (cost $1,913 and $1,313)

 

2,419

 

1,888

 

Policy loans

 

4,049,727

 

4,059,640

 

Short-term investments, available-for-sale (cost approximates fair value)

 

966,488

 

964,507

 

Limited partnership and other corporation interests

 

201,123

 

210,146

 

Other investments

 

22,200

 

22,762

 

Total investments

 

22,977,087

 

23,068,596

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Cash

 

3,054

 

4,476

 

Reinsurance receivable

 

597,160

 

594,997

 

Deferred acquisition costs and value of business acquired

 

332,779

 

306,948

 

Investment income due and accrued

 

276,727

 

239,345

 

Premiums in course of collection

 

1,375

 

15,421

 

Collateral under securities lending agreements

 

60,189

 

51,749

 

Due from parent and affiliates

 

166,051

 

203,231

 

Goodwill

 

105,255

 

105,255

 

Other intangible assets

 

24,695

 

25,642

 

Other assets

 

507,464

 

460,573

 

Assets of discontinued operations

 

61,270

 

62,091

 

Separate account assets

 

22,294,042

 

22,489,038

 

Total assets

 

$

47,407,148

 

$

47,627,362

 

 

See notes to condensed consolidated financial statements.

 

(Continued)

 

3



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Condensed Consolidated Balance Sheets

March 31, 2011 (Unaudited) and December 31, 2010

(In Thousands, Except Share Amounts)

 

 

 

March 31, 2011

 

December 31, 2010

 

Liabilities and stockholder’s equity

 

 

 

 

 

Policy benefit liabilities:

 

 

 

 

 

Future policy benefits

 

$

20,463,429

 

$

20,420,875

 

Policy and contract claims

 

292,301

 

293,383

 

Policyholders’ funds

 

345,680

 

372,980

 

Provision for policyholders’ dividends

 

66,538

 

66,244

 

Undistributed earnings on participating business

 

6,880

 

6,803

 

Total policy benefit liabilities

 

21,174,828

 

21,160,285

 

 

 

 

 

 

 

General liabilities:

 

 

 

 

 

Due to parent and affiliates

 

544,004

 

537,474

 

Repurchase agreements

 

814,607

 

936,762

 

Commercial paper

 

98,402

 

91,681

 

Payable under securities lending agreements

 

60,189

 

51,749

 

Deferred income tax liabilities, net

 

59,645

 

57,798

 

Other liabilities

 

506,043

 

460,310

 

Liabilities of discontinued operations

 

61,228

 

62,042

 

Separate account liabilities

 

22,294,042

 

22,489,038

 

Total liabilities

 

45,612,988

 

45,847,139

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

Stockholder’s equity:

 

 

 

 

 

Preferred stock, $1 par value, 50,000,000 shares authorized; none issued and outstanding

 

 

 

Common stock, $1 par value, 50,000,000 shares authorized; 7,032,000 shares issued and outstanding

 

7,032

 

7,032

 

Additional paid-in capital

 

765,544

 

764,644

 

Accumulated other comprehensive income (loss)

 

234,523

 

242,516

 

Retained earnings

 

787,061

 

766,031

 

Total stockholder’s equity

 

1,794,160

 

1,780,223

 

Total liabilities and stockholder’s equity

 

$

47,407,148

 

$

47,627,362

 

 

See notes to condensed consolidated financial statements.

 

(Concluded)

 

4



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Condensed Consolidated Statements of Income

Three Months Ended March 31, 2011 and 2010

(In Thousands)

(Unaudited)

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Revenues:

 

 

 

 

 

Premium income, net of premiums ceded of $5,967 and $5,697

 

$

180,449

 

$

210,994

 

Fee income

 

119,964

 

109,639

 

Net investment income

 

291,866

 

279,356

 

Realized investment gains (losses), net:

 

 

 

 

 

Total other-than-temporary losses

 

 

(53,055

)

Other-than-temporary losses transferred to other comprehensive income

 

 

15,704

 

Other realized investment gains, net

 

6,649

 

17,097

 

Total realized investment gains (losses), net

 

6,649

 

(20,254

)

Total revenues

 

598,928

 

579,735

 

Benefits and expenses:

 

 

 

 

 

Life and other policy benefits, net of reinsurance recoveries of $10,631 and $6,149

 

173,739

 

147,853

 

Increase (decrease) in future policy benefits

 

38,622

 

101,731

 

Interest paid or credited to contractholders

 

125,029

 

116,290

 

Provision (benefit) for policyholders’ share of earnings on participating business

 

189

 

386

 

Dividends to policyholders

 

22,618

 

23,784

 

Total benefits

 

360,197

 

390,044

 

General insurance expenses

 

124,310

 

114,976

 

Amortization of deferred acquisition costs and value of business acquired

 

9,816

 

10,800

 

Interest expense

 

9,450

 

9,335

 

Total benefits and expenses, net

 

503,773

 

525,155

 

Income from operations before income taxes

 

95,155

 

54,580

 

Income tax expense

 

26,325

 

17,933

 

Net income

 

$

68,830

 

$

36,647

 

 

See notes to condensed consolidated financial statements.

 

5



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Condensed Consolidated Statements of Stockholder’s Equity

Year ended December 31, 2010 and Three Months Ended March 31, 2011 (Unaudited)

(In Thousands)

 

 

 

 

 

 

 

Accumulated Other

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Income (Loss)

 

 

 

 

 

 

 

 

 

Additional

 

Unrealized

 

Employee

 

 

 

 

 

 

 

Common

 

paid-in

 

gains (losses)

 

benefit plan

 

Retained

 

 

 

 

 

stock

 

capital

 

on securities

 

adjustments

 

earnings

 

Total

 

Balances, January 1, 2010

 

7,032

 

761,330

 

(90,110

)

(42,611

)

724,193

 

1,359,834

 

Net income

 

 

 

 

 

 

 

 

 

202,755

 

202,755

 

Other comprehensive income (loss), net of income taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-credit component of impaired losses on fixed maturities available-for-sale

 

 

 

 

 

6,346

 

 

 

 

 

6,346

 

Net change in unrealized gains (losses)

 

 

 

 

 

372,233

 

 

 

 

 

372,233

 

Employee benefit plan adjustment

 

 

 

 

 

 

 

(3,342

)

 

 

(3,342

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

577,992

 

Dividends

 

 

 

 

 

 

 

 

 

(160,917

)

(160,917

)

Capital contribution - stock-based compensation

 

 

 

1,855

 

 

 

 

 

 

 

1,855

 

Income tax benefit on stock-based compensation

 

 

 

1,459

 

 

 

 

 

 

 

1,459

 

Balances, December 31, 2010

 

7,032

 

764,644

 

288,469

 

(45,953

)

766,031

 

1,780,223

 

Net income

 

 

 

 

 

 

 

 

 

68,830

 

68,830

 

Other comprehensive income (loss), net of income taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-credit component of impaired losses on fixed maturities available-for-sale

 

 

 

 

 

18,556

 

 

 

 

 

18,556

 

Net change in unrealized gains (losses)

 

 

 

 

 

(26,549

)

 

 

 

 

(26,549

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

60,837

 

Dividends

 

 

 

 

 

 

 

 

 

(47,800

)

(47,800

)

Capital contribution - stock-based compensation

 

 

 

396

 

 

 

 

 

 

 

396

 

Income tax benefit on stock-based compensation

 

 

 

504

 

 

 

 

 

 

 

504

 

Balances, March 31, 2011

 

$

7,032

 

$

765,544

 

$

280,476

 

$

(45,953

)

$

787,061

 

$

1,794,160

 

 

See notes to condensed consolidated financial statements.

 

6



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Condensed Consolidated Statements of Cash Flows

Three Months Ended March 31, 2011 and 2010

(In Thousands)

(Unaudited)

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

68,830

 

$

36,647

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Earnings allocated to participating policyholders

 

189

 

386

 

Amortization of premiums / (accretion) of discounts on investments, net

 

(12,477

)

(7,544

)

Net realized (gains) losses on investments

 

(10,618

)

20,254

 

Net proceeds / (purchases) of trading securities

 

(39,573

)

(24,669

)

Interest credited to contractholders

 

123,874

 

115,117

 

Depreciation and amortization

 

12,859

 

14,975

 

Deferral of acquisition costs

 

(20,591

)

(24,310

)

Deferred income taxes

 

7,732

 

14,782

 

Other, net

 

124

 

671

 

Changes in assets and liabilities:

 

 

 

 

 

Policy benefit liabilities

 

(2,618

)

53,650

 

Reinsurance receivable

 

(1,342

)

5,801

 

Accrued interest and other receivables

 

(23,336

)

(49,469

)

Other assets

 

(1,553

)

(26,727

)

Other liabilities

 

(25,394

)

(80,226

)

Net cash provided by operating activities

 

76,106

 

49,338

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sales, maturities and redemptions of investments:

 

 

 

 

 

Fixed maturities available-for-sale

 

1,855,445

 

1,063,168

 

Mortgage loans on real estate

 

19,301

 

19,599

 

Equity investments and other limited partnership interests

 

10,962

 

14,258

 

Purchases of investments:

 

 

 

 

 

Fixed maturities available-for-sale

 

(1,542,484

)

(1,163,899

)

Mortgage loans on real estate

 

(271,997

)

(31,568

)

Equity investments and other limited partnership interests

 

(3,137

)

(1,815

)

Net change in short-term investments

 

95,509

 

(296,626

)

Net change in repurchase agreements

 

(122,155

)

109,994

 

Policy loans, net

 

2,649

 

457

 

Other, net

 

(30

)

(53

)

Net cash provided by (used in) investing activities

 

44,063

 

(286,485

)

 

See notes to condensed consolidated financial statements.

(Continued)

 

7



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Condensed Consolidated Statements of Cash Flows

Three Months Ended March 31, 2011 and 2010

(In Thousands)

(Unaudited)

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Cash flows from financing activities:

 

 

 

 

 

Contract deposits

 

$

555,655

 

$

552,816

 

Contract withdrawals

 

(654,611

)

(374,603

)

Change in due to parent and affiliates

 

43,598

 

(1,068

)

Dividends paid

 

(47,800

)

(66,000

)

Net commercial paper borrowings (repayments)

 

6,721

 

(2,787

)

Change in bank overdrafts

 

(25,658

)

(22,842

)

Income tax benefit of stock option exercises

 

504

 

525

 

Net cash provided by (used in) financing activities

 

(121,591

)

86,041

 

 

 

 

 

 

 

Net decrease in cash

 

(1,422

)

(151,106

)

Cash, beginning of period

 

4,476

 

170,978

 

Cash, end of period

 

$

3,054

 

$

19,872

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Net cash paid (received) during the periods for:

 

 

 

 

 

Income taxes

 

$

(53,522

)

$

737

 

Income tax payments withheld and remitted to taxing authorities

 

15,963

 

15,214

 

Interest

 

192

 

78

 

 

 

 

 

 

 

Non-cash investing and financing transactions during the periods:

 

 

 

 

 

Share-based compensation expense

 

$

396

 

$

399

 

Fair value of assets acquired in settlement of fixed maturity investments

 

387

 

 

 

See notes to condensed consolidated financial statements.

 

 

 

(Concluded)

 

8



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

1.  Organization and Basis of Presentation

 

Organization - Great-West Life & Annuity Insurance Company (“GWLA”) and its subsidiaries (collectively, the “Company”) is a direct wholly-owned subsidiary of GWL&A Financial Inc. (“GWL&A Financial”), a holding company formed in 1998.  GWL&A Financial is a direct wholly-owned subsidiary of Great-West Lifeco U.S. Inc. (“Lifeco U.S.”) and an indirect wholly-owned subsidiary of Great-West Lifeco Inc. (“Lifeco”).  The Company offers a wide range of life insurance, retirement and investment products to individuals, businesses and other private and public organizations throughout the United States.  The Company is an insurance company domiciled in the State of Colorado and is subject to regulation by the Colorado Division of Insurance.

 

Basis of presentation - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates are required to account for valuation of investments and other-than-temporary impairments, valuation and accounting for derivative instruments, policy benefit liabilities, deferred acquisition costs and value of business acquired, employee benefit plans and taxes on income.  Actual results could differ from those estimates.  However, in the opinion of management, these condensed consolidated financial statements include normal recurring adjustments necessary for the fair presentation of the Company’s financial position and the results of its operations.  The condensed consolidated financial statements include the accounts of the Company and its subsidiaries.  Intercompany transactions and balances have been eliminated in consolidation.

 

These condensed consolidated 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, 2010.  Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2011.

 

2.  Application of Recent Accounting Pronouncements

 

Recently adopted accounting pronouncements

 

In January 2010, the FASB issued ASU No. 2010-06 “Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements” (“ASU No. 2010-06”).  ASU No. 2010-06 provides for disclosure of significant transfers in and out of the fair value hierarchy Levels 1 and 2, and the reasons for these transfers.  In addition, ASU No. 2010-06 provides for separate disclosure about purchases, sales, issuances and settlements in the Level 3 hierarchy roll forward activity.  ASU No. 2010-06 is effective for interim and annual periods beginning after December 31, 2009, except for the provisions relating to purchases, sales, issuances and settlements of Level 3 investments, which are effective for fiscal years beginning after December 15, 2010.  The Company adopted the disclosure provisions of ASU 2010-06 for its fiscal year beginning January 1, 2010 and adopted the Level 3 purchase, sales, issuances and settlement provisions for its fiscal year beginning January 1, 2011.  The adoption ASU No. 2010-06 did not have an impact on the Company’s condensed consolidated financial position or the results of its operations.

 

In February 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-10 “Consolidation: Amendments for Certain Investment Funds” (“ASU No. 2010-10”).  ASU No. 2010-10 defers the effective date of the amendments to the consolidation requirements made by certain provisions of ASC topic 810 (formerly SFAS No. 167), specifically the evaluation of a company’s interests in mutual funds, private equity funds, hedge funds, real estate entities that measure their investments at fair value, real estate investment trusts and venture capital funds.  The deferral provisions of ASU No. 2010-10 will continue indefinitely.  ASU No. 2010-10 was effective for interim and annual periods in fiscal years beginning after November 15, 2009.

 

9



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The Company adopted ASU No. 2010-10 for its fiscal year beginning January 1, 2010.  The adoption of ASU No. 2010-10 did not have an impact on the Company’s condensed consolidated financial position or the results of its operations.

 

In April 2010, the FASB issued ASU No. 2010-15 “How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments” (“ASU No. 2010-15”).  ASU No. 2010-15 clarifies that an insurance company should not consider any separate account interests in an investment held for the benefit of policyholders to be its interests and that those interests should not be combined with interests of its general account in the same investment when assessing the investment for consolidation.  ASU No. 2010-15 also provides that an insurance company is required to consider a separate account as a subsidiary for purposes of evaluating whether the retention of specialized accounting for investments in consolidation is appropriate.  ASU No. 2010-15 is effective for fiscal years beginning after December 15, 2010.  The Company adopted ASU No. 2010-15 for its fiscal year beginning on January 1, 2011.  The adoption of ASU No. 2010-15 did not have an impact on the Company’s condensed consolidated financial position or the results of its operations.

 

In July 2010, the FASB issued ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU No. 2010-20”).  ASU No. 2010-20 provides for entities to disclose credit quality indicators, aging of past due amounts, the nature and extent of troubled debt restructurings, modifications as a result of troubled debt restructurings and significant sales or purchases, by disaggregated class, for its financing receivables.  ASU No. 2010-20 is effective for fiscal periods ending after December 15, 2010.  The Company adopted ASU No. 2010-20 for its fiscal year ended December 31, 2010.  The provisions of ASU No. 2010-20 related to troubled debt restructurings have been clarified in ASU No. 2011-02, see future adoption of new accounting pronouncements below.  The provisions of ASU No. 2010-20 relate only to financial statement disclosures regarding financing receivables and, accordingly, its adoption did not have an impact on the Company’s condensed consolidated financial position or the results of its operations.

 

Future adoption of new accounting pronouncements

 

In October 2010, the FASB issued ASU No. 2010-26 “Financial Services - Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts - a Consensus of the FASB Emerging Issues Task Force” (“ASU No. 2010-26”).  ASU No. 2010-26 provides guidance and modifies the definition of the types and nature of costs incurred by insurance enterprises that can be capitalized in connection with the acquisition of new or renewal insurance contracts.  Further, ASU No. 2010-26 clarifies which costs may not be capitalized as deferred acquisition costs.  ASU No. 2010-26 is effective for interim and annual periods in fiscal years beginning after December 15, 2011 with early adoption permitted.  The Company will adopt ASU No. 2010-26 for its fiscal year beginning January 1, 2012.  The Company is evaluating the impact of the adoption of ASU No. 2010-26.

 

In April 2011, the FASB issued ASU No. 2011-02 “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU No. 2011-02”).  ASU No. 2011-02 clarifies and defines the criteria to be met in a debt modification in order to be considered a troubled debt restructuring.  It also clarifies whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructures.  ASU No. 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011 with early adoption permitted and is to be applied retrospectively to the beginning of the annual period of adoption.  The Company will adopt ASU No. 2011-02 for its fiscal period ended June 30, 2011.  The Company is evaluating the impact of the adoption of ASU No. 2011-02.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

In April 2011, the FASB issued ASU No. 2011-03 “Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements (“ASU No. 2011-03”).  ASU No. 2011-03 removes from the assessment of effective control the criterion requiring a transferor to have the ability to repurchase or redeem the financial assets transferred in a repurchase arrangement.  This requirement was one of the criterion under ASC topic 860 that entities used to determine whether a transferor maintained effective control.  Entities are still required to consider all the effective control criterion under ASC topic 860, however, the elimination of this requirement may lead to more conclusions that a repurchase agreement should be accounted for as a secured borrowing rather than a sale.  ASU No. 2011-03 if effective for the first interim or annual period beginning on or after December 15, 2011.  The Company will adopt ASU No. 2011-03 for its fiscal year beginning January 1, 2012.  The Company is evaluating the impact of the adoption of ASU No. 2011-03.

 

3.  Related Party Transactions

 

Included in the condensed consolidated balance sheets at March 31, 2011 and December 31, 2010 are the following related party amounts:

 

 

 

March 31, 2011

 

December 31, 2010

 

Reinsurance receivable

 

$

484,236

 

$

483,564

 

Future policy benefits

 

2,142,288

 

2,183,167

 

 

Included in the condensed consolidated statements of income for the three month periods ended March 31, 2011 and 2010 are the following related party amounts:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Premium income, net of related party premium ceded of $741 and $794

 

$

30,247

 

$

31,434

 

Life and other policy benefits, net of reinsurance recoveries of $945 and $867

 

29,208

 

33,591

 

Increase (decrease) in future policy benefits

 

(29,374

)

(26,991

)

 

The Company’s wholly owned subsidiary, Great-West Life & Annuity Insurance Company of South Carolina (“GWSC”), and The Canada Life Assurance Company (“CLAC”), an affiliate, are parties to a reinsurance agreement pursuant to which GWSC assumes term life insurance from CLAC.  GWL&A Financial obtained two letters of credit for the benefit of the GWSC as collateral under the reinsurance agreement for balance sheet policy liabilities and capital support.  The first letter of credit is for $1,114,380 and renews annually until it expires on December 31, 2025.  The second letter of credit is for $70,000 and renews annually for an indefinite period of time.  At March 31, 2011 and December 31, 2010, there were no outstanding amounts related to the letters of credit.

 

A subsidiary of the Company, GW Capital Management, LLC, serves as a Registered Investment Advisor to Maxim Series Fund, Inc., an affiliated open-end management investment company, and to several affiliated insurance company separate accounts.  Included in fee income in the condensed consolidated statements of income are $16,350 and $14,102 of advisory and management fee income from these affiliated entities for the three-month periods ended March 31, 2011 and 2010, respectively.

 

The Company’s separate accounts invest in shares of Maxim Series Fund, Inc. and Putnam Funds, which are affiliates of the Company, and shares of other non-affiliated mutual funds and government and corporate bonds.  The Company’s separate accounts invest in mutual funds or other investment options that purchase guaranteed interest annuity contracts issued by the Company.  During the three-month periods ended March 31, 2011 and 2010, these purchases totaled $43,565 and $69,629 respectively.  As the general account investment contracts are also included in the separate account balances in the accompanying

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

condensed consolidated balance sheets, the Company has reduced the separate account assets and liabilities by $281,302 and $269,495 at March 31, 2011 and December 31, 2010, respectively, to eliminate these amounts in its condensed consolidated balance sheets at those dates.

 

The maximum amount of dividends, which can be paid to stockholders by insurance companies domiciled in the State of Colorado, is subject to restrictions relating to statutory capital and surplus and statutory net gain from operations.  Prior to the payment of any dividends, the Company seeks approval from the Colorado Insurance Commissioner.  During the three-month period ended March 31, 2011 and 2010, the Company paid dividends of $47,800 and $66,000, respectively, to its parent, GWL&A Financial.

 

4.  Summary of Investments

 

The following tables summarize fixed maturity investments and equity securities classified as available-for-sale and the amount of other-than-temporary impairments (“OTTI”) classified as the non-credit-related component of previously impaired fixed maturity investments that the Company does not intend to sell included in accumulated other comprehensive income (loss) (“AOCI”) at March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

 

 

Amortized

 

Gross unrealized

 

Gross unrealized

 

Estimated fair value

 

OTTI (gain) loss

 

 

 

cost

 

gains

 

losses

 

and carrying value

 

included in AOCI (1)

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

2,127,022

 

$

88,644

 

$

3,328

 

$

2,212,338

 

$

 

Obligations of U.S. states and their subdivisions

 

1,813,725

 

155,411

 

11,696

 

1,957,440

 

 

Corporate debt securities

 

7,539,946

 

489,732

 

132,982

 

7,896,696

 

4,071

 

Asset-backed securities (2)

 

2,040,361

 

59,169

 

128,025

 

1,971,505

 

(31,457

)

Residential mortgage-backed securities

 

689,617

 

22,849

 

1,655

 

710,811

 

65

 

Commercial mortgage-backed securities

 

799,473

 

26,380

 

20,789

 

805,064

 

 

Collateralized debt obligations

 

32,524

 

66

 

5,695

 

26,895

 

 

Total fixed maturities

 

$

15,042,668

 

$

842,251

 

$

304,170

 

$

15,580,749

 

$

(27,321

)

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments:

 

 

 

 

 

 

 

 

 

 

 

Financial services

 

$

192

 

$

522

 

$

 

$

714

 

$

 

Equity mutual funds

 

645

 

260

 

 

905

 

 

Airline industry

 

1,076

 

 

276

 

800

 

 

Total equity investments

 

$

1,913

 

$

782

 

$

276

 

$

2,419

 

$

 

 


(1) Indicates the amount of any OTTI (gain) loss included in AOCI that is included in gross unrealized gains and losses.

(2) OTTI (gain) loss included in AOCI, as presented above, includes both the initial recognition of non-credit losses and the effects of subsequent increases and decreases in estimated fair value for those fixed maturity securities that had previous non-credit impairment.  The non-credit loss component of OTTI (gain) loss for asset-backed securities was in an unrealized gain position of $31,457 at March 31, 2011 due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

 

 

December 31, 2010

 

 

 

Amortized

 

Gross unrealized

 

Gross unrealized

 

Estimated fair value

 

OTTI (gain) loss

 

 

 

cost

 

gains

 

losses

 

and carrying value

 

included in AOCI (1)

 

Fixed Maturities:

 

 

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

2,289,010

 

$

96,924

 

$

14,784

 

$

2,371,150

 

$

 

Obligations of U.S. states and their subdivisions

 

1,784,299

 

173,567

 

15,603

 

1,942,263

 

 

Corporate debt securities

 

7,625,810

 

557,104

 

144,486

 

8,038,428

 

5,439

 

Asset-backed securities (2)

 

2,104,420

 

51,663

 

154,157

 

2,001,926

 

(22,284

)

Residential mortgage-backed securities

 

730,293

 

20,888

 

12,119

 

739,062

 

505

 

Commercial mortgage-backed securities

 

812,915

 

28,049

 

20,615

 

820,349

 

 

Collateralized debt obligations

 

35,655

 

5

 

5,781

 

29,879

 

 

Total fixed maturities

 

$

15,382,402

 

$

928,200

 

$

367,545

 

$

15,943,057

 

$

(16,340

)

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments:

 

 

 

 

 

 

 

 

 

 

 

Financial services

 

$

192

 

$

533

 

$

 

$

725

 

$

 

Equity mutual funds

 

432

 

119

 

 

551

 

 

Airline industry

 

689

 

 

77

 

612

 

 

Total equity investments

 

$

1,313

 

$

652

 

$

77

 

$

1,888

 

$

 

 


(1) Indicates the amount of any OTTI (gain) loss included in AOCI that is included in gross unrealized gains and losses.

(2) OTTI (gain) loss included in AOCI, as presented above, includes both the initial recognition of non-credit losses and the effects of subsequent increases and decreases in estimated fair value for those fixed maturity securities that had previous non-credit impairment.  The non-credit loss component of OTTI (gain) loss for asset-backed securities was in an unrealized gain position of $22,284 at December 31, 2010 due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.

 

See Note 6 for additional information on policies regarding estimated fair value of fixed maturity and equity investments.

 

The amortized cost and estimated fair value of fixed maturity investments classified as available-for-sale at March 31, 2011, based on estimated cash flows, are shown in the table below.  Actual maturities will likely differ from these projections because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

March 31, 2011

 

 

 

Amortized cost

 

Estimated fair value

 

Maturing in one year or less

 

$

507,671

 

$

536,196

 

Maturing after one year through five years

 

2,832,009

 

3,034,362

 

Maturing after five years through ten years

 

3,334,996

 

3,605,419

 

Maturing after ten years

 

2,836,471

 

2,839,819

 

Mortgage-backed and asset-backed securities

 

5,531,521

 

5,564,953

 

 

 

$

15,042,668

 

$

15,580,749

 

 

Mortgage-backed (commercial and residential) and asset-backed securities, including those issued by U.S. government and U.S. agencies, include collateralized mortgage obligations that consist primarily of sequential and planned amortization classes with legal final stated maturities of up to thirty years and expected average lives of up to fifteen years.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The following table summarizes information regarding the sales of fixed maturity investments classified as available-for-sale for the three-month periods ended March 31, 2011 and 2010:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Proceeds from sales

 

$

1,522,818

 

$

776,449

 

Gross realized gains from sales

 

29,091

 

14,347

 

Gross realized losses from sales

 

19,442

 

40

 

 

Gross realized gains and losses from sales were primarily attributable to changes in interest rates.

 

The Company has a corporate fixed maturity security with fair values of $10,146 and $8,845 that has been non-income producing for the twelve months preceding March 31, 2011 and December 31, 2010, respectively. This security was written down to its fair value in the period it was deemed to be other-than-temporarily impaired.  No additional impairment has been recognized since the period in which it was deemed impaired.

 

The Company holds certain performing securities subject to deferred coupons in which the issuer has exercised its contractual right to defer the payment of the coupons.  At March 31, 2011 and December 31, 2010, the Company had total coupon payment receivables of $559 and $457, respectively.  The Company expects to receive these payments in 2012.  Based on the information presently available, management believes there is reasonable assurance of collection of the deferred coupons at the end of the deferral period.

 

Mortgage loans on real estate - The Company’s mortgage loans on real estate are comprised exclusively of domestic commercial collateralized real estate loans.  The tables below summarize the carry value of the mortgage loan portfolio by component as of March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

December 31, 2010

 

Principal

 

$

1,961,726

 

$

1,709,075

 

Write-offs

 

 

 

Unamortized premium (discount)

 

28,344

 

29,647

 

Allowance for credit loss

 

(16,300

)

(16,300

)

Total mortgage loans

 

$

1,973,770

 

$

1,722,422

 

 

Of the total principal balance in the mortgage loan portfolio, $8,322 and $8,470 related to impaired loans at March 31, 2011 and December 31, 2010, respectively.

 

The Company uses an internal risk assessment process as a primary credit quality indicator, which is updated quarterly, with regard to impairment review and credit loss calculations.  The Company follows a comprehensive approach with the management of mortgage loans that includes ongoing analysis of factors such as debt service coverage ratios, loan-to-value ratios, payment status, default or legal status, annual collateral property evaluations and general market conditions.  Management’s risk assessment process is subjective and includes the categorization of all loans, based on the above mentioned credit quality indicators, into one of the following categories:

 

·    Performing - generally indicates the loan has standard market risk and is within its original underwriting guidelines.

 

·    Non-performing - generally indicates that there is a potential for loss due to the deterioration of financial/monetary default indicators or potential foreclosure.  Due to the potential for loss, these loans are disclosed as impaired.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The Company’s allowance for credit loss is reviewed quarterly.  The determination of the calculation and the adequacy of the mortgage credit loss allowance and mortgage impairments involve judgments that incorporate qualitative and quantitative Company and industry mortgage performance data.  Management’s periodic evaluation and assessment of the adequacy of the allowance for credit losses and the need for mortgage impairments is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the fair value of the underlying collateral, composition of the loan portfolio, current economic conditions, loss experience and other relevant factors.  Loans that meet the non-performing category and other loans with certain substandard credit quality indicators are individually reviewed to determine if a specific impairment is required.  Loans reviewed for specific impairment are excluded from the analysis to estimate the credit loss allowance for the loans categorized as performing in the portfolio.

 

The recorded investment in impaired mortgage loans was $9,454 and $9,576 at March 31, 2011 and December 31, 2010, respectively.  The Company estimated no loss and therefore no specific allowance was recorded at March 31, 2011 or 2010.  The average recorded investment of impaired mortgage loans was $9,515 and $4,418 for the three-month periods ended March 31, 2011 and 2010, respectively.  The interest income earned and recognized on impaired loans during the three-month periods ended March 31, 2011 and 2010 was $64 and $152, respectively.  The interest income collected on impaired loans during the three-month periods ended March 31, 2011 and 2010 was $127 and $213, respectively.

 

The following tables summarize the recorded investment of the mortgage loan portfolio by risk assessment category as of March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

December 31, 2010

 

Performing

 

$

1,980,616

 

$

1,729,146

 

Non-performing

 

9,454

 

9,576

 

Total

 

$

1,990,070

 

$

1,738,722

 

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The following tables summarize activity in the allowance for mortgage loan credit losses for the three months ended March 31, 2011 and the year ended December 31, 2010:

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

Commercial
mortgages

 

Commercial
mortgages

 

Beginning balance

 

$

16,300

 

$

14,854

 

Charge offs

 

 

 

Recoveries

 

 

 

Provision increases

 

 

1,446

 

Provision decreases

 

 

 

Quantitative change in policy or methodology

 

 

 

Ending balance

 

$

16,300

 

$

16,300

 

 

 

 

 

 

 

Ending allowance balance from loans individually evaluated for impairment

 

$

 

$

 

Ending allowance balance from loans collectively evaluated for impairment

 

16,300

 

16,300

 

Ending allowance balance from loans acquired with deteriorated credit quality

 

 

 

 

 

 

 

 

 

Mortgage loans, gross of allowance, ending recorded investment

 

$

1,990,070

 

$

1,738,722

 

Ending recorded investment of loans individually evaluated for impairment

 

30,804

 

27,250

 

Ending recorded investment of loans collectively evaluated for impairment

 

1,959,266

 

1,711,472

 

Ending recorded investment of loans acquired with deteriorated credit quality

 

 

 

 

There was no specific impairment for the three-month periods ended March 31, 2011 and 2010.  No properties were acquired through foreclosure during the three months ended March 31, 2011.  One property was acquired through foreclosure during the year ended December 31, 2010.  The property acquired through foreclosure in 2010 was liquidated during 2010 for $513.  As of March 31, 2011 and December 31, 2010, there were four properties in the process of foreclosure which had a recorded investment of $2,154 and $2,158, respectively.  The Company did not complete any significant purchases or sales of mortgage loans during the three months ended March 31, 2011 or the year ended December 31, 2010.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The tables below summarize the recorded investment of the mortgage loan portfolio by aging category as of March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

 

 

Current

 

Loan balances 31-60
days past due

 

Loan balances 61-89
days past due

 

Loan balances greater than
90 days past due or in
process of foreclosure (1)

 

Total portfolio balance

 

Commercial mortgages

 

$

1,987,916

 

$

 

$

 

$

2,154

 

$

1,990,070

 

 


(1) Includes four loans in the amount of $2,154 in process of foreclosure.

 

 

 

December 31, 2010

 

 

 

Current

 

Loan balances 31-60
days past due

 

Loan balances 61-89
days past due

 

Loan balances greater than
90 days past due or in
process of foreclosure (1)

 

Total portfolio balance

 

Commercial mortgages

 

$

1,733,922

 

$

2,642

 

$

 

$

2,158

 

$

1,738,722

 

 


(1) Includes four loans in the amount of $2,158 in process of foreclosure.

 

Loan balances are considered past due when payment has not been received based on contractually agreed upon terms.  For loan balances greater than 90 days past due or in the process of foreclosure, all accrual of interest was discontinued.  There were no loans greater than 90 days past due and accruing interest at March 31, 2011 or at December 31, 2010.  The Company resumes interest accrual on loans when a loan returns to current status.  Interest accrual may also resume under new terms when loans are restructured or modified.

 

Occasionally, the Company elects to restructure certain mortgage loans if the economic benefits are considered to be more favorable than those achieved by acquiring the collateral through foreclosure.  At March 31, 2011, the Company had no loans classified as troubled debt restructurings.  At December 31, 2010, the Company had one loan, with a principal balance of $6,355, classified as a troubled debt restructuring with loan modifications which primarily reduced the interest rate for the life of the loan, but did not extend the maturity date or forgive any principal.  The Company did not create a specific allowance for the restructured loan.

 

Equity investments - The carrying value of the Company’s equity investments was $2,419 and $1,888 at March 31, 2011 and December 31, 2010, respectively.  The increase in the carrying value of the Company’s equity investments was due to additional airline industry securities received during the current period for defaulted fixed maturity investments previously held.

 

Limited partnership and other corporation interests - The Company invests in limited partnership interests, which include limited partnerships established for the purpose of investing in low-income housing that qualify for federal and state tax credits, and other corporation interests.  At March 31, 2011 and December 31, 2010, the Company had $201,123 and $210,146, respectively, invested in limited partnership and other corporation interests.

 

In the normal course of its activities, the Company is involved with other entities that are considered variable interest entities (“VIE”).  An entity would be determined to be a primary beneficiary, and thus consolidated when the entity has both (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.  When the Company becomes involved with a VIE and when the nature of the Company’s involvement with the entity changes, in order to determine if the Company is the primary beneficiary and must consolidate the entity, it evaluates:

 

·      The structure and purpose of the entity;

·      The risks and rewards created by and shared through the entity and

·      The entity’s participants’ ability to direct the activities, receive its benefits and absorb its losses.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Accordingly, the Company has determined its investment in low-income housing limited partnerships (“LIHLP”) to be considered a VIE.  The purpose of an LIHLP is to provide financing of affordable housing by making certain tax credits available to investors.  Beginning in 2002, the Company made initial cash investments for the various tax credits.  The Company is a 99% limited partner in various upper-tier LIHLPs.  The general partner is most closely involved in the development and management of the LIHLP project.  As limited partner, the Company has few or no voting rights, but expects to receive the tax credits allocated to the partnership and operating losses from depreciation and interest expense.  The Company is only an equity investor and views the LIHLP as a single investment.  The general partner has a small ownership of the partnership, which requires a de minimus capital contribution.  This equity investment is reduced based on fees paid at inception by the limited partner; therefore, the general partner does not qualify as having an equity investment at risk in the LIHLP project.  However, the limited partner does not have the direct or indirect ability through voting rights or similar rights to make decisions about the general partner’s activities that have a significant effect on the success of the partnership.

 

Although the Company is involved with the VIE, it determined that consolidation was not required because it has no power to direct the activities that most significantly impact the entities’ economic performance (exert influence over the entity’s operations).

 

The Company performs ongoing qualitative analyses of its involvement with VIEs to determine if consolidation is required.

 

The following tables present information about the nature and activities of the VIEs and the effect on the Company’s financial statements as of March 31, 2011 and December 31, 2010 as follows:

 

March 31, 2011

 

Limited partnership and

 

 

 

 

 

other corporation interests

 

Liabilities

 

Maximum exposure to loss

 

$

140,848

 

$

 

$

140,848

 

 

December 31, 2010

 

Limited partnership and

 

 

 

 

 

other corporation interests

 

Liabilities

 

Maximum exposure to loss

 

$

151,158

 

$

 

$

151,158

 

 

All of the Company’s investments in LIHLPs are guaranteed by third parties.  One of the guarantors, guaranteeing 7% of the LIHLPs at March 31, 2011 and December 31, 2010, filed for bankruptcy protection in 2009; however, the bankruptcy does not currently impact the guarantee.  At March 31, 2011, $115,956 of the interests, or 82%, are backed by third party guarantors with an investment grade rating.  At December 31, 2010, $123,853 of the interests, or 82%, are backed by third party guarantors with an investment grade rating.

 

The Company is not required to provide any additional funding to the LIHLPs unless the investment exceeds the minimum yield guarantee.  During the three months ended March 31, 2011 and the year ended December 31, 2010, the Company did not provide any additional financial or other support that it was not previously contractually required to provide.

 

Securities pledged, special deposits and securities lending - The Company pledges investment securities it owns to unaffiliated parties based on interest rate futures initial margin.  The fair value of margin deposits related to futures contracts was approximately $6,639 and $5,979 at March 31, 2011 and December 31, 2010, respectively.  These pledged securities are included in short-term investments in the accompanying condensed consolidated balance sheets.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The Company had securities on deposit with governmental authorities as required by certain insurance laws with fair values in the amounts of $14,228 and $14,144 at March 31, 2011 and December 31, 2010, respectively.  These deposits are included in fixed maturities in the accompanying condensed consolidated balance sheets.

 

The Company participates in a securities lending program whereby securities, which are included in fixed maturity investments in the accompanying condensed consolidated balance sheets, are loaned to third parties.  Securities with a cost or amortized cost in the amounts of $53,997 and $45,000 and estimated fair values in the amounts of $58,695 and $50,807 were on loan under the program at March 31, 2011 and December 31, 2010, respectively.  The Company received restricted cash collateral in the amounts of $60,189 and $51,749 at March 31, 2011 and December 31, 2010, respectively.

 

Impairment of fixed maturity and equity investments classified as available-for-sale - The Company classifies the majority of its fixed maturity investments and all of its equity investments as available-for-sale and records them at fair value with the related net unrealized gain or loss, net of policyholder related amounts and deferred taxes, in accumulated other comprehensive income (loss) in the stockholder’s equity section in the accompanying condensed consolidated balance sheets.  All available-for-sale securities with gross unrealized losses at the condensed consolidated balance sheet date are subjected to the Company’s process for the identification and evaluation of other-than-temporary impairments.

 

The assessment of whether an other-than-temporary impairment has occurred on fixed maturity investments where management does not intend to sell the fixed maturity investment and it is not more likely than not the Company will be required to sell the fixed maturity investment before recovery of its amortized cost basis, is based upon management’s case-by-case evaluation of the underlying reasons for the decline in fair value.  Management considers a wide range of factors, as described below, regarding the security issuer and uses its best judgment in evaluating the cause of the decline in its estimated fair value and in assessing the prospects for near-term recovery.  Inherent in management’s evaluation of the security are assumptions and estimates about the issuer’s operations and ability to generate future cash flows.  While all available information is taken into account, it is difficult to predict the ultimate recoverable amount from a distressed or impaired security.

 

Considerations used by the Company in the impairment evaluation process include, but are not limited to, the following:

 

·      Fair value is below cost;

·      The decline in fair value is attributable to specific adverse conditions affecting a particular instrument, its issuer, an industry or geographic area;

·      The decline in fair value has existed for an extended period of time;

·      A fixed maturity investment has been downgraded by a credit rating agency;

·      The financial condition of the issuer has deteriorated;

·      The payment structure of the fixed maturity investment and the likelihood of the issuer being able to make payments in the future and

·      Dividends have been reduced or eliminated or scheduled interest payments have not been made.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Unrealized losses on fixed maturity and equity investments classified as available-for-sale

 

The following tables summarize unrealized investment losses, including the non-credit-related portion of other-than-temporary impairment losses reported in accumulated other comprehensive income (loss), by class of investment at March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

 

 

Less than twelve months

 

Twelve months or longer

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

fair value

 

loss and OTTI

 

fair value

 

loss and OTTI

 

fair value

 

loss and OTTI

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

72,779

 

$

1,606

 

$

81,230

 

$

1,722

 

$

154,009

 

$

3,328

 

Obligations of U.S. states and their subdivisions

 

36,297

 

311

 

374,066

 

11,385

 

410,363

 

11,696

 

Corporate debt securities

 

420,287

 

5,331

 

1,137,633

 

127,651

 

1,557,920

 

132,982

 

Asset-backed securities

 

55,248

 

4,214

 

988,632

 

123,811

 

1,043,880

 

128,025

 

Residential mortgage-backed securities

 

14,921

 

88

 

84,328

 

1,567

 

99,249

 

1,655

 

Commercial mortgage-backed securities

 

14,160

 

70

 

132,517

 

20,719

 

146,677

 

20,789

 

Collateralized debt obligations

 

 

 

22,894

 

5,695

 

22,894

 

5,695

 

Total fixed maturities

 

$

613,692

 

$

11,620

 

$

2,821,300

 

$

292,550

 

$

3,434,992

 

$

304,170

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Airline industry

 

$

800

 

$

276

 

$

 

$

 

$

800

 

$

276

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total number of securities in an unrealized loss position

 

 

 

69

 

 

 

313

 

 

 

382

 

 

 

 

December 31, 2010

 

 

 

Less than twelve months

 

Twelve months or longer

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

fair value

 

loss and OTTI

 

fair value

 

loss and OTTI

 

fair value

 

loss and OTTI

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

892,025

 

$

14,551

 

$

22,471

 

$

233

 

$

914,496

 

$

14,784

 

Obligations of U.S. states and their subdivisions

 

391,101

 

11,332

 

99,720

 

4,271

 

490,821

 

15,603

 

Corporate debt securities

 

477,059

 

15,486

 

819,627

 

129,000

 

1,296,686

 

144,486

 

Asset-backed securities

 

52,814

 

1,505

 

1,071,557

 

152,652

 

1,124,371

 

154,157

 

Residential mortgage-backed securities

 

26,142

 

509

 

146,532

 

11,610

 

172,674

 

12,119

 

Commercial mortgage-backed securities

 

53,462

 

2,086

 

79,429

 

18,529

 

132,891

 

20,615

 

Collateralized debt obligations

 

5,745

 

29

 

23,112

 

5,752

 

28,857

 

5,781

 

Total fixed maturities

 

$

1,898,348

 

$

45,498

 

$

2,262,448

 

$

322,047

 

$

4,160,796

 

$

367,545

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity mutual funds

 

$

6

 

$

 

$

3

 

$

 

$

9

 

$

 

Airline industry

 

612

 

77

 

 

 

612

 

77

 

Total equity investments

 

$

618

 

$

77

 

$

3

 

$

 

$

621

 

$

77

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total number of securities in an unrealized loss position

 

 

 

183

 

 

 

237

 

 

 

420

 

 

Fixed maturity investments - Total unrealized losses and other-than-temporary impairment losses decreased by $63,375 or 17%, from December 31, 2010 to March 31, 2011.  This decrease in unrealized losses was across most asset classes and reflects recovery in market liquidity and tightening of credit spreads, although the economic uncertainty in certain asset classes still remains.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Unrealized losses on corporate debt securities decreased by $11,504 from December 31, 2010 to March 31, 2011.  The valuation of these securities has been influenced by market conditions with increased liquidity and tightening of credit spreads resulting in generally higher valuations of fixed income securities.  Management has classified the losses on these securities by sector, calculated as a percentage of total unrealized losses as follows:

 

Sector

 

March 31, 2011

 

December 31, 2010

 

Finance

 

74

%

78

%

Utility

 

9

%

8

%

Natural resources

 

4

%

4

%

Consumer

 

6

%

4

%

Transportation

 

1

%

1

%

Other

 

6

%

5

%

 

 

100

%

100

%

 

Unrealized losses on asset-backed and residential mortgage-backed securities decreased by $26,132, and $10,464, respectively, since December 31, 2010, generally due to tightening of credit spreads and increased market liquidity.

 

Asset-backed securities account for 42% of the unrealized losses and OTTI greater than twelve months.  Of the $123,811 of unrealized losses and OTTI over twelve months on asset-backed securities, 72% of the losses are on securities which continue to be rated investment grade.  Of the securities which are not rated investment grade, 84% of the losses are on securities guaranteed by monoline insurers.  The present value of the cash flows expected to be collected is not less than amortized cost.  Management does not have the intent to sell these assets prior to a full recovery; therefore, an OTTI was not recognized in earnings.  Accordingly, unless otherwise noted below in the other-than-temporary impairment recognition section, the underlying collateral on the asset-backed securities within the portfolio along with credit enhancement is sufficient to expect full repayment of the principal.

 

Of the $127,651 of unrealized losses and OTTI over twelve months on corporate debt securities, 67% are on securities which continue to be rated investment grade.  Of the non-investment grade corporate debt securities with unrealized losses and OTTI greater than twelve months, $33,072 of the losses are on investments held in foreign banks.  The prices of securities held in foreign banks have been impacted by their long duration combined with widening spreads and the low London Interbank Offering Rate (“LIBOR”) based floating rates.  Although foreign banks have suffered from the weak credit and economic environment, they benefit from central bank support.  Management does not have the intent to sell these assets prior to a full recovery; therefore, an OTTI was not recognized in earnings.

 

See Note 6 for additional discussion regarding fair value measurements.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Other-than-temporary impairment recognition - There were no other-than-temporary impairments on fixed maturity investments or equity securities for the three months ended March 31, 2011.  The Company recorded other-than-temporary impairments on fixed maturity investments and equity securities for the three months ended March 31, 2010 as follows:

 

 

 

Three months ended March 31, 2010

 

 

 

OTTI recognized in realized
gains/(losses)

 

OTTI
recognized
in AOCI (2)

 

 

 

 

 

Credit related (1)

 

Non-credit
related

 

Non-credit
related

 

Total

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

 

$

36

 

$

 

$

36

 

Corporate debt securities

 

 

267

 

 

267

 

Asset-backed securities

 

36,524

 

 

15,704

 

52,228

 

Collateralized debt obligations

 

34

 

 

 

34

 

Total fixed maturities

 

$

36,558

 

$

303

 

$

15,704

 

$

52,565

 

 

 

 

 

 

 

 

 

 

 

Equity investments:

 

 

 

 

 

 

 

 

 

Equity mutual funds

 

$

490

 

$

 

$

 

$

490

 

Total equity investments

 

$

490

 

$

 

$

 

$

490

 

 

 

 

 

 

 

 

 

 

 

Total OTTI impairments

 

$

37,048

 

$

303

 

$

15,704

 

$

53,055

 

 


(1) Of the credit-related other-than-temporary impairment on asset-backed securities, all was related to Ambac Financial Group, Inc. for the three months ended March 31, 2010.  Of the $36,558 in total fixed maturities, $36,524 is the bifurcated loss recognized on securities.

(2) Amounts are recognized in OCI in the period incurred.

 

The other-than-temporary impairments of fixed maturity securities where the loss portion is bifurcated and the credit related component is recognized in realized investment gains (losses) is summarized as follows:

 

Bifurcated credit loss balance, December 31, 2009

 

$

115,325

 

Credit loss recognized on securities

 

66,286

 

Bifurcated credit loss balance, December 31, 2010

 

181,611

 

Credit loss recognized on securities

 

 

Bifurcated credit loss balance, March 31, 2011

 

$

181,611

 

 

The credit loss portion on fixed maturities was determined as the difference between the securities’ amortized cost and the present value of expected future cash flows.  These expected cash flows were determined using judgment and the best information available to the Company and were discounted at the securities’ original effective interest rate.  Inputs used to derive expected cash flows included default rates, credit ratings, collateral characteristics and current levels of subordination.

 

5.  Derivative Financial Instruments

 

The Company uses derivative financial instruments for risk management purposes associated with certain invested assets and policy liabilities.  Derivatives are not used for speculative purposes.  As detailed below, derivatives are used to (a) hedge the economic effects of interest rate and stock market movements on the Company’s guaranteed minimum withdrawal benefit, also referred to as guaranteed lifetime withdrawal benefit, (“GMWB”) liabilities, (b) hedge the economic effect of a large increase in interest rates on the Company’s general account life insurance, group pension liabilities and separate account life insurance liabilities, (c) hedge the economic risks of other transactions such as future asset acquisitions or

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

dispositions, the timing of liability pricing, currency risks on non-US dollar denominated assets, and fee revenue based on equity market performance, and (d) convert floating rate assets to fixed rate assets for asset/liability management purposes.

 

Derivative transactions are entered into pursuant to master agreements that provide for a single net payment to be made by one party to the other on a daily basis, periodic payment dates, or at the due date, expiration or termination of the agreement.

 

The Company controls the credit risk of its derivative contracts through credit approvals, limits, monitoring procedures, and in some cases, requiring collateral.  The Company’s exposure is limited to the portion of the fair value of derivative instruments that exceeds the value of the collateral held and not to the notional or contractual amounts of the derivatives.  The Company incorporates the market’s perception of its own and the counterparty’s non-performance risk through review of credit spreads in determining the fair value of the portion of its over-the-counter (“OTC”) derivative assets and liabilities that are uncollateralized.  Fair values were adjusted accordingly based on an internal carry value adjustment model at March 31, 2011 and December 31, 2010.  As the Company enters into derivative transactions only with high quality institutions, no losses have been incurred due to non-performance by any of the counterparties.  Certain of these arrangements require collateral when the fair value exceeds certain thresholds and also include credit contingent provisions that provide for a reduction of these thresholds in the event of downgrade in the credit ratings of the Company and/or the counterparty.

 

Certain interest rate swaptions and swaps in a net asset position have cash pledged as collateral to the Company in accordance with the collateral support agreements with the counterparty.  As of March 31, 2011 and December 31, 2010, the $6,105 and $7,790, respectively, of unrestricted cash collateral received is included in other assets and the obligation to return is included in other liabilities.  The cash collateral is reinvested in a government money market fund.  These collateral amounts are not offset against the derivative fair values in the accompanying tables.

 

Requirements for collateral pledged to the Company are determined based on the counterparties’ credit ratings.  Requirements for collateral pledged by the Company are determined based on the Company’s credit rating.  In the event of credit downgrades, additional collateral is required.  At March 31, 2011, the Company did not have derivatives in a net liability position.  As a result, the Company would not be required to pledge any additional collateral in the event of a downgrade.

 

The Company may purchase a financial instrument that contains a derivative embedded in the financial instrument.  Upon purchasing the instrument, the Company determines if (a) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (b) a separate instrument with the same terms would qualify as a derivative instrument.  If the Company determines that these conditions are met, the embedded derivative is bifurcated from the host contract and accounted for as a freestanding derivative.

 

Cash flow hedges - Interest rate swap agreements are used to convert the interest rate on certain debt securities from a floating rate to a fixed rate.  Foreign currency exchange contracts are used to manage the foreign exchange rate risk associated with bonds denominated in other than U.S. dollars.  Interest rate futures are used to manage the interest rate risks of forecasted acquisitions of fixed rate maturity investments.  These derivatives are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities.  The Company’s derivatives treated as cash flow hedges are eligible for hedge accounting.

 

As of March 31, 2011, the Company estimates that $9,020 of net derivative gains included in accumulated other comprehensive income (loss) will be reclassified into net income within the next twelve months.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Fair value hedges - Interest rate futures are used to manage the risk of the change in the fair value of certain fixed rate maturity investments.  The Company’s derivatives treated as fair value hedges are eligible for hedge accounting.

 

Derivatives not designated as hedging instruments

 

GMWB Derivative Instruments - The Company introduced a variable annuity product with a GMWB in 2010.  This product utilizes an investment risk hedging program including purchases of the following derivative instruments: exchange-traded interest rate swap futures and exchange traded equity index futures on certain indices.  The Company anticipates adding OTC interest rate swaps as the product sales volume grows.  While these derivatives are economic hedges and used to manage risk, the Company will not elect hedge accounting on these transactions.  Although the hedge program is actively managed, it may not exactly offset changes in the GMWB liability due to, among other things, divergence between the performance of the underlying investments and the hedge instruments, high levels of volatility in the equity and interest rate markets and differences between actual contractholder behavior and what is assumed.  The performance of the underlying investments compared to the hedge instruments is further impacted by a time lag, since the data is not reported and incorporated into the required hedge position on a real time basis.

 

Interest Rate Risk Derivative Instruments - Interest rate risk derivative instruments are used to hedge the economic effect of a large increase in interest rates on the Company’s general account life insurance and group pension liabilities as well as certain separate account life insurance liabilities. While these derivatives are economic hedges and used to manage risk, the Company will not elect hedge accounting on these transactions.

 

The hedging program for the general account life insurance and group pension liabilities incorporates a combination of static hedges and dynamic (i.e. frequently re-balanced based on interest rate movements) hedges. These hedges are used to manage the potential variability in future interest payments due to a change in credited interest rates and the related change in cash flows due to increased surrenders. The Company has purchased the following derivative instruments: (a) OTC interest rate swaptions as static hedges and (b) OTC interest rate swaps, exchange-traded interest rate swap futures, and exchange-traded Eurodollar interest rate futures as dynamic hedges.

 

The hedging program for certain separate account life insurance liabilities is also a combination of static and dynamic hedges using OTC interest rate swaptions, OTC interest rate swaps, exchange-traded interest rate swap futures, and exchange-traded Eurodollar interest rate futures. These hedges are used to manage the potential change of cash flows due to increased surrenders. The costs and performance of these hedges are passed directly to the associated separate account liabilities through an adjustment to the liability credited rates.  The notional amount of the Company’s swaptions associated with the separate account liabilities was approximately 29% and 28% of the total swaption notional amount as of March 31, 2011 and December 31, 2010. The notional amount of the derivatives used in the dynamic hedging program associated with separate account liabilities was approximately 5% of the total notional within that program as of both March 31, 2011 and December 31, 2010.

 

Other Derivative Instruments - During 2011 and 2010, the Company utilized futures on equity indices to hedge the Company’s equity based fee income.  While these derivatives are economic hedges and used to manage risk, the Company did not elect hedge accounting on these transactions.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The following tables summarize derivative financial instruments at March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

 

 

 

 

Net derivatives

 

Asset derivatives

 

Liability derivatives

 

 

 

Notional amount

 

Fair value

 

Fair value (1)

 

Fair value (1)

 

Hedge designation/derivative type:

 

 

 

 

 

 

 

 

 

Derivatives designated as hedges:

 

 

 

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

212,200

 

$

7,708

 

$

8,786

 

$

1,078

 

Foreign currency exchange contracts

 

30,000

 

(1,487

)

 

1,487

 

Interest rate futures

 

32,200

 

 

 

 

Total cash flow hedges

 

274,400

 

6,221

 

8,786

 

2,565

 

 

 

 

 

 

 

 

 

 

 

Fair value hedges:

 

 

 

 

 

 

 

 

 

Interest rate futures

 

67,300

 

 

 

 

Total fair value hedges

 

67,300

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives designated as hedges

 

341,700

 

6,221

 

8,786

 

2,565

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

 

 

GMWB derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate swap futures

 

6,500

 

 

 

 

Futures on equity indices

 

645

 

 

 

 

Total GMWB derivative instruments

 

7,145

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate risk derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

426,102

 

5,850

 

8,107

 

2,257

 

Interest rate futures

 

1,885

 

 

 

 

Interest rate swap futures

 

19,100

 

 

 

 

Interest rate swaptions

 

1,042,000

 

3,205

 

3,205

 

 

Total interest rate risk derivative instruments

 

1,489,087

 

9,055

 

11,312

 

2,257

 

 

 

 

 

 

 

 

 

 

 

Total derivatives not designated as hedges

 

1,496,232

 

9,055

 

11,312

 

2,257

 

 

 

 

 

 

 

 

 

 

 

Total cash flow hedges, fair value hedges and derivatives not designated as hedges

 

$

1,837,932

 

$

15,276

 

$

20,098

 

$

4,822

 

 


(1) The estimated fair value of all derivatives in an asset position are reported within other assets and the estimated fair value of all derivatives in a liability position are reported within other liabilities in the condensed consolidated balance sheets.

 

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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

 

 

December 31, 2010

 

 

 

 

 

Net derivatives

 

Asset derivatives

 

Liability derivatives

 

 

 

Notional amount

 

Fair value

 

Fair value (1)

 

Fair value (1)

 

Hedge designation/derivative type:

 

 

 

 

 

 

 

 

 

Derivatives designated as hedges:

 

 

 

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

90,700

 

$

10,255

 

$

10,386

 

$

131

 

Foreign currency exchange contracts

 

30,000

 

(252

)

 

252

 

Interest rate futures

 

80,700

 

 

 

 

Total cash flow hedges

 

201,400

 

10,003

 

10,386

 

383

 

 

 

 

 

 

 

 

 

 

 

Fair value hedges:

 

 

 

 

 

 

 

 

 

Interest rate futures

 

128,900

 

 

 

 

Total fair value hedges

 

128,900

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives designated as hedges

 

330,300

 

10,003

 

10,386

 

383

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

 

 

GMWB derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate swap futures

 

5,300

 

 

 

 

Futures on equity indices

 

680

 

 

 

 

Total GMWB derivative instruments

 

5,980

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate risk derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

612,902

 

4,036

 

9,484

 

5,448

 

Interest rate futures

 

2,460

 

 

 

 

Interest rate swap futures

 

44,600

 

 

 

 

Interest rate swaptions

 

1,083,000

 

4,956

 

4,956

 

 

Total interest rate risk derivative instruments

 

1,742,962

 

8,992

 

14,440

 

5,448

 

 

 

 

 

 

 

 

 

 

 

Total derivatives not designated as hedges

 

1,748,942

 

8,992

 

14,440

 

5,448

 

 

 

 

 

 

 

 

 

 

 

Total cash flow hedges, fair value hedges, and derivatives not designated as hedges

 

$

2,079,242

 

$

18,995

 

$

24,826

 

$

5,831

 

 


(1) The estimated fair value of all derivatives in an asset position are reported within other assets and the estimated fair value of all derivatives in a liability position are reported within other liabilities in the condensed consolidated balance sheets.

 

Notional amounts are used to express the extent of the Company’s involvement in derivative transactions and represent a standard measurement of the volume of its derivative activity.  Notional amounts represent those amounts used to calculate contractual flows to be exchanged.  Notional amounts are not paid or received.

 

The Company had 39 and 117 swap transactions with an average notional amount of $20,377 and $19,745 during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively.  The Company had 354 and 979 futures transactions with an average number of contracts per transaction of 26 and 26 during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively.  The Company had three swaptions expire and two swaptions purchased during the three months ended March 31, 2011.  As of the year ended December 31, 2010, the Company had three swaptions expire.

 

26



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The change in notional amount of derivatives since December 31, 2010 was primarily due to the following:

 

·            The increase of $121,500 in notional value of interest rate swaps is due to cash flow hedges using interest rate swaps to convert the interest rate on certain debt securities from a floating rate to a fixed rate for asset/liability management purposes.

 

·            The decrease in the notional amount of interest rate swaps was the result of an overall reduction in the interest rate risk hedging program as part of an ongoing review of liability risks and projected hedge gains.

 

The Company recognized total derivative gains (losses) in net investment income of $2,187 and ($7,987) for the three months ended March 31, 2011 and 2010, respectively.  The preceding amounts are all shown net of any gains (losses) on the hedged assets in a fair value hedge that has been recorded in net investment income.  The Company realized net investment gains (losses) on closed derivative positions of ($2,894) and $1,235 for the three-month periods ended March 31, 2011 and 2010, respectively.

 

The following tables present the effect of derivative instruments in the condensed consolidated statement of income for the three-month periods ended March 31, 2011 and 2010 reported by cash flow hedges, fair value hedges and economic hedges:

 

 

 

Gain (loss) recognized

 

 

 

 

 

 

 

Gain (loss) recognized in net income on

 

 

 

in AOCI on derivatives

 

Gain (loss) reclassified from AOCI

 

derivatives (Ineffective portion and amount

 

 

 

(Effective portion)

 

into net income (Effective portion)

 

excluded from effectiveness testing)

 

 

 

Three months ended March 31,

 

Three months ended March 31,

 

Income
statement

 

Three months ended March 31,

 

Income
statement

 

 

 

2011

 

2010

 

2011

 

2010

 

location

 

2011

 

2010

 

location

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

(2,554

)

$

1,444

 

$

643

 

$

286

 

(A)

 

$

7

 

$

(1

)

(A)

 

Foreign currency exchange contracts

 

(1,235

)

1,798

 

 

 

 

 

 

 

 

 

Interest rate futures

 

(1,431

)

(447

)

11

 

27

 

(A)

 

287

 

 

(A)

 

Interest rate futures

 

 

 

 

 

 

 

6

 

 

(B)

 

Total cash flow hedges

 

$

(5,220

)

$

2,795

 

$

654

 

$

313

 

 

 

$

300

 

$

(1

)

 

 

 


(A)  Net investment income.

(B)  Realized investment gains (losses), net.  Represents realized gains (losses) on closed positions.

 

 

 

Gain (loss) on derivatives

 

Gain (loss) on hedged assets

 

 

 

recognized in net income

 

recognized in net income

 

 

 

Three months ended March 31,

 

Income
statement

 

Three months ended March 31,

 

Income
statement

 

 

 

2011

 

2010

 

location

 

2011

 

2010

 

location

 

Fair value hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate futures

 

$

518

 

$

(1,177

)

(A)

 

$

 

$

 

 

 

Interest rate futures

 

(776

)

272

 

(B)

 

 

 

 

 

Items hedged in interest rate futures

 

 

 

 

 

540

 

1,221

 

(A)

 

Total fair value hedges (1)

 

$

(258

)

$

(905

)

 

 

$

540

 

$

1,221

 

 

 

 


(1)   Hedge ineffectiveness of $282 and $316 for the three months ended March 31, 2011 and 2010, respectively, was recognized.

(A)  Net investment income.

(B)  Realized investment gains (losses), net.  Represents realized gains (losses) on closed positions.

 

27



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

 

 

Gain (loss) on derivatives

 

Gain (loss) on derivatives

 

 

 

recognized in net income

 

recognized in net income

 

 

 

Three months ended

 

Income statement

 

Three months ended

 

Income statement

 

 

 

March 31, 2011

 

location

 

March 31, 2010

 

location

 

Derivatives not designated as  hedging instruments:

 

 

 

 

 

 

 

 

 

GMWB derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate swap futures

 

$

56

 

(A)

 

$

 

 

 

Interest rate swap futures

 

(116

)

(B)

 

$

 

 

 

Futures on equity indices

 

(15

)

(A)

 

$

 

 

 

Futures on equity indices

 

(34

)

(B)

 

 

 

 

Total GMWB derivative instruments

 

(109

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate risk derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

1,816

 

(A)

 

 

 

 

Interest rate swaps

 

(1,484

)

(B)

 

 

 

 

Interest rate futures

 

178

 

(A)

 

 

 

 

Interest rate futures

 

(171

)

(B)

 

 

 

 

Interest rate swaptions

 

(93

)

(B)

 

 

 

 

Interest rate swaptions

 

(1,854

)

(A)

 

 

 

 

Total interest rate risk derivative instruments

 

(1,608

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other derivative instruments:

 

 

 

 

 

 

 

 

 

Interest rate futures

 

 

 

 

(3,559

)

(A)

 

Interest rate futures

 

 

 

 

963

 

(B)

 

Interest rate swaptions

 

 

 

 

(4,784

)

(A)

 

Futures on equity indicies

 

(226

)

(B)

 

 

 

 

Total other derivative instruments

 

(226

)

 

 

(7,380

)

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives not designated as hedging instruments

 

$

(1,943

)

 

 

$

(7,380

)

 

 

 


(A)  Net investment income

(B)  Realized investment gains (losses), net.  Represents realized gains (losses) on closed positions.

 

28



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

6.  Fair Value Measurements

 

The following tables summarize the carrying amounts and estimated fair values of the Company’s financial instruments at March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

Carrying

 

Estimated

 

Carrying

 

Estimated

 

Assets

 

amount

 

fair value

 

amount

 

fair value

 

Fixed maturities and short-term investments

 

$

16,727,848

 

$

16,727,848

 

$

17,051,738

 

$

17,051,738

 

Mortgage loans on real estate

 

1,973,770

 

2,003,318

 

1,722,422

 

1,809,356

 

Equity investments

 

2,419

 

2,419

 

1,888

 

1,888

 

Policy loans

 

4,049,727

 

4,049,727

 

4,059,640

 

4,059,640

 

Other investments

 

22,200

 

46,401

 

22,762

 

46,608

 

Collateral under securities lending agreements

 

60,189

 

60,189

 

51,749

 

51,749

 

Collateral under derivative counter-party collateral agreements

 

6,105

 

6,105

 

7,790

 

7,790

 

Derivative instruments

 

20,098

 

20,098

 

24,826

 

24,826

 

Separate account assets

 

22,294,042

 

22,294,042

 

22,489,038

 

22,489,038

 

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

Carrying

 

Estimated

 

Carrying

 

Estimated

 

Liabilities

 

amount

 

fair value

 

amount

 

fair value

 

Annuity contract benefits without life contingencies

 

$

7,916,335

 

$

7,728,388

 

$

7,976,954

 

$

7,912,850

 

Policyholders’ funds

 

345,680

 

345,680

 

372,980

 

372,980

 

Repurchase agreements

 

814,607

 

814,607

 

936,762

 

936,762

 

Commercial paper

 

98,402

 

98,402

 

91,681

 

91,681

 

Payable under securities lending agreements

 

60,189

 

60,189

 

51,749

 

51,749

 

Payable under derivative counterparty collateral agreements

 

6,105

 

6,105

 

7,790

 

7,790

 

Derivative instruments

 

4,822

 

4,822

 

5,831

 

5,831

 

Notes payable

 

541,700

 

541,700

 

532,332

 

532,332

 

 

Fixed maturity and equity investments

 

The fair values for fixed maturity and equity securities are based upon quoted market prices or estimates from independent pricing services.  However, in cases where quoted market prices are not readily available, such as for private fixed maturity investments, fair values are estimated.  To determine estimated fair value for these instruments, the Company generally utilizes discounted cash flows calculated at current market rates on investments of similar quality and term.  Fair value estimates are made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts of the Company’s financial instruments.

 

29



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Short-term investments, securities lending agreements, repurchase agreements and commercial paper

 

The carrying value of short-term investments, collateral and payable under securities lending agreements, repurchase agreements and commercial paper is a reasonable estimate of fair value due to their short-term nature.

 

Mortgage loans on real estate

 

Mortgage loan fair value estimates are generally based on discounted cash flows.  A discount rate matrix is incorporated whereby the discount rate used in valuing a specific mortgage generally corresponds to that mortgage’s remaining term and credit quality.  Management believes the discount rate used is commensurate with the credit, interest rate, term, servicing costs and risks of loans similar to the portfolio loans that the Company would make today given its internal pricing strategy.

 

Policy loans

 

Policy loans accrue interest at variable rates with no fixed maturity dates; therefore, estimated fair values approximate carrying values.

 

Other investments

 

Other investments include the Company’s percentage ownership of foreclosed lease interests in aircraft.  The estimated fair value is based on the present value of anticipated lease payments plus the residual value of the aircraft.  Also included in other investments is real estate held for investment.  The estimated fair value is based on appraised value.

 

Derivative counterparty collateral agreements

 

Included in other assets and other liabilities is cash collateral received from derivative counterparties and the obligation to return the cash collateral to the counterparties.  The carrying value of the collateral approximates fair value.

 

Derivative instruments

 

Included in other assets and other liabilities are derivative financial instruments.  The estimated fair values of OTC derivatives, primarily consisting of interest rate swaps and interest rate swaptions which are held for other than trading purposes, are the estimated amounts the Company would receive or pay to terminate the agreements at the end of each reporting period, taking into consideration current interest rates, counterparty credit risk and other relevant factors.

 

Separate account assets

 

Separate account assets include investments in mutual fund, fixed maturity and short-term securities.  Mutual funds are recorded at net asset value, which approximates fair value, on a daily basis.  The fixed maturity and short-term investments are valued in the same manner, and using the same pricing sources and inputs as the fixed maturity and short-term investments of the Company.

 

30



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

Annuity contract benefits without life contingencies

 

The estimated fair values of annuity contract benefits without life contingencies are estimated by discounting the projected expected cash flows to the maturity of the contracts utilizing risk-free spot interest rates plus a provision for the Company’s credit risk.

 

Policyholders’ funds

 

The estimated fair values of policyholders’ funds are the same as the carrying amounts since the Company can change the interest crediting rates with thirty days notice.

 

Notes payable

 

The estimated fair values of the notes payable to GWL&A Financial are based upon discounted cash flows at current market rates on high quality investments.

 

Fair value hierarchy

 

The Company’s assets and liabilities recorded at fair value have been categorized based upon the following fair value hierarchy:

 

·          Level 1 inputs, which are utilized for general and separate account assets and liabilities, utilize observable, quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.  Financial assets and liabilities utilizing Level 1 inputs include actively exchange-traded equity securities.

 

·          Level 2 inputs utilize other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs, which are utilized for general and separate account assets and liabilities, include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.  The fair values for some Level 2 securities were obtained from pricing services.  The inputs used by the pricing services are reviewed at least quarterly or when the pricing vendor issues updates to its pricing methodology.  For fixed maturity securities and separate account assets and liabilities, inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, evaluated bids, offers and reference data including market research publications.  Additional inputs utilized for assets and liabilities classified as Level 2 are:

 

·       Asset-backed, residential mortgage-backed, commercial mortgage-backed securities and collateralized debt obligations - new issue data, monthly payment information, collateral performance and third party real estate analysis.

 

·       U.S. states and their subdivisions - material event notices.

 

·       Equity investments - exchange rates, various index data and news sources.

 

·       Short-term investments - valued at amortized cost, which approximates fair value.

 

·       Derivative financial instruments - reported trades, swap curves, credit spreads, recovery rates, restructuring, currency volatility, net present value of cash flows and news sources.

 

31



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

·       Separate account assets and liabilities - exchange rates, various index data and news sources, amortized cost (which approximates fair value), reported trades, swap curves, credit spreads, recovery rates, restructuring, currency volatility, net present value of cash flows and quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

 

See Note 5 for further discussions of derivatives and their impact on the Company’s condensed consolidated financial statements

 

·          Level 3 inputs are unobservable and include situations where there is little, if any, market activity for the asset or liability.  In general, the prices of Level 3 securities, which include both general and separate account assets and liabilities, were obtained from single broker quotes and internal pricing models.  If the broker’s inputs are largely unobservable, the valuation is classified as a Level 3.  Broker quotes are validated through an internal analyst review process, which includes validation through known market conditions and other relevant data.  Internal models are usually cash flow based utilizing characteristics of the underlying collateral of the security such as default rate and other relevant data.  Inputs utilized for securities classified as Level 3 are as follows:

 

·       Corporate debt securities - single broker quotes which may be in an illiquid market or otherwise deemed unobservable.

 

·       Asset-backed securities - internal models utilizing asset-backed securities index spreads.

 

·      Separate account assets - single broker quotes which may be in an illiquid market or otherwise deemed unobservable or net asset value per share of the underlying investments.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

The following tables present information about the Company’s financial assets and liabilities carried at fair value on a recurring basis as of March 31, 2011 and December 31, 2010 and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value:

 

32



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

 

 

Assets and liabilities measured at

 

 

 

fair value on a recurring basis

 

 

 

March 31, 2011

 

 

 

Quoted prices

 

Significant

 

 

 

 

 

 

 

in active

 

other

 

Significant

 

 

 

 

 

markets for

 

observable

 

unobservable

 

 

 

 

 

identical assets

 

inputs

 

inputs

 

 

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

 

$

2,212,338

 

$

 

$

2,212,338

 

Obligations of U.S. states and their subdivisions

 

 

1,957,440

 

 

1,957,440

 

Corporate debt securities

 

 

7,838,258

 

58,438

 

7,896,696

 

Asset-backed securities

 

 

1,677,921

 

293,584

 

1,971,505

 

Residential mortgage-backed securities

 

 

710,811

 

 

710,811

 

Commercial mortgage-backed securities

 

 

805,064

 

 

805,064

 

Collateralized debt obligations

 

 

26,878

 

17

 

26,895

 

Total fixed maturities available- for-sale

 

 

15,228,710

 

352,039

 

15,580,749

 

Fixed maturities held for trading:

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

 

77,026

 

 

77,026

 

Corporate debt securities

 

 

51,679

 

 

51,679

 

Asset-backed securities

 

 

43,651

 

 

43,651

 

Commercial mortgage-backed securities

 

 

8,255

 

 

8,255

 

Total fixed maturities held for trading

 

 

180,611

 

 

180,611

 

Equity investments available-for-sale:

 

 

 

 

 

 

 

 

 

Financial services

 

 

714

 

 

714

 

Equity mutual funds

 

905

 

 

 

905

 

Airline industry

 

800

 

 

 

800

 

Total equity investments

 

1,705

 

714

 

 

2,419

 

Short-term investments available-for-sale

 

180,121

 

786,367

 

 

966,488

 

Collateral under securities lending agreements

 

60,189

 

 

 

60,189

 

Collateral under derivative counterparty collateral agreements

 

6,105

 

 

 

6,105

 

Derivatives designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

8,786

 

 

8,786

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

8,107

 

 

8,107

 

Interest rate swaptions

 

 

3,205

 

 

3,205

 

Total derivative instruments (assets)

 

 

20,098

 

 

20,098

 

Separate account assets (1)

 

11,684,771

 

10,341,390

 

4,783

 

22,030,944

 

Total assets

 

$

11,932,891

 

$

26,557,890

 

$

356,822

 

$

38,847,603

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Collateral under securities lending agreements

 

$

60,189

 

$

 

$

 

$

60,189

 

Collateral under derivative counterparty collateral agreements

 

6,105

 

 

 

6,105

 

Derivatives designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

1,078

 

 

1,078

 

Foreign currency exchange contracts

 

 

1,487

 

 

1,487

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

2,257

 

 

2,257

 

Total derivative instruments (liabilities)

 

 

4,822

 

 

4,822

 

Separate account liabilities (1)

 

50

 

387,022

 

 

387,072

 

Total liabilities

 

$

66,344

 

$

391,844

 

$

 

$

458,188

 

 


(1)   Includes only separate account instruments which are carried at the fair value of the underlying invested assets owned by the separate accounts.

 

33



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

 

 

Assets and liabilities measured at

 

 

 

fair value on a recurring basis

 

 

 

December 31, 2010

 

 

 

Quoted prices

 

Significant

 

 

 

 

 

 

 

in active

 

other

 

Significant

 

 

 

 

 

markets for

 

observable

 

unobservable

 

 

 

 

 

identical assets

 

inputs

 

inputs

 

 

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

$

 

$

2,371,150

 

$

 

$

2,371,150

 

Obligations of U.S. states and their subdivisions

 

 

1,942,263

 

 

1,942,263

 

Corporate debt securities

 

 

7,979,736

 

58,692

 

8,038,428

 

Asset-backed securities

 

 

1,711,438

 

290,488

 

2,001,926

 

Residential mortgage-backed securities

 

 

739,062

 

 

739,062

 

Commercial mortgage-backed securities

 

 

820,349

 

 

820,349

 

Collateralized debt obligations

 

 

29,865

 

14

 

29,879

 

Total fixed maturities available- for-sale

 

 

15,593,863

 

349,194

 

15,943,057

 

Fixed maturities held for trading:

 

 

 

 

 

 

 

 

 

U.S. government direct obligations and U.S. agencies

 

 

41,834

 

 

41,834

 

Corporate debt securities

 

 

49,961

 

 

49,961

 

Asset-backed securities

 

 

44,060

 

 

44,060

 

Commercial mortgage-backed securities

 

 

8,319

 

 

8,319

 

Total fixed maturities held for trading

 

 

144,174

 

 

144,174

 

Equity investments available-for-sale:

 

 

 

 

 

 

 

 

 

Financial services

 

 

725

 

 

725

 

Equity mutual funds

 

551

 

 

 

551

 

Airline industry

 

612

 

 

 

612

 

Total equity investments

 

1,163

 

725

 

 

1,888

 

Short-term investments available-for-sale

 

140,922

 

823,585

 

 

964,507

 

Collateral under securities lending agreements

 

51,749

 

 

 

51,749

 

Collateral under derivative counterparty collateral agreements

 

7,790

 

 

 

7,790

 

Derivatives designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

10,386

 

 

10,386

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

9,484

 

 

9,484

 

Interest rate swaptions

 

 

4,956

 

 

4,956

 

Total derivative instruments (assets)

 

 

24,826

 

 

24,826

 

Separate account assets (1)

 

11,222,384

 

10,838,983

 

4,278

 

22,065,645

 

Total assets

 

$

11,424,008

 

$

27,426,156

 

$

353,472

 

$

39,203,636

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Derivatives designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

 

$

131

 

$

 

$

131

 

Foreign currency exchange contracts

 

 

252

 

 

252

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

5,448

 

 

5,448

 

Total derivative instruments (liabilities)

 

 

5,831

 

 

5,831

 

Separate account liabilities (1)

 

93

 

301,108

 

 

301,201

 

Total liabilities

 

$

93

 

$

306,939

 

$

 

$

307,032

 

 


(1)   Includes only separate account instruments which are carried at the fair value of the underlying invested assets owned by the separate accounts.

 

34



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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

All transfers between levels are recognized at the beginning of the reporting period in which the transfer occurred.  There were no significant transfers between Level 1 and Level 2 during the three months ended March 31, 2011 or during the year ended December 31, 2010.

 

The following tables present additional information about assets and liabilities carried at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

 

 

 

Recurring Level 3 financial assets and liabilities

 

 

 

Three months ended March 31, 2011

 

 

 

 

 

Fixed maturities

 

 

 

 

 

 

 

 

 

Fixed maturities

 

available-for-

 

Fixed maturities

 

 

 

 

 

 

 

available-for-

 

sale: asset-

 

available-for-sale:

 

 

 

 

 

 

 

sale: corporate

 

backed

 

collateralized

 

Separate

 

 

 

 

 

debt securities

 

securities

 

debt obligations

 

accounts

 

Total

 

Balance, January 1, 2011

 

$

58,692

 

$

290,488

 

$

14

 

$

4,278

 

$

353,472

 

Realized and unrealized gains and losses:

 

 

 

 

 

 

 

 

 

 

 

Gains (losses) included in other comprehensive income (loss)

 

(1,118

)

11,921

 

3

 

192

 

10,998

 

Purchases

 

 

 

 

473

 

473

 

Sales

 

 

 

 

(60

)

(60

)

Settlements

 

(4,090

)

(8,825

)

 

 

(12,915

)

Transfers into Level 3 (1)

 

7,333

 

 

 

 

7,333

 

Transfers out of Level 3 (1)

 

(2,379

)

 

 

(100

)

(2,479

)

Balance, March 31, 2011

 

$

58,438

 

$

293,584

 

$

17

 

$

4,783

 

$

356,822

 

Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets held at March 31, 2011

 

$

 

$

 

$

 

$

 

$

 

 


(1) Transfers into Level 3 are due primarily to decreased observability of inputs in valuation methodologies.  Transfers out of Level 3 are due primarily to increased observability of inputs in valuation methodologies.

 

 

 

Recurring Level 3 financial assets and liabilities

 

 

 

Three months ended March 31, 2010

 

 

 

 

 

Fixed maturities

 

Fixed maturities

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

available-for-

 

available-for-

 

Fixed maturities

 

 

 

 

 

 

 

 

 

available-for-

 

sale: asset-

 

sale: commercial

 

available-for-sale:

 

 

 

 

 

 

 

 

 

sale: corporate

 

backed

 

mortgage-backed

 

collateralized

 

Derivative

 

Separate

 

 

 

 

 

debt securities

 

securities

 

securities

 

debt obligations

 

instruments

 

accounts

 

Total

 

Balance, January 1, 2010

 

$

188,936

 

$

392,365

 

$

58,270

 

$

1,729

 

$

(3,317

)

$

9,960

 

$

647,943

 

Realized and unrealized gains and losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains (losses) included in net income

 

450

 

(27,380

)

 

 

 

 

(26,930

)

Gains (losses) included in other comprehensive income (loss)

 

7,620

 

33,508

 

 

54

 

1,797

 

222

 

43,201

 

Purchases, issuances and settlements

 

(11,818

)

(66,122

)

 

(36

)

 

(2,724

)

(80,700

)

Transfers in (out) of Level 3 (1)

 

(64,566

)

(7,198

)

(58,270

)

 

 

(2,100

)

(132,134

)

Balance, March 31, 2010

 

$

120,622

 

$

325,173

 

$

 

$

1,747

 

$

(1,520

)

$

5,358

 

$

451,380

 

Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets held at March 31, 2010

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

 


(1)  Transfers in and out of Level 3 are from and to Level 2 and are due primarily to enhanced review and corroboration of market prices with multiple pricing vendors.

 

Non-recurring fair value measurements — The Company had no assets measured at fair value on a non-recurring basis at March 31, 2011.  The Company held $980 of adjusted cost basis limited partnership interests which were impaired during the year ended December 31, 2010 based on the fair value disclosed in the limited partnership financial statements.  These limited partnership interests were recorded at estimated fair value and represent a non-recurring fair value measurement. The estimated fair value was categorized as Level 3.  The Company had no liabilities measured at fair value on a non-recurring basis at March 31, 2011 or December 31, 2010.

 

7.  Goodwill and Other Intangible Assets

 

At March 31, 2011 and December 31, 2010, the balance of goodwill, all of which is within the Retirement Services segment, was $105,255.

 

35



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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The following tables summarize other intangible assets, all of which are within the Retirement Services segment, as of March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

 

 

Gross carrying

 

Accumulated

 

 

 

 

 

amount

 

amortization

 

Net book value

 

Customer relationships

 

$

36,314

 

$

(13,334

)

$

22,980

 

Preferred provider agreements

 

7,970

 

(6,255

)

1,715

 

Total

 

$

44,284

 

$

(19,589

)

$

24,695

 

 

 

 

December 31, 2010

 

 

 

Gross carrying

 

Accumulated

 

 

 

 

 

amount

 

amortization

 

Net book value

 

Customer relationships

 

$

36,314

 

$

(12,701

)

$

23,613

 

Preferred provider agreements

 

7,970

 

(5,941

)

2,029

 

Total

 

$

44,284

 

$

(18,642

)

$

25,642

 

 

Amortization expense of other intangible assets included in general insurance expenses was $947 and $998 for the three-month periods ended March 31, 2011 and 2010, respectively.  Except for goodwill, the Company has no intangible assets with indefinite lives.  The Company did not incur costs to renew or extend the term of acquired intangible assets during the three months ended March 31, 2011.

 

The estimated future amortization of other intangible assets using current assumptions, which are subject to change, for the years ended December 31, 2011 through December 31, 2015 is as follows:

 

Year ended December 31,

 

Amount

 

2011

 

$

3,793

 

2012

 

3,590

 

2013

 

3,410

 

2014

 

3,215

 

2015

 

3,012

 

 

36



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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

8.  Other Comprehensive Income

 

The following tables present the composition of other comprehensive income (loss) for the three months ended March 31, 2011 and 2010:

 

 

 

Three months ended March 31, 2011

 

 

 

Before-tax

 

Tax (expense)

 

Net-of-tax

 

 

 

amount

 

benefit

 

amount

 

Unrealized holding gains (losses) arising during the period on available-for-sale fixed maturity investments

 

$

(12,818

)

$

4,486

 

$

(8,332

)

Net changes during the period related to cash flow hedges

 

(5,220

)

1,827

 

(3,393

)

Reclassification adjustment for (gains) losses realized in net income

 

(10,700

)

3,745

 

(6,955

)

Net unrealized gains (losses)

 

(28,738

)

10,058

 

(18,680

)

Future policy benefits, deferred acquisition costs and value of business acquired adjustments

 

16,441

 

(5,754

)

10,687

 

Other comprehensive income (loss)

 

$

(12,297

)

$

4,304

 

$

(7,993

)

 

 

 

Three months ended March 31, 2010

 

 

 

Before-tax

 

Tax (expense)

 

Net-of-tax

 

 

 

amount

 

benefit

 

amount

 

Unrealized holding gains (losses) arising during the period on available-for-sale fixed maturity investments

 

$

304,041

 

$

(106,415

)

$

197,626

 

Net changes during the period related to cash flow hedges

 

2,795

 

(978

)

1,817

 

Reclassification adjustment for (gains) losses realized in net income

 

24,011

 

(8,404

)

15,607

 

Net unrealized gains (losses)

 

330,847

 

(115,797

)

215,050

 

Future policy benefits, deferred acquisition costs and value of business acquired adjustments

 

(59,348

)

20,772

 

(38,576

)

Net unrealized gains (losses)

 

271,499

 

(95,025

)

176,474

 

Employee benefit plan adjustment

 

(317

)

111

 

(206

)

Other comprehensive income (loss)

 

$

271,182

 

$

(94,914

)

$

176,268

 

 

37



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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

9.  Components of Net Periodic (Benefit) Cost

 

Net periodic (benefit) cost of the Defined Benefit Pension Plan and the Post-Retirement Medical Plan included in general insurance expenses in the accompanying condensed consolidated statements of income for the three months ended March 31, 2011 and 2010 include the following components:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

Defined benefit pension plan

 

Post-retirement medical plan

 

Components of periodic (benefit) cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

959

 

$

1,008

 

$

151

 

$

176

 

Interest cost

 

5,147

 

5,083

 

147

 

191

 

Expected return on plan assets

 

(5,302

)

(4,946

)

 

 

Amortization of transition obligation

 

(347

)

(378

)

 

 

Amortization of unrecognized prior service cost (benefit)

 

13

 

21

 

(413

)

(412

)

Amortization of loss (gain) from earlier periods

 

1,395

 

1,571

 

(148

)

(102

)

Net periodic (benefit) cost

 

$

1,865

 

$

2,359

 

$

(263

)

$

(147

)

 

The Company will make a contribution at least equal to the minimum contribution of $12,000 to its Defined Benefit Pension Plan during the year ending December 31, 2011.  The Company expects to contribute approximately $706 to its Post-Retirement Medical Plan during the year ending December 31, 2011.

 

10.   Federal Income Taxes

 

The provision for income taxes for the three months ended March 31, 2011 and 2010 is comprised of the following:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Current

 

$

18,593

 

$

3,151

 

Deferred

 

7,732

 

14,782

 

Total income tax provision

 

$

26,325

 

$

17,933

 

 

The following table presents a reconciliation between the statutory federal income tax rate and the Company’s effective federal income tax rate for the three months ended March 31, 2011 and 2010:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Statutory federal income tax rate

 

35.0

%

35.0

%

Income tax effect of:

 

 

 

 

 

Investment income not subject to federal tax

 

(1.8

)%

(2.0

)%

Tax credits

 

(2.7

)%

(2.8

)%

State income taxes, net of federal benefit

 

0.9

%

0.7

%

Income tax contingency provisions

 

(3.2

)%

2.0

%

Other, net

 

(0.5

)%

 

Effective federal income tax rate

 

27.7

%

32.9

%

 

38



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

During the three months ended March 31, 2011, the Company recorded an increase in unrecognized tax benefits in the amount of $1,600.  The Company anticipates an increase in the range of $5,000 to $7,000 to unrecognized tax benefits within the next twelve months due to changes in the composition of the consolidated group.  Due to the impact of deferred tax accounting, the majority of the increase in unrecognized tax benefits does not affect the effective tax rate.

 

The Company files income tax returns in the U.S. federal jurisdiction and with various states.  With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by taxing authorities for years 2006 and prior.  Tax years 2007, 2008 and 2009 are open to federal examination by the Internal Revenue Service.  The Company does not expect significant increases or decreases to unrecognized tax benefits relating to federal, state or local audits.

 

11.  Segment Information

 

The Company has three reportable segments: Individual Markets, Retirement Services and Other.  The Individual Markets segment distributes life insurance and individual annuity products to both individuals and businesses through various distribution channels.  Life insurance products in-force includes participating and non-participating term life, whole life, universal life and variable universal life.  The Retirement Services segment provides retirement plan enrollment services, communication materials, various retirement plan investment options and educational services to employer-sponsored defined contribution/defined benefit plans and 401(k) and 403(b) plans, as well as comprehensive administrative and record-keeping services for financial institutions and employers.  The Company’s Other segment includes corporate items not directly allocated to any of its other business segments, interest expense on long-term debt and the activities of a wholly-owned subsidiary whose sole business is the assumption of a certain block of term life insurance from an affiliated company.

 

The following table summarizes the financial results of the Company’s Individual Markets segment for the three-month periods ended March 31, 2011 and 2010:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Revenues:

 

 

 

 

 

Premium income

 

$

150,159

 

$

180,560

 

Fee income

 

15,972

 

13,827

 

Net investment income

 

177,386

 

173,735

 

Net realized gains (losses) on investments

 

3,426

 

(6,866

)

Total revenues

 

346,943

 

361,256

 

Benefits and expenses:

 

 

 

 

 

Policyholder benefits

 

280,433

 

314,313

 

Operating expenses

 

25,900

 

24,780

 

Total benefits and expenses

 

306,333

 

339,093

 

Income before income taxes

 

40,610

 

22,163

 

Income tax expense

 

11,107

 

7,627

 

Net income

 

$

29,503

 

$

14,536

 

 

39



Table of Contents

 

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

The following table summarizes the financial results of the Company’s Retirement Services segment for the three-month periods ended March 31, 2011 and 2010:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Revenues:

 

 

 

 

 

Premium income

 

$

2,014

 

$

1,106

 

Fee income

 

102,801

 

94,647

 

Net investment income

 

99,596

 

94,276

 

Net realized gains (losses) on investments

 

3,203

 

(13,730

)

Total revenues

 

207,614

 

176,299

 

Benefits and expenses:

 

 

 

 

 

Policyholder benefits

 

53,687

 

52,381

 

Operating expenses

 

95,413

 

94,140

 

Total benefits and expenses

 

149,100

 

146,521

 

Income before income taxes

 

58,514

 

29,778

 

Income tax expense

 

16,563

 

9,357

 

Net income

 

$

41,951

 

$

20,421

 

 

The following table summarizes the financial results of the Company’s Other segment for the three-month periods ended March 31, 2011 and 2010:

 

 

 

Three months ended March 31,

 

 

 

2011

 

2010

 

Revenues:

 

 

 

 

 

Premium income

 

$

28,275

 

$

29,328

 

Fee income

 

1,192

 

1,165

 

Net investment income

 

14,884

 

11,345

 

Net realized gains on investments

 

20

 

342

 

Total revenues

 

44,371

 

42,180

 

Benefits and expenses:

 

 

 

 

 

Policyholder benefits

 

26,078

 

23,350

 

Operating expenses

 

22,263

 

16,191

 

Total benefits and expenses

 

48,341

 

39,541

 

Income (loss) before income taxes

 

(3,970

)

2,639

 

Income tax expense (benefit)

 

(1,346

)

949

 

Net income (loss)

 

$

(2,624

)

$

1,690

 

 

12.  Share-Based Compensation

 

Lifeco, of which the Company is an indirect wholly-owned subsidiary, has a stock option plan that provides for the granting of options on its common shares to certain of its officers and employees and those of its subsidiaries, including the Company.  During the three-month periods ended March 31, 2011 and 2010, the Company recognized $396 and $399, respectively, in its condensed consolidated statements of income related to share-based compensation expense under the Lifeco stock option plan.

 

During the three months ended March 31, 2011, Lifeco granted 523,300 stock options to employees of the Company.  The stock options vest evenly over a five-year period ending in February 2016.  Compensation expense of $2,391, computed using the accelerated method of recognition, will be recognized in the Company’s financial statements over the vesting period of these stock option grants.

 

40



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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY

Notes to Condensed Consolidated Financial Statements

Three Months Ended March 31, 2011 and 2010

(Dollars in Thousands)

(Unaudited)

 

13.  Commitments and Contingencies

 

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 resolutions of these proceedings are not expected to have a material adverse effect on the Company’s condensed consolidated financial position, results of its operations or cash flows.

 

The Company has a revolving credit facility agreement in the amount of $50,000 for general corporate purposes.  The credit facility matures on May 26, 2013.  Interest accrues at a rate dependent on various conditions and terms of borrowings.  The agreement requires, among other things, the Company to maintain a minimum adjusted net worth, as defined, of $1,000,000 plus 50% of its net income, if positive and as defined in the credit facility agreement (both compiled on the unconsolidated statutory accounting basis prescribed by the National Association of Insurance Commissioners), for each quarter ending after March 31, 2010.  The Company had no borrowings under the credit facility at March 31, 2011 or December 31, 2010 and was in compliance with all covenants.

 

The Company makes commitments to fund partnership interests and mortgage loans on real estate investments in the normal course of its business.  The amounts of these unfunded commitments at March 31, 2011 and December 31, 2010 were $175,139 and $95,688, respectively, all of which is due within one year from the dates indicated.

 

14.  Subsequent Event

 

On April 29, 2011, the Company’s Board of Directors declared a dividend of $47,800 to be paid to its sole shareholder, GWL&A Financial, during the second quarter of 2011.

 

41



Table of Contents

 

Item 2.                       Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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 its products, investment spreads or yields, or the earnings or profitability of its 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 rating, volatility and other risks associated with its investment portfolio and other factors.  Readers should also consider other matters, including any risks and uncertainties discussed in documents filed by the Company and certain of its subsidiaries with the Securities and Exchange Commission.

 

Company Results of Operations

 

The following discussion addresses the Company’s results of operations for the three month period ended March 31, 2011, compared with the same period in 2010.  The discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” to which the reader is directed for additional information.

 

Three months ended March 31, 2011 compared with the three months ended March 31, 2010

 

 

 

Three months ended March 31,

 

Income statement data (In millions)

 

2011

 

2010

 

Premium income

 

$

180

 

$

211

 

Fee income

 

120

 

110

 

Net investment income

 

292

 

279

 

Net realized investment gains (losses)

 

7

 

(20

)

Total revenues

 

599

 

580

 

Policyholder benefits

 

360

 

390

 

Operating expenses

 

144

 

135

 

Total benefits and expenses

 

504

 

525

 

Income from operations before income taxes

 

95

 

55

 

Income tax expense

 

26

 

18

 

Net income

 

$

69

 

$

37

 

 

The Company’s consolidated net income increased by $32 million, or 86%, to $69 million for the three months ended March 31, 2011 when compared to 2010. The increase is primarily related to a $26 million increase in net realized and unrealized investment gains (losses), net of policyholder amounts and a $10 million increase in fee income.

 

Premium income decreased by $31 million, or 15%, to $180 million for the three months ended March 31, 2011 when compared to 2010. This decrease is primarily related to a $38 million decrease in sales of the single premium whole life product in the Company’s Individual Markets segment.

 

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Fee income increased by $10 million, or 9%, to $120 million for the three months ended March 31, 2011 when compared to 2010.  The increase is primarily related to higher variable fee income in the Retirement Services segment as a result of higher average account balances due to the performance of the U.S. equities market as seen by the higher S&P 500 index average in 2011 compared to 2010. The S&P 500 index is up by 13% at March 31, 2011 when compared to March 31, 2010. The average of the S&P 500 index level during the three months ended March 31, 2011 is up by 16% when compared to the three months ended March 31, 2010.

 

 

 

March 31,

 

S&P 500 Index

 

2011

 

2010

 

Index close

 

1,326

 

1,169

 

Index average

 

1,303

 

1,124

 

 

Net investment income increased by $13 million, or 5%, to $292 million for the three months ended March 31, 2011 when compared to 2010. The increase is primarily due to increased interest income of $5 million due to an increase in invested assets and $8 million higher net unrealized gains (losses) on derivatives and held for trading assets.

 

Net realized investment gains (losses) increased by $27 million from a loss of $20 million in the three months ended March 31, 2010 to a gain of $7 million in 2011. The $7 million gain in 2011 is due to $7 million of net realized gains on the sale of investments.  The $20 million loss in 2010 is due to $37 million of credit related other-than-temporary impairments (“OTTI”) losses primarily on fixed maturity securities guaranteed by Ambac Financial Group, Inc. (“Ambac”) (See discussion under Fixed Maturity Investments below) offset by $17 million of net realized gains on the sale of investments.

 

Total benefits and expenses decreased by $21 million, or 4%, to $504 million for the three months ended March 31, 2011 when compared to 2010. The decrease is primarily attributable to a decrease in future policy benefits and expenses of $33 million in the Company’s Individual Markets segment due to decreased sales. This was partially offset by an $8 million increase in benefits and expenses in the Other segment.

 

Income tax expense increased by $8 million, or 44%, to $26 million for the three months ended March 31, 2011 when compared to 2010. This increase is primarily due to a 73% increase in net income before taxes partially offset by a decrease in the effective tax rate due to the release of one-time uncertain tax positions.

 

The segment information below discusses the reasons for these changes.

 

Segment Results of Operations

 

The Company has three reportable segments: Individual Markets, Retirement Services and Other.  The Individual Markets segment distributes life insurance and individual annuity products to both individuals and businesses through various distribution channels.  Life insurance products in-force includes participating and non-participating term life, whole life, universal life and variable universal life.  The Retirement Services segment provides retirement plan enrollment services, communication materials, various retirement plan investment options and educational services to employer-sponsored defined contribution/defined benefit plans and 401(k) and 403(b) plans, as well as comprehensive administrative and record-keeping services for financial institutions and employers.  The Company’s Other segment includes corporate items not directly allocated to any of its other business segments, interest expense on long-term debt and the activities of a wholly-owned subsidiary whose sole business is the assumption of a certain block of term life insurance from an affiliated company.

 

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Individual Markets Results of Operations

 

Three months ended March 31, 2011 compared with the three months ended March 31, 2010

 

The following is a summary of certain financial data of the Company’s Individual Markets segment:

 

 

 

Three months ended March 31,

 

Income statement data (In millions)

 

2011

 

2010

 

Premium income

 

$

150

 

$

180

 

Fee income

 

16

 

14

 

Net investment income

 

177

 

174

 

Net realized investment gains (losses)

 

4

 

(7

)

Total revenues

 

347

 

361

 

Policyholder benefits

 

280

 

314

 

Operating expenses

 

26

 

25

 

Total benefits and expenses

 

306

 

339

 

Income before income taxes

 

41

 

22

 

Income tax expense

 

11

 

8

 

Net income

 

$

30

 

$

14

 

 

The following is a summary of the Individual Markets segment participant accounts at March 31, 2011 and December 31, 2010:

 

 

 

March 31,

 

(In thousands)

 

2011

 

2010

 

Participant accounts

 

517

 

519

 

 

Net income for the Individual Markets segment increased by $16 million, or 114%, to $30 million for the three months ended March 31, 2011 when compared to 2010. The increase is primarily related to a $13 million increase in net realized and unrealized investment gains (losses), net of policyholder related amounts and a decrease of $4 million in acquisition expenses, net of deferrals, on the single premium whole life product due to decreased sales in 2011.

 

Premium income decreased by $30 million, or 17%, to $150 million for the three months ended March 31, 2011 when compared to 2010. The decrease is primarily related to sales in the single premium whole life product marketed through banks which decreased by $38 million.  In 2011, the Company began replacing the single premium whole life product with a single premium universal life product which had deposits of $34 million for the three months ended March 31, 2011.

 

Fee income increased by $2 million, or 14%, to $16 million for the three months ended March 31, 2011 when compared to 2010.  The increase is primarily related to higher account balances as a result of sales since March 31, 2010 on the business-owned life insurance (“BOLI”) product.

 

Net investment income remained relatively constant, increasing by $3 million to $177 million during the three months ended March 31, 2011.  The increase is primarily due to $6 million lower unrealized losses on derivatives and held for trading assets offset by decreased interest income of $3 million.

 

Net realized investment gains (losses) increased by $11 million from a loss of $7 million for the three months ended March 31, 2010 to a gain of $4 million in 2011. The $4 million gain in 2011 is due to $4 million of net realized gains on the sale of investments. The $7 million loss in 2010 is due to $16 million of credit related OTTI losses primarily on fixed maturity securities guaranteed by Ambac offset by $9 million of net realized gains on the sale of investments.

 

Total benefits and expenses decreased by $33 million, or 10%, to $306 million for the three months ended March 31, 2011 when compared to 2010. The decrease is primarily attributable to a decrease in future policy benefits and expenses related to the decreased sales premium mentioned above.

 

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Income tax expense increased by $3 million, or 38%, to $11 million for the three months ended March 31, 2011 when compared to 2010.  This increase is primarily due to an 87% increase in net income before taxes partially offset by the decrease in the effective tax rate due to a decrease in the income tax contingency provision.

 

Retirement Services Results of Operations

 

Three months ended March 31, 2011 compared with the three months ended March 31, 2010

 

The following is a summary of certain financial data of the Company’s Retirement Services segment:

 

 

 

Three months ended March 31,

 

Income statement data (In millions)

 

2011

 

2010

 

Premium income

 

$

2

 

$

1

 

Fee income

 

103

 

95

 

Net investment income

 

100

 

94

 

Net realized investment gains (losses)

 

3

 

(14

)

Total revenues

 

208

 

176

 

Policyholder benefits

 

54

 

52

 

Operating expenses

 

95

 

94

 

Total benefits and expenses

 

149

 

146

 

Income before income taxes

 

59

 

30

 

Income tax expense

 

17

 

9

 

Net income

 

$

42

 

$

21

 

 

The following is a summary of the Retirement Services segment participant accounts at March 31, 2011 and December 31, 2010:

 

 

 

March 31,

 

(In thousands) 

 

2011

 

2010

 

Participant accounts

 

4,463

 

4,376

 

 

Net income for the Retirement Services segment increased by $21 million, or 100%, to $42 million during the three months ended March 31, 2011 when compared to 2010.  The increase is primarily related to a $13 million increase in net realized and unrealized investment gains (losses), net of policyholder related amounts and an $8 million increase in fee income.

 

Fee income increased by $8 million, or 8%, to $103 million for the three months ended March 31, 2011 when compared to 2010.  The increase is primarily related to higher variable fee income as a result of higher average account balances due to the performance of the U.S. equities market as seen by the higher S&P 500 index average in 2011 compared to 2010 as well as an increase in participants.

 

Net investment income increased by $6 million, or 6%, to $100 million for the three months ended March 31, 2011 when compared to 2010.  The increase is due to an additional $2 million of unrealized gains on derivatives and held for trading assets and increased interest income of $4 million due to higher invested asset balances.

 

Net realized investment gains (losses) increased by $17 million from a loss of $14 million during the three months ended March 31, 2010 to a gain of $3 million in 2011. The $3 million gain in 2011 is due to $3 million of net realized gains on the sale of investments. The $14 million loss in 2010 is due to $21 million of credit related OTTI losses primarily on fixed maturity securities guaranteed by Ambac offset by $7 million of net realized gains on the sale of investments.

 

Income tax expense increased by $8 million, or 89%, to $17 million for the three months ended March 31, 2011 when compared to 2010. This increase is primarily due to a 97% increase in net income before taxes.

 

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The following table provides information for the Retirement Service’s segment participant account values at March 31, 2011 and 2010:

 

 

 

March 31,

 

(In millions)

 

2011

 

2010

 

General account - Fixed options:

 

 

 

 

 

Public / Non-profit

 

$

3,455

 

$

3,517

 

401(k)

 

4,357

 

3,705

 

 

 

$

7,812

 

$

7,222

 

Separate account -Variable options:

 

 

 

 

 

Public / Non-profit

 

$

8,784

 

$

7,528

 

401(k)

 

7,397

 

6,508

 

 

 

$

16,181

 

$

14,036

 

Proprietary mutual fund:

 

 

 

 

 

Public / Non-profit

 

$

321

 

$

615

 

401(k)

 

2,184

 

1,252

 

Institutional

 

51

 

3

 

 

 

$

2,556

 

$

1,870

 

Retail investment options and administrative services only:

 

 

 

 

 

Public / Non-profit

 

$

60,684

 

$

51,773

 

401(k)

 

25,959

 

21,429

 

Institutional

 

42,719

 

37,973

 

 

 

$

129,362

 

$

111,175

 

 

Account values invested in the general account fixed investment options have increased by $590 million, or 8%, at March 31, 2011 compared to March 31, 2010 primarily due to an increase in new participant contributions and interest credited to existing account balances.

 

Account values invested in the separate account variable investment options have increased by $2,145 million, or 15%, at March 31, 2011 compared to March 31, 2010.  The increase is primarily due to new sales and an overall increase in the U.S. equity markets.

 

Account values invested in the proprietary mutual fund investment options have increased by $686 million, or 37%, at March 31, 2011 compared to March 31, 2010.  The increase is primarily due to new sales and an overall increase in the U.S. equity markets.

 

Participant account values invested in retail investment options and participant account values where only administrative services and recordkeeping functions are provided have increased by $18,187 million, or 16%, at March 31, 2011 compared to March 31, 2010.  The increase is primarily due to new sales and an overall increase in the U.S. equity markets.

 

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Other Results of Operations

 

Three months ended March 31, 2011 compared with the three months ended March 31, 2010

 

The following is a summary of certain financial data of the Company’s Other segment:

 

 

 

Three months ended March 31,

 

Income statement data (In millions)

 

2011

 

2010

 

Premium income

 

$

28

 

$

30

 

Fee income

 

1

 

1

 

Net investment income

 

15

 

11

 

Net realized investment gains

 

 

1

 

Total revenues

 

44

 

43

 

Policyholder benefits

 

26

 

24

 

Operating expenses

 

22

 

16

 

Total benefits and expenses

 

48

 

40

 

Income (loss) before income taxes

 

(4

)

3

 

Income tax expense

 

(1

)

1

 

Net income (loss)

 

$

(3

)

$

2

 

 

Net income for the Company’s Other segment decreased by $5 million from a gain of $2 million during the three months ended March 31, 2010 to a loss of $3 million during the comparable period of 2011. The decrease is primarily due to a $6 million increase in operating expenses related to increased guarantee fund assessments and consulting expenses on special initiatives.

 

General Account Investments

 

The Company’s primary investment objective is to acquire assets with duration and cash flow characteristics reflective of its liabilities, while meeting industry, size, issuer and geographic diversification standards.  Formal liquidity and credit quality parameters have also been established.

 

The Company follows rigorous procedures to control interest rate risk and observes strict asset and liability matching guidelines.  These guidelines ensure that even under changing market conditions, the Company’s assets should meet the cash flow and income requirements of its liabilities.  Using dynamic modeling to analyze the effects of a range of possible market changes upon investments and policyholder benefits, the Company works to ensure that its investment portfolio is appropriately structured to fulfill financial obligations to its policyholders.

 

A summary of the Company’s general account investment assets and assets as a percentage of total general account investments at March 31, 2011 and December 31, 2010 is as follows:

 

(In millions)

 

March 31, 2011

 

December 31, 2010

 

Fixed maturities, available-for-sale

 

$

15,581

 

67.8

%

$

15,943

 

69.1

%

Fixed maturities, held for trading

 

181

 

0.8

%

144

 

0.6

%

Mortgage loans on real estate

 

1,974

 

8.6

%

1,722

 

7.5

%

Equity investments, available-for-sale

 

2

 

0.0

%

2

 

0.0

%

Policy loans

 

4,050

 

17.6

%

4,060

 

17.6

%

Short-term investments, available-for-sale

 

966

 

4.2

%

965

 

4.2

%

Limited partnership and other corporation interests

 

201

 

0.9

%

210

 

0.9

%

Other investments

 

22

 

0.1

%

23

 

0.1

%

Total investment assets

 

$

22,977

 

100.0

%

$

23,069

 

100.0

%

 

Fixed Maturity Investments

 

Fixed maturity investments include public and privately placed corporate bonds, government bonds and mortgage-backed and asset-backed securities.  The Company’s strategy related to mortgage-backed and asset-backed securities is to focus on those investments with low prepayment risk and minimal credit risk. 

 

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The Company does not invest in higher-risk collateralized mortgage obligations such as interest-only and principal-only strips, and currently has no plans to invest in such securities.

 

Private placement investments are generally less marketable than publicly traded assets, yet they typically offer enhanced covenant protection that allows the Company, if necessary, to take appropriate action to protect its investment.  The Company believes that the cost of the additional monitoring and analysis required by private placement investments is more than offset by their enhanced yield.

 

The National Association of Insurance Commissioners (the “NAIC”) adopted a revised rating methodology for non-agency residential mortgage-backed securities (“RMBS”) that became effective December 31, 2009 and commercial mortgage-backed securities (“CMBS”) that became effective December 31, 2010.  The NAIC’s objective with the rating methodology for non-agency RMBS and CMBS was to increase the accuracy in assessing expected losses, and to use the improved assessment to determine a more appropriate capital requirement for non-agency RMBS and CMBS.  The revised methodology reduces regulatory reliance on rating agencies and allows for greater regulatory input into the assumptions used to estimate expected losses from non-agency RMBS and CMBS.

 

One of the Company’s primary objectives is to ensure that its fixed maturity portfolio is maintained at a high average quality to limit credit risk.  If not externally rated, the securities are rated by the Company on a basis intended to be similar to that of the rating agencies.  The Company’s internal rating methodology generally takes into account ratings from Standard & Poors Ratings Services and Moody’s Investor Services, Inc. However, ratings presented for non-agency RMBS are based on final ratings from the revised NAIC rating methodology as discussed above.  The Company’s CMBS ratings were not affected by the revised NAIC rating methodology.

 

The distribution of the Company’s fixed maturity portfolio by the Company’s internal credit rating at March 31, 2011 and December 31, 2010 is summarized as follows:

 

Credit Rating

 

March 31, 2011

 

December 31, 2010

 

AAA

 

37.3

%

38.5

%

AA

 

14.5

%

14.0

%

A

 

22.3

%

21.9

%

BBB

 

23.6

%

23.3

%

BB and below (Non-investment grade)

 

2.3

%

2.3

%

Total

 

100.0

%

100.0

%

 

The following table contains the sector distribution of the Company’s corporate fixed maturity investment portfolio, calculated as a percentage of fixed maturities:

 

Sector

 

March 31, 2011

 

December 31, 2010

 

Utility

 

15.7

%

15.3

%

Finance

 

10.1

%

10.0

%

Consumer

 

8.7

%

8.7

%

Natural resources (1)

 

4.5

%

4.8

%

Transportation

 

2.4

%

2.6

%

Other

 

8.7

%

8.4

%

 


(1) Exposure of 2.6% and 2.9% to the oil and gas sector is included in natural resources at March 31, 2011 and December 31, 2010, respectively.

 

The Company holds fixed maturity investments guaranteed by monoline insurers.  Monoline insurers provide guarantees on debt for issuers, often in the form of credit wraps, which enhance the credit of the issuer.  Monoline insurers guarantee the timely repayment of bond principal and interest when a bond issuer defaults and generally provide credit enhancement for certain securities.  During 2009, The Financial Guaranty Insurance Company (“FGIC”), a monoline insurer, was ordered to suspend all claims payments by the New York Insurance Department.  During the first quarter of 2010, Ambac Financial Group, Inc. (“Ambac”), a monoline insurer, was ordered to suspend claims payments on residential mortgage-backed

 

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securities by the State of Wisconsin Insurance Department.  On January 25, 2011, a Plan of Rehabilitation supported by Ambac’s regulator was approved by a Wisconsin state court judge.  The Company is not yet certain of the amount or timing of recoveries under the Plan.  The Company assesses OTTI on a regular basis on these securities.  The financial health of several other monoline insurers has been in question recently and several insurers have experienced ratings downgrades.

 

The Company does not have any direct bond holdings of the actual monoline insurers.  Excluding FGIC and Ambac holdings where the insurer has been ordered to suspend claims as discussed above, the Company’s insured holdings at March 31, 2011 and December 31, 2010 are as follows:

 

 

 

 

 

 

 

Indirect

 

 

 

 

 

 

 

exposure

 

 

 

Guarantor quality rating

 

March 31,

 

Guarantor (In millions)

 

S&P

 

Moody’s

 

2011

 

MBIA Inc.

 

B

 

B3

 

$

217

 

Assured Guaranty Corp. (formerly Financial Security Assurance, Inc.)

 

AA+

 

Aa3

 

132

 

Berkshire Hathaway Assurance Corporation

 

AA+

 

Aa1

 

34

 

National Public Finance Guaranty Corporation

 

BBB

 

Baa1

 

156

 

 

 

 

 

 

 

$

539

 

 

 

 

 

 

 

 

Indirect

 

 

 

 

 

 

 

exposure

 

 

 

Guarantor quality rating

 

December 31,

 

Guarantor (In millions)

 

S&P

 

Moody’s

 

2010

 

MBIA Inc.

 

B

 

B3

 

$

211

 

Assured Guaranty Corp. (formerly Financial Security Assurance, Inc.)

 

AA+

 

Aa3

 

129

 

Berkshire Hathaway Assurance Corporation

 

AA+

 

Aa1

 

34

 

National Public Finance Guaranty Corporation

 

BBB

 

Baa1

 

156

 

 

 

 

 

 

 

$

530

 

 

At March 31, 2011 and December 31, 2010, the Company had $427 million and $418 million, respectively, of asset-backed securities insured by monolines other than FGIC and Ambac.  At March 31, 2011 and December 31, 2010, the overall credit quality of the Company’s monoline-insured asset-backed securities, including the benefits of monoline insurance, was A- and A, respectively.  At March 31, 2011 and December 31, 2010, the Company had other insured securities with a fair value of $112 million, primarily exposed to state/municipal bond authorities and utilities and financial services companies.

 

The Company had exposure to the subprime market in the form of home equity loan asset-backed securities of $929 million, or 4% of total invested assets of $22,977 million as of March 31, 2011 and $949 million, or 4% of total investments of $23,069 million as of December 31, 2010.  The majority of the securities held at March 31, 2011 are investment grade rated, 74% of which have a rating of AAA.  The majority of the mortgages backing these securities are fixed rate loans, which typically have lower default and loss rates than adjustable rate loans.  Of these pools, 54% were originated before 2005, which is associated with lower default and loss rates compared to pools that were originated from 2005 through 2008.  The weighted average credit enhancement level for these securities is 35% (excluding any monoline guarantees) as of March 31, 2011.  This credit enhancement represents subordinated securities or surplus collateral that would absorb losses prior to losses being allocated to the Company’s securities.

 

The Company has no exposure to sub-prime collateralized debt obligations, asset-backed commercial paper or structured investment vehicles.  The Company’s exposure to Alt A mortgage-backed securities at March 31, 2011 is $1 million.  The underlying mortgages of Alt A securities have a risk potential that is greater than prime but less than sub-prime.  The borrowers behind these mortgages typically have clean credit histories, but the mortgage itself will generally have some issues that increase its risk profile.  These

 

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issues may include higher loan-to-value and debt-to-income ratios or inadequate documentation of the borrower’s income.

 

Fair Value Measurements and Impairment of Fixed Maturity and Equity Investments Classified as Available-for-Sale

 

Security valuation methods can be subjective.  Each fixed maturity and equity investment is categorized in a hierarchy based on the observability of inputs into the valuation methodology with Level 3 being the least observable.  Total assets and liabilities measured using significant unobservable inputs (Level 3) increased by $4 million at March 31, 2011 from December 31, 2010.  Net Level 3 assets and liabilities at March 31, 2011 were $357 million or 1% of total assets and liabilities compared to net Level 3 assets and liabilities of $353 million or 1% at December 31, 2010.  The use of internal models for Level 3 assets and liabilities did not affect the Company’s operations, liquidity or capital resources during the period.

 

Due to market conditions beginning in 2008, which have continued into 2011 the Company used internal models to determine fair value for asset-backed securities backed by home improvement loans.  Using these models instead of an external source resulted in a decrease to unrealized losses of $45 million at March 31, 2011.  The internal models utilized asset-backed index spread assumptions versus credit default spread assumptions used by the external source.

 

The Company classifies substantially all of its fixed maturity and all of its equity investments as available-for-sale and records them at fair value with the related net gain or loss, net of policyholder related amounts and deferred taxes, being recorded in accumulated other comprehensive income (loss) in the stockholder’s equity section in the accompanying condensed consolidated balance sheets. The Company has recorded a decrease in gross unrealized losses of $63 million and decrease in gross unrealized gains of $86 million during the three months ended March 31, 2011. This resulted in a $27 million decrease to accumulated other comprehensive income (loss), net of policyholder related amounts and deferred taxes. All available-for-sale securities with gross unrealized losses at the balance sheet date are subjected to the Company’s process for identification and evaluation of other-than-temporary impairments.

 

While many unrealized losses have now existed for longer than twelve months, the Company believes this is attributable to general market conditions related to changes in interest rates and credit spreads and not reflective of the financial condition of the issuer or collateral backing the securities.  The continued decrease in unrealized losses reflects recovery in market liquidity and tightening of credit spreads, although the economic uncertainty in certain asset classes still remains.  The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before the recovery of their amortized cost basis, which may be maturity; therefore, the Company does not consider these investments to be other-than-temporarily impaired at March 31, 2011.

 

During the three months ended March 31, 2011, the Company did not record any other-than-temporary losses on its fixed maturity investments.  During the three months ended March 31, 2010, the Company recorded net other-than-temporary losses recognized in earnings of $37 million on its fixed maturity investments.  (See Note 4 to the accompanying condensed consolidated financial statements).

 

Following the recognition of the other-than-temporary impairment for fixed maturities, the Company accretes the new cost basis to par or to estimated future value over the remaining life of the security based on the future estimated cash flows by adjusting the security’s yields.  See Note 4 to the accompanying condensed consolidated financial statements for a further discussion of impaired fixed maturity investments.

 

Securities Lending and Cash Collateral Reinvestment Practices

 

All cash collateral related to the securities lending program, repurchase agreements and dollar repurchase agreement practices is invested in U.S. Government or U.S. Government Agency securities.  Some cash collateral may be invested in short-term repurchase agreements which are also collateralized by U.S. Government or U.S. Government Agency securities.  In addition, the securities lending agent indemnifies the Company against borrower risk, meaning that the lending agent agrees contractually to replace securities not returned due to a borrower default.  As of March 31, 2011 and December 31, 2010, the Company had $59 million and $51 million, respectively, of securities out on loan, $754 million and $657

 

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million, respectively, in short-term repurchase agreements and $815 million and $937 million, respectively, in dollar repurchase liabilities, all of which are fully collateralized as described above.  The Company does not enter into these types of transactions for liquidity purposes, but rather for yield enhancement on its investment portfolio.

 

Derivative Counterparty Collateral

 

All collateral received from derivative counterparties is in the form of cash and is included as an asset in the condensed consolidated balance sheet, with an offsetting liability for the obligation to return the collateral.  The Company received unrestricted cash of $6 million and $8 million as of March 31, 2011 and December 31, 2010, respectively.  The cash collateral is reinvested in a government money market fund.

 

Mortgage Loans on Real Estate

 

The Company’s mortgage loans on real estate are comprised exclusively of domestic commercial collateralized real estate loans.  The mortgage loan portfolio is diversified with regard to geographical markets and commercial real estate property types within the United States.  The Company originates, directly or through correspondents, real estate mortgages with the intent to hold to maturity.  The Company does not generally purchase or sell mortgage loans.  The Company’s portfolio includes loans which are fully amortizing, amortizing with a balloon balance at maturity, interest only to maturity and interest only for a number of years followed by an amortizing period.  The Company does not invest in interest only strips nor does it originate single family residential mortgage loans.

 

The weighted average loan-to-value ratio for the Company’s mortgage loans on real estate was 54% and 53% at March 31, 2011 and December 31, 2010, respectively.  The debt service coverage ratio was 2.02 and 2.00 times at March 31, 2011 and December 31, 2010, respectively.  During the three months ended March 31, 2011 and the year ended December 31, 2010, the Company originated 19 and 29 new loans with principal balances of $272 million and $345 million, respectively.  At origination, the weighted average loan-to-value ratio was 59% and 50% and the debt service coverage ratio was 2.04 and 2.43 times at March 31, 2011 and December 31, 2010, respectively.

 

The Company originates interest only and amortizing commercial mortgage loans.  During the three months ended March 31, 2011 and the year ended December 31, 2010, the Company originated mortgage loans structured with an interest only component in the amount of $135 million and $212 million, respectively, compared to a total mortgage loan portfolio at March 31, 2011 and December 31, 2010 of $1,974 million and $1,722 million, respectively.  The weighted average loan-to-value ratio of the interest only loans originated in 2011 and 2010 was 57% and 48%, respectively.

 

See Note 4 to the accompanying condensed consolidated financial statements for a further discussion of mortgage loans.

 

Other Investments

 

Other investments consist primarily of equity investments, policy loans, short-term investments, limited partnerships and investment in real estate.  The Company anticipates limited participation in equity and real estate markets during 2011.

 

See Note 4 to the accompanying condensed consolidated financial statements for a further discussion of impaired equity investments.

 

Derivatives

 

The Company introduced a guaranteed minimum withdrawal benefit, also referred to as guaranteed lifetime withdrawal benefit, (“GMWB”) product, Great-West® SecureFoundationSM, into the 401(k) markets in 2010.  In the past, the Company had limited use of derivatives; however, with the introduction of the GMWB product combined with the interest rate risk hedging program introduced during 2009, the Company’s use of derivatives has increased with additional usage expected. The Company uses certain derivatives, such as futures, swaps and interest rate swaptions for purposes of managing interest rate, equity and foreign

 

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currency exchange risks and fee revenue.  These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, when used for hedging purposes, these instruments typically reduce risk.  The Company controls the credit risk of its over-the-counter derivative contracts through credit approvals, limits, monitoring procedures and in most cases, requiring collateral.  Risk of loss is generally limited to the portion of the fair value of derivative instruments which exceeds the value of the collateral held and not to the notional or contractual amounts of the derivatives.  The Company enters into derivative transactions only with high quality institutions.

 

Note 5 to the consolidated financial statements contain a discussion of the Company’s derivative position.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the Company’s management to adopt accounting policies to enable them to make a significant variety of accounting and actuarial 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 information available at the time the estimates were made.

 

Critical accounting policies are those that management believes are important to the portrayal of the Company’s results of operations and financial condition and which require management to make difficult, subjective and/or complex judgments.  Critical accounting estimates cover accounting and actuarial matters that are inherently uncertain because the future resolution of such matters is unknown.  Many of these policies, estimates and related judgments are common in the insurance and financial services industries.  The Company believes that its most critical accounting estimates include the following:

 

·             Valuation of investments and other-than-temporary impairments.

·             Valuation and accounting for derivative instruments.

·             Valuation of policy benefit liabilities.

·             Valuation of deferred acquisition costs and value of business acquired.

·             Accounting for employee benefit plans.

·             Accounting for taxes on income.

 

A discussion of each of these critical accounting policies may be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

New Accounting Pronouncements

 

See Note 2 to the accompanying condensed consolidated financial statements for a discussion of new accounting pronouncements that the Company has recently adopted or will adopt in the future.

 

Liquidity and Capital Resources

 

Liquidity refers to a company’s ability to generate sufficient cash flows to meet the needs of its operations.  The Company manages its operations to create stable, reliable and cost-effective sources of cash flows to meet all of its obligations.

 

The principal sources of the Company’s liquidity are premiums and contract deposits, fees, investment income and investment maturities and sales.  Funds provided from these sources are reasonably predictable and normally exceed liquidity requirements for payment of policy benefits, payments to policy and contractholders in connection with surrenders and withdrawals and general 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.  A primary liquidity concern regarding cash flows from operations is the risk of early policyholder and contractholder withdrawals.  A primary liquidity concern regarding investment activity is the risks of defaults and market volatilities.  In addition, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities.  The sources of

 

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the funds that may be required in such situations include the issuance of commercial paper or other debt instruments.  Management believes that the liquidity profile of its assets is sufficient to satisfy the liquidity requirements of reasonably foreseeable scenarios.

 

Generally, the Company has met its operating requirements by utilizing cash flows from operations and maintaining appropriate levels of liquidity in its investment portfolio.  Included in cash flows from operating activities are net purchases of trading securities of $40 million and $25 million for the three-month periods ended March 31, 2011 and 2010, respectively.  The Company intends to reinvest these securities in higher yielding permanent investments.  Liquidity for the Company has remained strong, as evidenced by the amounts of short-term investments and cash that totaled $970 million and $969 million as of March 31, 2011 and December 31, 2010.  In addition, 98% of the bond portfolio carried an investment grade rating at March 31, 2011 and December 31, 2010, thereby providing significant liquidity to the Company’s overall investment portfolio.

 

The Company continues to be well capitalized, with sufficient borrowing capacity to meet the anticipated needs of its business.  The Company’s financial strength provides the capacity and flexibility to enable it to raise funds in the capital markets through the issuance of commercial paper.  The Company had $98 million and $92 million of commercial paper outstanding at March 31, 2011 and December 31, 2010, respectively.  The commercial paper has been given a rating of A-1+ by Standard & Poor’s Ratings Services and a rating of P-1 by Moody’s Investors Service, each being the highest rating available.  Through the recent financial market volatility, the Company continued to have the ability to access the capital markets for funds.  The loss of this access in the future would not have a significant impact to the Company’s liquidity as the commercial paper is not used to fund daily operations and is an insignificant amount in relation to total invested assets.

 

The Company also has available a revolving credit facility agreement, which expires on May 26, 2013, in the amount of $50 million for general corporate purposes.  The Company had no borrowings under this credit facility at March 31, 2011.  The Company does not anticipate the need for borrowings under this facility and the loss of its availability would not significantly impact its liquidity.

 

Capital resources provide protection for policyholders and financial strength to support the underwriting of insurance risks and allow for continued business growth.  The amount of capital resources that may be needed is determined by the Company’s senior management and Board of Directors, as well as by regulatory requirements.  The allocation of resources to new long-term business commitments is designed to achieve an attractive return, tempered by considerations of risk and the need to support the Company’s existing business.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

The Company has established processes and procedures to effectively identify, monitor, measure and manage the risks associated with its invested assets and its interest rate sensitive insurance and annuity products.  Management has identified investment portfolio management, including the use of derivative instruments, insurance and annuity product design and asset/liability management as three critical means to accomplish a successful risk management program.

 

The major risks to which the Company is exposed include the following:

 

·          Market risk - the potential of loss arising from adverse fluctuations in interest rates and equity market prices and the levels of their volatility.

·          Insurance risk - the potential of loss resulting from claims, persistency and expense experience exceeding that assumed in the liabilities held.

·          Credit risk - the potential of loss arising from an obligor’s inability or unwillingness to meet its obligations to the Company.

·          Operational and corporate risk - the potential of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from other external events.

 

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A discussion of each of these risk factors may be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 under Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”.

 

Item 4.  Controls and Procedures

 

(a)                                  As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934).  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 facilitating timely decisions regarding required disclosure of any material information relating to the Company that is required to be disclosed by it in the reports that are filed or submitted under the Securities Exchange Act of 1934.

 

(b)                                 There have been no changes in the Company’s internal control over financial reporting that occurred during the three months ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

 

Part II - Other Information

 

Item 1.   Legal Proceedings

 

There are no material pending legal proceedings to which the Company or any of its subsidiaries are a party or of which any of their property is the subject.

 

Item 1A.  Risk Factors

 

In the normal course of its business, the Company is exposed to certain operational, regulatory and financial risks and uncertainties.  The most significant risks include the following:

 

·          Competition could negatively affect the ability of the Company to maintain or increase market share or profitability;

·          The insurance and financial services industries are heavily regulated and changes in regulation may reduce profitability;

·          A downgrade or potential downgrade in the Company’s financial strength or claims paying ratings could result in a loss of business and negatively affect results of operations and financial condition;

·          Deviations from assumptions regarding future persistency, mortality and interest rates used in calculating liabilities for future policyholder benefits and claims could adversely affect the Company’s results of operations and financial condition;

·          The Company may be required to accelerate the amortization of deferred acquisition costs or valuation of business acquired, or recognize impairment in the value of goodwill, which could adversely affect its results of operations and financial condition;

·          If the companies that provide reinsurance default or fail to perform or the Company is unable to obtain adequate reinsurance for some of the risks underwritten, the Company could incur significant losses adversely affecting results of operations and financial condition;

·          Interest rate fluctuations could have a negative impact on results of operations and financial condition;

·          Market fluctuations and general economic conditions may adversely affect results of operations and financial condition;

·          Changes in U.S. federal income tax law could make some of the Company’s products less attractive to consumers and increase its tax costs;

·          The Company may be subject to litigation resulting in substantial awards or settlements and this may adversely affect its reputation and results of operations;

·          The Company’s risk management policies and procedures may leave it exposed to unidentified or unanticipated risk, which could adversely affect its business, results of operations and financial condition and

 

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·          The Company may experience difficulty in marketing and distributing products through its current and future distribution channels.

 

A discussion of each of these risk factors may be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 under Item 1A, “Risk Factors”.  There are no material changes from Risk Factors as previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2010 under Item 1A, “Risk Factors”.

 

Item 6.  Exhibits

 

Index to Exhibits

 

Exhibit Number

 

Title

 

Page

 

31.1

 

 

Rule 13a-14(a)/15-d14(a) Certification

 

56

 

31.2

 

 

Rule 13a-14(a)/15-d14(a) Certification

 

57

 

32

 

 

18 U.S.C. 1350 Certification

 

58

 

Signature

 

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.

 

Great-West Life & Annuity Insurance Company

 

By:

/s/ Glen R. Derback

 

Date:

May 9, 2011

 

Glen R. Derback, Senior Vice President and Controller

 

 

 

 

(Duly authorized officer and chief accounting officer)

 

 

 

 

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