SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to
Commission file number 333-57212, 333-104539, 333-104546, 333-104547,
333-104548
ING USA ANNUITY LIFE INSURANCE COMPANY
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(Exact name of registrant as specified in its charter)
Iowa 41-0991508
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(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
1475 Dunwoody Drive, West Chester, Pennsylvania 19380-1478
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (610) 425-3400
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Former name, former address and formal fiscal year, if changed since last report
Indicate by check ___ whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: As of May 14, 2004, 250,000
shares of Common Stock, $10 Par Value, are authorized, issued, and outstanding,
all of which were directly owned by Lion Connecticut Holdings Inc.
NOTE: WHEREAS ING USA ANNUITY AND LIFE INSURANCE COMPANY MEETS THE CONDITIONS
SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10Q, THIS FORM IS BEING
FILED WITH THE REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION H(2).
1
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Form 10Q for period ended March 31, 2004
INDEX
PAGE
PART I. FINANCIAL INFORMATION (Unaudited)
Item 1. Financial Statements:
Condensed Statements of Income 3
Condensed Balance Sheets 4
Condensed Statements of Changes in Shareholder's Equity 6
Condensed Statements of Cash Flows 7
Notes to Condensed Financial Statements 8
Item 2. Management's Narrative Analysis of the Results of
Operations and Financial Condition 42
Item 4. Controls and Procedures 54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 55
Item 6. Exhibits and Reports on Form 8-K 55
Signatures 56
2
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements
Condensed Statements of Income
(Unaudited)
(Millions)
Three months ended March 31,
2004 2003
--------------- ---------------
Revenue:
Premiums $ 5.6 $ 7.4
Fee income 128.9 80.6
Net investment income 298.5 279.9
Net realized capital gains (losses) 0.5 (6.7)
Other income 2.2 3.8
--------------- ---------------
Total revenue 435.7 365.0
--------------- ---------------
Benefits, losses and expenses:
Benefits:
Interest credited and other benefits to policyholders 291.0 300.8
Underwriting, acquisition, and insurance expenses:
General expenses 51.8 52.3
Commissions 112.3 53.4
Policy acquisition costs deferred (122.6) (84.0)
Amortization of deferred policy acquisition costs and value
of business acquired 66.3 60.0
Other:
Expense and charges reimbursed under modified
coinsurance agreements 0.6 0.2
Interest expense 3.7 3.3
--------------- ---------------
Total benefits, losses and expenses 403.1 386.0
--------------- ---------------
Income (loss) before income taxes and cumulative effect
of change in accounting principle 32.6 (21.0)
Income tax expense (benefit) 10.0 (7.5)
--------------- ---------------
Net income (loss) before cumulative effect of change
in accounting principle 22.6 (13.5)
Cumulative effect of change in accounting principle (2.3) -
--------------- ---------------
Net income (loss) $ 20.3 $ (13.5)
=============== ===============
The accompanying notes are an integral part of these financial statements.
3
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Balance Sheets
(Unaudited)
(Millions, except share data)
March 31, December 31,
2004 2003
--------------- ---------------
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost of
$15,695.6 at 2004 and $15,558.3 at 2003) $ 16,441.5 $ 16,075.5
Equity securities, at fair value:
Common stock (cost of $13.5 at 2004 and 2003) 13.8 13.7
Preferred stock (cost of $5.2 at 2004 and $1.5 at 2003) 5.3 1.7
Investment in mutual funds (cost of $35.3 at 2004 and $100.5 at 2003) 36.9 104.8
Mortgage loans on real estate 3,475.6 3,388.7
Real estate 4.5 4.5
Policy loans 173.4 177.1
Short-term investments 10.0 0.3
Other investments 83.8 56.0
Securities pledged to creditors (amortized cost of
$357.8 at 2004 and $22.2 at 2003) 374.6 22.3
--------------- ---------------
Total investments 20,619.4 19,844.6
Cash and cash equivalents 168.1 65.1
Short-term investments under securities loan agreement 396.7 22.9
Accrued investment income 196.3 185.7
Reinsurance recoverable 20.8 15.4
Receivable for securities sold 288.2 11.7
Deferred policy acquisition costs 1,356.4 1,826.7
Value of business acquired 90.8 111.5
Sales inducements to Contractholders 467.3 -
Due from affiliates 367.5 117.7
Deferred income tax asset - 28.6
Other assets 21.8 20.1
Assets held in separate accounts 19,714.9 18,220.1
--------------- ---------------
Total assets $ 43,708.2 $ 40,470.1
=============== ===============
The accompanying notes are an integral part of these financial statements.
4
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Balance Sheets
(Unaudited)
(Millions, except share data)
March 31, December 31,
2004 2003
--------------- ---------------
Liabilities and Shareholder's Equity
Policy liabilities and accruals:
Future policy benefits and claims reserves $ 19,461.0 $ 18,781.1
Notes to affiliates 35.0 35.0
Due to affiliates 56.1 60.7
Payables for securities purchased 289.4 -
Borrowed money 1,206.0 607.1
Current income taxes 14.4 19.4
Deferred income taxes 32.2 -
Other liabilities 229.0 209.5
Liabilities related to separate accounts 19,714.9 18,220.1
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Total liabilities 41,038.0 37,932.9
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Shareholder's equity
Common stock (250,000 shares authorized, issued and outstanding;
$10.00 per share value) 2.5 2.5
Additional paid-in capital 3,812.7 3,812.7
Accumulated other comprehensive income 302.7 190.0
Retained deficit (1,447.7) (1,468.0)
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Total shareholder's equity 2,670.2 2,537.2
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Total liabilities and shareholder's equity $ 43,708.2 $ 40,470.1
=============== ===============
The accompanying notes are an integral part of these financial statements.
5
ING USA Annuity and Life Insurance Company,
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Statements of Changes in Shareholder's Equity
(Unaudited)
(Millions)
Accumulated
Additional Other Total
Common Paid-In Comprehensive Retained Shareholder's
Stock Capital Income Deficit Equity
-------------- --------------- --------------- --------------- ----------------
Balance at December 31, 2002 $ 2.5 $ 3,724.0 $ 135.1 $(1,512.9) $ 2,348.7
Contribution of capital - 88.7 - - 88.7
Comprehensive loss:
Net loss - - - (13.5) (13.5)
Other comprehensive loss net of tax:
Unrealized loss on securities
($154.5 pretax) - - (100.4) - (100.4)
----------------
Comprehensive loss (113.9)
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Balance at March 31, 2003 $ 2.5 $ 3,812.7 $ 34.7 $ (1,526.4) $ 2,323.5
============== =============== =============== =============== ================
$ 2.5 $ 3,812.7 $ 190.0 $ (1,468.0) $ 2,537.2
Balance at December 31, 2003
Comprehensive income:
Net income - - - 20.3 20.3
Other comprehensive income net of tax:
Unrealized gain on securities
($173.4 pretax) - - 112.7 - 112.7
----------------
Comprehensive income 133.0
-------------- --------------- --------------- --------------- ----------------
Balance at March 31, 2004 $ 2.5 $ 3,812.7 $ 302.7 $ (1,447.7) $ 2,670.2
============== =============== =============== =============== ================
The accompanying notes are an integral part of these financial statements.
6
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Statements of Cash Flows
(Unaudited)
(Millions)
Three months ended March 31,
2004 2003
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Net cash provided by operating activities $ 950.2 $ 887.6
Cash Flows from Investing Activities:
Proceeds from the sale, maturity, or repayment of:
Fixed maturities available for sale 4,919.8 5,332.7
Equity securities 69.0 -
Mortgage loans on real estate 67.2 128.2
Acquisition of investments:
Fixed maturities available for sale (5,381.5) (6,387.1)
Equity securities (3.8) -
Mortgage loans on real estate (154.1) (88.9)
Short-term and other investments (419.5) (654.8)
(Increase) decrease in policy loans 3.7 2.5
Proceeds from sale of real estate - 1.8
Purchase of property and equipment (0.4) -
Other invested assets - (28.1)
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Net cash used in investing activities (899.6) (1,693.7)
--------------- ---------------
Cash Flows from Financing Activities:
Deposits for investment contracts 646.7 419.4
Maturities and withdrawals from insurance and investment contracts (475.4) (328.2)
Cash received from reinsurance recapture - 134.4
Transfers from (to) separate accounts (118.9) (254.2)
Borrowed money - 698.9
Contribution of capital from parent - 88.7
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Net cash provided by financing activities 52.4 759.0
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Net increase (decrease) in cash and cash equivalents 103.0 (47.1)
Cash and cash equivalents, beginning of period 65.1 199.1
--------------- ---------------
Cash and cash equivalents, end of period $ 168.1 152.0
=============== ===============
Supplemental cash flow information:
Income taxes (received) paid, net $ 5.0 (2.4)
=============== ===============
Interest paid $ 2.0 $ 2.6
=============== ===============
The accompanying notes are an integral part of these financial statements.
7
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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1. Significant Accounting Policies
Basis of Presentation
ING USA Annuity and Life Insurance Company ("ING USA" or the "Company"), a
wholly-owned subsidiary of Lion Connecticut Holdings Inc. ("Lion" or
"Parent"), is a stock life insurance company organized under the laws of
the State of Iowa. ING USA was originally incorporated under the laws of
the State of Minnesota on January 2, 1973, in the name of St. Paul Life
Insurance Company. On December 21, 1993, the Company redomesticated from
Minnesota to Delaware.
On January 1, 2004, the Company redomesticated from Delaware to Iowa. In
addition, on January 1, 2004 (the "merger date"), Equitable Life Insurance
Company of Iowa ("Equitable Life"), USG Annuity & Life Company ("USG") and
United Life & Annuity Insurance Company ("ULA") (the "Merger Companies"),
merged with and into Golden American Life Insurance Company ("Golden
American"). Immediately after the merger, Golden American changed its name
to ING USA Annuity and Life Insurance Company. As of the merger date, the
Merger Companies ceased to exist and were merged into ING USA. Lion is an
indirect, wholly-owned subsidiary of ING Groep N.V. ("ING"), a global
financial services holding company based in The Netherlands. ING USA is
authorized to do business in the District of Columbia and all states except
New York. ING USA is licensed as a life insurance company under the laws of
the State of Delaware until December 31, 2003 and Iowa since January 1,
2004.
Prior to the merger date, ING USA was a wholly-owned subsidiary of
Equitable Life from December 30, 2001 through December 31, 2003. Formerly,
from October 24, 1997, until December 30, 2001, Equitable of Iowa
Companies, Inc. ("EIC" or "Former Holding Company") directly owned 100% of
Golden American's stock.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("FAS 141"), excludes transfers of net assets or exchanges of
shares between entities under common control, and notes that certain
provisions under Accounting Principles Board Opinion No. 16, "Business
Combinations" ("APB 16"), provide a source of guidance for such
transactions. In accordance with APB 16, financial information of the
combined entity is presented as if the entities had been combined for the
full year, and all comparative financial statements are restated and
presented as if the entities had previously been combined, in a manner
similar to a pooling-of-interests.
The unaudited condensed financial statements have been prepared in a manner
similar to a pooling-of-interests, in accordance with the provisions of APB
16 in order to present the condensed financial position and results of
operations of the Company and the Merger Companies, as if the entities had
previously been combined. The unaudited condensed balance sheets and
statements of income give effect to the consolidation transaction as if it
had occurred on December 31, 2003 and January 1, 2003, respectively.
8
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The financial statements and notes as of March 31, 2004 and December 31,
2003 and for the three-month periods ended March 31, 2004 and 2003
("interim periods"), have been prepared in accordance with accounting
principles generally accepted in the United States of America and are
unaudited. The condensed financial statements reflect all adjustments which
are in the opinion of management, necessary for the fair presentation of
the financial position, results of the operation and cash flows for the
interim periods.
Description of Business
The Company offers various insurance products including deferred and
immediate annuities, variable annuities, interest sensitive and traditional
life insurance, and health insurance. All health insurance is ceded to
other insurers. The Company's products are marketed by broker/dealers,
financial institutions, insurance agents, and a career agency force. The
Company's primary customers are consumers and corporations.
Recently Adopted Accounting Standards
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts
The Company adopted Statement of Position ("SOP") 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts," on January 1, 2004. SOP 03-1
establishes several new accounting and disclosure requirements for certain
nontraditional long-duration contracts and for separate accounts including,
among other things, a requirement that assets and liabilities of separate
account arrangements that do not meet certain criteria be accounted for as
general account assets and liabilities, and that the revenue and expenses
related to such arrangements be consolidated within the respective line
items in the Condensed Statements of Income. In addition, the SOP requires
additional liabilities be established for certain guaranteed death and
other benefits and for products with certain patterns of cost of insurance
charges, and that sales inducements provided to contractholders be
recognized on the balance sheet separately from deferred acquisition costs
and amortized as a component of benefits expense using methodology and
assumptions consistent with those used for amortization of deferred policy
acquisition costs.
The Company evaluated all requirements of SOP 03-1 and determined that it
is affected by the SOP's requirements to establish additional liabilities
for certain guaranteed benefits and products with patterns of cost
insurance charges resulting in losses in later policy durations from the
insurance benefit function and to defer, amortize, and recognize
separately, sales inducements to contractholders. Requirements for certain
separate account arrangements that do not meet the established criteria for
separate asset and liability recognition are applicable to the Company,
however, the Company's policies on separate account assets and liabilities
have historically been, and continue to be, in conformity with the
requirements newly established. Upon adoption of the SOP, the Company
9
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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recognized a cumulative effect of a change in accounting principle of
$(2.3) million on January 1, 2004.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended and interpreted by FAS No.
137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement 133," and FAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of FASB 133, and certain FAS 133 implementation
issues." This standard, as amended, requires companies to record all
derivatives on the balance sheet as either assets or liabilities and
measure those instruments at fair value. The manner in which companies are
to record gains or losses resulting from changes in the fair values of
those derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting. FAS No. 133 was effective for the Company's
financial statements beginning January 1, 2001. Adoption of FAS No. 133 did
not have a material effect on the Company's financial position or results
of operations given the Company's limited derivative holdings and embedded
derivatives.
The Company occasionally purchases a financial instrument that contains a
derivative that is "embedded" in the instrument. In addition, the Company's
insurance products are reviewed to determine whether they contain an
embedded derivative. The Company assesses whether the economic
characteristics of the embedded derivative are clearly and closely related
to the economic characteristics of the remaining component of the financial
instrument or insurance product (i.e., the host contract) and whether a
separate instrument with the same terms as the embedded instrument would
meet the definition of a derivative instrument. When it is determined that
the embedded derivative possesses economic characteristics that are not
clearly and closely related to the economic characteristics of the host
contract and that a separate instrument with the same terms would qualify
as a derivative instrument, the embedded derivative is separated from the
host contract and carried at fair value. However, in cases where the host
contract is measured at fair value, with changes in fair value reported in
current period earnings or the Company is unable to reliably identify and
measure the embedded derivative for separation from its host contracts, the
entire contract is carried on the balance sheet at fair value and is not
designated as a hedging instrument.
In 2003, the Derivative Implementation Group ("DIG") responsible for
issuing guidance on behalf of the FASB for implementation of FAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" issued
Statement Implementation Issue No. B36, "Embedded Derivatives: Modified
Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk
Exposures That Are Unrelated or Only Partially Related to the Credit
Worthiness of the Obligor under Those Instruments" ("DIG B36"). Under this
interpretation, modified coinsurance and coinsurance with funds withheld
reinsurance agreements as well as other types of receivables and payables
where interest is determined by reference to a pool of fixed maturity
assets or total return debt index may be determined to contain embedded
derivatives that are required to be bifurcated. The Company adopted DIG B36
10
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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on October 1, 2003 and has modified coinsurance treaties that are
applicable to the guidance. The applicable contracts, however, were
determined to generate embedded derivatives with a fair value of zero.
Therefore, the guidance, while implemented, does not impact the Company's
financial position, results of operations, or cash flows.
Variable Interest Entities
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46). In December 2003, the FASB modified
FIN 46 to make certain technical corrections and address certain
implementation issues that had arisen. FIN 46 provides a new framework for
identifying variable interest entities (VIEs) and determining when a
company should include the assets, liabilities, noncontrolling interests
and results of activities of a VIE in its consolidated financial
statements.
In general, a VIE is a corporation, partnership, limited-liability
corporation, trust, or any other legal structure used to conduct activities
or hold assets that either (1) has an insufficient amount of equity to
carry out its principal activities without additional subordinated
financial support, (2) has a group of equity owners that are unable to make
significant decisions about its activities, or (3) has a group of equity
owners that do not have the obligation to absorb losses or the right to
receive returns generated by its operations.
FIN 46 requires a VIE to be consolidated if a party with an ownership,
contractual or other financial interest in the VIE (a variable interest
holder) is obligated to absorb a majority of the risk of loss from the
VIE's activities, is entitled to receive a majority of the VIE's residual
returns (if no party absorbs a majority of the VIE's losses), or both. A
variable interest holder that consolidates the VIE is called the primary
beneficiary. Upon consolidation, the primary beneficiary generally must
initially record all of the VIE's assets, liabilities and noncontrolling
interests at fair value and subsequently account for the VIE as if it were
consolidated based on majority voting interest. FIN 46 also requires
disclosures about VIEs that the variable interest holder is not required to
consolidate but in which it has a significant variable interest.
11
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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At March 31, 2004, the Company held the following investments that, for
purposes of FIN 46, were evaluated and determined that the investments do
not require consolidation in the Company's financial statements:
(Millions)
Asset Type Purpose Book Value (1) Market Value
---------------------------------------- -------------------------- ---------------- ----------------
Private Corporate Securities - synthetic
leases; project financings; credit tenant
leases Investment Holdings $ 2,734.0 $ 2,929.5
Foreign Securities - US VIE subsidiaries
of foreign companies Investment Holdings 551.2 596.0
Commercial Mortgage Obligations (CMO) Investment Holdings 6,597.2 6,884.2
Collateralized Debt Obligations (CDO) Investment Holdings
and/or
Collateral Manager 61.6 56.7
Asset-Backed Securities (ABS) Investment Holdings 1,231.8 1,250.5
Commercial Mortgage Backed Securities
(CMBS) Investment Holdings 820.5 870.8
(1) Represents maximum exposure to loss except for those structures for which the Company also receives asset
management fees.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from reported results using those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, money market instruments
and other debt issues with a maturity of 90 days or less when purchased.
Investments
All of the Company's fixed maturity and equity securities are currently
designated as available-for-sale. Available-for-sale securities are
reported at fair value and unrealized gains and losses on these securities
are included directly in shareholder's equity, after adjustment for related
charges in deferred policy acquisition costs, value of business acquired,
and deferred income taxes.
The Company analyzes the general account investments to determine whether
there has been an other than temporary decline in fair value below the
amortized cost basis in accordance with FAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." Management considers
the length of the time and the extent to which the market value has been
less than cost; the financial condition and near-term prospects of the
issuer; future economic conditions and market forecasts; and the Company's
intent and ability to retain the investment in the issuer for a period of
time sufficient to allow for recovery in market value. If it is probable
12
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
that all amounts due according to the contractual terms of a debt security
will not be collected, an other than temporary impairment is considered to
have occurred.
In addition, the Company invests in structured securities that meet the
criteria of Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets." Under Issue No. EITF
99-20, a determination of the required impairment is based on credit risk
and the possibility of significant prepayment risk that restricts the
Company's ability to recover the investment. An impairment is recognized if
the fair value of the security is less than amortized cost and there has
been an adverse change in cash flow since the remeasurement date.
When a decline in fair value is determined to be other than temporary, the
individual security is written down to fair value and the loss is accounted
for as a realized loss.
Realized capital gains and losses on all other investments are included in
the Condensed Statements of Income. Unrealized capital gains and losses on
all other investments are reflected in shareholder's equity, net of related
income taxes.
Purchases and sales of fixed maturities and equity securities (excluding
private placements) are recorded on the trade date. Purchases and sales of
private placements and mortgage loans are recorded on the closing date.
Fair values for fixed maturities are obtained from independent pricing
services or broker/dealer quotations. Fair values for privately placed
bonds are determined using a matrix-based model. The matrix-based model
considers the level of risk-free interest rates, current corporate spreads,
the credit quality of the issuer and cash flow characteristics of the
security. The fair values for equity securities are based on quoted market
prices. For equity securities not actively traded, estimated fair values
are based upon values of issues of comparable yield and quality or
conversion value where applicable.
The Company engages in securities lending whereby certain securities from
its portfolio are loaned to other institutions for short periods of time.
Initial collateral, primarily cash, is required at a rate of 102% of the
market value of the loaned domestic securities. The collateral is deposited
by the borrower with a lending agent, and retained and invested by the
lending agent according to the Company's guidelines to generate additional
income. The market value of the loaned securities is monitored on a daily
basis with additional collateral obtained or refunded as the market value
of the loaned securities fluctuates.
Reverse dollar repurchase agreement and reverse repurchase agreement
transactions are accounted for as collateralized borrowings, where the
amount borrowed is equal to the sales price of the underlying securities.
The investment in mutual funds represents an investment in mutual funds
managed by the Company, and is carried at fair value.
13
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Mortgage loans on real estate are reported at amortized cost less
impairment writedowns. If the value of any mortgage loan is determined to
be impaired (i.e., when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement), the carrying value of the mortgage loan is reduced to the
present value of expected cash flows from the loan, discounted at the
loan's effective interest rate, or to the loan's observable market price,
or the fair value of the underlying collateral. The carrying value of the
impaired loans is reduced by establishing a permanent writedown charged to
realized loss.
Investments in real estate are reported at historical cost, less
accumulated depreciation and impairment writedowns, with the exception of
land, which is not depreciated. If the value of any real estate is
determined to be impaired (i.e., when it is probable that the Company will
be unable to recover the carrying value of the real estate), the carrying
value of the real estate is reduced to the current fair value. The carrying
value of the impaired real estate is reduced by establishing a permanent
writedown charged to realized loss.
Policy loans are carried at unpaid principal balances, net of impairment
reserves.
Short-term investments, consisting primarily of money market instruments
and other fixed maturity issues purchased with an original maturity of 91
days to one year, are considered available for sale and are carried at fair
value, which approximates amortized cost.
The Company's use of derivatives is limited to hedging purposes. The
Company enters into interest rate and currency contracts, including swaps,
caps, floors, options, futures, and embedded derivatives, to reduce and
manage risks associated with changes in value, yield, price, cash flow or
exchange rates of assets or liabilities held or intended to be held.
Changes in the fair value of open derivative contracts are recorded in net
realized capital gains and losses.
On occasion, the Company sells call options written on underlying
securities that are carried at fair value. Changes in fair value of these
options are recorded in net realized capital gains or losses.
Deferred Policy Acquisition Costs and Value of Business Acquired
Deferred Policy Acquisition Costs ("DAC") is an asset, which represents
certain costs of acquiring certain insurance business, which are deferred
and amortized. These costs, all of which vary with and are primarily
related to the production of new and renewal business, consist principally
of commissions, certain underwriting and contract issuance expenses, and
certain agency expenses. Value of Business Acquired ("VOBA") is an asset,
which represents the present value of estimated net cash flows embedded in
the Company's contracts, which existed at the time the Company was acquired
by ING. DAC and VOBA are evaluated for recoverability at each balance sheet
14
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
date and these assets would be reduced to the extent that gross profits are
inadequate to recover the asset.
The amortization methodology varies by product type based upon two
accounting standards: FAS No. 60, "Accounting and Reporting by Insurance
Enterprises" ("FAS No. 60") and FAS No. 97, "Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and Realized
Gains and Losses from the Sale of Investments" ("FAS No. 97").
Under FAS No. 60, acquisition costs for traditional life insurance
products, which primarily include whole life and term life insurance
contracts, are amortized over the premium payment period in proportion to
the premium revenue recognition.
Under FAS No. 97, acquisition costs for universal life and investment-type
products, which include universal life policies and fixed and variable
deferred annuities, are amortized over the life of the blocks of policies
(usually 25 years) in relation to the emergence of estimated gross profits
from surrender charges, investment margins, mortality and expense margins,
asset-based fee income, and actual realized gains (losses) on investments.
Amortization is adjusted retrospectively when estimates of current or
future gross profits to be realized from a group of products are revised.
DAC and VOBA are written off to the extent that it is determined that
future policy premiums and investment income or gross profits are not
adequate to cover related expenses.
Activity for the periods ended March 31, 2004 and 2003 within VOBA was as
follows:
(Millions)
Balance at December 31, 2002 $ 134.5
Adjustment for FAS No. 115 (2.5)
Interest accrued at 5% 1.8
Amortization (2.6)
--------------
Balance at March 31, 2003 $ 131.2
==============
Balance at December 31, 2003 $ 111.5
Adjustment for FAS No. 115 (16.4)
Interest accrued at 5% 1.4
Amortization (5.7)
--------------
Balance at March 31, 2004 $ 90.8
==============
The estimated amount of VOBA to be amortized, net of interest, over the
next five years is $13.3 million, $14.4 million, $13.7 million, $9.4
million and $9.5 million for the years 2004, 2005, 2006, 2007 and 2008,
respectively. Actual amortization incurred during these years may vary as
assumptions are modified to incorporate actual results.
15
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
As part of the regular analysis of DAC/VOBA, at the end of third quarter of
2002, the Company unlocked its long-term rate of return assumptions. The
Company reset long-term assumptions for the separate account returns to
9.0% (gross before fund management fees and mortality and expense and other
policy charges), as of December 31, 2002, reflecting a blended return of
equity and other sub-accounts. The initial unlocking adjustment in 2002 was
primarily driven by the sustained downturn in the equity markets and
revised expectations for future returns.
The Company remained unlocked during 2003 and has continued to remain
unlocked during the first quarter of 2004. In 2003, the Company reset
long-term assumptions for the separate account returns from 9.0% to 8.5%
(gross before fund management fees and mortality and expense and other
policy charges) maintaining a blended return of equity and other
sub-accounts. The 2003 unlocking adjustment from the previous year was
primarily driven by improved market performance. During the three months
ended March 31, 2004, the Company recorded a deceleration of DAC/VOBA
amortization of $2.7 million pretax, $1.8 million net of $0.9 million of
federal income tax expense.
Separate Accounts
Separate Account assets and liabilities generally represent funds
maintained to meet specific investment objectives of contractholders who
bear the investment risk, subject, in limited cases, to minimum guaranteed
rates. Investment income and investment gains and losses generally accrue
directly to such contractholders. The assets of each account are legally
segregated and are not subject to claims that arise out of any other
business of the Company.
Separate Account assets supporting variable options under universal life
and annuity contracts are invested, as designated by the policyholder or
participant (who bears the investment risk subject, in limited cases, to
minimum guaranteed rates) under a contract in shares of mutual funds which
are managed by the Company, or in other selected mutual funds not managed
by the Company.
Separate Account assets are carried at fair value. At March 31, 2004 and
2003, unrealized gains of $112.8 million and $153.6 million, respectively,
after taxes, on assets supporting a guaranteed interest option are
reflected in shareholder's equity.
Separate Account liabilities are carried at fair value, except for those
relating to the guaranteed interest option. Reserves relating to the
guaranteed interest option are maintained at fund value and reflect
interest credited at rates ranging from 2.4% to 7.5% in 2004 and 2003.
16
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Separate Account assets and liabilities are carried at fair value and shown
as separate captions in the Consolidated Balance Sheets. Deposits,
investment income and net realized and unrealized capital gains and losses
of the Separate Accounts are not reflected in the Consolidated Financial
Statements (with the exception of realized and unrealized capital gains and
losses on the assets supporting the guaranteed interest option). The
Consolidated Statements of Cash Flows do not reflect investment activity of
the Separate Accounts.
Assets and liabilities of separate account arrangements that do not meet
the criteria in SOP 03-1 for presentation in the separate caption in the
Condensed Balance Sheets, and revenue and expenses related to such
arrangements, are consolidated in the financial statements with the general
account.
Policy Liabilities and Accruals
Future policy benefits include reserves for universal life, immediate
annuities with life contingent payouts and traditional life insurance
contracts. Reserves for universal life products are equal to cumulative
deposits less withdrawals and charges plus credited interest thereon.
Reserves for traditional life insurance contracts represent the present
value of future benefits to be paid to or on behalf of policyholders and
related expenses less the present value of future net premiums.
Reserves for immediate annuities with life contingent payout contracts are
computed on the basis of assumed investment yield, mortality, and expenses,
including a margin for adverse deviations. Such assumptions generally vary
by plan, year of issue and policy duration. Reserve interest rates ranged
from 3.0% to 9.3% for all periods presented. Investment yield is based on
the Company's experience.
Mortality and withdrawal rate assumptions are based on relevant Company
experience and are periodically reviewed against both industry standards
and experience.
Other policyholders' fund include reserves for deferred annuity investment
contracts and immediate annuity without life contingent payouts. Reserves
on such contracts are equal to cumulative deposits less charges and
withdrawals plus credited interest thereon (rates range from 2.4% to 9.0%
for all periods presented) net of adjustments for investment experience
that the Company is entitled to reflect in future credited interest.
Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts and are
higher than the contract's expected ongoing crediting rates for periods
after the inducement. As of January 1, 2004, such amounts are reported
separately on the balance sheet in accordance with SOP 03-1. Prior to 2004,
sales inducements were recorded as a component of DAC on the Condensed
17
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Balance Sheet. Sales inducements are amortized as a component of benefit
expense using methodology and assumptions consistent with those used for
amortization of DAC.
Revenue Recognition
For universal life and certain annuity contracts, charges assessed against
policyholders' funds for the cost of insurance, surrender, expenses,
actuarial margin and other fees are recorded as revenue as charges are
assessed against policyholders. Other amounts received for these contracts
are reflected as deposits and are not recorded as revenue. Related policy
benefits are recorded in relation to the associated premiums or gross
profit so that profits are recognized over the expected lives of the
contracts. When annuity payments with life contingencies begin under
contracts that were initially investment contracts, the accumulated balance
in the account is treated as a single premium for the purchase of an
annuity and reflected as an offsetting amount in both premiums and current
and future benefits in the Condensed Statement of Income.
Reinsurance
The Company utilizes indemnity reinsurance agreements to reduce its
exposure to large losses in all aspects of its insurance business. Such
reinsurance permits recovery of a portion of losses from reinsurers,
although it does not discharge the primary liability of the Company as
direct insurer of the risks reinsured. The Company evaluates the financial
strength of potential reinsurers and continually monitors the financial
condition of reinsurers. Only those reinsurance recoverable balances deemed
probable of recovery are reflected as assets on the Company's Condensed
Balance Sheets.
Participating Insurance
Participating business approximates 10% of the Company's ordinary life
insurance in force and 25% of premium income. The amount of dividends to be
paid is determined annually by the Board of Directors. Amounts allocable to
participating policyholders are based on published dividend projections or
expected dividend scales. Dividends of $4.1 and $5.9 were incurred during
the three months ended March 31, 2004 and 2003, respectively.
Income Taxes
The Company is taxed at regular corporate rates after adjusting income
reported for financial statement purposes for certain items. Deferred
income tax expenses/benefits result from changes during the year in
cumulative temporary differences between the tax basis and book basis of
assets and liabilities.
18
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. Investments
Fixed maturities available for sale as of March 31, 2004 were as follows:
(Millions)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. government and government
agencies and authorities $ 30.3 1.9 $ - $ 32.2
State, municipalities and political
subdivisions 31.2 - 0.8 30.4
U.S. corporate securities:
Public utilities 1,518.9 109.4 2.7 1,625.6
Other corporate securities 7,125.1 435.9 10.8 7,550.2
--------------- --------------- --------------- ---------------
Total U.S. corporate securities 8,644.0 545.3 13.5 9,175.8
--------------- --------------- --------------- ---------------
Foreign securities:
Government 415.6 27.7 2.1 441.2
Other 2,073.3 127.6 8.8 2,192.1
--------------- --------------- --------------- ---------------
Total foreign securities 2,488.9 155.3 10.9 2,633.3
--------------- --------------- --------------- ---------------
Mortgage-backed securities 3,490.4 85.4 12.4 3,563.4
Other asset-backed securities 1,368.6 27.2 14.8 1,381.0
Total fixed maturities, including fixed
maturities pledged to creditors 16,053.4 815.1 52.4 16,816.1
Less: fixed maturities pledged to
creditors 357.8 17.6 0.8 374.6
--------------- --------------- --------------- ---------------
Fixed maturities $ 15,695.6 $ 797.5 $ 51.6 $16,441.5
=============== =============== =============== ===============
19
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Fixed maturities available for sale as of December 31, 2003 were as
follows:
(Millions)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. government and government
agencies and authorities $ 195.5 $ 2.0 $ 0.1 $ 197.4
State, municipalities and political
subdivisions 31.7 - 2.5 29.2
U.S. corporate securities:
Public utilities 1,341.2 84.3 8.0 1,417.5
Other corporate securities 7,020.6 346.7 35.8 7,331.5
--------------- --------------- -------------- --------------
Total U.S. corporate securities 8,361.8 431.0 43.8 8,749.0
--------------- --------------- -------------- --------------
Foreign securities:
Government 487.1 21.7 3.9 504.9
Other 1,984.4 96.0 24.1 2,056.3
--------------- --------------- -------------- --------------
Total foreign securities 2,471.5 117.7 28.0 2,561.2
--------------- --------------- -------------- --------------
Mortgage-backed securities 3,247.0 66.7 21.8 3,291.9
Other asset-backed securities 1,273.0 17.2 21.1 1,269.1
Total fixed maturities, including fixed
maturities pledged to creditors 15,580.5 634.6 117.3 16,097.8
Less: fixed maturities pledged to
creditors 22.2 0.1 - 22.3
--------------- --------------- -------------- --------------
Fixed maturities $ 15,558.3 $ 634.5 $ 117.3 $ 16,075.5
=============== =============== ============== ==============
At March 31, 2004 and December 31, 2003, net unrealized appreciation is
$762.7 million and $517.3 million, respectively, on available-for-sale
fixed maturities, including fixed maturities pledged to creditors.
The aggregate unrealized losses and related fair values of investments with
unrealized losses as of March 31, 2004, are shown below by duration:
Unrealized Fair
Loss Value
------------------ ------------------
(Millions)
Duration category:
Less than six months below cost $ 11.8 $ 1,093.6
More than six months and less than twelve months below cost 24.2 998.0
More than twelve months below cost 16.4 100.6
------------------ ------------------
Fixed maturities $ 52.4 $ 2,192.2
================== ==================
20
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Of the losses more than 6 months and less than 12 months in duration of
$24.2 million, there were $17.5 million in unrealized losses that are
primarily related to interest rate movement or spread widening for other
than credit-related reasons. Business and operating fundamentals are
performing as expected. The remaining losses of $6.7 million as of March
31, 2004 included the following significant items:
$3.5 million of unrealized losses related to securities reviewed for
impairment under the guidance prescribed by EITF 99-20. This category
includes U.S. government-backed securities, principal protected
securities and structured securities which did not have an adverse
change in cash flows for which the carrying amount was $212.9 million.
$1.9 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $5.2 million.
The remaining unrealized losses totaling $1.3 million related to a
carrying amount of $10.6 million.
Of the losses more than 12 months in duration of $16.4 million, there were
$13.4 million related to securities reviewed for impairment under the
guidance prescribed by EITF 99-20. This category includes U.S.
government-backed securities, principal protected securities and structured
securities which did not have an adverse change in cash flows for which the
carrying amount was $57.2 million.
The amortized cost and fair value of total fixed maturities as of March 31,
2004 are shown below by contractual maturity. Actual maturities may differ
from contractual maturities because securities may be restructured, called,
or prepaid.
Amortized Fair
Cost Value
------------------ ------------------
(Millions)
Due to mature:
One year or less $ 754.6 $ 788.8
After one year through five years 3,133.9 3,339.2
After five years through ten years 4,231.3 4,511.0
After ten years 2,254.2 2,361.8
Mortgage-backed securities 4,310.8 4,434.3
Other asset-backed securities 1,368.6 1,381.0
Less: fixed maturities pledged to creditors 357.8 374.6
------------------ ------------------
Fixed maturities $ 15,695.6 $ 16,441.5
================== ==================
At March 31, 2004 and December 31, 2003, fixed maturities with fair values
of $14.5 million and $20.1 million, respectively, were on deposit as
required by regulatory authorities.
21
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The Company did not have any investments in a single issuer, other than
obligations of the U.S. government, with a carrying value in excess of 10%
of the Company's shareholder's equity at March 31, 2004.
The Company enters into reverse dollar repurchase agreement and reverse
repurchase agreement transactions to increase its return on investments and
improve liquidity. These transactions involve a sale of securities and an
agreement to repurchase substantially the same securities as those sold.
The dollar rolls and reverse repurchase agreements are accounted for as
short-term collateralized financings and the repurchase obligation is
reported on the Condensed Balance Sheets in borrowed money. The repurchase
obligation totaled $758.3 and $534.2 million at March 31, 2004 and December
31, 2003, respectively.
The primary risk associated with short-term collateralized borrowings is
that the counterparty will be unable to perform under the terms of the
contract. The Company's exposure is limited to the excess of the net
replacement cost of the securities over the value of the short-term
investments, an amount that was not material at March 31, 2004. The Company
believes the counterparties to the dollar roll and reverse repurchase
agreements are financially responsible and that the counterparty risk is
immaterial.
During the three months ended March 31, 2004, the Company determined that
76 fixed maturities had an other than temporary impairment. As a result,
for the three months ended March 31, 2004, the Company recognized a pre-tax
loss of $6.1 million to reduce the carrying value of the fixed maturities
to their fair value of $53.3 million. During the three months ended March
31, 2003, the Company determined that 153 fixed maturities had other than
temporary impairments. As a result, for the three months ended March 31,
2003, the Company recognized a pre-tax loss of $56.6 million to reduce the
carrying value of the fixed maturities to their combined fair value of
$209.4 million.
3. Financial Instruments
Estimated Fair Value
The following disclosures are made in accordance with the requirements of
FAS No. 107, "Disclosures about Fair Value of Financial Instruments." FAS
No. 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it
is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value
or other valuation techniques.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In that
regard, the derived fair value estimates, in many cases, could not be
realized in immediate settlement of the instrument. FAS No. 107 excludes
certain financial instruments and all nonfinancial instruments from its
22
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
The following valuation methods and assumptions were used by the Company in
estimating the fair value of the above financial instruments:
Fixed maturities securities: The fair values for the actively traded
marketable bonds are determined based upon the quoted market prices. The
fair values for marketable bonds without an active market are obtained
through several commercial pricing services which provide the estimated
fair values. Fair values of privately placed bonds are determined using a
matrix-based pricing model. The model considers the current level of
risk-free interest rates, current corporate spreads, the credit quality of
the issuer and cash flow characteristics of the security. Using this data,
the model generates estimated market values which the Company considers
reflective of the fair value of each privately placed bond. Fair values for
privately placed bonds are determined through consideration of factors such
as the net worth of the borrower, the value of collateral, the capital
structure of the borrower, the presence of guarantees and the Company's
evaluation of the borrower's ability to compete in their relevant market.
Equity securities: Fair values of these securities are based upon quoted
market value.
Mortgage loans on real estate: The fair values for mortgage loans on real
estate are estimated using discounted cash flow analyses and rates
currently being offered in the marketplace for similar loans to borrowers
with similar credit ratings. Loans with similar characteristics are
aggregated for purposes of the calculations.
Real estate: The fair values for real estate are estimated using three
methods of review: a discounted cash flow analyses utilizing rates
currently being offered in the marketplace, market value/sales comparisons
of similar products in the subject property market, and cost to reproduce
the asset. These reviews are done periodically; however, a major event,
such as signing/loss of a tenant, physical change to the property, or local
governmental zoning or regulation changes, will trigger an immediate
valuation review.
Cash, short-term investments and policy loans: The carrying amounts for
these assets approximate the assets' fair values.
Assets held in separate accounts: Assets held in separate accounts are
reported at the quoted fair values of the individual securities in the
separate accounts.
Notes to affiliates: Estimated fair value of the Company's notes to
affiliates are based upon discounted future cash flows using a discount
rate approximating the current market value.
23
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Investment contract liabilities (included in future policy benefits and
claims' reserves):
With a fixed maturity: Fair value is estimated by discounting cash flows at
interest rates currently being offered by, or available to, the Company for
similar contracts.
Without a fixed maturity: Fair value is estimated as the amount payable to
the policyholder upon demand. However, the Company has the right under such
contracts to delay payment of withdrawals which may ultimately result in
paying an amount different than that determined to be payable on demand.
Liabilities related to separate accounts: Liabilities related to separate
accounts are reported at full account value in the Company's historical
balance sheet. Estimated fair values of separate account liabilities are
equal to their carrying amount.
The carrying values and estimated fair values of certain of the Company's
financial instruments at March 31, 2004 and December 31, 2003 were as
follows:
2004 2003
------------------------------ ------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------------------------ ------------------------------
(Millions)
Assets:
Fixed maturity, including securities
pledged to creditors $ 6,816.1 $ 16,816.1 $ 16,097.8 $ 16,097.8
Equity securities 56.0 56.0 120.2 120.2
Mortgage loans on real estate 3,475.6 3,732.8 3,388.7 3,581.4
Real estate 4.5 4.8 4.5 4.8
Policy loans 173.4 173.4 177.1 177.1
Cash and short-term investments 178.1 178.1 65.4 65.4
Other investments 83.8 83.8 56.0 56.0
Assets held in separate accounts 19,714.9 19,714.9 18,220.1 18,220.1
Liabilities:
Notes to affiliates 35.0 56.6 35.0 57.3
Investment contract liabilities:
Deferred annuities 16,852.2 16,138.8 16,020.5 15,067.9
Supplementary contracts and
immediate annuities 251.8 251.8 250.9 250.9
Liabilities related to separate accounts 19,714.9 19,714.9 18,220.1 18,220.1
Fair value estimates are made at a specific point in time, based on
available market information and judgments about various financial
instruments, such as estimates of timing and amounts of future cash
flows. Such estimates do not reflect any premium or discount that
could result from offering for sale at one time the Company's entire
holdings of a particular financial instrument, nor do they consider
the tax impact of the realization of unrealized gains or losses. In
many cases, the fair value estimates cannot be substantiated by
comparison to independent markets, nor can the disclosed value be
realized in immediate settlement of the instruments. In evaluating the
24
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Company's management of interest rate, price and liquidity risks, the
fair values of all assets and liabilities should be taken into
consideration, not only those presented above.
Derivative Financial Instruments
Interest Rate Caps
Interest rate caps are used to manage the interest rate risk in the
Company's bond portfolio. Interest rate caps are purchased contracts
that provide the Company with an annuity in an increasing interest
rate environment. The notional amount, carrying value and estimated
fair value of the Company's open interest rate caps as of March 31,
2004 were $1,036.2 million, $1.0 thousand and $1.0 thousand,
respectively. The notional amount, carrying value and estimated fair
value (liabilities are denoted with parentheses) of the Company's open
interest rate caps as of December 31, 2003 were $1,036.2 million,
$20.0 thousand and $20.0 thousand, respectively.
Interest Rate Swaps
Interest rate swaps are used to manage the interest rate risk in the
Company's bond portfolio as well as the Company's liabilities.
Interest rate swaps represent contracts that require the exchange of
cash flows at regular interim periods, typically monthly or quarterly.
The notional amount, carrying value and estimated fair value of the
Company's open interest rate swaps as of March 31, 2004 were $1,294.4
million, $(58.1) million and $(58.1) million, respectively. The
notional amount, carrying value and estimated fair value of the
Company's open interest rate swaps as of December 31, 2003 were
$1,266.5 million, $(91.2) million and $(91.2) million, respectively.
Futures
Futures contracts are used to hedge against a decrease in certain
indexes. Such decrease results in increased reserve liabilities, and
the futures offset this increased expense. The underlying reserve
liabilities are carried at market value with the change in value
running through the statement of income, which is offset by the daily
cash movement of the futures. The notional amount, carrying value and
estimated fair value of the Company's open interest rate swaps as of
March 31, 2004, were $732.8 million, $(0.6) million and $(0.6)
million, respectively. The notional amount, carrying value and
estimated fair value of the Company's open interest rate swaps as of
December 31, 2003, were $491.3 million, $0.8 million and $0.8 million,
respectively.
Foreign Exchange Swaps
Foreign exchange swaps are used to reduce the risk of a change in the
value, yield or cash flow with respect to invested assets. Foreign
exchange swaps represent contracts that require the exchange of
foreign currency cash flows for US dollar cash flows at regular
interim periods, typically quarterly or semi-annually. The notional
amount, carrying value and estimated fair value of the Company's open
foreign exchange rate swaps as of March 31, 2004 were $146.7 million,
$(18.8) million and $(18.8) million, respectively. The notional
amount, carrying value and estimated fair value of the Company's open
25
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
foreign exchange rate swaps as of December 31, 2003 were $128.2
million, $(19.4) million and $(19.4) million, respectively.
Options
S&P Options are used to hedge against an increase in the S&P Index.
Such increase results in increased reserve liabilities, and the
options offset this increased expense. The options are accounted for
in a consistent manner with the underlying reserve liabilities, both
of which are carried at fair value with the change in value running
through the statement of income. If the options mature in the money,
the amount received is recorded in income to offset the increased
expense for the reserve liabilities. The notional amount, carrying
value and estimated fair value of the Company's open options as of
March 31, 2004 were $1,491.2 million, $103.0 million, and $103.0
million, respectively. The notional amount, carrying value and
estimated fair value of the Company's open options as of December 31,
2003 were $1,287.8 million, $100.9 million, and $100.9 million,
respectively.
Embedded Derivatives
The Company also had investments in certain fixed maturity instruments
and retail annuity products that contain embedded derivatives,
including those whose market value is at least partially determined
by, among other things, levels of or changes in domestic and/or
foreign interest rates (short- or long-term), exchange rates,
prepayment rates, equity markets or credit ratings/spreads. The
estimated fair value of the embedded derivatives within such
securities as of March 31, 2004 and December 31, 2003 was $(0.5)
million and $(1.1) million, respectively. The estimated fair value of
the embedded derivatives within retail annuity products as of March
31, 2004 and December 31, 2003, was $273.3 million and $238.9 million,
respectively.
26
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
4. Net Investment Income
Sources of net investment income were as follows:
Three months Three months
ended ended
March 31, March 31,
(Millions) 2004 2003
------------------ ------------------
Fixed maturities $ 231.3 $ 238.0
Equity securities 0.1 -
Mortgage loans 53.3 50.5
Real estate 0.1 0.5
Policy loans 2.9 2.4
Short-term investments and cash equivalents 0.2 0.7
Other 27.8 1.6
------------------ ------------------
Gross investment income 315.7 293.7
Less: investment expenses 17.2 13.8
------------------ ------------------
Net investment income $ 298.5 $ 279.9
================== ==================
5. Dividend Restrictions and Shareholder's Equity
The Company's ability to pay dividends to its Parent is subject to the
prior approval of insurance regulatory authorities for payment of
dividends, which exceed an annual limit. The Company did not pay common
stock dividends during the period ended March 31, 2004 or the year ended
December 31, 2003.
The Insurance Department of the State of Iowa (the "Department"), effective
January 1, 2004, recognizes as net income and capital and surplus those
amounts determined in conformity with statutory accounting practices
prescribed or permitted by the Department, which differ in certain respects
from accounting principles generally accepted in the United States.
Statutory net loss was $1.9 million and $68.9 million, for the three
months ended March 31, 2004 and 2003, respectively. Statutory capital and
surplus was $1,089.3 million and $969.6 million as of March 31, 2004 and
2003, respectively.
As of March 31, 2004, the Company does not utilize any statutory accounting
practices, which are not prescribed by state regulatory authorities that,
individually or in the aggregate, materially affect statutory capital and
surplus.
27
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
6. Capial Gains and Losses
Realized capital gains and losses are comprised of the difference between
the carrying value of investments and proceeds from sale, maturity, and
redemption, as well as losses incurred due to the impairment of
investments. Net realized capital gains (losses) on investments were as
follows:
Three months Three months
ended ended
March 31, March 31,
(Millions) 2004 2003
------------------ ------------------
Fixed maturities $ 49.1 $ (4.9)
Equity securities 3.5 -
Derivatives (52.1) (1.8)
------------------ ------------------
Pretax realized capital gains (losses) $ 0.5 $ (6.7)
================== ==================
After-tax realized capital gains (losses) $ 0.3 $ (4.4)
================== ==================
Proceeds from the sale of total fixed maturities and the related gross
gains and losses were as follows:
Three months Three months
ended ended
March 31, March 31,
(Millions) 2004 2003
------------------ ------------------
Proceeds on sales $ 2,971.7 $ 3,912.5
Gross gains 64.0 80.6
Gross losses 5.9 18.6
Changes in shareholder's equity related to changes in accumulated other
comprehensive income were as follows:
Three months Three months
ended ended
March 31, March 31,
(Millions) 2004 2003
------------------ ------------------
Fixed maturities $ 245.3 $ 62.4
Equity securities (2.6) -
DAC/VOBA (60.8) (50.2)
Derivatives 1.3 (0.6)
Sales inducements (18.4) -
Other - (1.1)
------------------ ------------------
Subtotal 164.8 10.5
Increase in deferred income taxes (52.1) (110.9)
------------------ ------------------
Net changes in accumulated other
comprehensive income (loss) $ 112.7 $ (100.4)
================== ==================
28
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Shareholder's equity included the following accumulated other comprehensive
income (loss):
March 31, March 31,
(Millions) 2004 2003
------------------- ------------------
Net unrealized capital gains (losses):
Fixed maturities $ 762.7 $ 670.2
Equity securities 2.5 (3.4)
DAC/VOBA (271.3) (439.7)
Derivatives (12.8) (0.6)
Sales inducements (18.4) -
Other - (0.8)
------------------- ------------------
Subtotal 462.7 225.7
Less: deferred income taxes 160.0 191.0
------------------- ------------------
Net accumulated other comprehensive
income $ 302.7 $ 34.7
=================== ==================
Changes in accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities, were as follows:
Three months Three months
ended ended
March 31, March 31,
(Millions) 2004 2003
Unrealized holding gains (losses) arising ------------------ ------------------
during the year (1) $ 164.0 $ (100.5)
Less: reclassification adjustment for gains
(losses) and other items included in
net income(2) 51.3 (0.1)
------------------ -------------------
Net unrealized gains (losses) on securities $ 112.7 $ (100.4)
================== ===================
(1) Pretax unrealized holding gains (losses) arising during the
period were $106.6 million and $(65.3) million for the three
months ended March 31, 2004 and 2003, respectively.
(2) Pretax reclassification adjustments for gains (losses) and other
items included in net income were $33.3 million and $(0.1)
million for the three months ended March 31, 2004 and 2003,
respectively.
7. Additional Insurance Benefits and Minimum Guarantees
Under SOP 03-1, the Company calculates additional liabilities ("SOP
reserves") for certain guaranteed benefits and for Universal Life products
with certain patterns of cost of insurance charges. The SOP reserve
recognized for such products is in addition to the liability previously
held (the Account Value) and is to recognize the portion of contract
assessments received in early years used to compensate the insurer for
services provided in later years.
29
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The SOP reserve for products with cost of insurance charges is calculated
as an estimate intended to represent a calculated reserve using the same
assumptions used in the determination of estimated gross profits, according
to which, deferred acquisition costs are amortized. ING USA calculates a
benefit ratio for each block of business subject to the SOP, and calculates
an SOP reserve by accumulating amounts equal to the benefit ratio
multiplied by the assessments for each period, reduced by excess death
benefits during the period. The SOP reserve is accumulated at interest
using the contract-credited rate for the period. The calculated reserve
includes a provision for Universal Life contracts with patterns of Cost of
Insurance Charges that produce expected gains from the insurance benefit
function followed by losses from that function in later years.
The SOP reserve for annuities with minimum guaranteed death benefits
("MGDB") is determined each period by estimating the expected value of
death benefits in excess of the projected account balance and recognizing
the excess ratably over the accumulation period based on total expected
assessments. The Company regularly evaluates estimates used to adjust the
additional liability balance, with a related charge or credit to benefit
expense, if actual experience or other evidence suggests that earlier
assumptions should be revised. The following assumptions and methodology
were used to determine the MGDB SOP reserve at March 31, 2004:
Area Assumptions/Basis for Assumptions
--------------------------------- -------------------------------------
Data used Based on 101 investment performance
scenarios stratified based on 10,000
random generated scenarios
Mean investment performance 8.5%
Volatility 20.0%
Mortality 60.0%, 60.0%, 75.0%, 75.0% of the
90-95 ultimate mortality table for
standard, rachet, rollup and
combination rollup and rachet,
respectively
Lapse rates Vary by contract type and duration;
range between 1.0% and 40.0%
Discount rates 6.5%, based on the portfolio earned
rate of the general account
The SOP reserve for annuities with guaranteed minimum accumulation benefits
("GMAB") and guaranteed minimum withdrawal benefits ("GMWB") are considered
to be derivatives under Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", and are recognized at fair value
through earnings.
The SOP reserve for the guaranteed minimum income benefits ("GMIB") is
determined each period by estimating the expected value of the annutization
benefits in excess of the projected account balance at the date of
annuitization and recognizing the excess ratably over the accumulation
period based on total expected assessments. The Company regularly evaluates
estimates used and adjusts the additional liability balance, with a related
charge or credit to benefit expense, if the actual experience or other
evidence suggests that earlier assumptions should be revised. The
assumptions used for calculating the additional GMIB liability at March 31,
2004, are consistent with those used for the calculating the additional
30
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
MGDB liability. In addition, the calculation of the GMIB liability assumes
dynamic lapses and dynamic annuitization reflecting the extent to which the
benefit, at the time of payment, has a positive value.
The separate account liabilities subject to SOP 03-1 for minimum guaranteed
benefits, and the additional liabilities recognized related to minimum
guarantees, by type, as of March 31, 2004, and the paid and incurred
amounts by type for the three months ended March 31, 2004 are as follows:
Minimum Guaranteed Guaranteed
Guaranteed Minimum Minimum
Death Accumulation/ Income
Benefit Withdrawal Benefit Benefit
(MGDB) (GMAB/GMWB) (GMIB)
---------------- ---------------------- --------------
Separate account liability
balance $ 20,898.6 $ 1,295.6 $ 5,489.8
Additional liability balance:
Balance at January 1, 2004 $ 56.5 14.5 13.6
Incurred guaranteed benefits 10.0 (6.2) 3.7
Paid guaranteed benefits (5.2) - -
---------------- ---------------------- --------------
Balance at March 31, 2004 $ 61.3 $ 8.3 $ 17.3
================ ====================== ==============
The net amount at risk (net of reinsurance) and the weighted average
attained age of contractholders by type of minimum guaranteed benefit, are
as follows as of March 31, 2004:
Minimum Guaranteed Guaranteed
Guaranteed Minimum Minimum
Death Accumulation/ Income
Benefit Withdrawal Benefit Benefit
(MGDB) (GMAB/GMWB) (GMIB)
-------------- ----------------------- ---------------
Net Amount at Risk (net of reinsurance) $ 462.0 $ 79.9 $ 223.3
Weighted Average Attained Age 64 59 59
The aggregate fair value of assets, by major investment asset category,
supporting separate accounts with additional insurance benefits, and
minimum investment return guarantees as of March 31, 2004 are:
(Millions)
-----------
Private corporate securities $ 5,404.4
Public corporate securities 8,167.6
Collateralized mortgage obligations 1,248.8
Commercial mortgage backed securities 2,409.1
Commercial mortgages 3,668.7
---------------
Total $ 20,898.6
===============
31
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
8. Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts and are
higher than the contract's expected ongoing crediting rates for periods
after the inducement. Such amounts are reported separately on the balance
sheet as of January 1, 2004. Prior to 2004, these amounts were included in
DAC. Sales inducements are amortized as a component of benefit expense
using methodology and assumptions consistent with those used for
amortization of DAC. During the three months ended March 31, 2004, the
company capitalized and amortized $24.9 million and $25.2 million,
respectively, of sales inducements. The unamortized balance of capitalized
sales inducements, net of unrealized gains and losses, is $467.3 million as
of March 31, 2004.
9. Income Taxes
Effective January 1, 2004, the Company files a stand-alone federal income
tax return. Prior to that date, the Company and each of the Merger
Companies, filed federal income tax returns with their respective filing
groups.
At March 31, 2004, the Company has net operating loss carryforwards of
approximately $487.0 million for federal income tax purposes which are
available to offset future taxable income. If not used, these carryforwards
will expire between 2015 and 2017.
Income tax expense (benefit) from continuing operations included in the
condensed financial statements are as follows:
Three months Three months
ended ended
March 31, March 31,
(Millions) 2004 2003
------------------ -------------------
Current tax (benefit):
Federal $ - $ (2.1)
------------------ -------------------
Total current tax (benefit) - (2.1)
------------------ -------------------
Deferred tax (benefit):
Operations and capital loss carryforwards 6.2 -
Other federal deferred tax 3.8 (5.4)
------------------ -------------------
Total deferred tax (benefit) 10.0 (5.4)
------------------ -------------------
Total income tax expense (benefit) $ 10.0 $ (7.5)
================== ===================
32
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Income taxes were different from the amount computed by applying the
federal income tax rate to income from continuing operations before
income taxes for the following reasons:
Three months Three months