UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 33-28976
IDS LIFE INSURANCE COMPANY
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(Exact name of registrant as specified in its charter)
MINNESOTA 41-0823832
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
227 AXP FINANCIAL CENTER, MINNEAPOLIS, MINNESOTA 55474
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(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) (612) 671-3131
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [Not Applicable]
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS I(1) (a)
and (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE PERMITTED
ABBREVIATED NARRATIVE DISCLOSURE.
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PART I
ITEM 1. BUSINESS
IDS Life Insurance Company (the "Company") is a stock life insurance company
organized under the laws of the State of Minnesota. The Company is a wholly
owned subsidiary of American Express Financial Corporation ("AEFC") and serves
all states except New York. The Company distributes its fixed and variable
insurance and annuities products exclusively through the American Express
Financial Advisors' ("AEFA") retail sales force. The Company has four wholly
owned subsidiaries that distribute their products through the various AEFA
distribution channels. IDS Life Insurance Company of New York ("IDS Life of New
York") is a wholly owned subsidiary of the Company and serves New York State
residents. IDS Life of New York distributes its fixed and variable insurance and
annuity products exclusively through AEFA's retail sales force. The Company also
owns American Enterprise Life Insurance Company ("American Enterprise Life"), an
Indiana corporation, which primarily issues fixed and variable annuity contracts
for sale through non-affiliated representatives and agents of third party
distributors. American Centurion Life Assurance Company ("American Centurion
Life") is also a subsidiary of the Company. American Centurion Life offers fixed
and variable annuities to American Express(R) Cardmembers and others in New
York, as well as fixed and variable annuities for sale through non-affiliated
representatives and agents of third party distributors, in New York. The Company
owns American Partners Life Insurance Company ("American Partners Life"), an
Arizona corporation which offers fixed and variable annuity contracts to
American Express(R) Cardmembers and others who reside in states other than New
York. The Company also owns IDS REO 1, LLC and American Express Corporation.
These subsidiaries hold real estate, mortgage loans on real estate and/or
affordable housing investments.
Business sold through AEFA's retail distribution channel for IDS Life Insurance
Company and IDS Life of New York represents the majority of the insurance and
annuity business for the Company. Business sold through third-party distribution
for American Enterprise Life and American Centurion Life ranks second. Business
sold through the direct channel for American Partners Life and American
Centurion Life ranks a distant third.
Regulation
The Company, American Enterprise Life and American Partners Life are subject to
comprehensive regulation by the Minnesota Department of Commerce (Insurance
Division), the Indiana Department of Insurance, and the Arizona Department of
Insurance, respectively. American Centurion Life and IDS Life of New York are
regulated by the New York State Department of Insurance. The laws of the other
states in which these companies do business also regulate such matters as the
licensing of sales personnel and, in some cases, the marketing and contents of
insurance policies and annuity contracts. The primary purpose of such regulation
and supervision is to protect the interests of policyholders.
Regulatory scrutiny of market conduct practices of insurance companies,
including sales, marketing and replacements of life insurance and annuities and
"bonus" annuities, has increased significantly in recent years and is affecting
the manner in which companies approach various operational issues, including
compliance. The number of private lawsuits alleging violations of laws in
connection with insurance and annuity market conduct has increased (see Legal
Proceedings on page 8). Virtually all states mandate participation in insurance
guaranty associations, which assess insurance companies in order to fund claims
of contract owners of insolvent insurance companies.
On the federal level, there is periodic interest in enacting new regulations
relating to various aspects of the insurance industry, including taxation of
annuities and life insurance policies, accounting procedures, as well as the
treatment of persons differently because of gender, with respect to terms,
conditions, rates or benefits of an insurance contract. New federal regulation
in any of these areas could potentially have an adverse effect upon the Company
and its insurance subsidiaries. More specifically, recent federal legislative
proposals aimed at promoting tax-advantaged savings through Lifetime Savings
Accounts and Retirement Savings Account and the dividend exclusion proposal may
adversely impact the Company's sales of annuity and life insurance products if
enacted.
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Ratings
The Company believes it is the 20th largest life insurance company in the United
States based on consolidated assets. The Company had consolidated assets at
December 31, 2002 of approximately $60 billion, based on generally accepted
accounting principles and had total statutory capital and surplus as of December
31, 2002 of $2.4 billion.
The Company receives ratings from independent rating agencies. Generally, its
four insurance subsidiaries do not receive an individual rating, but receive the
same rating as the Company. These agencies evaluate the financial soundness and
claims-paying ability of insurance companies based on a number of different
factors. The ratings reflect each agency's estimation of the Company's ability
to meet its contractual obligations such as making annuity payouts and paying
death benefits and other distributions from the contracts. As such, the ratings
relate to the Company's general account and not to the variable accounts. This
information generally does not relate to the management or performance of the
variable subaccounts of the contracts.
Ratings are important to maintaining public confidence in the Company and its
subsidiaries. Lowering of the Company's ratings could have a material adverse
effect on the Company's ability to market products and could lead to increased
surrenders of the Company's products. Rating agencies continually review the
financial performance and condition of insurers. Also, the rating agencies have
a variety of policies and practices regarding the relationships among ratings of
affiliated entities. As such, the ratings of the Company could be affected by
changes in ratings of its subsidiaries and/or American Express Company. As of
the end of 2002, the Company was rated "A+" (Superior) by A.M. Best Company,
Inc. and its claims-paying ability/financial strength was rated "Aa3"
(Excellent) by Moody's Investors Service, Inc. (Moody's), and "AA" (Very Strong)
by Fitch. In light of the Company's desire to maintain these ratings, the
Company's parent contributed $400 million of capital to the Company in 2002.
The foregoing ratings reflect each rating agency's opinion of the Company's
financial strength, operating performance and ability to meet its obligations to
contract owners. Such factors are of primary concern to contract owners, agents
and intermediaries, but also may be of interest to investors.
Risk Based Capital
The National Association of Insurance Commissioners ("NAIC") adopted Risk Based
Capital ("RBC") requirements for life insurance companies. The RBC requirements
are to be used as minimum capital requirements by the NAIC and states to
identify companies that merit further regulatory action. At December 31, 2002,
the Company had total adjusted capital of approximately $2.6 billion. As defined
by the NAIC, total adjusted capital includes certain asset valuation reserves
excluded from the $2.4 billion of statutory capital and surplus referred to
above. The Minnesota Department of Commerce, the Company's insurance regulator,
requires insurance companies to maintain a minimum RBC called the "authorized
control level". If total adjusted capital fell below the authorized control
level, the Minnesota Department of Commerce would be authorized to exercise
management control over the Company. For the Company, authorized control level
capital was $435 million at December 31, 2002.
In addition, insurance companies are expected to maintain capital at a level
above that which would require a company to file an action plan with the
Department. This is referred to as the "company action level". For the Company,
company action level capital was approximately $870 million at December 31,
2002.
As described above, the Company maintains levels of risk-based capital far in
excess of the authorized control and company action levels required by the
Minnesota Department of Commerce. The level of capital maintained in the Company
is thought to be appropriate by management and is more commensurate with
standards necessary to maintain the Company's ratings with the various credit
and claims-paying rating agencies.
The General Account
Assets supporting the contract values associated with fixed account life
insurance and annuity products, as well as those associated with the fixed
account options under variable insurance and annuity products, (collectively,
the
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"fixed accounts") are part of an insurer's "general account". Under fixed
accounts, the insurer bears the investment risk. In investing its general
account assets, the Company seeks to maintain a dependable and targeted
difference or "spread" between the interest rate earned on general account
assets and the interest rate the insurer credits to contract owners' fixed
accounts. This spread is a major driver of net income for the Company.
General account assets also include funds accumulated through insurance premiums
and cost of insurance charges. These premiums and charges are major sources of
revenue for the Company.
In the general account, the Company primarily invests in fixed income securities
over a broad range of maturities for the purpose of providing a targeted rate of
return on its investments while controlling risk. The majority of these fixed
income securities are interest bearing investments such as government
obligations, mortgage-backed obligations and various corporate debt instruments.
The Company has the discretion to set the rate of interest credited to contract
owners' accounts. However, this discretion is limited by the contract's
guaranteed minimum interest rate. This rate varies among fixed accounts and is
as low as 3% and as high as 5%. (Approximately ten states have adopted
regulations providing for a guaranteed minimum interest rate that is less than
3%. In some states it is as low as 1.5%; in other states it is tied to an index.
The NAIC recently adopted a model regulation providing for an indexed guaranteed
minimum interest rate, and it is anticipated that a number of states will follow
this model.) The interest rates credited to contract owners' fixed accounts are
generally reset at shorter intervals than the maturity of underlying
investments. Therefore, margins may be negatively impacted by increases in the
general level of interest rates. In a low interest rate environment, such as
that experienced recently, margins may be negatively impacted as interest rates
available on the Company's investments approaches the guaranteed minimum
interest rates on the insurance or annuity contracts. The Company's investment
committee deploys several strategies to help manage risk. See the Risk
Management section that follows for more details on the investment committee and
the specific strategies employed.
The Variable Accounts
Variable life insurance and annuity products offer variable account investment
options in addition to the fixed account options described above. Under variable
accounts, the contract owners bear the investment risk. The variable accounts
are registered as unit investment trusts under the Investment Company Act of
1940. Generally, the variable accounts consist of a number of subaccounts, each
of which invests in shares of a particular fund.
Contract owners can allocate their payments among variable subaccounts that
invest in underlying funds. The underlying funds are managed both by internal
and third-party money managers. Internally managed funds for the Company's
variable annuities include the nineteen AXP Variable Portfolio Funds. Internally
managed funds for the Company's variable life business include the AXP Variable
Portfolio Funds and the seven IDS Life Series Fund portfolios. The Company's
variable life insurance and annuities also offer funds managed by third-party
money managers. For example, the investment advisers under the American Express
Retirement Advisor Advantage(R) Variable Annuity ("RAVA") and the American
Express(R) Variable Universal Life IV/Variable Universal Life IV - Estate Series
include AIM Advisors Inc., Alliance Capital Management, L.P., American Century
Investment Management, Inc., Calvert Asset Management Company, Inc., Evergreen
Investment Management Company, LLC., Fidelity Management & Research Company,
Franklin Mutual Advisers, LLC, Franklin Advisers, Inc., Franklin Advisory
Services, LLC, Goldman Sachs Asset Management, L.P., INVESCO Funds Group, Inc.,
Janus Capital, Lazard Asset Management, LLC, MFS Investment Management(R),
Pioneer Investment Management, Inc., Putnam Investment Management, LLC, Strong
Capital Management, Inc., Liberty Wanger Asset Management, L.P. and Wells Fargo
Funds Management, LLC. These funds invest in portfolios containing a variety of
securities including common stocks, bonds, managed assets and/or short-term
securities. The value of these subaccounts fluctuates with the investment return
of the funds in which the subaccounts invest. The Company's major source of
revenue from the variable products is the fees it receives. These fees may
include management and other fees from underlying internally managed funds,
revenues from underlying non-proprietary mutual funds and mortality and expense
risk fees from variable subaccounts.
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Variable life insurance and annuities are "separate account" products rather
than general account products. State insurance law prohibits charging variable
accounts with liabilities of the general account business. Under the subaccounts
of each variable account, the Company credits or charges income, capital gains
and capital losses only to that subaccount. Beginning in 2003, AEFA will replace
the Company as the principal underwriter (distributor) of the Company's variable
products. AEFA continues to serve as the principal underwriter (distributor) of
the variable life insurance and annuity products of the Company's four insurance
subsidiaries.
Insurance: Product Features and Risks
The Company and its subsidiaries issue a wide range of insurance products
including variable life insurance, universal life insurance, traditional whole
life and term life insurance products, long-term care insurance and disability
income insurance. The Company has no short-duration life insurance liabilities.
The Company issues only non-participating contracts.
Variable Life Insurance. The Company's biggest-selling life insurance products
are variable life insurance policies. Retail advisors of AEFA sell primarily the
Company's variable life insurance. Variable life insurance provides life
insurance coverage along with investment returns linked to the underlying
investments the policyholder chooses. These products also offer a fixed account
with a guaranteed minimum interest rate of 4% or 4.5%. The Company ranked fourth
in variable life insurance sales in 2002. Beginning in 1999, the Company
reinsured 80% of the mortality risk attributable to individual flexible premium
variable life insurance sales. This means that on these more recent product
sales, the insurer has the risk for only 20% of each policy's death benefit from
the first dollar of coverage. In contrast and prior to this arrangement, the
Company generally retained risk up to $750,000 on each insured life and
reinsured only amounts in excess of $750,000. Generally, the prior arrangement
left the Company with more of the risk for the death benefit limit than the more
recent practice. Beginning in late 2002, the Company began reinsuring 90% of the
mortality risk on new sales of individual flexible premium variable life and
fixed universal life insurance.
The Company's variable life insurance products include American Express(R)
Variable Universal Life IV/Variable Universal Life IV - Estate Series which are
individual flexible premium policies. The Estate Series policy is available to
policyholders with initial specified amounts of $1 million or more. These
policies were introduced in December 2002. The Company also issues American
Express Succession Select(SM), a flexible premium survivorship policy that
insures two lives. Succession Select is often used for estate planning purposes.
Finally, the Company issues American Express(R) Single Premium Variable Life, an
individual single premium variable life insurance policy.
Universal Life Insurance. The Company's universal life insurance products
provide life insurance coverage and cash value that increases by a fixed
interest rate. The rate is periodically reset according to the terms of the
policy at the discretion of the Company. The policies also provide a guaranteed
minimum interest rate, generally 4% or 4.5%, and a few as high as 5%.
The Company's universal life insurance products include Life Protection Plus,
Life Protection - Select and Life Protection Select - Estate Series. The Estate
Series policy is available to policyholders with initial specified amounts of $1
million or more.
Traditional Life Insurance Products. The Company's traditional life insurance
products include whole life insurance and term life insurance. Whole life
insurance combines a death benefit with a cash value that generally increases
gradually in amount over a period of years, and does not pay a dividend. The
Company has sold very little traditional whole life insurance in recent years.
Term life insurance provides only a death benefit, does not build up cash value
and does not pay a dividend. The policyholder chooses the term of coverage at
the time of issue. During the chosen term, the Company cannot raise premium
rates even if claims experience were to deteriorate. Beginning in 2001, the
Company has reinsured 90% of the mortality risk attributable to new term
insurance sales. This means that on these more recent product sales, the insurer
has the risk for only 10% of each policy's death benefit from the
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first dollar of coverage. In contrast and prior to this arrangement, the Company
generally retained risk up to $750,000 on each insured life and reinsured only
amounts in excess of $750,000. Generally, the prior arrangement left the Company
with more of the risk for the death benefit limit than the more recent practice.
Long-Term Care Insurance. The Company entered the individual long-term care
insurance (LTC) market in 1989 and believes it has a significant presence in
this market. The Company's long-term care insurance products provide benefits
for documented nursing home, assisted living or home or health care expenses.
These products were sold on a guaranteed renewable basis, whereby the owners
retain the right to renew the policies each year as long as premiums are paid,
but the Company has the right to increase premium rates on a going forward
basis.
In recent years, the Company has experienced greater than expected claims and
lower than expected lapse rates with respect to its LTC block. To respond to
this trend, the Company has pursued and is pursuing many courses of action. As
of December 31, 2002, the Company has discontinued offering LTC insurance.
Retail advisors of AEFA will now sell only non-proprietary LTC products offered
by General Electric Capital Assurance Company ("GECA"). The Company is also
expecting to outsource claims administration in May 2003 to GECA.
Disability Income. The Company also issues disability income (DI) insurance. DI
insurance provides monthly benefits to individuals who are unable to earn income
at either their occupation at time of disability ("own occupation") or at any
suitable occupation ("any occupation"). Depending upon the Company's
occupational and medical underwriting criteria, applicants for DI insurance can
choose "own occupation" and "any occupation" coverage for varying benefit
periods up to age 65. Applicants may also choose various benefit riders to help
them integrate individual DI benefits with social security or similar benefit
plans and to help them protect their DI benefits from the risk of inflation. The
Company believes it has a significant presence in the DI market.
Insurance Risks. The Company's sales of individual life insurance in 2002, as
measured by scheduled annual premiums and excluding lump sum premiums, consisted
of 82% variable life, 8% universal life and 10% term life.
The insurance business is highly competitive, and competitors consist of both
stock and mutual insurance companies. Competitive factors applicable to the
insurance business include product features, the interest rates credited to
products, the charges deducted from the cash values of such products, investment
performance, the financial strength of the organization, distribution and
management expenses, claims-paying ratings and the services provided to
policyholders.
For long-term profitability, it is crucial to ensure adequate pricing to cover
insurance risks, and to accumulate adequate reserves. Reserves are a measure of
the assets the Company estimates are needed now to adequately provide for future
benefits and expenses. These reserves are discussed in more detail in the
Critical Accounting Policies section that follows.
Annuities: Product Features and Risks
The Company and its subsidiaries issue variable and fixed annuities, immediate
and deferred, to a broad range of consumers through multiple distribution
channels. Retail advisors of AEFA can only offer the Company's variable and
fixed annuities, and in certain circumstances variable and fixed annuities
offered by American Enterprise Life. Retail advisors do not offer annuity
products of competitors. Annuities may be deferred, where assets accumulate
until the contract is surrendered, the contract owner dies, or the contract
owner begins receiving benefits under an annuity payout option; or immediate,
where payments begin within one year of issue and continue for life or for a
fixed period only.
The Company believes it is one of the largest issuers of annuities in the United
States. In 2002, the Company, on a consolidated basis, ranked eleventh among the
top annuity writers. The Company and its subsidiaries posted annuity sales in
2002 of over $7.3 billion, an increase of 60% over 2001 levels.
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Variable Annuities. Like variable life insurance, variable annuities provide
contract owners with investment returns linked to the underlying investments the
contract owner chooses. These products also offer a fixed account with a
guaranteed minimum interest rate of 3% to 4%. One of the Company's variable
annuities, RAVA, was the fourth largest-selling annuity in the country in 2002.
Fixed Annuities. The Company's fixed annuities provide cash value that increases
by a fixed interest rate. The rate is periodically reset according to the terms
of the contract at the discretion of the issuer. The contracts provide a
guaranteed minimum interest rate, generally 3% to 4%.
Annuity Risks. The relative proportion between fixed and variable annuities
sales is generally driven by the relative performance of the equity and fixed
income markets. In times of lackluster performance in equity markets, fixed
sales are generally stronger. In times of superior performance in equity
markets, variable sales are generally stronger. In addition, investment
management performance is critical to the profitability of annuity business.
In past years, innovative features for annuity products have been continually
evolving. These features include minimum death benefit guarantees that protect
beneficiaries from a drop in death benefits due to performance of the related
underlying investments. The Company and its subsidiaries issue annuity contracts
with a variety of guaranteed minimum death benefit features. These guarantees
are supported by general account assets. The Company's exposure to risk from
these guarantees will generally increase when equity markets decline.
The standard guaranteed minimum death benefit in the Company's current
"flagship" annuity, RAVA provides that if the contract owner and annuitant are
age 80 or younger on the date of death, the beneficiary will receive the greater
of (i) the contract value, (ii) purchase payments minus adjusted partial
surrenders, or (iii) the contract value as of the most recent sixth contract
anniversary plus purchase payments and minus adjusted partial surrenders since
that anniversary.
For additional protection, the Company's contract owners may purchase a maximum
anniversary value death benefit. The Company contract owners also may purchase
an enhanced earnings death benefit and an enhanced earnings plus death benefit.
These are optional benefits available for an additional charge. The maximum
anniversary value death benefit guarantees that the death benefit will not be
less than the highest contract value achieved on a contract anniversary before
the contract owner reaches the age of 81, adjusted for partial withdrawals. The
enhanced earnings death benefit riders are intended to provide additional
benefits to a beneficiary to offset expenses after the contract owner's death.
The Company bears the risk that protracted under-performance of the financial
markets could result in guaranteed minimum death benefits being higher than what
accumulated contract owner account balances would support.
American Enterprise Life and other subsidiaries of the Company also offer
variable annuities with a variety of guaranteed minimum death benefit features
and certain optional benefits. For example, American Enterprise Life issues
certain variable annuity contracts that contain a guaranteed minimum income
benefit feature which, if elected by the contract owner after a stipulated
waiting period from contract issuance, guarantees a minimum lifetime annuity
based on predetermined annuity purchase rates that may be in excess of what the
contract account value can purchase at then-current annuity purchase rates.
American Enterprise Life bears the risk that protracted under-performance of the
financial markets could result in guaranteed minimum income benefits being
higher than what accumulated contract owner account balances would support.
To the extent that the guaranteed minimum death benefit is higher than the
current account value at the time of death, a cost is incurred by the issuer of
the policy. Current accounting literature does not prescribe advance recognition
of the projected future net costs associated with these guarantees, and
accordingly, the Company currently does not record a liability corresponding to
these future obligations for death benefits in excess of annuity account value.
At present, the amount paid in excess of contract value is expensed when
payable. Amounts expensed in 2002 and 2001 were $37 million and $16 million,
respectively. A proposed AICPA Statement of Position, "Accounting and Reporting
by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and
for Separate Accounts"
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(the "Proposed SOP"), would require the recording of a liability for the
expected net costs associated with these guarantees under certain circumstances,
if adopted as proposed. The impact of the Proposed SOP is currently being
evaluated.
For long-term profitability, it is crucial to ensure adequate pricing to cover
risks, and to accumulate adequate reserves. Reserves are a measure of the assets
the Company estimates are needed now to adequately provide for future benefits
and expenses. These reserves are discussed in more detail in the Critical
Accounting Policies section that follows.
ITEM 2. PROPERTIES
The Company occupies office space in Minneapolis, Minnesota, which is leased or
owned by its parent, AEFC. The Company reimburses AEFC for rent based on direct
and indirect allocation methods. IDS Life Insurance Company of New York and
American Centurion Life rent office space in Albany, New York. Facilities
occupied by the Company and its subsidiaries are believed to be adequate for the
purposes for which they are used and are well maintained.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to litigation and arbitration proceedings in the ordinary
course of its business, none of which is expected to have a material adverse
affect on the Company.
In recent years, life insurance companies have been named as defendants in
lawsuits, including class action lawsuits, alleging improper life insurance
sales practices, alleged agent misconduct, failure to properly supervise agents
and other matters relating to life insurance policies and annuity contracts. The
Company and its affiliates were named defendants in three purported class-action
lawsuits alleging improper insurance and annuity sales practices including
improper replacement of existing annuity contracts and insurance policies,
improper use of annuities to fund tax deferred contributory retirement plans,
alleged agent misconduct, failure to properly supervise agents and other matters
relating to life insurance policies and annuity contracts. (Benacquisto v. IDS
Life Insurance Company; filed Minnesota State Court 12/13/1996; Mork, et. al. v.
IDS Life Insurance Company; filed Minnesota State Court 3/21/1997; Thoresen v.
IDS Life Insurance Company, et. al.; filed Minnesota State Court 10/13/1998). A
fourth lawsuit was filed against the Company and its affiliates in federal
court. (Benacquisto, et. al. v. IDS Life Insurance Company, et.al.; filed United
States District Court-Minnesota 8/2000). In January 2000, AEFC reached an
agreement in principle to settle the four class action lawsuits described above.
It is expected the settlement will provide $215 million of benefits to more than
two million participants in exchange for a release by class members of all
insurance and annuity state and federal market conduct claims dating back to
1985.
The settlement received court approval. Implementation of the settlement
commenced October 15, 2001 and is substantially complete. Claim review payments
have been made. Numerous individuals opted out of the settlement described above
and therefore did not release their claims against AEFC and its subsidiaries.
Some of these class members who opted out were represented by counsel and
presented separate claims to AEFC and the Company. Most of their claims have
been settled.
In November 2002, a suit, captioned Haritos et. al. v. American Express
Financial Corporation and IDS Life Insurance Company, was filed in the United
States District Court for the District of Arizona. The suit is filed by the
plaintiffs who purport to represent a class of all persons that have purchased
financial plans from AEFA advisors during an undefined class period. Plaintiffs
allege that the sale of the plans violate the Investment Advisers Act of 1940.
The suit seeks an unspecified amount of damages, rescission and injunctive
relief. The Company believes that it has meritorious defenses to this suit and
intends to defend this case vigorously.
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The outcome of any litigation or threatened litigation cannot be predicted with
any certainty. However, in the aggregate, the Company does not consider any
lawsuits in which it is named as a defendant to have a material impact on the
Company's financial position or operating results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
ITEM 6. SELECTED FINANCIAL DATA
Item omitted pursuant to General Instructions I(2) (a) of Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
2002 Compared to 2001:
Consolidated net income was $382 million in 2002, compared to consolidated net
loss of $65 million in 2001. Consolidated income before income tax expense
totaled $470 million in 2002, compared with a consolidated loss before income
tax benefit and cumulative effect of accounting change of $189 million in 2001.
The significant increase in net income was primarily a result of the 2001
writedown and sale of high-yield securities that reduced risk within the
investment portfolio, as explained below.
Total revenues increased by 34% to $2.8 billion in 2002, compared with $2.1
billion in 2001. The increase was primarily due to higher net investment income
and lower levels of realized losses, primarily reflecting the impact of the 2001
high-yield securities' realized losses. In addition, invested assets were higher
in 2002. Insurance premiums and policyholder and contractholder charges also
increased. Partially offsetting were declines in management and other fees, as
separate account assets dropped 20% from 2001 levels.
Insurance and investment contract considerations received increased to $8.3
billion in 2002, compared with $5.8 billion in 2001. The increase is primarily
due to higher fixed annuity sales in both the advisor distribution channel and
through third parties.
Net investment income, the largest component of revenues, increased by $76
million from the prior year. This increase primarily reflects the effect of
credit related yield adjustments on fixed maturity investments in 2001 and
higher invested asset levels in 2002, which were somewhat offset by lower
portfolio yields in 2002, driven by investment portfolio repositioning as
described below. Investment income also benefited from the effect of less
depreciation in the S&P 500 this year on the value of options hedging
outstanding equity indexed annuities, which is offset in the related provisions
for losses and benefits.
Policyholder and contractholder charges, which consist primarily of cost of
insurance charges on universal life-type policies, increased 7% to $523 million
in 2002, compared with $490 million in 2001. This increase relates to the 10%
growth in total life insurance inforce, which grew to $119 billion at December
31, 2002.
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Management and other fees decreased 14 percent to $405 million in 2002, compared
with $473 million in 2001. This decrease was primarily due to lower levels of
average separate account assets, resulting primarily from market depreciation of
equity securities as weak equity markets continued throughout the year. The
Company provides investment management services for many of the mutual funds
that are available as investment options for variable annuities and variable
life insurance. The Company also receives mortality and expense risk fees from
the separate accounts based on the level of assets.
Net realized losses on investments were $5 million in 2002, compared to net
realized losses of $650 million in 2001. The 2002 net realized losses include
$146 million from impairments recognized on available-for-sale securities during
the year (including $45 million related to directly-held WorldCom debt
holdings). The Company sold approximately $10.5 billion of its invested assets
on a consolidated basis during 2002. In addition, approximately $3 billion in
investments were redeemed during the year. The cash generated by these sales and
redemptions has been or will be invested. The net realized loss for 2001 was
comprised of a $143 million pretax net loss in the first quarter resulting
primarily from the recognition of impairment losses and the sale of certain
high-yield securities; a $227 million writedown in the second quarter to
recognize the impact of higher default rate assumptions on certain structured
investments; a $262 million writedown of lower-rated securities (most of which
were sold during 2001) in the second quarter primarily in connection with the
Company's decision to lower its risk profile by reducing the level of its
high-yield fixed maturity investment portfolio, allocating holdings toward
stronger credits, and reducing the concentration of exposure to individual
companies and industry sectors; and $18 million of other net losses primarily
related to the sale and write-down of other investments.
Total benefits and expenses increased to $2.4 billion in 2002 from $2.3 billion
in 2001. The largest component of expenses, interest credited to policyholder
accounts for universal life-type insurance and investment contracts, increased
2% to $1.2 billion, reflecting the growth in fixed annuities in force and the
effect of less depreciation in the S&P 500 on equity indexed annuities, despite
lower interest crediting rates from the lower interest rate environment. The $56
million increase in total death and other benefits reflects higher insurance
claims and a significant increase in guaranteed minimum death benefits on
variable annuity contracts with $37 million expensed in 2002 versus $16 million
in 2001. 2001's results also include an $11 million charge for anticipated
insured loss claims from the September 11th terrorist attacks while 2002 results
include a $7 million reversal of a portion of these reserves as a result of
lower than anticipated insured loss claims. Deferred acquisition costs (DAC) of
$3.3 billion and $3.1 billion are on the Company's balance sheet at December 31,
2002 and 2001, respectively. These balances are approximately $1.7 billion
related to life and health insurance and $1.6 billion to annuities. In 2001,
approximately $1.6 billion related to life and health insurance and $1.5 billion
to annuities. Amortization of DAC decreased to $312 million in 2002, compared to
$371 million in 2001. The decrease in 2002's amortization was primarily from the
$67 million amortization increase in the first quarter of 2001 of DAC for
variable annuity and insurance products as a result of the significant decline
in equity-based separate account values and the associated fee revenues. In
addition, during the third quarter of 2002 the Company completed a comprehensive
review of its DAC related practices that resulted in a net increase in DAC
amortization, as described below.
Other insurance and operating expenses increased to $438 million in 2002,
compared to $408 million in 2001. This increase was primarily due to lower
levels of expenses deferred in 2002 as described below and from business growth
and technology costs related to growth initiatives.
The costs of acquiring new business, including for example, direct sales
commissions, related sales incentive bonuses and awards, underwriting costs,
policy issue costs and other related costs, have been deferred on the sale of
insurance and annuity contracts. The DAC for universal life and variable
universal life insurance and certain installment annuities are amortized as a
percentage of the estimated gross profits expected to be realized on the
policies. DAC for other annuities are amortized using the interest method. For
traditional life, disability income and long-term care insurance policies, the
costs are amortized in proportion to premium revenue.
Amortization of DAC requires the use of certain assumptions including interest
margins, mortality rates, persistency rates, maintenance expense levels and
customer asset value growth rates for variable products. The customer asset
value growth rate is the rate at which contract values are assumed to appreciate
in the future. This rate is net of asset
-10-
fees, and anticipates a blend of equity and fixed income investments. Management
routinely monitors a wide variety of trends in the business, including
comparisons of actual and assumed experience. Management reviews and, where
appropriate, adjusts its assumptions with respect to customer asset value growth
rates on a quarterly basis.
Management monitors other principal DAC assumptions, such as persistency rates,
mortality rates, interest margins and maintenance expense levels each quarter.
Unless management identifies a material deviation over the course of the
quarterly monitoring process, management reviews and updates these DAC
assumptions annually in the third quarter of each year. When assumptions are
changed, the percentage of estimated gross profits or portion of interest
margins used to amortize DAC may also change. A change in the required
amortization percentage is applied retrospectively; an increase in amortization
percentage will result in an acceleration of DAC amortization while a decrease
in amortization percentage will result in a deceleration of DAC amortization.
The impact on results of operations of changing assumptions with respect to the
amortization of DAC can be either positive or negative in any particular period,
and is reflected in the period that such changes are made. In 2002, excluding
the third quarter, the impact of resetting these assumptions, along with the
impact of unfavorable equity market performance, was an acceleration of $22
million pretax of DAC amortization. Third quarter impacts are described below.
During the third quarter of 2002, the Company completed a comprehensive review
of its DAC related practices. The specific areas reviewed included costs
deferred, DAC amortization periods, customer asset value growth rate assumptions
(which are typically reviewed on a quarterly basis) and other assumptions,
including mortality rates and product persistency (which are typically updated
on an annual basis in the third quarter). As a result of this review, the
Company took certain actions that resulted in a net $37 million increase in
expenses in the third quarter of 2002.
The Company reset its customer asset value growth rate assumptions for variable
annuity and variable life products to anticipate near-term and long-term growth
at an annual rate of 7%. The customer asset value growth rate is the rate at
which contract values are assumed to appreciate in the future. This rate is net
of asset fees, and anticipates a blend of equity and fixed income investments.
Prior to resetting these assumptions, the Company was projecting long-term
customer asset value growth at 7.5% and near-term growth at approximately twice
that rate. The impact of resetting these assumptions, along with the impact of
unfavorable third quarter 2002 equity market performance, was an acceleration of
$173 million pretax of DAC amortization.
Going forward, the Company intends to continue to use a mean reversion method as
a guideline in setting the near-term customer asset value growth rate, also
referred to as the mean reversion rate. In periods when market performance
results in actual contract value growth at a rate different than that assumed,
the Company will reassess the near-term rate in order to continue to project its
best estimate of long-term growth. For example, if actual contract value growth
during a quarter is less than 7% on an annualized basis, the Company would
increase the mean reversion rate assumed over the near term to the rate needed
to achieve the long-term annualized growth rate of 7% by the end of that period,
assuming this long-term view is still appropriate.
The Company revised certain mortality and persistency assumptions for universal
and variable universal life insurance products and fixed and variable annuity
products to better reflect actual experience and future expectations. The
Company updated the mortality table used in pricing universal and variable
universal life products and in valuing the associated DAC. The most recently
published life insurance industry mortality table was used as a starting point,
and was then modified based on the Company's experience. The Company also
observed that recent persistency of its universal life products was consistently
better than expected, and determined the trend justified an improvement in
assumed persistency rates. Additionally, the Company reviewed and updated
persistency assumptions for fixed and variable deferred annuity products. The
Company also reviewed the periods over which DAC is amortized for fixed and
variable deferred annuity products. Analysis showed that significant volumes of
advisor-distributed fixed annuities were expected to persist beyond the
Company's ten-year DAC amortization period. As a result, the Company extended
the amortization period from 10 to 15 years to be more consistent with the
period over which significant profits were expected and that would result in a
more appropriate matching of revenues and expense. Similarly, the Company made
slight increases in the amortization periods used for certain blocks of
advisor-distributed variable annuities. These changes, along with revised
assumptions projecting more favorable persistency and mortality rates, resulted
in a decrease in DAC expense of $155 million pretax.
-11-
Finally, the Company reviewed its acquisition costs to clarify those costs that
vary with and are primarily related to the acquisition of new and renewable
annuity and insurance contracts. The Company revised the types and amounts of
costs deferred, in part to reflect the impact of advisor platform changes and
the effects of related reengineering. This resulted in an increase in expense of
$19 million pretax recognized in the third quarter of 2002.
The adjustments made to customer asset value growth rate assumptions should
reduce the risk of adverse DAC adjustments going forward, while changes made to
mortality and persistency assumptions and DAC amortization periods somewhat
increase the risk of adverse adjustments. Overall, the Company believes it is
less exposed to the risk of adverse DAC adjustments as a result of these
changes. The changes relating to the types and amounts of costs deferred will
somewhat accelerate the recognition of ongoing expenses, although the impact of
this should be offset to some extent as reengineering and other cost control
initiatives are expected to mitigate their impact.
2001 Compared to 2000:
Consolidated net loss was $65 million in 2001, compared to consolidated net
income of $586 million in 2000. Consolidated loss before income tax benefit and
cumulative effect of accounting change totaled $189 million in 2001, compared
with consolidated income before income tax expense of $807 million in 2000. This
decline was primarily the result of a $633 million increase in net realized loss
on investments and a $245 million decrease in investment income.
Total revenues decreased to $2.1 billion in 2001, compared with $3.0 billion in
2000. The decrease was primarily due to decreases in net investment income and
from the realized investments losses. Net investment income, the largest
component of revenues, decreased by $245 million from the prior year, primarily
reflecting credit related yield adjustments on fixed maturity investments and
overall lower investment yields.
Total premiums and investment contract deposits received decreased to $5.8
billion in 2001, compared with $6.9 billion in 2000. The reduction is primarily
due to lower variable annuity sales.
Policyholder and contractholder charges, which consist primarily of cost of
insurance charges on universal life-type policies, increased 12 percent to $490
million in 2001, compared with $438 million in 2000. This increase reflects
increased total life insurance in force, which grew 10 percent to $108 billion
at December 31, 2001.
Management and other fees decreased 21 percent to $473 million in 2001, compared
with $598 million in 2000. This decrease reflects lower average separate account
assets outstanding, resulting primarily from equity market depreciation. The
Company provides investment management services for many of the mutual funds
that are available as investment options for variable annuities and variable
life insurance. The Company also receives a mortality and expense risk fee from
the separate accounts.
Net realized losses on investments were $650 million in 2001, compared to net
realized losses of $17 million in 2000. The net loss for the year was comprised
of a $143 million pretax net loss in the first quarter resulting primarily from
the recognition of impairment losses and the sale of certain high-yield
securities; a $227 million writedown in the second quarter to recognize the
impact of higher default rate assumptions on certain structured investments; a
$262 million writedown of lower-rated securities (most of which were sold during
2001) in the second quarter primarily in connection with the Company's decision
to lower its risk profile by reducing the level of its high-yield fixed maturity
investment portfolio, allocating holdings toward stronger credits, and reducing
the concentration of exposure to individual companies and industry sectors; and
$18 million of other net losses primarily related to the sale and write-down of
other investments.
Total benefits and expenses increased slightly to $2.3 billion in 2001 from $2.2
billion in 2000. The largest component of expenses, interest credited to
policyholder accounts for universal life-type insurance and investment
contracts, decreased slightly to $1.1 billion, reflecting a slight decrease in
fixed annuities in force and lower interest
-12-
crediting rates due to the lower interest rate environment. Amortization of DAC
increased to $371 million in 2001, compared to $362 million in 2000. The
increase was primarily due to DAC unlocking adjustments (see footnote one of the
attached financial statements for the definition of unlocking adjustments),
which resulted in a net increase in amortization of $33.6 million in 2001 and a
net decrease in amortization of $12.3 million in 2000. Amortization, excluding
unlocking adjustments, was significantly less in 2001 than in 2000, due
primarily to the significant drop in equity-based separate account values and
associated fee revenue.
Other insurance and operating expenses increased to $408 million in 2001,
compared to $379 million in 2000. This increase was primarily a result of
business growth and technology costs related to growth initiatives.
Impact of Market Volatility on Results of Operations
Various aspects of the Company's business can be significantly impacted by
equity market levels and other market-based factors. One of these items is the
management fee revenue which is based on the market value of separate account
assets. Other areas impacted by market volatility involve DAC (as noted above),
structured investments and the variable annuity guaranteed minimum death benefit
feature. The value of the Company's structured investment portfolio is impacted
by various market factors. These investments include collateralized debt
obligations and secured loan trusts (backed by high-yield bonds and bank loans),
which are held by the Company through interests in special purpose entities. The
carrying value of these investments is based on estimated cash flow projections,
which are affected by factors such as default rates, persistency of defaults,
recovery rates and interest rates, among others. Persistency of, or increases
in, these default rates could result in negative adjustments to the market
values of these investments in the future, which would adversely impact results
of operations. Conversely, a decline in the default rates would result in higher
values and would benefit future results of operations.
The majority of the variable annuity contracts offered by the Company contain
guaranteed minimum death benefit (GMDB) provisions. At time of issue, these
contracts typically guarantee the death benefit payable will not be less than
the amount invested, regardless of the performance of the customer's account.
Most contracts also provide for some type of periodic adjustment of the
guaranteed amount based on the change in the value of the contract. A large
portion of the Company's contracts containing a GMDB provision adjust once every
six years. The periodic adjustment of these contracts can either increase or
decrease the guaranteed amount though not below the amount invested adjusted for
withdrawals. When market values of the customer's accounts decline, the death
benefit payable on a contract with a GMDB may exceed the accumulated contract
value. Currently, the amount paid in excess of contract value is expensed when
payable.
Certain Critical Accounting Policies
The Company's significant accounting policies are described in Note 1 to the
Consolidated Financial Statements. The following provides information about
certain critical accounting policies that are important to the Consolidated
Financial Statements and that involve estimates requiring significant management
assumptions and judgments about the effect of matters that are uncertain. These
policies relate to the recognition of impairment within the investment
portfolio, deferred policy acquisition costs and insurance and annuity reserves.
Investments
All fixed maturity securities and marketable equity securities are classified as
available-for-sale and carried at fair value. Unrealized gains and losses on
securities classified as available-for-sale are carried as a separate component
of accumulated other comprehensive income (loss), net of the related deferred
policy acquisition costs and income taxes. Gains and losses are recognized in
the results of operations upon disposition of the securities using the specific
identification method. In addition, losses are also recognized when management
determines that a decline in value is other-than-temporary, which requires
judgment regarding the amount and timing of recovery. Indicators of
other-than-temporary impairment for fixed maturity securities include, but are
not limited to, issuer downgrade, default or bankruptcy. The Company also
considers the extent to which cost exceeds fair value, the duration of time
-13-
of that decline, and management's judgment about the issuer's current and
prospective financial condition. The charges are reflected in net realized gain
(loss) on investments within the Consolidated Statements of Income.
Fair value of fixed maturity and equity securities is generally based on quoted
market prices. However, the Company's investment portfolio also contains
structured investments of various asset quality, including collateralized debt
obligations (CDOs) and secured loan trusts (SLTs) (backed by high-yield bonds
and bank loans), which are not readily marketable. As a result, the carrying
values of these structured investments are based on estimated cash flow
projections which require a significant degree of management judgment as to
default and recovery rates of the underlying investments and, as such, are
subject to change. If actual future cash flows are less than projected,
additional losses would be realized.
The reserve for losses on mortgage loans on real estate is measured as the
excess of the loan's recorded investment over its present value of expected
principal and interest payments discounted at the loan's effective interest rate
or the fair value of collateral. Additionally, the level of the reserve for
losses considers other factors, including historical experience and current
economic and political conditions. Management regularly evaluates the adequacy
of the reserve for mortgage loan losses and believes it is adequate to absorb
estimated losses in the portfolio.
Deferred policy acquisition costs
The costs of acquiring new business, including for example, direct sales
commissions, related sales incentive bonuses and awards, underwriting costs,
policy issue costs and other related costs, have been deferred on the sale of
insurance and annuity contracts. The DAC for universal life and variable
universal life insurance and certain installment annuities are amortized as a
percentage of the estimated gross profits expected to be realized on the
policies. DAC for other annuities are amortized using the interest method. For
traditional life, disability income and long-term care insurance policies, the
costs are amortized in proportion to premium revenue.
Amortization of DAC requires the use of certain assumptions including interest
margins, mortality rates, persistency rates, maintenance expense levels and
customer asset value growth rates for variable products. The customer asset
value growth rate is the rate at which contract values are assumed to appreciate
in the future. This rate is net of asset fees, and anticipates a blend of equity
and fixed income investments. Management routinely monitors a wide variety of
trends in the business, including comparisons of actual and assumed experience.
Management reviews and, where appropriate, adjusts its assumptions with respect
to customer asset value growth rates on a quarterly basis.
Management monitors other principal DAC assumptions, such as persistency rates,
mortality rates, interest margins and maintenance expense levels each quarter.
Unless management identifies a material deviation over the course of the
quarterly monitoring, management reviews and updates these DAC assumptions
annually in the third quarter of each year. When assumptions are changed, the
percentage of estimated gross profits or portion of interest margins used to
amortize DAC may also change. A change in the required amortization percentage
is applied retrospectively; an increase in amortization percentage will result
in an acceleration of DAC amortization while a decrease in amortization
percentage will result in a deceleration of DAC amortization. The impact on
results of operations of changing assumptions with respect to the amortization
of DAC can be either positive or negative in any particular period, and is
reflected in the period that such changes are made.
Liabilities for future policy benefits
Liabilities for fixed and variable universal life insurance and fixed and
variable deferred annuities are accumulation values.
Liabilities for equity indexed deferred annuities issued before 1999 are equal
to the present value of guaranteed benefits and the intrinsic value of
index-based benefits. Liabilities for equity indexed deferred annuities issued
in 1999 or later are equal to the accumulation of host contract values covering
guaranteed benefits and the market value of embedded equity options.
-14-
Liabilities for fixed annuities in a benefit status are based on established
industry mortality tables and interest rates ranging from 5% to 9.5%, depending
on year of issue, with an average rate of approximately 6.5%.
Liabilities for future benefits on traditional life insurance, principally term
and whole life insurance, are based on the net level premium method, using
anticipated mortality, policy persistency and interest earning rates.
Anticipated mortality rates are based on established industry mortality tables,
with modifications based on Company experience. Anticipated policy persistency
rates vary by policy form, issue age and policy duration with persistency on
level term and cash value plans generally anticipated to be better than
persistency on yearly renewable term insurance plans. Anticipated interest rates
range from 4% to 10%, depending on policy form, issue year and policy duration.
Liabilities for future disability income and long-term care policy benefits
include both policy reserves and claim reserves. Policy reserves are based on
the net level premium method, using anticipated morbidity, mortality, policy
persistency and interest earning rates. Anticipated morbidity and mortality
rates are based on established industry morbidity and mortality tables.
Anticipated policy persistency rates vary by policy form, issue age, policy
duration and, for disability income policies, occupation class. Anticipated
interest rates for disability income and long-term care policy reserves are 3%
to 9.5% at policy issue and grade to ultimate rates of 5% to 7% over 5 to 10
years.
Claim reserves are calculated based on claim continuance tables and anticipated
interest earnings. Anticipated claim continuance rates are based on established
industry tables. Anticipated interest rates for claim reserves for both
disability income and long-term care range from 5% to 8%.
Liabilities for reported and unpaid life insurance claims are equal to the death
benefits payable. For disability income and long-term care claims, unpaid claims
liabilities are equal to benefit amounts due and accrued. Liabilities for
incurred but not reported claims are estimated based on periodic analysis of the
actual reported claim lag. Where applicable, amounts recoverable from reinsurers
are separately recorded as receivables. For life insurance, no claim adjustment
expense reserve is held. The claim adjustment expense reserves for disability
income and long-term care are based on the claim reserves.
Risk Management
The sensitivity analysis discussed below estimates the effects of hypothetical
sudden and sustained changes in the applicable market conditions of two
different types of market risk on the ensuing year's earnings, based on year-end
positions. The market changes, assumed to occur as of year-end, are a 100 basis
point increase in market interest rates and a 10 percent decline in the value of
equity securities held in separate accounts. Computations of the prospective
effects of hypothetical interest rate and equity market changes are based on
numerous assumptions, including relative levels of market interest rates and
equity prices, as well as the levels of assets and liabilities. The hypothetical
changes and assumptions will be different from what actually occur. Furthermore,
the computations do not incorporate actions that management could take if the
hypothetical market changes actually took place. As a result, actual earnings
consequences will differ from those quantified below.
The Company primarily invests in fixed income securities over a broad range of
maturities for the purpose of providing fixed annuity and fixed universal life
contractholders with a competitive rate of return on their investments while
controlling risk, and to provide a dependable and targeted spread between the
interest rate earned on investments and the interest rate credited to
contractholders' accounts. The Company does not invest in securities to generate
short-term trading profits.
IDS Life and each of its insurance subsidiaries' investment committees meet
periodically. With respect to IDS Life of New York and American Centurion Life,
the full Board acts as the investment committee. At these meetings, the
committee or Board reviews models projecting different interest rate scenarios,
risk/return measures, and their effect on profitability. The committee or Board
also reviews the distribution of assets in the portfolio by type and credit risk
sector. The objective of the committee or Board is to structure the investment
security portfolio based upon the type and expected behavior of products in the
liability portfolio so as to meet contractual obligations and to achieve
targeted levels of profitability within defined risk parameters.
-15-
Rates credited to contract owners' accounts are generally reset at shorter
intervals than the maturity of underlying investments. Therefore, margins may be
negatively impacted by increases in the general level of interest rates. Part of
the investment committee's or Board's strategy includes the use of derivatives,
such as interest rate caps, swaps and floors, for risk management purposes.
These derivatives help protect margins by increasing investment returns if there
is a sudden and severe rise in interest rates, thereby mitigating the impact of
an increase in rates credited to contract owner's fixed accounts. Conversely, in
a low interest rate environment, such as that experienced recently, margins may
be negatively impacted as the interest rates available on the Company's
investments approaches the guaranteed minimum interest rates on insurance or
annuity contracts. This negative impact may be compounded by the fact that many
of the Company's interest bearing investments are callable or prepayable by the
issuer and calls and prepayments are more likely to occur in a low interest rate
environment.
The negative effect on the Company's pretax earnings of a 100 basis point
increase in interest rates, which assumes repricings and customer behavior based
on the application of proprietary models to the book of business at December 31,
2002, would be approximately $11 million.
On a certain annuity product, the interest is credited to contractholders'
accounts based upon the relative change in a major stock market index between
the beginning and end of the product's term. As a means of hedging the Company's
obligation under the provisions of this product, the committee's strategy is to
purchase and write options on a major stock market index, and to purchase
futures which are marked to market daily and exchange traded, exposing the
Company to no counterparty risk. At December 31, 2002 equity-based derivatives
with a net notional amount of $225 million were outstanding to hedge these
equity market exposures.
The amount of the fee income the Company receives is based upon the daily market
value of the separate account assets. As a result, the Company's fee income
would be negatively impacted by a decline in the equity markets. Another part of
the investment committee's strategy is to use index options to manage the equity
market risk related to fee income. These derivatives help protect fee income by
providing option income when there is a significant decline in the equity
markets. The Company did not have equity-based derivatives outstanding at
December 31, 2002 for this purpose.
The negative effect on the Company's pretax earnings of a 10 percent decline in
equity prices would be approximately $23 million based on separate account
assets under management as of December 31, 2002.
Liquidity and Capital Resources
The liquidity requirements of the Company are generally met by funds provided by
premiums, investment income, proceeds from sales of investments as well as
maturities, periodic repayments of investment principal and capital
contributions. Maturities of the Company's investments is largely matched with
the expected future payments of insurance and annuity obligations.
The primary uses of funds are policy benefits, commissions and operating
expenses, policy loans, dividends and investment purchases.
The Company has available lines of credit with AEFC aggregating $200 million
($100 million committed and $100 million uncommitted). There were no borrowings
outstanding at December 31, 2002. At December 31, 2002, the Company had
outstanding reverse repurchase agreements totaling $225 million. Both the line
of credit and the reverse repurchase agreements are used strictly as short-term
sources of funds.
At December 31, 2002, investments in fixed maturities comprised 84 percent of
the Company's total invested assets and primarily include corporate debt,
mortgage and other asset-backed securities. Approximately 49 percent is invested
in GNMA, FNMA and FHLMC mortgage-backed securities which are considered AAA
quality. The Company's corporate securities comprise a diverse portfolio with
the largest concentrations accounting for
-16-
approximately 63 percent of the portfolio, in the following industries: banking
and finance, utilities, communication and media and transportation.
At December 31, 2002, approximately 7 percent of the Company's investments in
fixed maturities were below investment grade bonds. These investments may be
subject to a higher degree of risk than the investment grade issues because of
the borrower's generally greater sensitivity to adverse economic conditions,
such as a recession or increasing interest rates, and in certain instances, the
lack of an active secondary market. Expected returns on below investment grade
bonds reflect consideration of such factors. The Company has identified those
fixed maturities for which a decline in fair value is determined to be
other-than-temporary, and has written them down to fair value with a charge to
earnings.
During 2002, the Company continued to hold investments in CDOs and SLTs, some of
which are also managed by a related party. The Company invested in CDOs and SLTs
as part of its investment strategy in order to pay a competitive rate to
contractholders' accounts. The Company's exposure as an investor is limited
solely to its aggregate investment in the CDOs and SLTs, and it has no
obligations or commitments, contingent or otherwise, that could require any
further funding of such investments. As of December 31, 2002, the carrying
values of the CDO residual tranches and SLT notes were $13 million and $657
million, respectively. CDOs and SLTs are illiquid investments. As an investor in
the residual tranche of CDOs, the Company's return correlates to the performance
of portfolios of high-yield bonds and/or bank loans. As a noteholder of SLTs,
the Company's return is based on a reference portfolio of loans. The carrying
value of the CDO and SLT investments and the Company's projected return are
based on discounted cash flow projections that require a significant degree of
management judgment as to assumptions primarily related to default and recovery
rates of the high-yield bonds and/or bank loans either held directly by the CDO
or in the reference portfolio of the SLT and, as such, are subject to change.
Generally, the SLTs are structured such that the principal amount of the loans
in the reference portfolio may be up to five times that of the par amount of the
notes held by the Company. Although the exposure associated with the Company's
investment in CDOs and SLTs is limited to the carrying value of such
investments, they are volatile investments and have a substantial degree of risk
associated with them because the amount of the initial value of the loans and/or
other debt obligations in the related portfolios is significantly greater than
the Company's exposure. Deterioration in the value of the high-yield bonds or
bank loans would likely result in deterioration of the Company's investment
return with respect to the relevant CDO or SLT, as the case may be. In the event
of significant deterioration of a portfolio, the relevant CDO or SLT may be
subject to early liquidation, which could result in further deterioration of the
investment return or, in severe cases, loss of the carrying amount.
During 2001, the Company placed a majority of its rated CDO securities and
related accrued interest, as well as a relatively minor amount of other liquid
securities, (collectively referred to as transferred assets), having an
aggregate book value of $675 million, into a securitization trust. In return,
the Company received $90 million in cash (excluding transaction expenses)
relating to sales to unaffiliated investors and retained interests in the trust
with allocated book amounts aggregating $586 million. As of December 31, 2002,
the retained interests had a carrying value of $562 million, of which $388
million is considered investment grade. The Company has no obligations,
contingent or otherwise, to such unaffiliated investors. One of the results of
this transaction is that increases or decreases in future cash flows of the
individual CDOs are combined into one overall cash flow for purposes of
determining the carrying value of the retained interests and related impact on
results of operations.
At December 31, 2002, net unrealized gains on available-for-sale fixed maturity
securities included $1,029 million of gross unrealized gains and $186 million of
gross unrealized losses. The Company does not classify fixed maturity securities
as held-to-maturity.
At December 31, 2002, the Company had a reserve for losses on mortgage loans
totaling $35 million and on real estate investments totaling $nil.
In 2002, the Company received capital contributions from AEFC totaling $400
million and paid dividends of $70 million to AEFC.
-17-
The economy and other factors cause insurance companies to go under regulatory
supervision. These situations result in assessments by state guaranty
associations to cover losses to policyholders of insolvent or rehabilitated
companies. Some assessments can be partially recovered through a reduction in
future premium taxes in certain states. The Company established an asset for
guaranty association assessments paid to those states allowing a reduction in
future premium taxes over a reasonable period of time. The asset is being
amortized as premium taxes are reduced. The Company has also estimated the
potential effect of future assessments on the Company's financial position and
results of operations and has established a reserve for such potential
assessments.
The National Association of Insurance Commissioners (NAIC) established
risk-based capital (RBC) standards for life insurance companies to determine
capital requirements based upon the risks inherent in its operations. These
standards require the computation of a RBC amount which is then compared to a
company's actual total adjusted statutory capital. The computation involves
applying factors to various statutory financial data to address four primary
risks: asset default, adverse insurance experience, interest rate risk and
external events. These standards provide for regulatory attention when the
percentage of total adjusted capital to authorized control level RBC is below
certain levels. As of December 31, 2002, the Company's total adjusted capital
was well in excess of the levels requiring regulatory attention. In 2003, any
dividend distributions in excess of 10 percent of the statutory capital of the
Company would require approval of the Department of Commerce of the State of
Minnesota.
Forward-Looking Statements
Certain statements in item #7 of this Form 10-K Annual Report contain
forward-looking statements which are subject to risks and uncertainties that
could cause results to differ materially from such statements. The words
"believe," "expect," "anticipate," "optimistic," "intend," "plan," "aim,"
"will," "should," "could," "likely," and similar expressions are intended to
identify forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date on
which they are made. The Company undertakes no obligation to publicly update or
revise any forward-looking statements. Important factors that could cause actual
results to differ materially from the Company's forward-looking statements
include, but are not limited to: fluctuations in external markets, which can
affect the amount and types of investment products sold, the market value of its
managed assets, management and other fees received based on those assets and the
amount of amortization of DAC; potential deterioration in high-yield and other
investments, which could result in further losses in the Company's investment
portfolio; changes in assumptions relating to DAC which also could impact the
amount of DAC amortization; the ability to sell certain high-yield investments
at expected values and within anticipated timeframes and to maintain its
high-yield portfolio at certain levels in the future; the types and the value of
certain death benefit features on variable annuity contracts; the affect of
assessments and other surcharges for guaranty funds; the response of reinsurance
companies under reinsurance contracts; the impact of reinsurance rates and the
availability and adequacy of reinsurance to protect the Company against losses;
negative changes in the Company's and its subsidiaries' credit ratings;
increasing competition in all the Company's major businesses; the adoption of
recently issued rules related to the consolidation of variable interest
entities, including those involving CDOs and SLTs that the Company invests in
which could affect both the Company's balance sheet and results of operations;
and outcomes of litigation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Items required under this section are included in the Management's Discussion
and Analysis of financial condition and results of operations under the section
titled Risk Management.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
1. Financial Statements and Schedules Required under Regulation S-X.
Index to financial statements
-18-
The following consolidated financial statements of IDS Life Insurance
Company are included in Item 8:
Report of Independent Auditors 24
Consolidated Balance Sheets at December 31, 2002 and 2001 25-26
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000 27
Consolidated Statements of Stockholder's Equity for the years ended
December 31, 2002, 2001 and 2000 28-29
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 30-31
Notes to Consolidated Financial Statements 32-51
All information on schedules to the consolidated financial statements
required by Article 7 of Regulation S-X is included in the consolidated
financial statements or is not required. Therefore, all schedules have been
omitted.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Item omitted pursuant to General Instructions I(2) (c) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Item omitted pursuant to General Instructions I(2) (c) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Item omitted pursuant to General Instructions I(2) (c) of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item omitted pursuant to General Instructions I(2) (c) of Form 10-K.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, the Company carried
out an evaluation under the supervision and with the participation of the
Company's management, including the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"), of the effectiveness of its disclosure controls and
procedures. Based on that evaluation, the CEO and CFO have concluded that the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time
-19-
periods specified in Securities and Exchange Commission rules and forms. The CEO
and CFO also note that subsequent to the date of their evaluation, there were no
significant changes in the Company's internal controls or in other factors that
could significantly affect the internal controls, including any corrective
actions with regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
See Index to Financial Statements and Financial Statement
Schedules.
(2) Financial Statement Schedules
See index to Financial Statements and Financial Statement Schedules.
All information on schedules to the consolidated financial
statements required by Article 7 of Regulation S-X is included in
the consolidated financial statements or is not required.
Therefore, all schedules have been omitted.
(3) Exhibits
3.1 Copy of Certificate of Incorporation of IDS Life Insurance
Company filed electronically as Exhibit 3.1 to
Post-Effective Amendment No. 5 to Registration Statement No.
33-28976 is incorporated herein by reference.
3.2 Copy of the Amended By-laws of IDS Life Insurance Company
filed electronically as Exhibit 3.2 to Post-Effective
Amendment No. 5 to Registration Statement No. 33-28976 is
incorporated herein by reference.
3.3 Copy of Resolution of the Board of Directors of IDS Life
Insurance Company, dated May 5, 1989, establishing IDS Life
Account MGA filed electronically as Exhibit 3.3 to
Post-Effective Amendment No. 5 to Registration Statement No.
33-28976 is incorporated herein by reference.
4.1 Copy of Non-tax qualified Group Annuity Contract, Form
30363C, filed electronically as Exhibit 4.1 to
Post-Effective Amendment No. 5 to Registration Statement No.
33-28976 is incorporated herein by reference.
4.2 Copy of Non-tax qualified Group Annuity Certificate, Form
30360C, filed electronically as Exhibit 4.2 to
Post-Effective Amendment No. 5 to Registration Statement No.
33-28976 is incorporated herein by reference.
4.3 Copy of Endorsement No. 30340C-GP to the Group Annuity
Contract filed electronically as Exhibit 4.3 to
Post-Effective Amendment No. 5 to Registration Statement No.
33-28976 is incorporated herein by reference.
4.4 Copy of Endorsement No. 30340C to the Group Annuity
Certificate filed electronically as Exhibit 4.4 to
Post-Effective Amendment No. 5 to Registration Statement No.
33-28976 is incorporated herein by reference.
-20-
4.5 Copy of Tax qualified Group Annuity Contract, Form 30369C,
filed electronically as Exhibit 4.5 to Post-Effective
Amendment No. 10 to Registration Statement No. 33-28976 is
incorporated herein by reference.
4.6 Copy of Tax qualified Group Annuity Certificate, Form
30368C, filed electronically as Exhibit 4.6 to
Post-Effective Amendment No. 10 to Registration Statement
No. 33-28976 is incorporated herein by reference.
4.7 Copy of Group IRA Annuity Contract, Form 30372C, filed
electronically as Exhibit 4.7 to Post-Effective Amendment
No. 10 to Registration Statement No. 33-28976 is
incorporated herein by reference.
4.8 Copy of Group IRA Annuity Certificate, Form 30371C, filed
electronically as Exhibit 4.8 to Post-Effective Amendment
No. 10 to Registration Statement No. 33-28976 is
incorporated herein by reference.
4.9 Copy of Non-tax qualified Individual Annuity Contract, Form
30365D, filed electronically as Exhibit 4.9 to
Post-Effective Amendment No. 10 to Registration Statement
No. 33-28976 is incorporated herein by reference.
4.10 Copy of Endorsement No. 30379 to the Individual Annuity
Contract, filed electronically as Exhibit 4.10 to Post
Effective Amendment No. 10 to Registration Statement No.
33-28976 is incorporated herein by reference.
4.11 Copy of Tax qualified Individual Annuity Contract, Form
30370C, filed electronically as Exhibit 4.11 to
Post-Effective Amendment No. 10 to Registration Statement
No. 33-28976 is incorporated herein by reference.
4.12 Copy of Individual IRA Annuity Contract, Form 30373C, filed
electronically as Exhibit 4.12 to Post-Effective Amendment
No. 10 to Registration Statement No. 33-28976 is
incorporated herein by reference.
4.13 Copy of Endorsement No. 33007 filed electronically as
Exhibit 4.13 to Post-Effective Amendment No. 12 to
Registration Statement No. 33-28976 is incorporated herein
by reference.
4.14 Copy of Group Annuity Contract, Form 30363D, filed
electronically as Exhibit 4.1 to Post-Effective Amendment
No. 2 to Registration Statement No. 33-50968 is incorporated
herein by reference.
4.15 Copy of Group Annuity Certificate, Form 30360D, filed
electronically as Exhibit 4.2 to Post-Effective Amendment
No. 2 to Registration Statement No. 33-50968 is incorporated
herein by reference.
4.16 Form of Deferred Annuity Contract, Form 30365E, filed
electronically as Exhibit 4.3 to Post-Effective Amendment
No. 2 to Registration Statement No. 33-50968 is incorporated
herein by reference.
4.17 Copy of Group Deferred Variable Annuity Contract, Form
34660, filed electronically as Exhibit 4.1 to Post-Effective
Amendment No. 2 to Registration Statement No. 33-48701 is
incorporated herein by reference.
-21-
4.18 Copy of Non-tax qualified Group Annuity Contract, Form
33111, filed electronically as Exhibit 4.1 to Registration
Statement No. 333-42793 is incorporated herein by reference.
4.19 Copy of Non-tax qualified Group Annuity Certificate, Form
33114, filed electronically as Exhibit 4.2 to Registration
Statement No. 333-42793 is incorporated herein by reference.
4.20 Copy of Tax qualified Group Annuity Contract, Form 33112,
filed electronically as Exhibit 4.3 to Registration
Statement No. 333-42793 is incorporated herein by reference.
4.21 Copy of Tax qualified Group Annuity Certificate, Form 33115,
filed electronically as Exhibit 4.4 to Registration
Statement No. 333-42793 is incorporated herein by reference.
4.22 Copy of Group IRA Annuity Contract, Form 33113, filed
electronically as Exhibit 4.5 to Registration Statement No.
333-42793 is incorporated herein by reference.
4.23 Copy of Group IRA Annuity Certificate, Form 33116, filed
electronically as Exhibit 4.6 to Registration Statement No.
333-42793 is incorporated herein by reference.
4.24 Copy of Non-tax qualified Individual Annuity Contract, Form
30484, filed electronically as Exhibit 4.7 to Post-Effective
Amendment No. 1 to Registration Statement No. 333-42793 is
incorporated herein by reference.
4.25 Copy of Tax qualified Individual Annuity Contract, Form
30485, filed electronically as Exhibit 4.8 to Post-Effective
Amendment No. 1 to Registration Statement No. 333-42793 is
incorporated herein by reference.
4.26 Copy of Individual IRA Contract, Form 30486, filed
electronically as Exhibit 4.9 to Post-Effective Amendment
No. 1 to Registration Statement No. 333-42793 is
incorporated herein by reference.
21. Copy of List of Subsidiaries filed electronically as Exhibit
22 to Post-Effective Amendment No. 8 to Registration
Statement No. 33-28976 is incorporated herein by reference.
27. Financial data schedule is filed electronically herewith.
Exhibits 99.1 and 99.2
Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
Exhibits 99.3 and 99.4
Certification pursuant to 15 U.S.C. as adopted pursuant to
section 302 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K filed in the fourth quarter of 2002.
Form 8-K, dated November 20, 2002, Item 5, reporting that the Company
has entered into an agreement with an outside party to become the
primary provider of long-term care insurance policies effective
January 1, 2003.
-22-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
IDS LIFE INSURANCE COMPANY
Registrant
3/27/2003 By /s/ Timothy V. Bechtold
----------------------------------------
Date Timothy V. Bechtold, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been duly signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
3/27/2003 By /s/ Gumer C. Alvero
----------------------------------------
Date Gumer C. Alvero, Director and Executive Vice
President - Annuities
3/27/2003 By /s/ Timothy V. Bechtold
----------------------------------------
Date Timothy V. Bechtold, President
3/27/2003 By /s/ Barry J. Murphy
----------------------------------------
Date Barry J. Murphy, Director
3/27/2003 By /s/ Stephen W. Roszell,
----------------------------------------
Date Stephen W. Roszell, Director
3/27/2003 By /s/ Bridget M. Sperl
----------------------------------------
Date Bridget M. Sperl, Executive Vice President -
Client Services
3/27/2003 By /s/ John T. Sweeney
----------------------------------------
Date John T. Sweeney, Executive Vice
President - Finance
3/27/2003 By /s/ Philip C. Wentzel
----------------------------------------
Date Philip C. Wentzel, Vice President and
Controller
-23-
Report of Independent Auditors
The Board of Directors
IDS Life Insurance Company
We have audited the accompanying consolidated balance sheets of IDS Life
Insurance Company (a wholly-owned subsidiary of American Express Financial
Corporation) as of December 31, 2002 and 2001, and the related consolidated
statements of income, stockholder's equity and cash flows for each of the three
years in the period ended December 31, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of IDS Life Insurance
Company at December 31, 2002 and 2001, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States.
January 27, 2003
Minneapolis, Minnesota
-24-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS
December 31,
(In thousands, except share amounts)
ASSETS 2002 2001
Investments:
Available-for-sale:
Fixed maturities, at fair value (amortized cost: 2002, $23,209,226; 2001,
$20,022,072) $24,052,104 $20,157,137
Common stocks, at fair value (cost: 2002,
$19; 2001, $805) 21 1,704
Mortgage loans on real estate 3,417,651 3,680,394
Policy loans 597,144 619,571
Other investments 752,558 621,897
-------------- --------------
Total investments 28,819,478 25,080,703
Cash and cash equivalents 4,424,061 1,150,251
Amounts recoverable from reinsurers 633,510 529,166
Amounts due from brokers 501 90,794
Other accounts receivable 56,245 46,349
Accrued investment income 296,595 278,199
Deferred policy acquisition costs 3,309,783 3,107,187
Deferred income taxes, net -- 156,308
Other assets 117,788 123,246
Separate account assets 21,980,674 27,333,697
------------ ------------
Total assets $59,638,635 $57,895,900
=========== ===========
See accompanying notes to consolidated financial statements.
-25-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS (continued)
December 31,
(In thousands, except share amounts)
LIABILITIES AND STOCKHOLDER'S EQUITY 2002 2001
Liabilities:
Future policy benefits:
Fixed annuities $23,411,314 $19,592,273
Universal life-type insurance 3,515,010 3,433,904
Traditional life insurance 247,441 241,165
Disability income and long-term care insurance 1,466,171 1,227,172
Policy claims and other policyholders' funds 85,400 71,879
Amounts due to brokers 3,342,989 1,740,031
Deferred income taxes, net 182,059 --
Other liabilities 463,326 437,017
Separate account liabilities 21,980,674 27,333,697
------------- -------------
Total liabilities 54,694,384 54,077,138
------------- -------------
Commitments and contingencies
Stockholder's equity:
Capital stock, $30 par value per share;
100,000 shares authorized, issued and outstanding 3,000 3,000
Additional paid-in capital 1,088,327 688,327
Accumulated other comprehensive income, net of tax:
Net unrealized securities gains 497,319 83,443
Net unrealized derivative gains (losses) 764 1,332
-------------- ----------------
Total accumulated other comprehensive income 498,083 84,775
Retained earnings 3,354,841 3,042,660
------------- -------------
Total stockholder's equity 4,944,251 3,818,762
------------- -------------
Total liabilities and stockholder's equity $59,638,635 $57,895,900
=========== ===========
See accompanying notes to consolidated financial statements.
-26-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31,
(In thousands)
2002 2001 2000
------------ ------------- ---------
REVENUES
Premiums:
Traditional life insurance $ 67,978 $ 59,415 $ 56,187
Disability income and long-term care insurance 273,737 255,428 231,311
--------- --------- ---------
Total premiums 341,715 314,843 287,498
Net investment income 1,561,856 1,485,688 1,730,605
Policyholder and contractholder charges 522,777 489,583 438,127
Management and other fees 404,787 473,406 598,168
Net realized loss on investments (4,507) (649,752) (16,975)
---------- ---------- ----------
Total revenues 2,826,628 2,113,768 3,037,423
--------- --------- ---------
BENEFITS AND EXPENSES
Death and other benefits:
Traditional life insurance 36,881 35,519 29,042
Universal life-type insurance and investment contracts 221,544 175,247 131,467
Disability income and long-term care insurance 52,962 44,725 40,246
Increase in liabilities for future policy benefits:
Traditional life insurance 2,768 7,231 5,765
Disability income and long-term care insurance 134,605 123,227 113,239
Interest credited on universal life-type insurance and
investment contracts 1,157,636 1,137,636 1,169,641
Amortization of deferred policy acquisition costs 312,402 371,342 362,106
Other insurance and operating expenses 437,823 407,798 378,653
--------- --------- ---------
Total benefits and expenses 2,356,621 2,302,725 2,230,159
--------- --------- ---------
Income (loss) before income tax expense (benefit) and
cumulative effect of accounting change 470,007 (188,957) 807,264
Income tax expense (benefit) 87,826 (145,222) 221,627
--------- ---------- ---------
Income (loss) before cumulative effect of accounting change
382,181 (43,735) 585,637
Cumulative effect of accounting change (net of income tax
benefit of $11,532) -- (21,416) --
--------- ---------- ---------
Net income (loss) $ 382,181 $ (65,151) $ 585,637
========== =========== ==========
See accompanying notes to consolidated financial statements.
-27-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
For the three years ended December 31, 2002
(In thousands)
Accumulated
other
Additional comprehensive Total
Capital paid-in income (loss), Retained stockholder's
stock capital net of tax earnings equity
Balance, January 1, 2000 $3,000 $288,327 $(411,230) $2,932,174 $2,812,271
Comprehensive income:
Net income - - - 585,637 585,637
Net unrealized holding gains on
available-for-sale securities arising
during the year, net of deferred
policy acquisition costs of ($5,154)
and income tax expense of ($46,921) - - 87,138 - 87,138
Reclassification adjustment for
gains included in net income, net
of income tax expense of $5,192 - - (9,642) - (9,642)
------ ------
Other comprehensive income - - 77,496 - 77,496
------ ------
Comprehensive income - - - - 663,133
Cash dividends - - - (410,000) (410,000)
------ -------- --------- ---------- -----------
Balance, December 31, 2000 3,000 288,327 (333,734) 3,107,811 3,065,404
Comprehensive income:
Net loss - - - (65,151) (65,151)
Cumulative effect of adopting SFAS No.
133, net of income tax benefit of $626
- - (1,162) - (1,162)
Net unrealized holding losses on
available-for-sale securities
arising during the year, net of
deferred policy acquisition costs
of ($20,191) and income tax
benefit of $6,064 - - (11,262) - (11,262)
Reclassification adjustment for losses on
available-for-sale securities included
in net loss, net of income tax benefit
of $228,003 - - 423,434 - 423,434
Reclassification adjustment for losses on
derivatives included in net loss, net
of income tax benefit of $4,038
- - 7,499 - 7,499
--------- -----------
Other comprehensive income - - 418,509 - 418,509
-------- ----------
Comprehensive income - - - - 353,358
Capital contribution - 400,000 - 400,000
------ -------- --------- ----------- ----------
Balance, December 31, 2001 $3,000 $688,327 $ 84,775 $3,042,660 $3,818,762
See accompanying notes to consolidated financial statements.
-28-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(continued) For the three years ended December 31, 2002
(In thousands)
Accumulated
other
Additional comprehensive Total
Capital paid-in income (loss), Retained stockholder's
stock capital net of tax earnings equity
Balance, December 31, 2001 $3,000 $ 688,327 $ 84,775 $3,042,660 $3,818,762
Comprehensive income:
Net income - - - 382,181 382,181
Net unrealized holding gains on
available-for-sale securities arising
during the year, net of deferred
policy acquisition costs of ($75,351)
and income tax expense of ($228,502) - - 424,360 - 424,360
Reclassification adjustment for gains on
available-for-sale securities included
in net income, net of income tax
expense of $5,645 - - (10,484) - (10,484)
Reclassification adjustment for gains on
derivatives included in net income,
net of income tax expense of $305 - - (568) - (568)
-------- ----------
Other comprehensive income - - 413,308 - 413,308
-------- ----------
Comprehensive income - - - - 795,489
Cash dividends - - (70,000) (70,000)
Capital contribution - 400,000 - - 400,000
------ ---------- -------- ----------- -----------
Balance, December 31, 2002 $3,000 $1,088,327 $498,083 $3,354,841 $4,944,251
====== ========== ======== ========== ==========
See accompanying notes to consolidated financial statements.
-29-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
(In thousands)
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 382,181 $ (65,151) $ 585,637
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Cumulative effect of accounting change, net of tax -- 21,416 --
Policy loans, excluding universal life-type insurance:
Issuance (35,345) (43,687) (61,313)
Repayment 49,256 54,004 56,088
Change in amounts recoverable from reinsurers (104,344) (112,686) (89,312)
Change in other accounts receivable (9,896) (4,025) 6,254
Change in accrued investment income (5,139) 56,729 8,521
Change in deferred policy acquisition costs, net (277,947) (175,723) (291,634)
Change in liabilities for future policy benefits for
traditional life, disability income and long-term care
insurance 245,275 223,177 206,377
Change in policy claims and other policyholder's funds 13,521 19,812 27,467
Deferred income tax provision (benefit) 116,995 (246,205) 37,704
Change in other liabilities 26,309 (24,509) (120,256)
Amortization of premium, net 65,869 108,958 37,909
Net realized loss on investments 4,507 649,752 16,975
Policyholder and contractholder charges, non-cash (232,725) (217,496) (151,745)
Other, net 13,820 (83,023) (9,279)
--------- --------- ---------
Net cash provided by operating activities $ 252,337 $ 161,343 $ 259,393
See accompanying notes to consolidated financial statements.
-30-
IDS LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended December 31,
(In thousands)
2002 2001 2000
CASH FLOWS FROM INVESTING ACTIVITIES
Held-to-maturity securities:
Purchases $ - $ - $ (4,487)
Maturities, sinking fund payments and calls - - 589,742
Sales - - 50,067
Available-for-sale securities:
Purchases (16,287,891) (9,477,740) (1,454,010)
Maturities, sinking fund payments and calls 3,078,509 2,706,147 1,019,403
Sales 10,093,228 5,493,141 1,237,116
Other investments, excluding policy loans:
Purchases (543,843) (442,876) (706,082)
Sales 509,588 370,636 435,633
Change in amounts due from brokers 90,293 (75,492) (15,157)
Change in amounts due to brokers 1,602,958 1,293,684 298,236
------------ ---------- -----------
Net cash (used in) provided by investing activities (1,457,158) (132,500) 1,450,461
------------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Activities related to universal life-type insurance and
investment contracts:
Considerations received 4,638,111 2,088,114 1,842,026
Surrenders and other benefits (1,655,631) (2,810,401) (3,974,966)
Interest credited to account balances 1,157,636 1,137,636 1,169,641
Universal life-type insurance policy loans:
Issuance (80,831) (83,720) (134,107)
Repayment 89,346 72,805 82,193
Capital contribution 400,000 400,000 -
Dividends paid (70,000) - (410,000)
------- ---------- -----------
Net cash provided by (used in) financing activities 4,478,631 804,434 (1,425,213)
------------ ---------- -----------
Net increase in cash and cash equivalents 3,273,810 833,277 284,641
Cash and cash equivalents at beginning of year 1,150,251 316,974 32,333
------------ ---------- -----------
Cash and cash equivalents at end of year $ 4,424,061 $ 1,150,251 $ 316,974
============ =========== ===========
Supplemental disclosures:
Income taxes paid $ - $ - $ 225,704
Interest on borrowings 7,906 23,688 3,299
See accompanying notes to consolidated financial statements.
-31-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands)
1. Summary of significant accounting policies
Nature of business
IDS Life Insurance Company (the Company) is a stock life insurance company
organized under the laws of the State of Minnesota whose products are
primarily distributed through branded financial advisors. The Company is a
wholly-owned subsidiary of American Express Financial Corporation (AEFC),
which is a wholly-owned subsidiary of American Express Company. The Company
serves residents of all states except New York. IDS Life Insurance Company
of New York is a wholly-owned subsidiary of the Company and serves New York
State residents. The Company also wholly-owns American Enterprise Life
Insurance Company, which issues fixed and variable annuity contracts for
sale through insurance agencies and broker-dealers who may also be
associated with financial institutions, such as banks. American Centurion
Life Assurance Company is a wholly-owned subsidiary that offers fixed and
variable annuities to American Express(R) Cardmembers and others in New
York and through insurance agencies and broker-dealers who may also be
associated with financial institutions, such as banks, in New York.
American Partners Life Insurance Company is a wholly-owned subsidiary that
offers fixed and variable annuities to American Express(R) Cardmembers and
others who reside in states other than New York. The Company also
wholly-owns IDS REO 1, LLC and American Express Corporation. These
subsidiaries hold real estate, mortgage loans on real estate and/or
affordable housing investments.
The Company's principal products are deferred annuities and universal life
insurance which are issued primarily to individuals. It offers single
premium and flexible premium deferred annuities on both a fixed and
variable dollar basis. Immediate annuities are offered as well. The
Company's fixed deferred annuities guarantee a relatively low annual
interest rate during the accumulation period (the time before annuity
payments begin). However, the Company has the option of paying a higher
rate set at its discretion. In addition, persons owning one type of annuity
may have their interest calculated based on any increase in a broad-based
stock market index. The Company also offers variable annuities, including
the American Express Retirement Advisor AdvantageSM Variable Annuity and
the American Express Retirement Advisor SelectSM Variable Annuity. Life
insurance products currently offered by the Company include universal life
(fixed and variable, single life and joint life), single premium life and
term products. Waiver of premium and accidental death benefit riders are
generally available with these life insurance products. The Company also
markets disability income insurance. Although the Company discontinued
marketing proprietary long-term care insurance at the end of 2002,
long-term care insurance is available through a non-proprietary product
distributed by an affiliate.
Under the Company's variable life insurance and variable annuity products
described above, the purchaser may choose among investment options that
include the Company's "general account" as well as from a variety of
portfolios including common stocks, bonds, managed assets and/or short-
term securities.
Basis of presentation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
-32-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United
States which vary in certain respects from reporting practices prescribed
or permitted by state insurance regulatory authorities (see Note 4).
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Revenue Recognition
Profits on fixed deferred annuities are the excess of contractholder
charges and investment income earned from investment of contract
considerations over interest credited to contract values, amortization of
deferred acquisition costs, and other expenses. Profits on variable
deferred annuities also include the excess of management and other fees
over the costs of guaranteed benefits provided. Policyholder and
contractholder charges include policy fees and surrender charges.
Management and other fees include investment management fees from
underlying proprietary mutual funds, certain fee revenues from underlying
nonproprietary mutual funds and mortality and expense risk fees from the
variable annuity separate accounts.
Profits on fixed universal life insurance are the excess of contractholder
charges and investment income earned from investment of contract
considerations over interest credited to contract values, death and other
benefits paid in excess of contract values, amortization of deferred
acquisition costs, and other expenses. Profits on variable universal life
insurance also include management and other fees. Policyholder and
contractholder charges include the monthly cost of insurance charges, issue
and administrative fees and surrender charges. These charges also include
the minimum death benefit guarantee fees received from the variable life
insurance separate accounts. Management and other fees include investment
management fees from underlying proprietary mutual funds, certain fee
revenues from underlying nonproprietary mutual funds and mortality and
expense risk fees from the variable life insurance separate accounts.
Premiums on traditional life, disability income and long-term care
insurance policies are recognized as revenue when due, and related benefits
and expenses are associated with premium revenue in a manner that results
in recognition of profits over the lives of the insurance policies. This
association is accomplished by means of the provision for future policy
benefits and the deferral and subsequent amortization of policy acquisition
costs.
Investments - Fixed maturity and equity securities
All fixed maturity securities and marketable equity securities are
classified as available-for-sale and carried at fair value. Unrealized
gains and losses on securities classified as available-for-sale are carried
as a separate component of accumulated other comprehensive income (loss),
net of the related deferred policy acquisition costs and income taxes.
Gains and losses are recognized in the results of operations upon
disposition of the securities using the specific identification method. In
addition, losses are also recognized when management determines that a
decline in a security's fair value is other-than-temporary, which requires
judgment regarding the amount and timing of recovery.
-33-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
Indicators of other-than-temporary impairment for fixed maturity securities
include, but are not limited to, issuer downgrade, default, or bankruptcy.
The Company also considers the extent to which cost exceeds fair value, the
duration of time of that decline, and management's judgment about the
issuer's current and prospective financial condition. The charges are
reflected in net realized loss on investments within the Consolidated
Statements of Income.
Fair value of fixed maturity and equity securities is generally based on
quoted market prices. However, the Company's investment portfolio also
contains structured investments of various asset quality, including
collateralized debt obligations (CDOs) and secured loan trusts (backed by
high-yield bonds and bank loans), which are not readily marketable. As a
result, the carrying values of these structured investments are based on
estimated cash flow projections which require a significant degree of
management judgment as to default and recovery rates of the underlying
investments and, as such, are subject to change. The Company's CDO
investments are accounted for in accordance with Emerging Issues Task Force
(EITF) Issue 99-20 "Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial
Assets". The Company's secured loan trusts are accounted for in accordance
with EITF Issue 96-12 "Recognition of Interest Income and Balance Sheet
Classification of Structured Notes".
Net investment income, which primarily consists of interest earned on fixed
maturity securities, is generally accrued as earned using the effective
interest method, which makes an adjustment of the yield for security
premiums, discounts and anticipated prepayments on mortgage-backed
securities. Prepayment estimates are based on information received from
brokers who deal in mortgage-backed securities.
Investments - Mortgage loans on real estate
Mortgage loans on real estate reflect principal amounts outstanding less
reserves for losses. The estimated fair value of the mortgage loans is
determined by discounted cash flow analyses using mortgage interest rates
currently offered for mortgages of similar maturities.
The reserve for losses is measured as the excess of the loan's recorded
investment over its present value of expected principal and interest
payments discounted at the loan's effective interest rate or the fair value
of collateral. Additionally, the level of the reserve for losses considers
other factors, including historical experience and current economic and
political conditions. Management regularly evaluates the adequacy of the
reserve for mortgage loan losses and believes it is adequate to absorb
estimated losses in the portfolio.
The Company generally stops accruing interest on mortgage loans for which
interest payments are delinquent more than three months. Based on
management's judgment as to the ultimate collectibility of principal,
interest payments received are either recognized as income or applied to
the recorded investment in the loan.
Investments - Policy loans
Policy loans are carried at the aggregate of the unpaid loan balances,
which do not exceed the cash surrender values of the related policies.
-34-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
Investment - Other investments
Included in Other investments are affordable housing investments, trading
securities, syndicated loans and real estate. Affordable housing
investments are carried at amortized cost as the Company has no influence
over the operating or financial policies of the general partner. Trading
securities are held at fair market value with changes in value recognized
in the Consolidated Statements of Income within Net investment income.
Syndicated loans reflect principal amounts outstanding less reserves for
losses and real estate is carried at its estimated fair value.
Cash and cash equivalents
The Company considers investments with a maturity at the date of their
acquisition of three months or less to be cash equivalents. These
securities are carried principally at amortized cost, which approximates
fair value.
Deferred policy acquisition costs
The costs of acquiring new business, including for example, direct sales
commissions, related sales incentive bonuses and awards, underwriting
costs, policy issue costs and other related costs, have been deferred on
the sale of insurance and annuity contracts. The deferred acquisition costs
(DAC) for universal life and variable universal life insurance and certain
installment annuities are amortized as a percentage of the estimated gross
profits expected to be realized on the policies. DAC for other annuities
are amortized using the interest method. For traditional life, disability
income and long-term care insurance policies, the costs are amortized in
proportion to premium revenue.
Amortization of DAC requires the use of certain assumptions including
interest margins, mortality rates, persistency rates, maintenance expense
levels and customer asset value growth rates for variable products. The
customer asset value growth rate is the rate at which contract values are
assumed to appreciate in the future. This rate is net of asset fees, and
anticipates a blend of equity and fixed income investments. Management
routinely monitors a wide variety of trends in the business, including
comparisons of actual and assumed experience. Management reviews and, where
appropriate, adjusts its assumptions with respect to customer asset value
growth rates on a quarterly basis.
Management monitors other principal DAC assumptions, such as persistency
rates, mortality rate, interest margin and maintenance expense level
assumptions each quarter. Unless management identifies a material deviation
over the course of the quarterly monitoring, management reviews and updates
these DAC assumptions annually in the third quarter of each year.
When assumptions are changed, the percentage of estimated gross profits or
portion of interest margins used to amortize DAC may also change. A change
in the required amortization percentage is applied retrospectively; an
increase in amortization percentage will result in an acceleration of DAC
amortization while a decrease in amortization percentage will result in a
deceleration of DAC amortization. The impact on results of operations of
changing assumptions with respect to the amortization of DAC can be either
positive or negative in any particular period, and is reflected in the
period that such changes are made. These adjustments are collectively
referred to as unlocking
-35-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
adjustments. Unlocking adjustments resulted in net increases in
amortization of $40,000 in 2002 and $33,600 in 2001, with a net decrease in
amortization of $12,300 in 2000.
Guaranteed Minimum Death Benefits
The majority of the variable annuity contracts offered by the Company
contain guaranteed minimum death benefit (GMDB) provisions. At time of
issue, these contracts typically guarantee that the death benefit payable
will not be less than the amount invested, regardless of the performance of
the customer's account. Most contracts also provide for some type of
periodic adjustment of the guaranteed amount based on the change in value
of the contract. A large portion of the Company's contracts containing a
GMDB provision adjust once every six years. The periodic adjustment of
these contracts can either increase or decrease the guaranteed amount,
though not below the amount invested, adjusted for withdrawals. When market
values of the customer's accounts decline, the death benefit payable on a
contract with a GMDB may exceed the accumulated contract value. Currently,
the amount paid in excess of contract value is expensed when payable.
Amounts expensed in 2002, 2001 and 2000 were $37,361, $16,202 and $835,
respectively.
Liabilities for future policy benefits
Liabilities for fixed and variable universal life insurance and fixed and
variable deferred annuities are accumulation values.
Liabilities for equity indexed deferred annuities issued before 1999 are
equal to the present value of guaranteed benefits and the intrinsic value
of index-based benefits. Liabilities for equity indexed deferred annuities
issued in 1999 or later are equal to the accumulation of host contract
values covering guaranteed benefits and the market value of embedded equity
options.
Liabilities for fixed annuities in a benefit status are based on
established industry mortality tables and interest rates ranging from 5% to
9.5%, depending on year of issue, with an average rate of approximately
6.5%.
Liabilities for future benefits on traditional life insurance, principally
term and whole life insurance, are based on the net level premium method,
using anticipated mortality, policy persistency and interest earning rates.
Anticipated mortality rates are based on established industry mortality
tables, with modifications based on Company experience. Anticipated policy
persistency rates vary by policy form, issue age and policy duration with
persistency on level term and cash value plans generally anticipated to be
better than persistency on yearly renewable term insurance plans.
Anticipated interest rates range from 4% to 10%, depending on policy form,
issue year and policy duration.
Liabilities for future disability income and long-term care policy benefits
include both policy reserves and claim reserves. Policy reserves are based
on the net level premium method, using anticipated morbidity, mortality,
policy persistency and interest earning rates. Anticipated morbidity and
mortality rates are based on established industry morbidity and mortality
tables. Anticipated policy persistency rates vary by policy form, issue
age, policy duration and, for disability income policies,
-36-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
occupation class. Anticipated interest rates for disability income and
long-term care policy reserves are 3% to 9.5% at policy issue and grade to
ultimate rates of 5% to 7% over 5 to 10 years.
Claim reserves are calculated based on claim continuance tables and
anticipated interest earnings. Anticipated claim continuance rates are
based on established industry tables. Anticipated interest rates for claim
reserves for both disability income and long-term care range from 5% to 8%.
Liabilities for reported and unpaid life insurance claims are equal to the
death benefits payable. For disability income and long-term care claims,
unpaid claims liabilities are equal to benefit amounts due and accrued.
Liabilities for incurred but not reported claims are estimated based on
periodic analysis of the actual reported claim lag. Where applicable,
amounts recoverable from reinsurers are separately recorded as receivables.
For life insurance, no claim adjustment expense reserve is held. The claim
adjustment expense reserves for disability income and long-term care are
based on the claim reserves.
The Company does not issue participating insurance contracts and has no
short-duration life insurance liabilities.
Reinsurance
Reinsurance premiums and benefits paid or provided are accounted for on a
basis consistent with that used in accounting for original policies issued
and with the terms of the reinsurance contracts.
The maximum amount of life insurance risk retained by the Company is $750
on any policy insuring a single life and $1,500 on any policy insuring a
joint-life combination. The Company generally retains 10% of the mortality
risk on new life insurance policies. Risk not retained is reinsured with
other life insurance companies. Risk on universal life and variable
universal life policies is reinsured on a yearly renewable term basis. Risk
on term insurance and long-term care policies is reinsured on a coinsurance
basis. The Company retains all accidental death benefit, disability income
and waiver of premium risk.
Federal income taxes
The Company's taxable income is included in the consolidated federal income
tax return of American Express Company. The Company provides for income
taxes on a separate return basis, except that, under an agreement between
AEFC and American Express Company, tax benefit is recognized for losses to
the extent they can be used on the consolidated tax return. It is the
policy of AEFC and its subsidiaries that AEFC will reimburse subsidiaries
for all tax benefits.
Separate account business
The separate account assets and liabilities represent funds held for the
exclusive benefit of the variable annuity and variable life insurance
contract owners. The Company receives investment management fees from the
proprietary mutual funds used as investment options for variable annuities
and variable life insurance. The Company receives mortality and expense
risk fees from the separate accounts.
-37-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
The Company makes contractual mortality assurances to the variable annuity
contract owners that the net assets of the separate accounts will not be
affected by future variations in the actual life expectancy experience of
the annuitants and beneficiaries from the mortality assumptions implicit in
the annuity contracts. The Company makes periodic fund transfers to, or
withdrawals from, the separate account assets for such actuarial
adjustments for variable annuities that are in the benefit payment period.
The Company also guarantees that the rates at which administrative fees are
deducted from contract funds will not exceed contractual maximums.
For variable life insurance, the Company guarantees that the rates at which
insurance charges and administrative fees are deducted from contract funds
will not exceed contractual maximums. The Company also guarantees that the
death benefit will continue to be payable at the initial level regardless
of investment performance so long as minimum premium payments are made.
Accounting developments
In July 2000, the Financial Accounting Standards Board's (FASB's) Emerging
Issues Task Force (EITF) issued a consensus on Issue 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial
Interests in Securitized Financial Assets." The Company adopted the
consensus as of January 1, 2001. Issue 99-20 prescribes procedures for
recording interest income and measuring impairment on retained and
purchased beneficial interests. The consensus primarily affects the
Company's CDO investments. Adoption of the consensus required the Company
to adjust the carrying amount of these investments downward by $21,416, net
of tax, which is reflected as a cumulative effect of accounting change in
the Consolidated Statement of Income.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended (SFAS No. 133), which requires an entity to
recognize all derivatives as either assets or liabilities on the balance
sheet and measure those instruments at fair value. Changes in the fair
value of a derivative are recorded in earnings or directly to other
comprehensive income, depending on the instrument's designated use.
The adoption of SFAS No. 133 resulted in a cumulative after-tax reduction
to other comprehensive income of $1,162. The cumulative impact to earnings
was not significant. See Note 8 for further discussion of the Company's
derivative and hedging activities.
SFAS No. 133 also provided a one-time opportunity to reclassify
held-to-maturity security investments to available-for-sale without
tainting the remaining securities in the held-to-maturity portfolio. The
Company elected to take the opportunity in 2001 to reclass all its
held-to-maturity investments to available-for-sale.
The Company adopted SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," which superseded
SFAS No. 125. The Statement was effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March
31, 2001. The Statement was effective for recognition and reclassification
of collateral and for disclosures relating to securitization transactions
and collateral for fiscal years ending after December 15, 2000. The impact
on the Company's financial position or results of operations of adopting
the Statement was not significant.
-38-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
1. Summary of significant accounting policies (continued)
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46), which addresses consolidation by
business enterprises of variable interest entities (VIEs). The accounting
provisions and expanded disclosure requirements for VIEs existing at
December 31, 2002, are fully effective for reporting periods beginning
after June 15, 2003. An entity shall be subject to consolidation according
to the provisions of FIN 46, if, by design, either (i) the total equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other
parties, or (ii) as a group, the holders of the equity investment at risk
lack: (a) direct or indirect ability to make decisions about an entity's
activities; (b) the obligation to absorb the expected losses of the entity
if they occur; or (c) the right to receive the expected residual return of
the entity if they occur. In general, FIN 46 will require a VIE to be
consolidated when an enterprise has a variable interest that will absorb a
majority of the VIE's expected losses or receive a majority of the VIE's
expected residual return.
It is likely that the Company will consolidate or disclose information
about VIEs when FIN 46 becomes effective in the third quarter of 2003. The
entities primarily impacted by FIN 46 relate to structured investments,
including CDOs and secured loan trusts (SLTs), which are owned by the
Company. The application of FIN 46 for CDOs and SLTs will have no effect on
the cash flows of the Company. The CDO entities contain debt issued to
investors, which are non-recourse to the Company and are solely supported
by portfolios of high-yield bonds and loans. The Company often invests in
the residual and rated debt tranches of the CDO structures that are either
managed by a related party or a third-party. With regards to those CDOs in
which the Company owns a residual tranche and which a related party
manages, the portfolios of high-yield bonds and loans have a fair value at
December 31, 2002 of approximately $2.0 billion for the benefit of the $2.7
billion in CDO debt investors.
Substantially all of the Company's interest in the rated debt tranches
along with rated tranches owned by AEFC were placed in a securitization
trust described in Note 2. The SLTs provide returns to investors primarily
based on the performance of an underlying portfolio of up to $3.3 billion
in high-yield loans. Currently, the underlying portfolio consists of $2.9
billion in high-yield loans with a market value of $2.6 billion, which are
managed by a related party.
While the potential consolidation of these entities may impact the results
of operations at adoption and for each reporting period thereafter, the
Company's maximum exposure to economic loss as a result of its investment
in these entities is represented by the carrying values at December 31,
2002 because any further reduction in the value of the assets will be
absorbed by the non-recourse debt or other unrelated entities. The CDO
residual tranches have an adjusted cost basis of $13,363 and the SLTs have
an adjusted cost basis of $656,565.
The Company continues to evaluate other relationships and interests in
entities that may be considered VIEs, including affordable housing
investments. The impact of adopting FIN 46 on the Consolidated Financial
Statements is still being reviewed.
-39-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
2. Investments
Fixed maturity and equity securities
The following is a summary of securities available-for-sale at December 31, 2002:
Gross Gross
Amortized Unrealized Unrealized Fair
Fixed maturities: Cost Gains Losses Value
U.S. Government agency obligations $ 84,075 $ 12,015 $ 687 $ 95,403
State and municipal obligations 29,202 2,522 - 31,724
Corporate bonds and obligations 9,614,296 611,060 116,345 10,109,011
Mortgage and other asset-backed
securities 12,145,797 393,342 10,067 12,529,072
Structured investments 1,306,245 2,112 59,101 1,249,256
Foreign government bonds and obligations 29,611 8,027 - 37,638
----------- ---------- -------- -----------
Total fixed maturity securities $23,209,226 $1,029,078 $186,200 $24,052,104
=========== ========== ======== ===========
Common stocks $ 19 $ 2 $ - $ 21
=========== ========== ======== ===========
The amortized cost and fair value of fixed maturity securities at December
31, 2002 by contractual maturity are as follows:
Amortized Fair
Cost Value
Due within one year $ 768,066 $ 779,833
Due from one to five years 2,740,513 2,887,899
Due from five to ten years 5,865,084 6,165,165
Due in more than ten years 1,689,766 1,690,135
Mortgage and other asset-backed securities 12,145,797 12,529,072
----------- -----------
Total $23,209,226 $24,052,104
=========== ===========
The timing of actual receipts may differ from contractual maturities
because issuers may have the right to call or prepay obligations.
-40-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
2. Investments (continued)
The following is a summary of securities available-for-sale at December 31, 2001:
Gross Gross
Amortized Unrealized Unrealized Fair
Fixed maturities: Cost Gains Losses Value
U.S. Government agency obligations $ 31,074 $ 2,190 $ 56 $ 33,208
State and municipal obligations 7,826 149 - 7,975
Corporate bonds and obligations 10,281,693 272,539 113,061 10,441,171
Mortgage and other asset-backed
securities 8,292,576 103,109 32,801 8,362,884
Structured investments 1,377,195 3,793 105,304 1,275,684
Foreign government bonds and obligations
31,708 4,507 - 36,215
----------- ------- -------- -----------
Total fixed maturity securities $20,022,072 $386,287 $251,222 $20,157,137
=========== ======== ======== ===========
Common stocks $ 805 $ 899 $ - $ 1,704
=========== ======== ======== ===========
Pursuant to the adoption of SFAS No. 133 the Company reclassified all
held-to-maturity securities with a carrying value of $6,463,613 and net
unrealized gains of $8,185 to available-for-sale as of January 1, 2001.
At December 31, 2002 and 2001, bonds carried at $14,523 and $14,639,
respectively, were on deposit with various states as required by law.
At December 31, 2002, fixed maturity securities comprised approximately 84
percent of the Company's total investments. These securities are rated by
Moody's and Standard & Poor's (S&P), except for approximately $1.4 billion
of securities which are rated by AEFC's internal analysts using criteria
similar to Moody's and S&P. Ratings are presented using S&P's convention
and if the two agencies' ratings differ, the lower rating is used. A
summary of fixed maturity securities, at fair value, by rating on December
31, is as follows:
Rating 2002 2001
AAA 53% 45%
AA 1 1
A 14 15
BBB 25 34
Below investment grade 7 5
--- ---
Total 100% 100%
=== ===
At December 31, 2002, approximately 93 percent of the securities rated AAA
are GNMA, FNMA and FHLMC mortgage-backed securities. No holdings of any
other issuer were greater than ten percent of stockholder's equity.
-41-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
2. Investments (continued)
Available-for-sale securities were sold during 2002 with proceeds of
$10,093,228 and gross realized gains and losses of $297,477 and $135,824,
respectively. Available-for-sale securities were sold during 2001 with
proceeds of $5,493,141 and gross realized gains and losses of $116,565 and
$390,732, respectively. Available-for-sale securities were sold during 2000
with proceeds of $1,237,116 and gross realized gains and losses of $25,101
and $21,147, respectively.
During the years ended December 31, 2002, 2001, and 2000, the Company also
recognized losses of $145,524, $348,730, and $38,816 respectively due to
other-than-temporary impairments on structured investments and corporate
debt securities. These amounts are reflected in the net realized loss on
investments in the Consolidated Statements of Income. The 2001 realized
losses and other-than temporary impairments include the effect of the
write-downs and sale of high-yield securities discussed below.
The net unrealized gain on available-for-sale securities as of December 31,
2002 and 2001, was $842,880 and $135,964, respectively, with the $706,916
change, net of taxes and deferred policy acquisition costs, reflected as a
separate component in accumulated other comprehensive income for the year
ended December 31, 2002. For the years ended December 31, 2001 and 2000 the
change in net unrealized losses on available-for-sale securities was a
decrease of $667,340 and $122,196, respectively.
During 2001, the Company recorded pretax losses of $828,175 to recognize
the impact of higher default rate assumptions on certain structured
investments; to write down lower rated securities (most of which were sold
during 2001) in connection with Company's decision to lower its risk
profile by reducing the level of its high-yield portfolio, allocating
holdings toward stronger credits, and reducing the concentration of
exposure to individual companies and industry sectors; to write down
certain other investments; and, to adopt EITF Issue 99-20, as previously
discussed. Within the Consolidated Statements of Income, $623,958 of these
losses are included in Net realized losses on investments and $171,269 are
included in Net investment income, with the remaining losses recorded as a
cumulative effect of accounting change.
During 2001, the Company placed a majority of its rated CDO securities and
related accrued interest, (collectively referred to as transferred assets),
having an aggregate book value of $675,347, into a securitization trust. In
return, the Company received $89,535 in cash relating to sales to
unaffiliated investors and retained interests with allocated book amounts
aggregating $585,812. As of December 31, 2002, the retained interests had a
carrying value of approximately $562,000, of which approximately $388,000
is considered investment grade. The book amount is determined by allocating
the previous carrying value of the transferred assets between assets sold
and the retained interests based on their relative fair values. Fair values
are based on the estimated present value of future cash flows. The retained
interests are accounted for in accordance with EITF Issue 99-20.
Fair values of fixed maturity and equity securities represent quoted market
prices and estimated values when quoted prices are not available. Estimated
values are determined by established procedures involving, among other
things, review of market indices, price levels of current offerings of
comparable issues, price estimates, estimated future cash flows and market
data from independent brokers.
-42-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
2. Investments (continued)
Mortgage loans on real estate
At December 31, 2002, approximately 12 percent of the Company's investments
were mortgage loans on real estate. Concentration of credit risk by region
of the United States and by type of real estate are as follows:
December 31, 2002 December 31, 2001
On Balance Funding On Balance Funding
Region Sheet Commitments Sheet Commitments
East North Central $ 611,886 $ - $ 670,387 $ 1,873
West North Central 493,310 25,500 549,015 -
South Atlantic 765,443 2,800 815,837 9,490
Middle Atlantic 318,699 19,100 352,821 9,363
New England 227,150 5,800 274,486 8,700
Pacific 355,622 5,250 355,945 14,618
West South Central 210,435 1,000 214,000 600
East South Central 63,859 - 55,798 -
Mountain 406,459 - 413,053 27
---------- ------- ---------- -------
3,452,863 59,450 3,701,342 44,671
Less reserves for losses 35,212 - 20,948 -
---------- ------- ---------- -------
Total $3,417,651 $59,450 $3,680,394 $44,671
========== ======= ========== =======
December 31, 2002 December 31, 2001
On Balance Funding On Balance Funding
Property type Sheet Commitments Sheet Commitments
Department/retail stores $ 991,984 $20,722 $1,117,195 $13,200
Apartments 622,185 - 694,214 11,531
Office buildings 1,178,434 25,628 1,203,090 7,650
Industrial buildings 344,604 13,100 333,713 2,263
Hotels/motels 102,184 - 108,019 -
Medical buildings 95,189 - 106,927 6,000
Nursing/retirement homes 35,873 - 39,590 -
Mixed use 54,512 - 86,972 27
Other 27,898 - 11,622 4,000
---------- ------- ---------- -------
3,452,863 59,450 3,701,342 44,671
Less reserves for losses 35,212 - 20,948 -
---------- ------- ---------- -------
Total $3,417,651 $59,450 $3,680,394 $44,671
========== ======= ========== =======
Mortgage loan fundings are restricted by state insurance regulatory
authorities to 80 percent or less of the market value of the real estate at
the time of origination of the loan. The Company holds the mortgage
document, which gives it the right to take possession of the property if
the borrower fails to perform according to the terms of the agreement.
Commitments to fund mortgages are made in the ordinary course of business.
The fair value of the mortgage commitments is $nil.
-43-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
2. Investments (continued)
At December 31, 2002, 2001 and 2000, the Company's investment in impaired
loans was $33,130, $39,601 and $24,999, respectively, with related reserves
of $9,100, $7,225 and $4,350, respectively.
During 2002, 2001 and 2000, the average recorded investment in impaired
loans was $36,583, $24,498 and $27,063, respectively.
The Company recognized $1,090, $1,285 and $1,033 of interest income related
to impaired loans for the years ended December 31, 2002, 2001 and 2000,
respectively.
The following table presents changes in the reserves for mortgage loan
losses:
2002 2001 2000
Balance, January 1 $20,948 $11,489 $28,283
Provision for mortgage loan losses 14,264 14,959 (14,894)
Loan payoffs - - (1,200)
Foreclosures and write-offs - (5,500) (700)
------- ------- -------
Balance, December 31 $35,212 $20,948 $11,489
======= ======= =======
Sources of investment income and realized losses on investments
Net investment income for the years ended December 31 is summarized as
follows:
2002 2001 2000
Income on fixed maturities $1,331,547 $1,276,966 $1,473,560
Income on mortgage loans 274,524 290,608 286,611
Other (15,642) (41,927) 9,834
----------- ----------- ----------
1,590,429 1,525,647 1,770,005
Less investment expenses 28,573 39,959 39,400
---------- ---------- ----------
Total $1,561,856 $1,485,688 $1,730,605
========== ========== ==========
Net realized losses on investments for the years ended December 31 is
summarized as follows:
2002 2001 2000
Fixed maturities $ 16,129 $(622,897) $(34,862)
Mortgage loans (15,586) (17,834) 16,794
Other investments (5,050) (9,021) 1,093
--------- ---------- --------
Total $ (4,507) $(649,752) $(16,975)
========= ========== =========
-44-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
3. Income taxes
The Company qualifies as a life insurance company for federal income tax
purposes. As such, the Company is subject to the Internal Revenue Code
provisions applicable to life insurance companies.
The income tax expense (benefit) for the years ended December 31 consists
of the following:
2002 2001 2000
Federal income taxes
Current $(30,648) $ 88,121 $176,397
Deferred 116,996 (234,673) 37,704
------- ---------- --------
86,348 (146,552) 214,101
State income taxes-current 1,478 1,330 7,526
-------- --------- --------
Income tax expense (benefit) before cumulative effect of
accounting change 87,826 (145,222) 221,627
Cumulative effect of accounting change income tax benefit
- (11,532) -
-------- ---------- --------
Income tax expense (benefit) $ 87,826 $(156,754) $221,627
======== ========== ========
Income tax expense (benefit) before the cumulative effect of accounting
change differs from that computed by using the federal statutory rate of
35%. The principal causes of the difference in each year are shown below:
2002 2001 2000
Provision Rate Provision Rate Provision Rate
Federal income taxes based
on the statutory rate $164,502 35.0% ($66,136) (35.0)% $282,542 35.0%
Tax-exempt interest and
dividend income (5,260) (1.1) (4,663) (2.5) (3,788) (0.5)
State taxes, net of federal
benefit 961 0.2 865 0.4 4,892 0.6
Affordable housing credits (70,000) (14.9) (73,200) (38.7) (54,569) (6.8)
Other, net (2,377) (0.5) (2,088) (1.1) (7,450) (0.8)
--------- -------- ---------- ------- --------- -----
Total income taxes $ 87,826 18.7% ($145,222) (76.9)% $221,627 27.5%
======== ======= ========== ======= ======== =====
A portion of life insurance company income earned prior to 1984 was not
subject to current taxation but was accumulated, for tax purposes, in a
"policyholders' surplus account". At December 31, 2002, the Company had a
policyholders' surplus account balance of $20,114. The policyholders'
surplus account is only taxable if dividends to the stockholder exceed the
stockholder's surplus account or if the Company is liquidated. Deferred
income taxes of $7,040 have not been established because no distributions
of such amounts are contemplated.
-45-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
3. Income taxes (continued)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred income tax assets and
liabilities as of December 31 are as follows:
2002 2001
Deferred income tax assets:
Policy reserves $ 683,144 $ 705,637
Other investments 319,829 333,857
Other 29,789 24,640
----------- ----------
Total deferred income tax assets 1,032,762 1,064,134
---------- ---------
Deferred income tax liabilities:
Deferred policy acquisition costs 929,751 861,892
Net unrealized gain - available-for-sale securities 267,787 45,934
Other 17,283 -
---------- ----------
Total deferred income tax liabilities 1,214,821 907,826
---------- ----------
Net deferred income tax (liability) asset $ (182,059) $ 156,308
========== ==========
The Company is required to establish a valuation allowance for any portion
of the deferred income tax assets that management believes will not be
realized. In the opinion of management, it is more likely than not that the
Company will realize the benefit of the deferred income tax assets and,
therefore, no such valuation allowance has been established.
4. Stockholder's equity
Retained earnings available for distribution as dividends to AEFC are
limited to the Company's surplus as determined in accordance with
accounting practices prescribed by state insurance regulatory authorities.
The Company's statutory unassigned surplus aggregated $1,323,324 and
$1,262,335 as of December 31, 2002 and 2001, respectively (see Note 3 with
respect to the income tax effect of certain distributions). In addition,
any dividend distributions in 2003 in excess of $240,838 would require
approval of the Department of Commerce of the State of Minnesota.
Statutory net income (loss) for the years ended December 31 and capital and
surplus as of December 31 are summarized as follows:
2002 2001 2000
Statutory net income (loss) $ 159,794 $ (317,973) $ 344,973
Statutory capital and surplus 2,408,379 1,947,350 1,778,306
The National Association of Insurance Commissioners (NAIC) revised the
Accounting Practices and Procedures Manual in a process referred to as
Codification. The revised regulations took effect January 1, 2001. The
domiciliary states of the Company and its insurance subsidiaries adopted
the provisions of the revised manual, with the exception of certain
provisions not adopted by its subsidiaries organized in the state of New
York. The revised manual changed, to some extent, prescribed statutory
accounting practices and resulted in changes to the accounting practices
that the Company uses to prepare its statutory-basis financial statements.
The impact of implementing these changes was a decrease of $39,997 to the
Company's statutory-basis capital and surplus as of January 1, 2001.
Effective January 1, 2002 the Company's subsidiaries organized in the state
of New York
-46-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
4. Stockholder's equity (continued)
adopted additional provisions of the manual which resulted in an increase
of $5,597 to the Company's statutory-basis capital and surplus as of
January 1, 2002.
5. Related party transactions
The Company loans funds to AEFC under a collateral loan agreement. The
balance of the loan was $nil at December 31, 2002 and 2001. This loan can
be increased to a maximum of $75,000 and pays interest at a rate equal to
the preceding month's effective new money rate for the Company's permanent
investments. Interest income on related party loans totaled $nil in 2002,
2001 and 2000.
The Company participates in the American Express Company Retirement Plan
which covers all permanent employees age 21 and over who have met certain
employment requirements. Company contributions to the plan are based on
participants' age, years of service and total compensation for the year.
Funding of retirement costs for this plan complies with the applicable
minimum funding requirements specified by ERISA. The Company's share of the
total net periodic pension cost was $294, $263 and $250 in 2002, 2001 and
2000, respectively.
The Company also participates in defined contribution pension plans of
American Express Company which cover all employees who have met certain
employment requirements. Company contributions to the plans are a percent
of either each employee's eligible compensation or basic contributions.
Costs of these plans charged to operations in 2002, 2001 and 2000 were
$1,411, $662 and $1,707, respectively.
The Company participates in defined benefit health care plans of AEFC that
provide health care and life insurance benefits to retired employees and
retired financial advisors. The plans include participant contributions and
service related eligibility requirements. Upon retirement, such employees
are considered to have been employees of AEFC. AEFC expenses these benefits
and allocates the expenses to its subsidiaries. The cost of these plans
charged to operations in 2002, 2001 and 2000 was $1,835, $1,011 and $1,136,
respectively.
Charges by AEFC for use of joint facilities, technology support, marketing
services and other services aggregated $526,081, $505,526 and $582,836 for
2002, 2001 and 2000, respectively. Certain of these costs are included in
DAC. Expenses allocated to the Company may not be reflective of expenses
that would have been incurred by the Company on a stand-alone basis.
Included in other liabilities at December 31, 2002 and 2001 are $55,602 and
$68,919, respectively, payable to AEFC for federal income taxes.
6. Lines of credit
The Company has available lines of credit with AEFC aggregating $200,000
($100,000 committed and $100,000 uncommitted). The interest rate for any
borrowings is established by reference to various indices plus 20 to 45
basis points, depending on the term. There were no borrowings outstanding
under this agreement at December 31, 2002 and 2001.
-47-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
7. Commitments and contingencies
At December 31, 2002, 2001 and 2000, traditional life and universal
life-type insurance in force aggregated $119,173,734, $108,255,014 and
$98,060,472 respectively, of which $38,008,734, $25,986,706 and $17,429,851
was reinsured at the respective year ends. The Company also reinsures a
portion of the risks assumed under long-term care policies. Under all
reinsurance agreements, premiums ceded to reinsurers amounted to $129,345,
$114,534 and $89,506 and reinsurance recovered from reinsurers amounted to
$60,567, $43,388, and $32,500 for the years ended December 31, 2002, 2001
and 2000, respectively. Reinsurance contracts do not relieve the Company
from its primary obligation to policyholders.
At December 31, 2002, the Company had no commitments to purchase
investments other than mortgage loan fundings (see Note 2).
The Company is a party to litigation and arbitration proceedings in the
ordinary course of its business, none of which is expected to have a
material adverse affect on the Company.
In recent years, life insurance companies have been named as defendants in
lawsuits, including class action lawsuits, alleging improper life insurance
sales practices, alleged agent misconduct, failure to properly supervise
agents and other matters relating to life insurance policies and annuity
contracts. The Company and its affiliates were named defendants in three
purported class-action lawsuits alleging improper insurance and annuity
sales practices including improper replacement of existing annuity
contracts and insurance policies, improper use of annuities to fund tax
deferred contributory retirement plans, alleged agent misconduct, failure
to properly supervise agents and other matters relating to life insurance
policies and annuity contracts. A fourth lawsuit was filed against the
Company and its affiliates in federal court. In January 2000, AEFC reached
an agreement in principle to settle the four class action lawsuits
described above. It is expected the settlement will provide $215,000 of
benefits to more than two million participants in exchange for a release by
class members of all insurance and annuity state and federal market conduct
claims dating back to 1985. The settlement received court approval.
Implementation of the settlement commenced October 15, 2001 and is
substantially complete. Claim review payments have been made. Numerous
individuals opted out of the settlement described above and therefore did
not release their claims against AEFC and its subsidiaries. Some of these
class members who opted out were represented by counsel and presented
separate claims to AEFC and the Company. Most of their claims have been
settled.
The outcome of any litigation or threatened litigation cannot be predicted
with any certainty. However, in the aggregate, the Company does not
consider any lawsuits in which it is named as a defendant to have a
material impact on the Company's financial position or operating results.
The IRS routinely examines the Company's federal income tax returns and is
currently conducting an audit for the 1993 through 1996 tax years.
Management does not believe there will be a material adverse effect on the
Company's consolidated financial position as a result of these audits.
-48-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
8. Derivative financial instruments
The Company maintains an overall risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned
fluctuations in earnings caused by interest rate and equity market
volatility. The Company does not enter into derivative instruments for
speculative purposes. As prescribed by SFAS No. 133, derivative instruments
that are designated and qualify as hedging instruments are classified as
cash flow hedges, fair value hedges, or hedges of a net investment in a
foreign operation, based upon the exposure being hedged. The Company
currently has economic hedges that either do not qualify or are not
designated for hedge accounting treatment under SFAS No. 133.
The Company enters into interest rate swaps, caps and floors to manage the
Company's interest rate risk and options and futures to manage equity-based
risk. The values of derivative financial instruments are based on market
values, dealer quotes or pricing models.
Market risk is the possibility that the value of the derivative financial
instruments will change due to fluctuations in a factor from which the
instrument derives its value, primarily an interest rate or equity market
index. The Company is not impacted by market risk related to derivatives
held for non- trading purposes beyond that inherent in cash market
transactions. Derivatives held for purposes other than trading are largely
used to manage risk and, therefore, the cash flow and income effects of the
derivatives are inverse to the effects of the underlying transactions.
Credit risk is the possibility that the counterparty will not fulfill the
terms of the contract. The Company monitors credit risk related to
derivative financial instruments through established approval procedures,
including setting concentration limits by counterparty, and requiring
collateral, where appropriate. A vast majority of the Company's
counterparties are rated A or better by Moody's and Standard & Poor's.
Interest rate caps, swaps and floors are primarily used to protect the
margin between interest rates earned on investments and the interest rates
credited to related annuity contract holders. No interest rate swaps or
floors were outstanding as of December 31, 2002. The interest rate caps
expire in January 2003. The fair value of the interest rate caps is
included in Other assets. Changes in the value of the interest rate caps
are included in Other insurance and operating expenses.
A purchased (written) option conveys the right (obligation) to buy or sell
an instrument at a fixed price for a set period of time or on a specific
date. The Company writes and purchases index options to manage the risks
related to annuity products that pay interest based upon the relative
change in a major stock market index between the beginning and end of the
product's term (equity-indexed annuities). The Company views this strategy
as a prudent management of equity market sensitivity, such that earnings
are not exposed to undue risk presented by changes in equity market levels.
The equity indexed annuities contain embedded derivatives, essentially the
equity based return of the product, which must be separated from the host
contract and accounted for as derivative instruments per SFAS No. 133. As a
result of fluctuations in equity markets, and the corresponding changes in
value of the embedded derivatives, the amount of interest credited incurred
by the Company related to the annuity product will positively or negatively
impact reported earnings.
-49-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
8. Derivative financial instruments (continued)
The purchased and written options are carried at fair value and included in
Other assets and Other liabilities, respectively. The fair value of the
embedded options are included in Future policy benefits for fixed
annuities. The changes in fair value of the options are recognized in Other
insurance and operating expenses and the embedded derivatives are
recognized in Interest credited on universal life-type insurance and
investment contracts. The purchased and written options expire on various
dates through 2009.
The Company also purchases futures to hedge its obligations under equity
indexed annuities. The futures purchased are marked-to-market daily and
exchange traded, exposing the Company to no counterparty risk. The futures
contracts mature in 2003.
Index options may be used to manage the equity market risk related to the
fee income that the Company receives from its separate accounts and the
underlying mutual funds. The amount of the fee income received is based
upon the daily market value of the separate account and mutual fund assets.
As a result, the Company's fee income could be impacted significantly by
fluctuations in the equity market. There are no index options outstanding
as of December 31, 2002 related to this strategy.
9. Fair values of financial instruments
The Company discloses fair value information for financial instruments for
which it is practicable to estimate that value. Fair values of life
insurance obligations and all non-financial instruments, such as DAC, are
excluded. Off-balance sheet intangible assets, such as the value of the
field force, are also excluded. Management believes the value of excluded
assets and liabilities is significant. The fair value of the Company,
therefore, cannot be estimated by aggregating the amounts presented.
2002 2001
Carrying Fair Carrying Fair
Financial Assets Value Value Value Value
Fixed maturities $24,052,104 $24,052,104 $20,157,137 $20,157,137
Common stocks 21 21 1,704 1,704
Mortgage loans on real estate 3,417,651 3,815,362 3,680,394 3,845,950
Cash and cash equivalents 4,424,061 4,424,061 1,150,251 1,150,251
Other investments 110,574 108,813 75,721 75,721
Derivatives 24,016 24,016 34,477 34,477
Separate account assets 21,980,674 21,980,674 27,333,697 27,333,697
Financial Liabilities
Future policy benefits for fixed annuities $21,911,497 $21,282,750 $18,139,462 $17,671,777
Derivatives 9,099 9,099 2,506 2,506
Separate account liabilities 19,391,316 18,539,425 24,280,092 23,716,854
-50-
IDS LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands)
9. Fair values of financial instruments
At December 31, 2002 and 2001, the carrying amount and fair value of future
policy benefits for fixed annuities exclude life insurance-related
contracts carried at $1,432,294 and $1,368,254, respectively, and policy
loans of $67,523 and $84,557, respectively. The fair value of these
benefits is based on the status of the annuities at December 31, 2002 and
2001. The fair value of deferred annuities is estimated as the carrying
amount less any applicable surrender charges and related loans. The fair
value for annuities in non-life contingent payout status is estimated as
the present value of projected benefit payments at rates appropriate for
contracts issued in 2002 and 2001.
At December 31, 2002 and 2001, the fair value of liabilities related to
separate accounts is estimated as the carrying amount less any applicable
surrender charges and less variable insurance contracts carried at
$2,589,358 and $3,053,605, respectively.
-51-