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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 30(a) OF THE INVESTMENT COMPANY ACT
OF 1940 AND SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________________ to
__________________________.
Commission file number 2-23772.
IDS Certificate Company
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(Exact name of registrant as specified in its charter)
Delaware 41-6009975
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
IDS Tower 10, Minneapolis, Minnesota 55440
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (612) 671-3131
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: None Name of each exchange on which registered: None
Securities registered pursuant to Section 12(g) of the Act:
Title of class: 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. [X]
Aggregate market value of the voting stock held by non-affiliates of the
registrant. None
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
150,000 Common shares
CERTAIN DOCUMENTS INCORPORATED BY REFERENCE.
None
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 reduced
disclosure format.
The Exhibit Index is located on sequential pages 18-20.
Item 1. Business
IDS Certificate Company (IDSC) is incorporated under the laws of
Delaware. Its principal executive offices are located in the IDS Tower,
Minneapolis, Minnesota, and its telephone number is (612) 671-3131. American
Express Financial Corporation (formerly known as IDS Financial Corporation), a
Delaware corporation, IDS Tower 10, Minneapolis, Minnesota 55440-0010, owns 100%
of the outstanding voting securities of IDSC. As of January 1, 1995 IDS
Financial Corporation changed its name to American Express Financial
Corporation. American Express Financial Corporation is a wholly owned subsidiary
of American Express Company (American Express), a New York Corporation, with
headquarters at American Express Tower, World Financial Center, New York, New
York.
IDSC is a face-amount certificate investment company, registered under
the Investment Company Act of 1940 (1940 Act). IDSC is in the business of
issuing face-amount certificates. Face-amount certificates issued by IDSC
entitle the certificate owner to receive, at maturity, a stated amount of money
and interest or credits declared from time to time by IDSC, in its discretion.
IDSC is continuously engaged in new product development. IDSC currently offers
nine certificates to the public: "IDS Cash Reserve Certificate," "IDS Flexible
Savings Certificate" (formerly "IDS Variable Term Certificate"), "IDS
Installment Certificate," "IDS Preferred Investors Certificate," "IDS Stock
Market Certificate" (marketed in some channels as "American Express Stock Market
Certificate"), "IDS Market Strategy Certificate," "American Express Investors
Certificate" (including a form of American Express Investors Certificate offered
to select investors who, among other things, invest at least $50 million in the
certificate), and "American Express Special Deposits." The American Express
Special Deposits is only marketed in England and Hong Kong and is not registered
for sale in the United States. All certificates are currently sold without a
sales charge. The IDS Installment Certificate, the IDS Flexible Savings
Certificate, the IDS Stock Market Certificate (including the American Express
Stock Market Certificate), the IDS Preferred Investors Certificate, the IDS
Market Strategy Certificate, the American Express Investors Certificate and the
American Express Special Deposits currently bear surrender charges for premature
surrenders. All of the above described certificates, except the American Express
Special Deposits, are distributed pursuant to a Distribution Agreement with
American Express Financial Advisors Inc. (formerly known as IDS Financial
Services Inc.), an affiliate of IDSC. With respect to the American Express
Investors Certificate and the American Express Stock Market Certificate,
American Express Financial Advisors Inc., in turn, has Selling Agent Agreements
with American Express Bank International (AEBI), a subsidiary of American
Express, and Coutts & Co. (USA) International (Coutts), a subsidiary of National
Westminster Bank PLC, for selling the certificates. With respect to the American
Express Special Deposits, IDSC has a Marketing Agreement with American Express
Bank Ltd. (AEB), a subsidiary of American Express, for marketing the
certificate. IDSC has a Distribution Agreement with American Express Service
Corporation (AESC) under which AESC can distribute the IDS Stock Market
Certificate and potentially other certificates through a direct marketing
channel of distribution known as American Express Financial Direct. As of
December 31, 1998, no certificates have been distributed through AESC. With
respect to IDS Stock Market Certificate, American Express Financial Advisors
Inc. has a Selling Agent Agreement effective March 1999 with Securities America
Inc., an affiliate of IDSC. There is no assurance that IDS certificates will be
distributed by AESC or sold by Securities America Inc.
AEBI and Coutts are Edge Act corporations organized under the
provisions of Section 25(a) of the Federal Reserve Act. American Express
Financial Advisors Inc. has entered into a consulting agreement with AEBI under
which AEBI provides consulting services related to any selling agent agreements
between American Express Financial Advisors Inc. and other Edge Act
corporations.
IDSC also offers one certificate in connection with certain employee
benefit plans available to eligible American Express Financial Corporation
employees, financial advisors, retirees, and eligible employees of the IDS
Mutual Fund Group, and to IRAs of persons retired as employees or financial
advisors with American Express Financial Corporation. This certificate is called
the Series D-1 Investment Certificate.
Except for the American Express Investors Certificate and the American
Express Special Deposits, all of the certificates are available as qualified
investments for Individual Retirement Accounts (IRAs), or 401(k) plans and other
qualified retirement plans.
The specified maturities of the certificates range from ten to twenty
years. Within that maturity period, most certificates have terms ranging from
three to thirty-six months. Interest rates change and certificate owners can
surrender their certificates without penalty at term end.
The IDS Cash Reserve Certificate is a single pay certificate that
permits additional investments and on which IDSC guarantees interest in advance
for a three-month term.
The IDS Flexible Savings Certificate is a single payment certificate
that permits a limited amount of additional payments and on which IDSC
guarantees interest in advance for a term of 6, 12, 18, 24, 30, or 36 months,
and potentially other terms, at the buyer's option.
The IDS Installment Certificate is an installment payment certificate
that declares interest in advance for a three-month period and offers bonuses in
the second through ninth years for regular investments.
The IDS Stock Market Certificate is a single payment certificate that offers the
certificate owner the opportunity to have all or part of his/her interest tied
to 52- week stock market performance, as measured by a broad stock market index,
with return of principal guaranteed by IDSC. The owner can also choose to earn a
fixed rate of interest. This certificate is sold to clients of American Express
Financial Advisors Inc., and is available through Securities America Inc. under
a Selling Agent Agreement effective March 1999 with American Express Financial
Advisors Inc., and may be available from time to time through American Express
Service Corporation under its Distribution Agreement with IDSC. This certificate
is marketed as the American Express Stock Market Certificate by AEBI and Coutts,
under Selling Agent Agreements with American Express Financial Advisors Inc., to
AEBI's clients and certain of Coutts' clients, respectively, who are neither
citizens nor residents of the United States.
The IDS Market Strategy Certificate is a single payment certificate
that pays interest at a fixed rate or that offers the owner the opportunity to
have all or part of his/her interest tied to 52- week stock market performance
as measured by a broad stock market index, for a series of 52- week terms
starting every month or at intervals the owner selects.
The American Express Investors Certificate is a single payment
certificate that generally permits additional payments within 15 days of term
renewal. Interest rates are guaranteed in advance by IDSC for a term of 1, 2, 3,
6, 12, 24, or 36 months, at the buyer's option. This certificate is currently
sold by AEBI and Coutts, under Selling Agent Agreements with American Express
Financial Advisors Inc., only to AEBI's clients and certain of Coutts' clients,
respectively, who are neither citizens nor residents of the United States.
The IDS Preferred Investors Certificate is a single payment certificate
that combines a fixed rate of return with IDSC's guarantee of principal for
investments of $250,000 to $5,000,000.
The American Express Special Deposits is a single payment certificate
that generally permits additional payments within 15 days of term renewal.
Interest rates are guaranteed in advance by IDSC for a term of 1, 2, 3, 6, 12,
24, or 36 months (by the date of term renewal in the case of 1- month terms), at
the buyer's option. This certificate is currently marketed by AEB through its
London and Hong Kong offices, under a Marketing Agreement with IDSC, only to
AEB's clients who are neither citizens nor residents of the United States. This
certificate is not registered for sale in the United States.
To IDSC's knowledge, IDSC is by far the largest issuer of face-amount
certificates in the United States. However, such certificates compete with many
other investments offered by banks, savings and loan associations, mutual funds,
broker-dealers and others, which may be viewed by potential clients as offering
a comparable or superior combination of safety and return on investment. In
particular, some of IDSC's products are designed to be competitive with the
types of investment offered by banks and thrifts. Since IDSC's face-amount
certificates are securities, their offer and sale are subject to regulation
under federal and state securities laws. IDSC's certificates are backed by its
qualified assets on deposit and are not insured by any governmental agency or
other entity.
For all the certificates, except for the American Express Investors
Certificate, IDS Preferred Investors Certificate, and the American Express
Special Deposits, IDSC's current policy is to re-evaluate the certificate rates
weekly to respond to marketplace changes. For the American Express Investors
Certificate, IDS Preferred Investors Certificate, and the American Express
Special Deposits, IDSC's current policy is to re-evaluate the rates on a daily
basis. For each product, IDSC refers to an independent index to set the rates
for new sales. Except for American Express Special Deposits, IDSC must set the
rates for an initial purchase of the certificate within a specified range of the
rate from such index. For renewals, IDSC uses such rates as an indication of the
competitors' rates, but is not required to set rates within a specified range.
For the IDS Flexible Savings Certificate, IDS Cash Reserve Certificate
and the IDS Series D-1 Investment Certificate, the published rates of the BANK
RATE MONITOR Top 25 Market Average tm for various length bank certificates of
deposit are used as the guide in setting rates. For the IDS Installment
Certificate, the average interest rate for money market deposit accounts, as
published by the BANK RATE MONITOR Top 25 Market Average (the BRM Average), is
used as a guide in setting rates. For the American Express Investors
Certificate, IDS Preferred Investors Certificate, and American Express Special
Deposits, the published average rates for comparable length dollar deposits
available on an interbank basis, referred to as the London Interbank Offered
Rates (LIBOR), are used as a guide in setting rates.
To compete with popular short-term investment vehicles such as
certificates of deposit, money market certificates and money market mutual funds
that offer comparable yields, liquidity and safety of principal, IDSC offers the
IDS Cash Reserve Certificate and the IDS Flexible Savings Certificate. The
yields and features on these products are designed to be competitive with such
short-term products. The American Express Investors Certificate, IDS Preferred
Investors Certificate and American Express Special Deposits also compete with
short-term products but use LIBOR rates. The IDS Installment Certificate is
intended to help clients save systematically and may compete with passbook
savings and NOW accounts. The IDS Stock Market Certificate, American Express
Stock Market Certificate and IDS Market Strategy Certificate are designed to
offer interest tied to a major stock market index and principal guaranteed by
IDSC. Certain banks offer certificates of deposit that have features similar to
the Stock Market Certificate and Market Strategy Certificate.
IDSC's gross income is derived principally from interest and dividends
generated by its investments. IDSC's net income is determined by deducting from
such gross income its provision for certificate reserves, and other expenses,
including taxes, the fee paid to American Express Financial Corporation for
advisory and other services, the distribution fees paid to American Express
Financial Advisors Inc., and marketing fees paid to AEB.
Various forward-looking statements have been made in this 10-K Annual
Report, in particular with regard to Year 2000 issues. Forward-looking
statements may also be made by IDSC in other documents. In addition, from to
time to time, IDSC through its management may make oral forward-looking
statements. Forward-looking statements are subject to uncertainties that could
cause actual results to differ materially from such 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. IDSC undertakes no obligation
to update publicly or revised any forward-looking statements.
The following table shows IDSC's certificate payments received and
certificate surrenders for the three years ended December 31, 1998:
1998 1997 1996
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($ in Millions)
Single Payment Certificates
Non-Qualified
Payments through:
American Express Financial Advisors Inc. $ 685.3 $ 860.2 $ 614.2
AEBI, AEB, and Coutts 303.0 483.5 304.9
Surrenders through:
American Express Financial Advisors Inc. 922.9 733.3 1,062.9
AEBI, AEB, and Coutts 370.6 287.5 297.4
Qualified
Payments through:
American Express Financial Advisors Inc. 122.4 135. 99.9
Surrenders through:
American Express Financial Advisors Inc. 164.7 141.0 165.4
Installment Payment Certificates
Through American Express Financial Advisors Inc.
Non-Qualified
Payments 80.4 99.5 108.3
Surrenders 118.5 103.2 98.0
Qualified
Payments 1.0 1.4 1.7
Surrenders 2.5 2.6 2.6
In 1998, approximately 27% of single payment certificate payments were
through AEBI, AEB, and Coutts, and approximately 11% of single payment
certificate payments and 1% of installment certificate payments were of
tax-qualified certificates for use in IRAs, 401(k) plans and other qualified
retirement plans.
The certificates offered by American Express Financial Advisors Inc.
are sold pursuant to a distribution agreement which is terminable on 60 days'
notice and is subject to annual approval by IDSC's Board of Directors, including
a majority of the directors who are not "interested persons" of American Express
Financial Advisors Inc. or IDSC as that term is defined in the 1940 Act. The
agreement provides for the payment of distribution fees to American Express
Financial Advisors Inc. for services provided thereunder. American Express
Financial Advisors Inc. is a wholly owned subsidiary of American Express
Financial Corporation. For the sale of the American Express Investors
Certificate and the American Express Stock Market Certificate, American Express
Financial Advisors Inc., in turn, has Selling Agent Agreements with AEBI and
Coutts. For the sale of IDS Stock Market Certificate, American Express Financial
Advisors Inc. has a Selling Agent Agreement with Securities America Inc.
effective March 1999. For the distribution of the IDS Stock Market Certificate
through American Express Financial Direct, IDSC has a distribution agreement
with American Express Service Corporation. For marketing American Express
Special Deposits, IDSC has a Marketing Agreement with AEB. These agreements are
terminable upon 60 days' notice and subject to annual review by directors who
are not "interested persons" of American Express Financial Advisors Inc. or IDSC
except that such annual review is not required for selling agent agreements.
IDSC receives advice, statistical data and recommendations with respect
to the acquisition and disposition of securities for its portfolio from American
Express Financial Corporation, under an investment management agreement which is
subject to annual review by IDSC's Board of Directors, including a majority of
the directors who are not "interested persons" of American Express Financial
Corporation or IDSC.
IDSC is required to maintain cash and "qualified investments" meeting
the standards of Section 28(b) of the 1940 Act, as modified by an order of the
Securities and Exchange Commission (the SEC). The amortized cost of said
investments must be at least equal to IDSC's net liabilities on all outstanding
face-amount certificates plus $250,000. So long as IDSC wishes to rely on the
SEC order, as a condition to the order IDSC has agreed to maintain an amount of
unappropriated retained earnings and capital equal to at least 5% of net
certificate reserves. For these purposes, net certificate reserves means
certificate reserves less outstanding certificate loans. In determining
compliance with this condition, qualified investments are valued in accordance
with the provisions of Minnesota Statutes where such provisions are applicable.
IDSC's qualified assets consist of cash and cash equivalents, first mortgage
loans on real estate, U.S. government and government agency securities,
municipal bonds, corporate bonds, preferred stocks and other securities meeting
specified standards. IDSC is subject to annual examination and supervision by
the State of Minnesota, Department of Commerce (Banking Division).
Distribution fees on sales of certain certificates are deferred and
amortized over the estimated lives of the related certificates, which is
approximately 10 years. Upon surrender, unamortized deferred distribution fees
and any related surrender charges are recognized in income. Thus, these
certificates must remain in effect for a period of time to permit IDSC to
recover such costs.
Item 2. Properties
None.
Item 3. Legal Proceedings
Registrant has no material pending legal proceedings other than
ordinary routine litigation incidental to its business.
Item 4. Submission of Matters to a Vote of Security Holders
Item omitted pursuant to General Instructions I(2)(c) of Form 10-K.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
There is no market for the Registrant's common stock since it is a
wholly owned subsidiary of American Express Financial Corporation and,
indirectly, of American Express. Frequency and amount of cash dividends declared
during the past two years are as follows:
Dividend Payable Date
For the year ended December 31, 1998:
April 8, 1998 $ 4,500,000
November 17, 1998 25,000,000
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$29,500,000
Dividend Payable Date
For the year ended December 31, 1997: $ NONE
Restriction on the Registrant's present or future ability to pay
dividends:
Certain series of installment certificates outstanding provide that
cash dividends may be paid by IDSC only in calendar years for which additional
credits of at least 1/2 of 1% on such series of certificates have been
authorized by IDSC. This restriction has been removed for 1999 and 2000 by
IDSC's declaration of additional credits in excess of this requirement.
Appropriated retained earnings resulting from the predeclaration of
additional credits to IDSC's certificate owners are not available for the
payment of dividends by IDSC. In addition, IDSC will discontinue issuance of
certificates subject to the predeclaration of additional credits and will make
no further predeclaration as to outstanding certificates if at any time the
capital and unappropriated retained earnings of IDSC should be less than 5% of
net certificate reserves (certificate reserves less certificate loans). At
December 31, 1998, the capital and unappropriated retained earnings amounted to
6.20% of net certificate reserves.
Item 6. Selected Financial Data
Summary of selected financial information
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The following selected financial information has been derived from the audited financial statements and should be
read in conjunction with those statements and the related notes to financial statements. Also see "Management's
discussion and analysis of financial condition and results of operations" for additional comments.
Year Ended Dec. 31, 1998 1997 1996 1995 1994
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($ thousands)
Statement of Operations Data
Investment income $273,135 $258,232 $251,481 $256,913 $207,975
Investment expenses 76,811 70,137 62,851 62,817 58,690
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Net investment income before provision for
certificate reserves and income tax benefit 196,324 188,095 188,630 194,096 149,285
Net provision for certificate reserves 167,108 165,136 171,968 176,407 107,288
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Net investment income before income
tax benefit 29,216 22,959 16,662 17,689 41,997
Income tax benefit 265 3,682 6,537 9,097 2,663
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Net investment income 29,481 26,641 23,199 26,786 44,660
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Net realized gain (loss) on investments:
Securities of unaffiliated issuers 5,143 980 (444) 452 (7,514)
Other - unaffiliated - - 101 (120) 1,638
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Net realized gain (loss) on investments
before income taxes 5,143 980 (343) 332 (5,876)
Income tax (expense) benefit (1,800) (343) 120 (117) 2,047
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Net realized gain (loss) on investments 3,343 637 (223) 215 (3,829)
Net income - wholly owned subsidiary 1,646 328 1,251 373 241
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Net income $34,470 $27,606 $24,227 $27,374 $41,072
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Cash Dividends Declared $29,500 $- $65,000 $- $40,200
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Balance Sheet Data
Total assets $3,834,244 $4,053,648 $3,563,234 $3,912,131 $3,040,857
Certificate loans 32,343 37,098 43,509 51,147 58,203
Certificate reserves 3,404,883 3,724,978 3,283,191 3,628,574 2,887,405
Stockholder's equity 222,033 239,510 194,550 250,307 141,852
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IDS Certificate Company (IDSC) is 100% owned by American Express Financial
Corporation (Parent).
Item 7.
Management's discussion and analysis of financial condition and results
of operations
Results of operations:
IDS Certificate Company's (IDSC) earnings are derived primarily from the
after-tax yield on invested assets less investment expenses and interest
credited on certificate reserve liabilities. Changes in earnings' trends occur
largely due to changes in the rates of return on investments and the rates of
interest credited to certificate owner accounts and also, the mix of fully
taxable and tax-advantaged investments in the IDSC portfolio.
During the year 1998, total assets and certificate reserves decreased due
primarily to certificate maturities and surrenders exceeding certificate sales.
The excess of certificate maturities and surrenders over certificate sales
resulted primarily from lower accrual rates declared by IDSC during the year.
The decrease in total assets in 1998 reflects also, a decrease in net unrealized
appreciation on investment securities classified as available for sale of $35
million and cash dividends paid to Parent of $30 million.
During the year 1997, total assets and certificate reserves increased due to
certificate sales exceeding certificate maturities and surrenders. The excess of
certificate sales over maturities and surrenders resulted primarily from a
special introductory offer of the seven- and 13-month term IDS Flexible Savings
Certificate. The increase in total assets in 1997 reflects also, an increase of
$27 million in net unrealized appreciation on investment securities classified
as available for sale.
1998 Compared to 1997:
Gross investment income increased 5.8% due primarily to a higher average balance
of invested assets partially offset by slightly lower yields.
Investment expenses increased 9.5% in 1998. The increase resulted primarily from
higher amortization of premiums paid for index options of $6.4 million, higher
interest expense on reverse repurchase and interest rate swap agreements of $5.2
million, and $3.9 million of fees paid under a transfer agent agreement with
American Express Client Service Corporation effective Jan. 1, 1998. Prior to
Jan. 1, 1998, transfer agent services were provided by AEFC under the investment
advisory and services fee agreement. These higher expenses were partially offset
by lower investment advisory and services fees of $8.1 million and lower
distribution fees of $.7 million.
Net provision for certificate reserves increased 1.2% due primarily to the net
of a higher average balance of certificate reserves and lower accrual rates
during 1998.
The decrease in income tax benefit resulted primarily from a lesser portion of
net investment income before income tax benefit being attributable to
tax-advantaged income.
1997 Compared to 1996:
Gross investment income increased 2.7% due primarily to a higher average balance
of invested assets.
Investment expenses increased 12% in 1997. The increase resulted primarily from
higher amortization of premiums paid for index options of $4.4 million, higher
distribution fees of $1.8 million and $3.2 million of interest expense on
reverse repurchase and interest rate swap agreements entered into in 1997. These
higher expenses were partially offset by $2.3 million lower amortization of
premiums paid for interest rate caps, corridors and floors due primarily to the
expiration of the cap and corridor agreements in 1996 and early 1997.
Net provision for certificate reserves decreased 4.0% due primarily to the net
of lower accrual rates and a higher average balance of certificate reserves
during 1997.
The decrease in income tax benefit resulted primarily from a lesser portion of
net investment income before income tax benefit being attributable to
tax-advantaged income.
Liquidity and cash flow:
IDSC's principal sources of cash are payments from sales of face-amount
certificates and cash flows from investments. In turn, IDSC's principal uses of
cash are payments to certificate owners for matured and surrendered
certificates, purchase of investments and payments of dividends to its Parent.
Certificate sales remained strong in 1998 reflecting clients' ongoing desire for
safety of principal. Sales of certificates totaled $1.1 billion in 1998 compared
to $1.5 billion in 1997 and $1.0 billion in 1996. The higher certificate sales
in 1997 over 1996 resulted primarily from a special introductory promotion of
the seven- and 13-month term IDS Flexible Savings Certificate which produced
sales of $238 million. Certificate sales in 1997 benefited also, from higher
sales of the IDS Preferred Investors Certificate of $113 million and sales of
the American Express Special Deposits Certificate of $85 million. The IDS
Preferred Investors Certificate was first offered for sale early in the last
quarter of 1996. The American Express Special Deposits Certificate was first
offered for sale to private banking clients of American Express Bank Ltd. in
Hong Kong late in the third quarter of 1997.
The special promotion of the seven- and 13-month term IDS Flexible Savings
Certificate was offered from Sept. 10, 1997 to Nov. 25, 1997, and applied only
to sales of new certificate accounts during the promotion period. Certificates
sold during the promotion period received a special interest rate, determined on
a weekly basis, of one percentage point above the Bank Rate Monitor Top 25
Market AverageTM of comparable length certificates of deposit.
Certificate maturities and surrenders totaled $1.7 billion during 1998 compared
to $1.3 billion in 1997 and $1.7 billion in 1996. The higher certificate
maturities and surrenders in 1998 resulted primarily from $242 million of
surrenders of the seven- and 13-month IDS Flexible Savings Certificate. The
higher certificate maturities and surrenders in 1996 resulted primarily from
$461 million of surrenders of the 11-month IDS Flexible Savings Certificate.
These surrenders resulted primarily from lower accrual rates declared by IDSC at
term renewal, reflecting interest rates available in the marketplace.
IDSC, as an issuer of face-amount certificates, is affected whenever there is a
significant change in interest rates. In view of the uncertainty in the
investment markets and due to the short-term repricing nature of certificate
reserve liabilities, IDSC continues to invest in securities that provide for
more immediate, periodic interest/principal payments, resulting in improved
liquidity. To accomplish this, IDSC continues to invest much of its cash flow in
intermediate-term bonds and mortgage-backed securities.
IDSC's investment program is designed to maintain an investment portfolio that
will produce the highest possible after-tax yield within acceptable risk
standards with additional emphasis on liquidity. The program considers
investment securities as investments acquired to meet anticipated certificate
owner obligations.
Under Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting
for Certain Investments in Debt and Equity Securities", debt securities that
IDSC has both the positive intent and ability to hold to maturity are carried at
amortized cost. Debt securities IDSC does not have the positive intent to hold
to maturity, as well as all marketable equity securities, are classified as
available for sale and carried at fair value. The available-for-sale
classification does not mean that IDSC expects to sell these securities, but
that under SFAS No. 115 positive intent criteria, these securities are available
to meet possible liquidity needs should there be significant changes in market
interest rates or certificate owner demand. See notes 1 and 3 to the financial
statements for additional information relating to SFAS No. 115.
At Dec. 31, 1998, securities classified as held to maturity and carried at
amortized cost were $.6 billion. Securities classified as available for sale and
carried at fair value were $2.7 billion. These securities, which comprise 88% of
IDSC's total invested assets, are well diversified. Of these securities, 97%
have fixed maturities of which 90% are of investment grade. Other than U.S.
Government Agency mortgage- backed securities, no one issuer represents more
than 1% of total securities. See note 3 to financial statements for additional
information on ratings and diversification.
During the year ended Dec. 31, 1998, IDSC accepted a tender offer of a
held-to-maturity security with an amortized cost and fair value of $6.2 million.
During the same period in 1998, securities classified as available for sale were
sold with an amortized cost and fair value of $343 million and $346 million,
respectively. The securities were sold in general management of the investment
portfolio.
There were no transfers of available-for-sale or held-to-maturity securities
during the years ended Dec. 31, 1998 and 1997.
Market risk and derivative financial instruments:
The sensitivity analysis of two different tests of market risk discussed below
estimate the effects of hypothetical sudden and sustained changes in the
applicable market conditions 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% decline in a major stock
market index. Computation of the prospective effects of hypothetical interest
rate and major stock market index changes are based on numerous assumptions,
including relative levels of market interest rates and the major stock market
index level, as well as the levels of assets and liabilities. The hypothetical
changes and assumptions will be different than what actually occurs in the
future. Furthermore, the computations do not anticipate actions that may be
taken by management if the hypothetical market changes actually occurred over
time. As a result, actual earnings affects in the future will differ from those
quantified below.
IDSC primarily invests in intermediate-term and long-term fixed income
securities to provide its certificate owners with a competitive rate of return
on their certificates while managing risk. These investment securities provide
IDSC with a historically dependable and targeted margin between the interest
rate earned on investments and the interest rate credited to certificate owners'
accounts. IDSC does not invest in securities to generate trading profits for its
own account.
IDSC's Investment Committee, which comprises senior business managers, meets
regularly to review models projecting different interest rate scenarios and
their impact on IDSC's profitability. The committee's objective is to structure
IDSC's portfolio of investment securities based upon the type and behavior of
the certificates in the certificate reserve liabilities, to achieve targeted
levels of profitability and meet certificate contractual obligations.
Rates credited to certificate owners' accounts are generally reset at shorter
intervals than the maturity of underlying investments. Therefore, IDSC's margins
may be negatively impacted by increases in the general level of interest rates.
Part of the committee's strategies include the purchase of derivatives, such as
interest rate caps, corridors, floors and swaps, for hedging purposes. On two
series of certificates, interest is credited to the certificate owners' accounts
based upon the relative change in a major stock market index between the
beginning and end of the certificates' terms. As a means of hedging its
obligations under the provisions of these certificates, the committee purchases
and writes call options on the major stock market index. See note 9 to the
financial statements for additional information regarding derivative financial
instruments.
The negative impact on IDSC's pretax earnings of the 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 Dec. 31, 1998 and
1997, would be approximately $7.5 million and $5.9 million for 1998 and 1997,
respectively. The 10% decrease in a major stock market index level would have a
minimal impact on IDSC's pretax earnings as of Dec. 31, 1998 and 1997, because
the income effect is a decrease in option income and a corresponding decrease in
interest credited to the IDS and American Express Stock Market Certificate
owners' accounts.
Year 2000 Issue:
IDSC is a wholly owned subsidiary of American Express Financial Corporation
(AEFC), which is a wholly owned subsidiary of American Express Company (American
Express). All of the major systems used by IDSC are maintained by AEFC and are
utilized by multiple subsidiaries and affiliates of AEFC. American Express is
coordinating Year 2000 (Y2K) efforts on behalf of all of its businesses and
subsidiaries. Representatives of AEFC are participating in these efforts. The
Y2K issue is the result of computer programs having been written using two
digits rather than four to define a year. Some programs may recognize a date
using "00" as the year 1900 rather than 2000. This misinterpretation could
result in the failure of major systems or miscalculations, which could have a
material impact on American Express and its businesses and subsidiaries through
business interruption or shutdown, financial loss, reputation damage and legal
liability to third parties. American Express and AEFC began addressing the Y2K
issue in 1995 and have established a plan for resolution, which involves the
remediation, decommissioning and replacement of relevant systems, including
mainframe, mid-range and desktop computers, application software, operating
systems, systems software, date back-up archival and retrieval services,
telephone and other communications systems, and hardware peripherals and
facilities dependent on embedded technology. As part of their plan, American
Express has generally followed and utilized the specific policies and guidelines
established by the
Federal Financial Institutions Examination Council, as well as other U.S. and
international regulatory agencies. Additionally, American Express continues to
participate in Y2K related industry consortia sponsored by various partners and
suppliers. Progress is reviewed regularly with IDSC's senior management and
American Express' senior management and Board of Directors.
American Express' and AEFC's Y2K compliance effort related to information
technology (IT) systems is divided into two initiatives. The first, which is the
much larger initiative, is known internally as "Millenniax," and relates to
mainframe and other technological systems maintained by the American Express
Technologies organization. The second, known as "Business T," relates to the
technological assets that are owned, managed or maintained by American Express'
individual business units, including AEFC. Business T also encompasses the
remediation of non-IT systems. These initiatives involve a substantial number of
employees and external consultants. This multiple sourcing approach is intended
to mitigate the risk of becoming dependent on any one vendor or resource. While
the vast majority of American Express' and AEFC's systems that require
modification are being remediated, in some cases they have chosen to migrate to
new applications that are already Y2K compliant.
American Express's and AEFC's plans for remediation with respect to Millenniax
and Business T include the following program phases: (i) employee awareness and
mobilization, (ii) inventory collection and assessment, (iii) impact analysis,
(iv) remediation/decommission, (v) testing and (vi) implementation. As part of
the first three phases, American Express and AEFC have identified their
mission-critical systems for purposes of prioritization. American Express' and
AEFC's goals are to complete testing of critical systems by early 1999, and to
continue compliance efforts, including but not limited to, the testing of
systems on an integrated basis and independent validation of such testing,
through 1999.** American Express and AEFC are currently on schedule to meet
these goals. With respect to systems maintained by American Express and AEFC,
the first three phases referred to above have been substantially completed for
both Millenniax and Business T. In addition, remediation of critical systems is
substantially complete. As of Dec. 31, 1998, for Millenniax for American
Express, the remediation/decommission, testing and implementation phases for
critical and non-critical systems in total are 82%, 75% and 60% complete,
respectively. For Millenniax for AEFC, such phases are 99%, 97% and 97%
complete, respectively. For Business T for American Express, such phases are
85%, 70% and 69% complete, respectively. For Business T for AEFC, such phases
are 74%, 62% and 62% complete, respectively.
American Express' most commonly used methodology for remediation is the sliding
window. Once an application/system has been remediated, American Express applies
specific types of tests, such as stress, regression, unit, future date and
baseline to ensure that the remediation process has achieved Y2K compliance
while maintaining the fundamental data processing integrity of the particular
system. To assist with remediation and testing, American Express is using
various standardized tools obtained from a variety of vendors.
American Express's cumulative costs since inception of the Y2K initiatives were
$383 million through Dec. 31, 1998 and are estimated to be in the range of
$135-$160 million for the remainder through 2000.** AEFC's cumulative costs
since inception of the Y2K initiative were $56 million through Dec. 31, 1998 and
are estimated to be in the range of $13-$19 million for the remainder through
2000.** These include both remediation costs and costs related to replacements
that were or will be required as a result of Y2K. These costs, which are
expensed as incurred, relate to both Millenniax and Business T, and have not
had, nor are they expected to have, a material adverse impact on American
Express', AEFC's or IDSC's results of operations or financial condition.**
Costs related to Millenniax, which represent most of the total Y2K costs of
American
Express, are managed by and included in the American Express corporate level
financial results; costs related to Business T are included in American
Express' individual business segment's financial results, including AEFC's.
American Express and AEFC have not deferred other critical technology projects
or investment spending as a result of Y2K. However, because American Express and
AEFC must continually prioritize the allocation of finite financial and human
resources, certain non-critical spending initiatives have been deferred.
American Express' and AEFC's major businesses are heavily dependent upon
internal computer systems, and all have significant interaction with systems of
third parties, both domestically and internationally. American Express and AEFC
are working with key external parties, including merchants, clients,
counterparties, vendors, exchanges, utilities, suppliers, agents and regulatory
agencies to mitigate the potential risks to American Express and AEFC of Y2K.
The failure of external parties to resolve their own Y2K issues in a timely
manner could result in a material financial risk to American Express or AEFC. As
part of their overall compliance program, American Express and AEFC are actively
communicating with third parties through face-to-face meetings and
correspondence, on an ongoing basis, to ascertain their state of readiness.
Although numerous third parties have indicated to American Express and AEFC in
writing that they are addressing their Y2K issues on a timely basis, the
readiness of third parties overall varies across the spectrum. Because American
Express' and AEFC's Y2K compliance is dependent on key third parties being
compliant on a timely basis, there can be no assurances that American Express'
and AEFC's efforts alone will resolve all Y2K issues.
At this point, American Express and AEFC are in the process of performing an
assessment of reasonably likely Y2K systems failures and related consequences.
American Express is also preparing specific Y2K contingency plans for all key
American Express business units, including AEFC, to mitigate the potential
impact of such failures. This effort is a full-scale initiative that includes
both internal and external experts under the guidance of an American
Express-wide steering committee. The contingency plans, which will be based in
part on an assessment of the magnitude and probability of potential risks, will
primarily focus on proactive steps to prevent Y2K failures from occurring, or if
they should occur, to detect them quickly, minimize their impact and expedite
their repair. The Y2K contingency plans will supplement disaster recovery and
business continuity plans already in place, and are expected to include measures
such as selecting alternative suppliers and channels of distribution, and
developing American Express' and AEFC's own technology infrastructure in lieu
of those provided by third parties. Development of the Y2K contingency plans is
expected to be substantially complete by the end of the first quarter of 1999,
and will continue to be refined throughout 1999 as additional information
related to American Express' and AEFC's exposures is gathered.**
** Statements in this Y2K discussion marked with two asterisks are
forward-looking statements which are subject to risks and uncertainties.
Important factors that could cause results to differ materially from these
forward-looking statements include, among other things, the ability of American
Express or AEFC to successfully identify systems containing two-digit codes, the
nature and amount of programming required to fix the affected systems, the costs
of labor and consultants related to such efforts, the continued availability of
such resources, and the ability of third parties that interface with American
Express and AEFC to successfully address their Y2K issues.
Ratios:
The ratio of stockholder's equity, excluding accumulated other comprehensive
income net of tax, to total assets less certificate loans and net unrealized
holding gains on investment securities at Dec. 31, 1998 and 1997 was 5.6% and
5.2%, respectively. IDSC's current regulatory requirement is a ratio of 5.0%.
Item 7A. Ouantitative and Qualitative Disclosures About Market Risk
See Item 7.
Item 8. Financial Statements and Supplementary Data
1. Financial Statements and Schedules Required under Regulation S-X
Index to Financial Statements and Schedules
Page
Financial Statements:
Responsibility for Preparation of Financial Statements 24
Report of Independent Auditors 25
Balance Sheets, Dec. 31, 1998 and 1997 26 - 27
Statements of Operations, year ended Dec. 31, 1998, 1997 and 1996 28 - 29
Statements of Comprehensive Income, year ended Dec. 31, 1998,
1997 and 1996 30
Statements of Stockholder's Equity, year ended Dec. 31, 1998,
1997 and 1996 31
Statements of Cash Flows, year ended Dec. 31, 1998, 1997 and 1996 32 - 33
Notes to Financial Statements 34 - 52
Schedules:
I - Investments in Securities of Unaffiliated Issuers, Dec. 31, 1998
II - Investments in and Advances to Affiliates and Income Thereon,
Dec. 31, 1998, 1997, and 1996
III - Mortgage Loans on Real Estate and Interest earned on
Mortgages, year ended Dec. 31, 1998
V - Qualified Assets on Deposit, Dec. 31, 1998
VI - Certificate Reserves, year ended Dec. 31, 1998
VII - Valuation and Qualifying Accounts, year ended Dec. 31, 1998, 1997
and 1996
Schedules I, III and VI for the year ended Dec. 31, 1997, and Schedule
VI for the year ended Dec. 31, 1996, are included in Registrant's Annual Reports
on Form 10-K for the fiscal years ended Dec. 31, 1997 and Dec. 31, 1996,
respectively, Commission file 2-23772, and are incorporated herein by reference.
All other Schedules required by Article 6 of the Regulation S-X are not
required under the related instructions or are inapplicable and therefore have
been omitted.
2. Supplementary Data
None
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None
PART III
Items omitted pursuant to General Instructions I(2)(c) of Form 10-K.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) List the following documents filed as a part of the report:
1. All financial statements. See Item 8.
2. Financial statement schedules. See Item 8.
3. Exhibits.
(3)a. Certificate of Incorporation, dated December 31, 1977, filed electronically as Exhibit 3(a) to Post-Effective
Amendment No. 10 to Registration Statement No. 2-89507, is incorporated herein by reference.
(3)b. Certificate of Amendment, dated April 2, 1984, filed electronically as Exhibit 3(b) to Post-Effective
Amendment No. 10 to Registration Statement No. 2-89507, is incorporated herein by reference.
(3)c. Certificate of Amendment, dated September 12, 1995, filed electronically as Exhibit 3(c) to Post-Effective
Amendment No. 44 to Registration Statement No. 2-55252, is incorporated herein by reference.
(3)d. By-Laws, dated December 31, 1977, filed electronically as Exhibit 3(c) to Post-Effective Amendment No. 10 to
Registration Statement No. 2-89507, is incorporated herein by reference.
(10)a. The Distribution Agreement dated November 18, 1988, between Registrant and IDS Financial Services Inc., filed
electronically as Exhibit 1(a) to Registration Statement No. 33-26844 is incorporated herein by reference.
(10)b. The Distribution Agreement dated March 29, 1996, between Registrant and American Express Service Corporation,
filed electronically as Exhibit 1(b) to Post-Effective Amendment No. 38 to Registration Statement No. 2-55252
for the D-1 Investment Certificate, is incorporated herein by reference.
(10)c. Selling Agent Agreement dated June 1, 1990, between American Express Bank International and IDS Financial
Services Inc., for the IDS Investors and IDS Stock Market Certificates, filed electronically as Exhibit 1(c)
to the Post-Effective Amendment No. 5 to Registration Statement No. 33-26844 for the IDS Investors
Certificate, is incorporated herein by reference.
(10)d. Marketing Agreement dated October 10, 1991, between Registrant and American Express Bank Ltd., filed
electronically as Exhibit 1(d) to the Post-Effective Amendment No. 31 to Registration Statement No. 2-55252
for the Series D-1 Investment Certificate, is incorporated herein by reference.
(10)e. Letter amendment dated January 9, 1997, to the Marketing Agreement dated October 10, 1991, between Registrant
and American Express Bank Ltd. filed electronically as exhibit 10(j) to Post-Effective Amendment No. 40 to
Registration Statement No. 2-55252 is incorporated herein by reference.
(10)f. Amendment to the Selling Agent Agreement dated December 12, 1994, between IDS Financial Services Inc. and
American Express Bank International, filed electronically as Exhibit 16(d) to Post-Effective Amendment No. 13
to Registration Statement No. 2-95577, is incorporated herein by reference.
(10)g. Selling Agent Agreement dated December 31, 1994, between IDS Financial Services Inc. and Coutts & Co. (USA)
International, filed electronically as Exhibit 16(e) to Post-Effective Amendment No. 13 to Registration
Statement No. 2-95577, is incorporated herein by reference.
(10)h. Consulting Agreement dated December 12, 1994, between IDS Financial Services Inc. and American Express Bank
International, filed electronically as Exhibit 16(f) to Post-Effective Amendment No. 13 to Registration
Statement No. 2-95577 incorporated herein by reference.
(10)i. Second amendment to Selling Agent Agreement between American Express Financial Advisors Inc. and
American Express Bank International dated as of May 2, 1995, filed electronically as Exhibit (1) to
Registrant's June 30, 1995, Quarterly Report on Form 10-Q, is incorporated herein by reference.
(10)j. The Investment Advisory and Services Agreement between Registrant and IDS/American Express Inc. dated January
12, 1984, filed electronically as Exhibit 10(a) to Registration Statement No. 2-89507 is incorporated herein
by reference.
(10)k. Form of Letter amendment dated April 7, 1997 to the Selling Agent Agreement dated June 1, 1990 between
American Express Financial Advisors Inc. and American Express Bank International, filed electronically
herewith as Exhibit 10(j) to Post-Effective Amendment No. 14 to Registration Statement 33-26044, is
incorporated herein by reference.
(10)l. Form of Selling Agent Agreement, dated March__, 1999 between American Express Financial Advisors Inc. and
Securities America Inc., filed electronically as Exhibit 10(k) to Post-Effective Amendment No. 24 to
Registration Statement 33-22503, is incorporated herein by reference.
(10)m. Depository and Custodial Agreement dated September 30, 1985, between IDS Certificate Company and IDS Trust
Company, filed electronically as Exhibit 10(b) to Registrant's Post-Effective Amendment No. 3 to Registration
Statement No. 2-89507 is incorporated herein by reference.
(10)n. Foreign Deposit Agreement dated November 21, 1990, between IDS Certificate Company and IDS Bank & Trust, filed
electronically as Exhibit 10(h) to Post-Effective Amendment No. 5 to Registration Statement No. 33-26844, is
incorporated herein by reference.
(24)a. Officers' Power of Attorney, dated September 18, 1998, filed electronically as Exhibit 24(a) to Post-Effective
Amendment No. 22 to Registration Statement No. 33-22503, is incorporated herein by reference.
(24)b. Directors' Power of Attorney, dated October 14, 1998, filed electronically as Exhibit 24(b) to Post-Effective
Amendment No. 22 to Registration Statement No. 33-22503, is incorporated herein by reference.
(b) Reports on Form 8-K filed during the last quarter of the period
covered by this report:
None
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.
REGISTRANT IDS Certificate Company
BY /s/ Paula R. Meyer*
NAME AND TITLE Paula R. Meyer, President
DATE March 26, 1999
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
BY /s/Paula R. Meyer* **
NAME AND TITLE Paula R. Meyer, President and Director
(Principal Executive Officer)
DATE March 26, 1999
BY /s/Jeffrey S. Horton*
NAME AND TITLE Jeffrey S. Horton, Vice President and Treasurer
(Principal Financial Officer)
DATE March 26, 1999
BY /s/Jay C. Hatlestad*
NAME AND TITLE Jay C. Hatlestad, Vice President and Controller
(Principal Accounting Officer)
DATE March 26, 1999
BY /s/David R. Hubers **
NAME AND TITLE David R. Hubers, Director
DATE March 26, 1999
BY /s/Charles W. Johnson **
NAME AND TITLE Charles W. Johnson, Director
DATE March 26, 1999
BY /s/Richard W. Kling **
NAME AND TITLE Richard W. Kling, Chairman of the Board
of Directors and Director
DATE March 26, 1999
* Signed pursuant to Officers' Power of Attorney dated September 8, 1998, filed
electronically as Exhibit 24(a) to Post-Effective Amendment No. 22 to
Registration Statement No. 33-22503, incorporated herein by reference.
- -------------------------------------------------------------------------------
Bruce A. Kohn
** Signed pursuant to Directors' Power of Attorney dated October 14, 1998,
filed electronically as Exhibit 24(b) to Post-Effective Amendment No. 22 to
Registration Statement No. 33-22503, incorporated herein by reference.
- -------------------------------------------------------------------------------
Bruce A. Kohn
(THIS PAGE INTENTIONALLY LEFT BLANK)
IDS Certificate Company
Responsibility for Preparation of Financial Statements
The management of IDS Certificate Company (IDSC) is responsible for the
preparation and fair presentation of its financial statements. The financial
statements have been prepared in conformity with generally accepted accounting
principles appropriate in the circumstances, and include amounts based on the
best judgment of management. IDSC's management is also responsible for the
accuracy and consistency of other financial information included in this Form
10-K.
In recognition of its responsibility for the integrity and objectivity of data
in the financial statements, IDSC maintains a system of internal control over
financial reporting. The system is designed to provide reasonable, but not
absolute, assurance with respect to the reliability of IDSC's financial
statements. The concept of reasonable assurance is based on the notion that the
cost of the internal control system should not exceed the benefits derived.
The internal control system is founded on an ethical climate and includes an
organizational structure with clearly defined lines of responsibility, policies
and procedures, and the careful selection and training of employees. Internal
auditors monitor and assess the effectiveness of the internal control system and
report their findings to management throughout the year. IDSC's independent
auditors are engaged to express an opinion on the year-end financial statements
and, with the coordinated support of the internal auditors, review the financial
records and related data and test the internal control system over financial
reporting.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Security Holders
IDS Certificate Company:
We have audited the accompanying balance sheets of IDS Certificate Company, a
wholly owned subsidiary of American Express Financial Corporation, as of
December 31, 1998 and 1997, and the related statements of operations,
comprehensive income, stockholder's equity, and cash flows for each of the three
years in the period ended December 31, 1998. Our audits also included the
financial statement schedules listed in the index at Item 8. These financial
statements and schedules are the responsibility of the management of IDS
Certificate Company. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and schedules are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedules. Our procedures included confirmation of investments owned as of
December 31, 1998 and 1997, by correspondence with custodians and brokers. 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 financial position of IDS Certificate Company at
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
ERNST & YOUNG LLP
Minneapolis, Minnesota
February 4, 1999
Balance Sheets, Dec. 31,
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Qualified Assets (note 2) 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
($ thousands)
Investments in unaffiliated issuers (notes 3, 4 and 10):
Held-to-maturity securities $592,815 $758,143
Available-for-sale securities 2,710,545 2,911,524
First mortgage loans on real estate 334,280 212,433
Certificate loans - secured by certificate reserves 32,343 37,098
Investments in and advances to affiliates 418 6,772
- ------------------------------------------------------------------------------------------------------------------------------------
Total investments 3,670,401 3,925,970
- ------------------------------------------------------------------------------------------------------------------------------------
Receivables:
Dividends and interest 46,579 48,817
Investment securities sold 3,085 1,635
- ------------------------------------------------------------------------------------------------------------------------------------
Total receivables 49,664 50,452
- ------------------------------------------------------------------------------------------------------------------------------------
Other (notes 9 and 10) 96,213 56,127
- ------------------------------------------------------------------------------------------------------------------------------------
Total qualified assets 3,816,278 4,032,549
- ------------------------------------------------------------------------------------------------------------------------------------
Other Assets
- ------------------------------------------------------------------------------------------------------------------------------------
Deferred federal income taxes (note 8) 1,095 -
Due from affiliate 1,082 -
Deferred distribution fees and other 15,789 21,099
- ------------------------------------------------------------------------------------------------------------------------------------
Total other assets 17,966 21,099
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $3,834,244 $4,053,648
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.
Balance Sheets, Dec. 31, (continued)
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholder's Equity
Liabilities 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
($ thousands)
Certificate Reserves (notes 5 and 10):
Installment certificates:
Reserves to mature $309,110 $343,219
Additional credits and accrued interest 15,062 19,554
Advance payments and accrued interest 894 968
Other 55 56
Fully paid certificates:
Reserves to mature 2,909,891 3,186,191
Additional credits and accrued interest 169,514 174,699
Due to unlocated certificate holders 357 291
- ------------------------------------------------------------------------------------------------------------------------------------
Total certificate reserves 3,404,883 3,724,978
- ------------------------------------------------------------------------------------------------------------------------------------
Accounts Payable and Accrued Liabilities:
Due to Parent (note 7A) 771 1,639
Due to Parent for federal income taxes 7,381 495
Due to affiliates (note 7B, 7C, 7D and 7E) 426 331
Reverse repurchase agreements 141,000 22,000
Payable for investment securities purchased 2,211 19,601
Accounts payable, accrued expenses and other (notes 9 and 10) 55,539 29,919
- ------------------------------------------------------------------------------------------------------------------------------------
Total accounts payable and accrued liabilities 207,328 73,985
- ------------------------------------------------------------------------------------------------------------------------------------
Deferred federal income taxes (note 8) - 15,175
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 3,612,211 3,814,138
- ------------------------------------------------------------------------------------------------------------------------------------
Commitments (note 4)
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholder's Equity (notes 5B, 5C, and 6)
- ------------------------------------------------------------------------------------------------------------------------------------
Common stock, $10 par - authorized and issued 150,000 shares 1,500 1,500
Additional paid-in capital 143,844 143,844
Retained earnings:
Appropriated for predeclared additional credits/interest 3,710 6,375
Appropriated for additional interest on advance payments 10 50
Unappropriated 63,623 55,948
Accumulated other comprehensive income - net of tax (note 1) 9,346 31,793
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholder's equity 222,033 239,510
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $3,834,244 $4,053,648
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.
Statements of Operations
- ------------------------------------------------------------------------------------------------------------------------------------
Year ended Dec. 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
($ thousands)
Investment Income
Interest income from investments:
Bonds and notes:
Unaffiliated issuers $209,408 $191,190 $184,653
Mortgage loans on real estate:
Unaffiliated 18,173 18,053 19,583
Affiliated - - 36
Certificate loans 1,896 2,200 2,533
Dividends 40,856 44,543 44,100
Other 2,802 2,246 576
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment income 273,135 258,232 251,481
- ------------------------------------------------------------------------------------------------------------------------------------
Investment Expenses
Parent and affiliated company fees (note 7):
Distribution 33,783 34,507 32,732
Investment advisory and services 9,084 17,233 16,989
Transfer agent 3,932 - -
Depositary 250 238 228
Options (note 9) 21,012 14,597 10,156
Interest rate caps, corridors and floors (note 9) - 35 2,351
Reverse repurchase agreements 3,689 1,217 -
Interest rate swap agreements (note 9) 4,676 1,956 -
Other 385 354 395
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment expenses 76,811 70,137 62,851
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income before provision
for certificate reserves and income tax benefit $196,324 $188,095 $188,630
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.
Statements of Operations (continued)
- ------------------------------------------------------------------------------------------------------------------------------------
Year ended Dec. 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
($ thousands)
Provision for Certificate Reserves (notes 5 and 9)
According to the terms of the certificates:
Provision for certificate reserves $9,623 $9,796 $10,445
Interest on additional credits 1,032 1,244 1,487
Interest on advance payments 44 50 61
Additional credits/interest authorized by IDSC:
On fully paid certificates 146,434 141,515 146,474
On installment certificates 11,001 13,560 14,574
- ------------------------------------------------------------------------------------------------------------------------------------
Total provision for certificate reserves before reserve recoveries 168,134 166,165 173,041
Reserve recoveries from terminations prior to maturity (1,026) (1,029) (1,073)
- ------------------------------------------------------------------------------------------------------------------------------------
Net provision for certificate reserves 167,108 165,136 171,968
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income before income tax benefit 29,216 22,959 16,662
Income tax benefit (note 8) 265 3,682 6,537
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income 29,481 26,641 23,199
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized gain (loss) on investments
Securities of unaffiliated issuers 5,143 980 (444)
Other-unaffiliated - - 101
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized gain (loss) on investments before income taxes 5,143 980 (343)
- ------------------------------------------------------------------------------------------------------------------------------------
Income tax (expense) benefit (note 8):
Current (1,800) (304) 772
Deferred - (39) (652)
- ------------------------------------------------------------------------------------------------------------------------------------
Total income tax (expense) benefit (1,800) (343) 120
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized gain (loss) on investments 3,343 637 (223)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income - wholly owned subsidiary 1,646 328 1,251
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $34,470 $27,606 $24,227
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.
Statements of Comprehensive Income
- ------------------------------------------------------------------------------------------------------------------------------------
Year ended Dec. 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
($ thousands)
Net income $34,470 $27,606 $24,227
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (note 1)
Unrealized (losses) gains on available-for-sale
securities:
Unrealized holding (losses) gains arising during year (32,020) 26,639 (25,853)
Income tax benefit (expense) 11,207 (9,324) 9,048
- ------------------------------------------------------------------------------------------------------------------------------------
Net unrealized holding (losses) gains arising during period (20,813) 17,315 (16,805)
- ------------------------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for (gains) losses included in net income (2,514) 59 2,802
Income tax expense (benefit) 880 (20) (981)
- ------------------------------------------------------------------------------------------------------------------------------------
Net reclassification adjustment for (gains) losses included in net income (1,634) 39 1,821
- ------------------------------------------------------------------------------------------------------------------------------------
Net other comprehensive (loss) income (22,447) 17,354 (14,984)
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income $12,023 $44,960 $9,243
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.
Statements of Stockholder's Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Year ended Dec. 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
($ thousands)
Common Stock
Balance at beginning and end of year $1,500 $1,500 $1,500
- ------------------------------------------------------------------------------------------------------------------------------------
Additional Paid-in Capital
Balance at beginning of year $143,844 $143,844 $168,844
Cash dividends declared - - (25,000)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at end of year $143,844 $143,844 $143,844
- ------------------------------------------------------------------------------------------------------------------------------------
Retained Earnings
Appropriated for predeclared additional credits/interest (note 5B)
Balance at beginning of year $6,375 $11,989 $18,878
Transferred to unappropriated retained earnings (2,665) (5,614) (6,889)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at end of year $3,710 $6,375 $11,989
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Appropriated for additional interest on advance payments (note 5C)
Balance at beginning of year $50 $50 $50
Transferred to unappropriated retained earnings (40) - -
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Balance at end of year $10 $50 $50
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Unappropriated (note 6)
Balance at beginning of year $55,948 $22,728 $31,612
Net income 34,470 27,606 24,227
Transferred from appropriated retained earnings 2,705 5,614 6,889
Cash dividends declared (29,500) - (40,000)
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Balance at end of year $63,623 $55,948 $22,728
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Accumulated other comprehensive income -
net of tax (note 1)
Balance at beginning of year $31,793 $14,439 $29,423
Net other comprehensive (loss) income (22,447) 17,354 (14,984)
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Balance at end of year $9,346 $31,793 $14,439
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Total stockholder's equity $222,033 $239,510 $194,550
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See notes to financial statements.
Statements of Cash Flows
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Year ended Dec. 31, 1998 1997 1996
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($ thousands)
Cash Flows from Operating Activities
Net income $34,470 $27,606 $24,227
Adjustments to reconcile net income to net
cash provided by operating activities:
Net income of wholly owned subsidiary (1,646) (328) (1,251)
Net provision for certificate reserves 167,108 165,136 171,968
Interest income added to certificate loans (1,180) (1,414) (1,631)
Amortization of premiums/discounts-net 22,620 15,484 14,039
Provision for deferred federal income taxes (3,088) (2,266) (1,124)
Net realized (gain) loss on investments before income taxes (5,143) (980) 343
Decrease (increase) in dividends and interest receivable 2,238 (4,804) 5,619
Decrease in deferred distribution fees 5,310 4,434 2,761
Increase in other assets (1,082) - -
Increase (decrease) in other liabilities 16,814 443 (679)
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Net cash provided by operating activities 236,421 203,311 214,272
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Cash Flows from Investing Activities
Maturity and redemption of investments:
Held-to-maturity securities 161,649 76,678 163,066
Available-for-sale securities 468,218 408,019 537,565
Other investments 76,894 79,929 52,189
Sale of investments:
Held-to-maturity securities 6,245 33,910 24,984
Available-for-sale securities 344,901 160,207 356,194
Other investments - - 385
Certificate loan payments 4,006 4,814 6,003
Purchase of investments:
Held-to-maturity securities (1,034) (4,565) (49,984)
Available-for-sale securities (663,347) (1,283,620) (617,138)
Other investments (189,905) (62,831) (28,617)
Certificate loan fundings (3,703) (5,021) (5,288)
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Net cash provided by (used in) investing activities $203,924 ($592,480) $439,359
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See notes to financial statements.
Statements of Cash Flows (continued)
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Year ended Dec. 31, 1998 1997 1996
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($ thousands)
Cash Flows from Financing Activities
Payments from certificate owners $1,192,026 $1,580,013 $1,129,023
Proceeds from reverse repurchase agreements 919,500 433,000 -
Dividend from wholly owned subsidiary 8,000 - -
Certificate maturities and cash surrenders (1,729,871) (1,324,175) (1,663,196)
Payments under reverse repurchase agreements (800,500) (411,000) -
Dividends paid (29,500) - (65,000)
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Net cash (used in) provided by financing activities (440,345) 277,838 (599,173)
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Net (decrease) increase in cash and cash equivalents - (111,331) 54,458
Cash and cash equivalents beginning of year - 111,331 56,873
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Cash and cash equivalents end of year $- $- $111,331
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Supplemental Disclosures Including Non-cash Transactions
Cash received (paid) for income taxes $1,217 ($104) $7,195
Certificate maturities and surrenders through
loan reductions 5,632 8,032 8,554
See notes to financial statements.
Notes to Financial Statements ($ in thousands unless indicated otherwise)
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1. Nature of business and summary of significant accounting policies
Nature of business
IDS Certificate Company (IDSC) is a wholly owned subsidiary of American Express
Financial Corporation (Parent), which is a wholly owned subsidiary of American
Express Company. IDSC is registered as an investment company under the
Investment Company Act of 1940 ("the 1940 Act") and is in the business of
issuing face-amount investment certificates. The certificates issued by IDSC are
not insured by any government agency. IDSC's certificates are sold primarily by
American Express Financial Advisors Inc.'s (an affiliate) field force operating
in 50 states, the District of Columbia and Puerto Rico. IDSC's Parent acts as
investment advisor for IDSC.
IDSC currently offers nine types of certificates with specified maturities
ranging from ten to twenty years. Within their specified maturity, most
certificates have interest rate terms of one- to 36-months. In addition, two
types of certificates have interest tied, in whole or in part, to any upward
movement in a broad-based stock market index. Except for two types of
certificates, all of the certificates are available as qualified investments for
Individual Retirement Accounts or 401(k) plans and other qualified retirement
plans.
IDSC's gross income is derived primarily from interest and dividends generated
by its investments. IDSC's net income is determined by deducting from such gross
income its provision for certificate reserves, and other expenses, including
taxes, the fee paid to Parent for investment advisory and other services, and
the distribution fees paid to American Express Financial Advisors, Inc.
Described below are certain accounting policies that are important to an
understanding of the accompanying financial statements.
Basis of financial statement presentation
The accompanying financial statements are presented in accordance with generally
accepted accounting principles. IDSC uses the equity method of accounting for
its wholly owned unconsolidated subsidiary, which is the method prescribed by
the Securities and Exchange Commission (SEC) for non-investment company
subsidiaries of issuers of face-amount certificates. Certain amounts from prior
years have been reclassified to conform to the current year presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities and the reported amounts of income and
expenses during the year then ended. Actual results could differ from those
estimates.
Fair values of financial instruments
The fair values of financial instruments disclosed in the notes to financial
statements are estimates based upon current market conditions and perceived
risks, and require varying degrees of management judgment.
Notes to Financial Statements ($ in thousands unless indicated otherwise)
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Preferred stock dividend income
IDSC recognizes dividend income from cumulative redeemable preferred stocks with
fixed maturity amounts on an accrual basis similar to that used for recognizing
interest income on debt securities. Dividend income from perpetual preferred
stock is recognized on an ex-dividend basis.
Comprehensive Income
Effective Jan. 1, 1998, IDSC adopted Statement of Financial Accounting Standards
(SFAS) No. 130, "Reporting Comprehensive Income." SFAS No. 130 requires the
reporting and display of comprehensive income and its components. Comprehensive
income is defined as the aggregate change in stockholder's equity excluding
changes in ownership interests. For IDSC, comprehensive income consists of net
income and unrealized gains or losses on available-for-sale securities net of
taxes. Prior year amounts have been reclassified to conform to the requirements
of the new Statement.
Securities
Cash equivalents are carried at amortized cost, which approximates fair value.
IDSC has defined cash and cash equivalents as cash in banks and highly liquid
investments with a maturity of three months or less at acquisition and are not
interest rate sensitive.
Debt securities that IDSC has both the positive intent and ability to hold to
maturity are carried at amortized cost. Debt securities IDSC does not have the
positive intent to hold to maturity, as well as all marketable equity
securities, are classified as available for sale and carried at fair value.
Unrealized holding gains and losses on securities classified as available for
sale are carried, net of deferred income taxes, as accumulated other
comprehensive income in stockholder's equity.
The basis for determining cost in computing realized gains and losses on
securities is specific identification. When there is a decline in value that is
other than temporary, the securities are carried at estimated realizable value
with the amount of adjustment included in income.
First mortgage loans on real estate
Mortgage loans are carried at amortized cost, less reserves for losses, which is
the basis for determining any realized gains or losses. The estimated fair value
of the mortgage loans is determined by a discounted cash flow analysis using
mortgage interest rates currently offered for mortgages of similar maturities.
Impairment 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. The amount of
the impairment is recorded in a reserve for mortgage loan losses.
Notes to Financial Statements ($ in thousands unless indicated otherwise)
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The reserve for mortgage loan losses is maintained at a level that management
believes is adequate to absorb estimated losses in the portfolio. The level of
the reserve account is determined based on several factors, including historical
experience, expected future principal and interest payments, estimated
collateral values, and current and anticipated economic and political
conditions. Management regularly evaluates the adequacy of the reserve for
mortgage loan losses.
IDSC 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.
Certificates
Investment certificates may be purchased either with a lump-sum payment or by
installment payments. Certificate owners are entitled to receive at maturity a
definite sum of money. Payments from certificate owners are credited to
investment certificate reserves. Investment certificate reserves accumulate at
specified percentage rates as declared by IDSC. Reserves also are maintained for
advance payments made by certificate owners, accrued interest thereon, and for
additional credits in excess of minimum guaranteed rates and accrued interest
thereon. On certificates allowing for the deduction of a surrender charge, the
cash surrender values may be less than accumulated investment certificate
reserves prior to maturity dates. Cash surrender values on certificates allowing
for no surrender charge are equal to certificate reserves. The payment
distribution, reserve accumulation rates, cash surrender values, reserve values
and other matters are governed by the 1940 Act.
Deferred distribution fee expense
On certain series of certificates, distribution fees are deferred and amortized
over the estimated lives of the related certificates, which is approximately 10
years. Upon surrender prior to maturity, unamortized deferred distribution fees
are recognized in expense and any related surrender charges are recognized as a
reduction in provision for certificate reserves.
Notes to Financial Statements ($ in thousands unless indicated otherwise)
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Federal income taxes
IDSC's taxable income or loss is included in the consolidated federal income tax
return of American Express Company. IDSC provides for income taxes on a separate
return basis, except that, under an agreement between Parent and American
Express Company, tax benefits are recognized for losses to the extent they can
be used in the consolidated return. It is the policy of Parent and its
subsidiaries that Parent will reimburse a subsidiary for any tax benefits
recorded.
Accounting developments
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This SOP, which is effective
Jan. 1, 1999, requires the capitalization of certain costs incurred to develop
or obtain software for internal use. Software utilized by IDSC is owned by
Parent and will be capitalized on Parent's financial statements. As a result,
the new rule will not have a material impact on IDSC's results of operations or
financial condition.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which is effective Jan. 1, 2000. This Statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and the resulting designation.
Earlier application of all of the provisions of this Statement is encouraged,
but it is permitted only as of the beginning of any fiscal quarter that begins
after issuance of the Statement. This Statement cannot be applied retroactively.
The ultimate financial impact of the new rule will be measured based on the
derivatives in place at adoption and cannot be estimated at this time.
Notes to Financial Statements ($ in thousands unless indicated otherwise)
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2. Deposit of assets and maintenance of qualified assets
A) Under the provisions of its certificates and the 1940 Act, IDSC was required
to have qualified assets (as that term is defined in Section 28(b) of the 1940
Act) in the amount of $3,353,920 and $3,694,204 at Dec. 31, 1998 and 1997,
respectively. IDSC had qualified assets of $3,799,689 at Dec. 31, 1998 and
$3,964,036 at Dec. 31, 1997, excluding net unrealized appreciation on
available-for-sale securities of $14,378 and $48,912 at Dec. 31, 1998 and 1997,
respectively and payable for securities purchased of $2,211 and $19,601 at Dec.
31, 1998 and 1997, respectively.
Qualified assets are valued in accordance with such provisions of Minnesota
Statutes as are applicable to investments of life insurance companies. Qualified
assets for which no provision for valuation is made in such statutes are valued
in accordance with rules, regulations or orders prescribed by the SEC. These
values are the same as financial statement carrying values, except for debt
securities classified as available for sale and all marketable equity
securities, which are carried at fair value in the financial statements but are
valued at amortized cost for qualified asset and deposit maintenance purposes.
B) Pursuant to provisions of the certificates, the 1940 Act, the central
depositary agreement and to requirements of various states, qualified assets of
IDSC were deposited as follows:
Dec. 31, 1998
-----------------------------------------------
Required
Deposits deposits Excess
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Deposits to meet certificate
liability requirements:
States $364 $327 $37
Central Depositary 3,543,964 3,317,295 226,669
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Total $3,544,328 $3,317,622 $226,706
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Dec. 31, 1997
-----------------------------------------------
Required
Deposits deposits Excess
- -----------------------------------------------------------------------------------------------------
Deposits to meet certificate
liability requirements:
States $363 $328 $35
Central Depositary 3,826,505 3,650,121 176,384
- -----------------------------------------------------------------------------------------------------
Total $3,826,868 $3,650,449 $176,419
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Notes to Financial Statements ($ in thousands unless indicated otherwise)
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The assets on deposit at Dec. 31, 1998 and 1997 consisted of securities having a
deposit value of $3,153,038 and $3,580,866, respectively; mortgage loans of
$334,280 and $212,433, respectively; and other assets of $57,010 and $33,569,
respectively.
American Express Trust Company is the central depositary for IDSC. See note 7C.
3. Investments in securities
A) Fair values of investments in securities represent market prices or estimated
fair values when quoted prices are not available. Estimated fair values are
determined by IDSC using established procedures, involving review of market
indexes, price levels of current offerings and comparable issues, price
estimates and market data from i