UNITED STATES
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 June 30, 2004
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
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ING USA Annuity and 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 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 [ ]
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 August 12, 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).
ING USA ANNUITY AND LIFE INSURANCE COMPANY
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Form 10Q for the period ended June 30, 2004
INDEX
Page
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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 46
Item 4. Controls and Procedures 59
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 60
Item 6. Exhibits and Reports on Form 8-K 60
Signatures 61
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 June 30, Six months ended June 30,
2004 2003 2004 2003
------------------------------- -------------------------------
Revenue:
Premiums $ 6.8 $ 7.4 $ 12.4 $ 14.8
Fee income 140.2 96.5 269.1 177.1
Net investment income 293.6 281.7 563.9 566.0
Net realized capital (losses) gains (9.7) 6.1 19.0 (5.0)
Other (expense) income (0.7) 0.3 1.5 4.1
------------------------------- -------------------------------
Total revenue 430.2 392.0 865.9 757.0
------------------------------- -------------------------------
Benefits, losses and expenses:
Benefits:
Interest credited and other benefits to policyholders 285.2 236.7 576.2 537.5
Underwriting, acquisition, and insurance expenses:
General expenses 58.1 53.8 109.9 106.1
Commissions 130.6 91.7 242.9 145.1
Policy acquisition costs deferred (152.3) (128.5) (274.9) (212.5)
Amortization of deferred policy acquisition costs
and value of business acquired 35.1 87.6 101.4 147.6
Other:
Expense and charges reimbursed under modified
coinsurance agreements 0.1 - 0.7 0.2
Interest expense 3.6 4.2 7.3 7.5
------------------------------- -------------------------------
Total benefits, losses and expenses 360.4 345.5 763.5 731.5
------------------------------- -------------------------------
Income before income taxes and cumulative
effect of change in accounting principle 69.8 46.5 102.4 25.5
Income tax expense 23.2 14.4 33.2 6.9
------------------------------- -------------------------------
Net income before cumulative effect of change
in accounting principle 46.6 32.1 69.2 18.6
Cumulative effect of change in accounting principle - - (2.3) -
------------------------------- -------------------------------
Net income $ 46.6 $ 32.1 $ 66.9 $ 18.6
=============================== ===============================
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)
June 30, December 31,
2004 2003
------------------ ------------------
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost of
$16,453.4 at 2004 and $15,558.3 at 2003) $ 16,563.2 $ 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 $6.4 at 2004 and $1.5 at 2003) 6.6 1.7
Investment in mutual funds (cost of $2.3 at 2004 and $100.5 at 2003) 2.4 104.8
Mortgage loans on real estate 3,553.2 3,388.7
Real estate 1.8 4.5
Policy loans 170.9 177.1
Short-term investments 22.1 0.3
Other investments 169.8 56.0
Securities pledged under securities lending agreement (amortized
cost of $391.7 at 2004 and $22.2 at 2003) 387.6 22.3
------------------ ------------------
Total investments 20,891.4 19,844.6
Cash and cash equivalents 98.3 65.1
Short-term investments under securities loan agreement 398.5 22.9
Accrued investment income 200.3 185.7
Reinsurance recoverable 629.4 634.8
Receivable for securities sold 49.4 11.7
Deferred policy acquisition costs 1,635.1 1,826.7
Value of business acquired 135.7 111.5
Sales inducements to Contractholders 496.1 -
Due from affiliates 174.9 117.7
Deferred income tax asset 99.8 28.6
Other assets 24.9 20.1
Assets held in separate accounts 20,821.7 18,220.1
------------------ ------------------
Total assets $ 45,655.5 $ 41,089.5
================== ==================
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)
June 30, December 31,
2004 2003
------------------ ------------------
Liabilities and Shareholder's Equity
Policy liabilities and accruals:
Future policy benefits and claims reserves $ 20,823.6 $ 19,400.5
Notes to affiliates 35.0 35.0
Due to affiliates 46.2 60.7
Payables for securities purchased 77.8 -
Payables under securities loan agreement 398.5 22.9
Borrowed money 669.9 584.2
Current income taxes 12.2 19.4
Other liabilities 291.7 209.5
Liabilities related to separate accounts 20,821.7 18,220.1
----------------- -----------------
Total liabilities 43,176.6 38,552.3
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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 3,852.7 3,812.7
Accumulated other comprehensive income 24.8 190.0
Retained deficit (1,401.1) (1,468.0)
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Total shareholder's equity 2,478.9 2,537.2
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Total liabilities and shareholder's equity $ 45,655.5 $ 41,089.5
================= =================
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
Dividends paid - - - (12.4) (12.4)
Contribution of capital - 88.7 - - 88.7
Comprehensive income:
Net income - - - 18.6 18.6
Other comprehensive income
net of tax:
Unrealized gain on securities
($97.4 pretax) - - 63.3 - 63.3
----------------
Comprehensive income 81.9
-------------- --------------- ---------------- --------------- ----------------
Balance at June 30, 2003 $ 2.5 $ 3,812.7 $ 198.4 $ (1,506.7) $ 2,506.9
============== =============== ================ =============== ================
Balance at December 31, 2003 $ 2.5 $ 3,812.7 $ 190.0 $ (1,468.0) $ 2,537.2
Contribution of capital - 40.0 - - 40.0
Comprehensive loss:
Net income - - - 66.9 66.9
Other comprehensive loss net of tax:
Unrealized loss on securities
(($254.2) pretax) - - (165.2) - (165.2)
----------------
Comprehensive loss (98.3)
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Balance at June 30, 2004 $ 2.5 $ 3,852.7 $ 24.8 $ (1,401.1) $ 2,478.9
============== =============== ================ =============== ================
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)
Six months ended June 30,
2004 2003
------------------ ------------------
Net cash provided by operating activities $ 648.1 $ 509.2
Cash Flows from Investing Activities:
Proceeds from the sale, maturity, or redemption of:
Fixed maturities, available for sale 9,907.8 10,921.9
Equity securities 103.2 3.6
Mortgage loans on real estate originated 182.9 285.8
Short-term investments 2,569.2 3,587.8
Acquisition of investments:
Fixed maturities, available for sale (11,211.7) (12,124.4)
Equity securities (5.0) (12.2)
Mortgage loans on real estate (350.3) (253.8)
Short-term investments (2,591.0) (3,689.6)
Policy loans 6.2 2.5
Proceeds from sale of real estate 2.7 1.4
Other investments (111.1) (33.9)
Other - (0.5)
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Net cash used in investing activities (1,497.1) (1,311.4)
------------------ ------------------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 1,959.9 1,817.3
Maturities and withdrawals from insurance and investment contracts (980.9) (851.3)
Reinsurance recapture - 134.5
Transfers to separate accounts (222.5) (512.8)
Short-term loans 85.7 130.0
Intercompany dividends - (12.4)
Intercompany loans - 59.1
Contribution of capital from Parent 40.0 88.7
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Net cash provided by financing activities 882.2 853.1
------------------ ------------------
Net increase in cash and cash equivalents 33.2 50.9
Cash and cash equivalents, beginning of period 65.1 199.1
------------------ ------------------
Cash and cash equivalents, end of period $ 98.3 $ 250.0
================== ==================
Supplemental cash flow information:
Income taxes paid (received), net $ 7.2 $ (2.2)
================== ==================
Interest paid $ 0.1 $ 5.2
================== ==================
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)
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The financial statements and notes as of June 30, 2004 and December 31,
2003 and for the three and six-month periods ended June 30, 2004 and 2003
("interim periods"), have been prepared in accordance with U.S. generally
accepted accounting principles and are unaudited. The condensed financial
statements reflect all normal recurring adjustments, which are, in the
opinion of management, necessary for the fair presentation of the financial
position, results of operations 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)
- --------------------------------------------------------------------------------
recognized a cumulative effect of a change in accounting principle of
$(3.6) million, before tax or $(2.3) million, net of $1.3 million of income
taxes, as of January 1, 2004.
The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments
In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments," adopting a
three-step impairment model for securities within its scope. The three-step
model is to be applied on a security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is
impaired if its fair value of the investment is less than its cost
basis.
Step 2: Evaluate whether an impairment is other-than-temporary.
Step 3: If the impairment is other-than-temporary, recognize an impairment
loss equal to the difference between the investment's cost and
its fair value.
The Company included this three-step model in the impairment evaluation for
the quarter ended June 30, 2004. This guidance resulted in no additional
impairments for the Company.
Earlier consensus reached by the EITF on this issue required that certain
quantitative and qualitative disclosures be made for unrealized losses on
debt and equity securities that have not been recognized as
other-than-temporary impairments. These disclosures were adopted by the
Company, effective December 31, 2003, and included in the Investments
footnote of the Notes to Condensed Financial Statements included in the
Company's December 31, 2003 Form 10-K. In addition to the disclosure
requirements adopted by the Company effective December 31, 2003, the final
consensus of EITF 03-01 reached in March 2004 included additional
disclosure requirements that are effective for fiscal years ending after
June 15, 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.
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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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
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
11
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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.
At June 30, 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 $ 2,962.6 $ 3,036.8
Foreign Securities - US VIE subsidiaries of
foreign companies Investment Holdings 538.4 551.1
Commercial Mortgage Obligations (CMO) Investment Holdings 3,465.9 3,461.1
Collateralized Debt Obligations (CDO) Investment Holdings
and/or
Collateral Manager 61.3 55.9
Asset-Backed Securities (ABS) Investment Holdings 1,488.5 1,482.0
Commercial Mortgage Backed Securities (CMBS) Investment Holdings 1,048.4 1,058.2
(1) Represents maximum exposure to loss except for those structures for which the Company also receives asset management fees.
New Accounting Pronouncements
FSP FAS 97-1
The implementation of the American Institute of Certified Public
Accountants ("AICPA") SOP 03-01, "Accounting and Reporting by Insurance
Enterprises for certain Nontraditional Long-Duration Contracts and for
Separate Accounts," has raised questions regarding the interpretation of
the requirements of SFAS No. 97, concerning when it is appropriate to
record an unearned revenue liability related to the insurance benefit
function. To clarify its position, in June of 2004 the Financial Accounting
Standards Board ("FASB") issued FSP FAS 97-1, "Situations in which
paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting
12
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
by Insurance Enterprises for certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments, Permit or Require
Accrual of an Unearned Revenue Liability." FSP FAS 97-1 outlines that SFAS
No. 97 is clear in its intent and language, and requires the recognition of
an unearned revenue liability for amounts that have been assessed to
compensate insurers for services provided over future periods. The
requirement of SOP 03-01 is not intended to amend or limit the requirement
of SFAS No. 97 to recognize a liability for unearned revenue only to those
situations where profits are expect to be followed by a loss. The guidance
contained in FSP FAS 97-1 is effective for financial statements with fiscal
periods beginning subsequent to July 18, 2004. The Company is currently
evaluating the impact of FSP FAS 97-1 and related accounting guidance and
anticipates a potential increase in the (net) liability established under
SOP 03-01 in future accounting periods.
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
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.
13
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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.
The Company engages in dollar repurchase agreements ("dollar rolls") and
repurchase agreements. These transactions involve a sale of securities and
an agreement to repurchase substantially the same securities as those sold.
Company policies require a minimum of 95% of the fair value of securities
pledged under dollar rolls and repurchase agreement transactions to be
maintained as collateral. Cash collateral received is invested in
short-term investments and the offsetting collateral liability is included
in borrowed money on the Condensed Balance Sheets.
14
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The Company enters into reverse repurchase agreements. These transactions
involve a purchase of securities and an agreement to sell substantially the
same securities as those purchased. Company policies require a minimum of
102% of the fair value of securities pledged under reverse repurchase
agreements to be pledged as collateral. The market value of the pledged
securities is monitored on a daily basis with additional collateral
obtained or refunded as the market value fluctuates.
The investment in mutual funds represents an investment in mutual funds
managed by the Company, and is carried at fair value.
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.
15
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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
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.
16
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Activity for the periods ended June 30, 2004 and 2003 within VOBA was as
follows:
(Millions)
Balance at December 31, 2002 $ 134.5
Adjustment for FAS No. 115 (18.5)
Interest accrued at 5% - 7% 3.5
Amortization (8.3)
------------------
Balance at June 30, 2003 $ 111.2
==================
Balance at December 31, 2003 $ 111.5
Adjustment for FAS No. 115 21.5
Interest accrued at 4% - 6% 3.4
Amortization (0.7)
------------------
Balance at June 30, 2004 $ 135.7
==================
The estimated amount of VOBA to be amortized, net of interest, over the
next five years is $3.3 million, $14.7 million, $14.0 million, $9.6 million
and $9.6 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.
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 certain minimum
guarantees. 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 June 30, 2004 and
2003, unrealized gains of $35.3 million and $216.3 million, respectively,
after taxes, on assets supporting a guaranteed interest option are
reflected in shareholder's equity.
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. The Consolidated Statements of Cash Flows do not reflect
investment activity of the Separate Accounts.
17
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 7.95% 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 8.0%
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
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, 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
18
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 $8.1 million and $8.6 million were
incurred during the six months ended June 30, 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.
19
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 June 30, 2004 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. government and government
agencies and authorities $ 388.5 $ 1.7 $ 0.4 $ 389.8
State, municipalities and political subdivisions 20.7 - 2.3 18.4
U.S. corporate securities:
Public utilities 1,714.9 54.4 25.4 1,743.9
Other corporate securities 7,247.9 197.8 113.8 7,331.9
--------------- --------------- --------------- ---------------
Total U.S. corporate securities 8,962.8 252.2 139.2 9,075.8
--------------- --------------- --------------- ---------------
Foreign securities:
Government 445.0 8.2 10.9 442.3
Other 2,092.5 64.8 43.4 2,113.9
--------------- --------------- --------------- ---------------
Total foreign securities 2,537.5 73.0 54.3 2,556.2
--------------- --------------- --------------- ---------------
Mortgage-backed securities 3,258.7 49.9 62.5 3,246.1
Other asset-backed securities 1,676.9 13.2 25.6 1,664.5
Total fixed maturities, including fixed
maturities pledged to creditors 16,845.1 390.0 284.3 16,950.8
Less: fixed maturities pledged to
creditors 391.7 3.6 7.7 387.6
--------------- --------------- --------------- ---------------
Fixed maturities $ 16,453.4 $ 386.4 $ 276.6 $ 16,563.2
=============== =============== =============== ===============
20
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:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) 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 June 30, 2004 and December 31, 2003, net unrealized appreciation is
$105.7 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 June 30, 2004, are shown below by duration:
Unrealized Fair
Loss Value
------------------ ------------------
(Millions)
Duration category:
Less than six months below cost $ 208.6 $ 7,280.3
More than six months and less than twelve months below cost 32.1 499.2
More than twelve months below cost 43.6 428.8
------------------ ------------------
Fixed maturities $ 284.3 $ 8,208.3
================== ==================
21
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 less than 6 months in duration of $208.6 million, there were
$146.7 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 $61.9 million as of June 30, 2004 included the
following significant items:
|X| $59.2 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 $2,589.1
million.
|X| $2.7 million of unrealized losses related to the airlines industry,
for which the carrying amount was $78.3 million.
Of the losses more than 6 months and less than 12 months in duration of
$32.1 million, there were $24.3 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 $7.8 million as of June 30,
2004 included the following significant items:
|X| $6.8 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 $162.9 million.
|X| $1.0 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $3.1 million.
Of the losses more than 12 months in duration of $43.6 million, there were
$23.1 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 $20.5 million as of June 30, 2004 included the
following significant items:
|X| $17.2 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 $142.4 million.
22
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
|X| $1.8 million of unrealized losses relating to the airlines industry,
for which the carrying amount was $22.1 million.
|X| $1.5 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $4.0.
The amortized cost and fair value of total fixed maturities as of June 30,
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 $ 206.4 $ 211.1
After one year through five years 3,625.8 3,707.6
After five years through ten years 3,954.1 4,037.2
After ten years 3,026.2 2,977.1
Mortgage-backed securities 4,355.7 4,353.3
Other asset-backed securities 1,676.9 1,664.5
Less: fixed maturities pledged to creditors 391.7 387.6
------------------ ------------------
Fixed maturities $ 16,453.4 $ 16,563.2
================== ==================
At June 30, 2004 and December 31, 2003, fixed maturities with fair values
of $14.1 million and $20.1 million, respectively, were on deposit as
required by regulatory authorities.
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 June 30, 2004.
The Company enters into dollar repurchase agreement and 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 repurchase agreements are accounted for as short-term
collateralized financing and the repurchase obligation is reported on the
Condensed Balance Sheets in borrowed money. At June 30, 2004 and December
31, 2003, the carrying value of the securities pledged in dollar rolls and
repurchase agreement transactions was $676.3 million and $536.8 million,
respectively. The carrying value of the securities pledged in dollar rolls
and repurchase agreement transactions is included in fixed maturities on
the Condensed Balance Sheets. The repurchase obligation totaled $670.0
million and $534.2 million at June 30, 2004 and December 31, 2003,
respectively.
23
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 June 30, 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 June 30, 2004, the Company determined that 15
fixed maturities had an other than temporary impairment. As a result, for
the three months ended June 30, 2004, the Company recognized a pre-tax loss
of $7.0 million to reduce the carrying value of the fixed maturities to
their fair value of $15.9 million. During the three months ended June 30,
2003, the Company determined that 130 fixed maturities had other than
temporary impairments. As a result, for the three months ended June 30,
2003, the Company recognized a pre-tax loss of $30.5 million to reduce the
carrying value of the fixed maturities to their combined fair value of
$141.9 million.
During the six months ended June 30, 2004, the Company determined that 70
fixed maturities had an other than temporary impairment. As a result, for
the six months ended June 30, 2004, the Company recognized a pre-tax loss
of $13.1 million to reduce the carrying value of the fixed maturities to
their fair value of $69.2 million. During the six months ended June 30,
2003, the Company determined that 170 fixed maturities had other than
temporary impairments. As a result, for the six months ended June 30, 2003,
the Company recognized a pre-tax loss of $87.0 million to reduce the
carrying value of the fixed maturities to their combined fair value of
$351.2 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
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
24
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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.
25
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 June 30, 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 $ 16,950.8 $ 16,950.8 $ 16,097.8 $ 16,097.8
Equity securities 22.8 22.8 120.2 120.2
Mortgage loans on real estate 3,553.2 3,649.2 3,388.7 3,581.4
Real estate 1.8 2.0 4.5 4.8
Policy loans 170.9 170.9 177.1 177.1
Cash and short-term investments 518.9 518.9 88.3 88.3
Other investments 169.8 169.8 56.0 56.0
Assets held in separate accounts 20,821.7 20,821.7 18,220.1 18,220.1
Liabilities:
Notes to affiliates 35.0 54.0 35.0 57.3
Investment contract liabilities:
Deferred annuities 16,833.6 15,757.2 16,072.4 15,069.0
Supplementary contracts and
immediate annuities 840.1 840.1 840.1 840.1
Liabilities related to separate accounts 20,821.7 20,821.7 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 Company's management of interest rate, price
26
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 June 30, 2004 were $736.2
million, $4.0 thousand and $4.0 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 June 30, 2004 were $1,573.4 million, $20.4
million and $20.4 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 June 30, 2004, were $(922.7)
million, $(4.5) million and $(4.5) 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
27
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
of June 30, 2004 were $18.5 million, $(19.9) million and $(19.9) million,
respectively. The notional amount, carrying value and estimated fair value
of the Company's open 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 June 30, 2004 were $1,762.1 million, $118.8 million, and
$118.8 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 securities as of June 30, 2004 and December 31, 2003 was $0 million
and $(1.1) million, respectively. The estimated fair value of the embedded
derivatives within retail annuity products as of June 30, 2004 and December
31, 2003, was $314.0 million and $238.9 million, respectively.
28
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
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ 241.4 $ 246.9
Equity securities 0.1 2.6
Mortgage loans 57.0 51.6
Real estate 0.1 -
Policy loans 2.0 1.4
Short-term investments and cash equivalents 0.3 0.7
Other 9.8 (5.5)
------------------ -------------------
Gross investment income 310.7 297.7
Less: investment expenses 17.1 16.0
------------------ -------------------
Net investment income $ 293.6 $ 281.7
================== ===================
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ 472.7 $ 484.9
Equity securities 0.1 2.6
Mortgage loans 110.3 102.2
Real estate 0.2 0.5
Policy loans 4.9 3.8
Short-term investments and cash equivalents 0.6 1.3
Other 9.4 0.5
------------------ -------------------
Gross investment income 598.2 595.8
Less: investment expenses 34.3 29.8
------------------ -------------------
Net investment income $ 563.9 $ 566.0
================== ===================
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 June 30, 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 income (loss) was $(10.7) million and $8.5 million, for the
29
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
three months ended June 30, 2004 and 2003, respectively. Statutory net loss
was $12.6 million and $60.4 million, for the six months ended June 30, 2004
and 2003, respectively. Statutory capital and surplus was $1,154.8 million
and $1,020.1 million as of June 30, 2004 and 2003, respectively.
As of June 30, 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.
6. Capital 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:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ 28.6 $ 75.7
Equity securities 5.3 (0.3)
Derivatives (14.9) (77.9)
Real Estate - (2.3)
Other - (0.2)
------------------ -------------------
Pretax realized capital gains (losses) 19.0 (5.0)
================== ===================
After-tax realized capital gains (losses) $ 12.4 $ (3.3)
================== ===================
Proceeds from the sale of total fixed maturities and the related gross
gains and losses were as follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Proceeds on sales $ 9,291.4 $ 8,032.9
Gross gains 86.1 188.5
Gross losses 38.3 26.1
30
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Changes in shareholder's equity related to changes in accumulated other
comprehensive income were as follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ (411.7) $ 378.3
Equity securities (4.5) 5.6
DAC/VOBA 145.6 (96.7)
Derivatives 2.7 (26.8)
Sales inducements (0.4) -
Other - 0.9
------------------ -------------------
Subtotal (268.3) 261.3
Decrease (increase) in deferred income taxes 103.1 (198.0)
------------------ -------------------
Net changes in accumulated other
comprehensive income $ (165.2) $ 63.3
================== ===================
Shareholder's equity included the following accumulated other comprehensive
income:
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Net unrealized capital gains (losses):
Fixed maturities $ 105.6 $ 986.1
Equity securities 0.7 2.1
DAC/VOBA (64.9) (486.2)
Derivatives (11.3) (26.8)
Sales inducements (0.5) -
Other - 1.2
------------------ -------------------
Subtotal 29.6 476.4
Less: deferred income taxes 4.8 278.0
------------------ -------------------
Net accumulated other comprehensive income $ 24.8 $ 198.4
================== ===================
Changes in accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities, were as follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Unrealized holding gains (losses) arising
during the year (1) $ (111.8) $ 113.7
Less: reclassification adjustment for gains
(losses) and other items included in
net income (2) 53.4 50.4
------------------ -------------------
Net unrealized gains (losses) on securities $ (165.2) $ 63.3
================== ===================
(1) Pretax unrealized holding gains (losses) arising during the period
were $(172.0) million and $174.9 million for the six months ended June
30, 2004 and 2003, respectively.
(2) Pretax reclassification adjustments for gains (losses) and other items
included in net income were $82.2 million and $77.5 million for the
six months ended June 30, 2004 and 2003, respectively.
31
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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.
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 June 30, 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 18.0%
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.
32
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 the guaranteed minimum income benefits ("GMIB") is
determined each period by estimating the expected val