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 September 30, 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, 333-116137
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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 November 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).
1
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Form 10-Q for period ended September 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 47
Item 4. Controls and Procedures 60
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 61
Item 6. Exhibits 61
Signatures 64
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 September 30, Nine months ended September 30,
2004 2003 2004 2003
----------------- ---------------- ----------------- ----------------
Revenue:
Premiums $ 6.6 $ $ 6.5 $ 19.0 $ 21.3
Fee income 148.7 108.7 417.8 285.8
Net investment income 266.0 272.2 829.9 838.2
Net realized capital gains 13.7 15.8 32.7 10.8
Other income 0.8 3.1 2.3 7.2
----------------- ---------------- ----------------- ----------------
Total revenue 435.8 406.3 1,301.7 1,163.3
----------------- ---------------- ----------------- ----------------
Benefits, losses and expenses:
Benefits:
Interest credited and other benefits to policyholders 276.4 272.4 852.6 809.9
Underwriting, acquisition, and insurance expenses:
General expenses 56.8 49.1 166.7 155.2
Commissions 140.1 91.2 383.0 236.3
Policy acquisition costs deferred (158.2) (132.6) (433.1) (345.1)
Amortization of deferred policy acquisition costs
and value of business acquired 76.6 88.5 178.0 236.1
Other:
Expense and charges reimbursed under modified
coinsurance agreements 0.8 0.3 1.5 0.5
Interest expense 3.0 4.8 10.3 12.3
----------------- ---------------- ----------------- ----------------
Total benefits, losses and expenses 395.5 373.7 1,159.0 1,105.2
----------------- ---------------- ----------------- ----------------
Income before income taxes and cumulative effect
of change in accounting principle 40.3 32.6 142.7 58.1
Income tax expense 37.2 3.8 70.4 10.7
----------------- ---------------- ----------------- ----------------
Income before cumulative effect of change
in accounting principle 3.1 28.8 72.3 47.4
Cumulative effect of change in accounting principle,
net of tax - - (2.3) -
----------------- ---------------- ----------------- ----------------
Net income $ 3.1 $ 28.8 $ 70.0 $ 47.4
================= ================ ================= ================
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)
September 30, December 31,
2004 2003
----------------- -----------------
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost of
$16,172.1 at 2004 and $15,025.0 at 2003) $ 16,628.5 $ 15,538.7
Equity securities available for sale, at fair value:
Common stock (cost of $16.4 at 2004 and $13.5 at 2003) 16.9 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 $1.6 at 2004 and $100.5 at 2003) 1.7 104.8
Mortgage loans on real estate 3,706.2 3,388.7
Real estate 1.8 4.5
Policy loans 171.4 177.1
Short-term investments 28.5 0.3
Other investments 168.0 56.0
Securities pledged (amortized cost of $1,427.1 at 2004 and $555.5 at 2003) 1,454.3 559.1
----------------- -----------------
Total investments 22,183.9 19,844.6
Cash and cash equivalents 42.5 65.1
Short-term investments under securities loan agreement 825.9 22.9
Accrued investment income 209.3 185.7
Reinsurance recoverable 990.0 651.9
Receivable for securities sold 172.5 11.7
Deferred policy acquisition costs 1,534.4 1,826.7
Value of business acquired 105.3 111.5
Sales inducements to contractholders 487.6 -
Due from affiliates 199.5 117.7
Deferred income taxes - 28.6
Other assets 30.5 20.1
Assets held in separate accounts 21,708.7 18,220.1
----------------- -----------------
Total assets $ 48,490.1 $ 41,106.6
================= =================
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)
September 30, December 31,
2004 2003
----------------- ----------------
Liabilities and Shareholder's Equity
Policy liabilities and accruals:
Future policy benefits and claims reserves $ 22,092.5 $ 19,400.5
Notes to affiliates 35.0 35.0
Notes payable 14.0 -
Due to affiliates 30.7 60.7
Payables for securities purchased 253.6 -
Payables under securities loan agreement 825.9 22.9
Borrowed money 676.1 584.2
Current income taxes 16.0 19.4
Deferred income taxes 23.7 -
Other liabilities 263.9 226.6
Liabilities related to separate accounts 21,708.7 18,220.1
----------------- ----------------
Total liabilities 45,940.1 38,569.4
----------------- ----------------
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 3,851.1 3,811.1
Accumulated other comprehensive income 92.8 190.0
Retained deficit (1,396.4) (1,466.4)
----------------- ----------------
Total shareholder's equity 2,550.0 2,537.2
----------------- ----------------
Total liabilities and shareholder's equity $ 48,490.1 $ 41,106.6
================= ================
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 $ 3,722.4 $ 135.1 $ (1,511.3) $ 2,348.7
Dividends paid - - (12.4) (12.4)
Contribution of capital - 88.7 - - 88.7
Comprehensive income:
Net income - - - 47.4 47.4
Other comprehensive income
net of tax:
Unrealized gain on securities
($164.0 pretax) - - 106.6 - 106.6
---------------
Comprehensive income - - - - 154.0
-------------- --------------- ---------------- -------------- ---------------
Balance at September 30, 2003 $ 2.5 $ 3,811.1 $ 241.7 $ (1,476.3) $ 2,579.0
============== =============== ================ ============== ===============
Balance at December 31, 2003 $ 2.5 $ 3,811.1 $ 190.0 $ (1,466.4) $ 2,537.2
Contribution of capital - 40.0 - - 40.0
Comprehensive loss:
Net income - - - 70.0 70.0
Other comprehensive loss
net of tax:
Unrealized loss on securities
(($149.5) pretax) - - (97.2) - (97.2)
---------------
Comprehensive loss (27.2)
-------------- --------------- ---------------- -------------- ---------------
Balance at September 30, 2004 $ 2.5 $ 3,851.1 $ $ 92.8 $ (1,396.4) $ 2,550.0
============== =============== ================ ============== ===============
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)
Nine months ended September 30,
2004 2003
------------------ ------------------
Net cash provided by operating activities $ 989.1 $ 560.1
Cash Flows from Investing Activities:
Proceeds from the sale, maturity, or redemption of:
Fixed maturities, available for sale 15,034.9 15,961.6
Equity securities, available for sale 104.0 12.0
Mortgage loans on real estate originated 303.7 402.2
Short-term investments 2,798.1 10,171.8
Acquisition of investments:
Fixed maturities, available for sale (17,118.0) (16,966.9)
Equity securities (8.1) (16.2)
Mortgage loans on real estate (625.2) (789.7)
Short-term investments (2,826.3) (10,318.8)
Policy loans 5.7 2.2
Proceeds from sale of real estate 2.7 1.4
Purchase of real estate - (2.7)
Other investments (107.2) (59.3)
Other - (0.4)
------------------ ------------------
Net cash used in investing activities (2,435.7) (1,602.8)
------------------ ------------------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 3,190.8 2,693.1
Maturities and withdrawals from investment contracts (1,597.6) (1,257.0)
Reinsurance recapture - 134.5
Transfers to separate accounts (315.1) (883.1)
Short-term loans 105.9 175.9
Intercompany dividends - (12.4)
Contribution of capital from Parent 40.0 88.7
------------------ ------------------
Net cash provided by financing activities 1,424.0 939.7
------------------ ------------------
Net decrease in cash and cash equivalents (22.6) (103.0)
Cash and cash equivalents, beginning of period 65.1 199.1
------------------ ------------------
Cash and cash equivalents, end of period $ 42.5 $ 96.1
================== ==================
Supplemental cash flow information:
Income taxes paid (received), net $ 8.0 $ (2.2)
================== ==================
Interest paid $ 10.0 $ 8.5
================== ==================
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 condensed financial statements and notes as of September 30, 2004 and
December 31, 2003 and for the three and nine-month periods ended September
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 adjustments (consisting
only of normal recurring accruals) 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. The results of
operations for the interim periods may not be considered indicative of
results to be expected for the full year.
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
9
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
requirements newly established. Upon adoption of the SOP, the Company
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 implementation of SOP 03-1 raised questions regarding the
interpretation of the requirements of Financial Accounting Standard ("FAS")
No. 97, concerning when it is appropriate to record an unearned revenue
liability related to the insurance benefit function. To clarify its
position, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position No. FAS 97-1 ("FSP FAS 97-1"), "Situations in Which
Paragraphs 17(b) and 20 of FASB Statement No. 97, `Accounting and Reporting
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," effective for fiscal periods
beginning subsequent to the date the guidance was issued, June 18, 2004.
The Company adopted FSP FAS 97-1 on July 1, 2004 and has evaluated the
impact of the guidance on whether the Company is required to establish an
unearned revenue reserve on its existing and new business. The adoption of
FSP FAS 97-1 did not have an impact on the Company's financial position,
results of operations or cash flows.
The Meaning of Other Than Temporary Impairment and its Application to
Certain Investments
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF Issue No. 03-1 ("EITF 03-1"), "The Meaning of Other Than Temporary
Impairment and Its Application to Certain Investments," requiring that a
three-step impairment model be applied to 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 the 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.
On September 30, 2004, the FASB issued FASB Staff Position No. EITF Issue
03-1-1 ("FSP EITF 03-1-1"), "Effective Date of Paragraphs 10-20 of EITF
Issue No. 03-1, `The Meaning of Other Than Temporary Impairment and Its
Application to Certain Investments,'" which delayed EITF 03-1's original
effective date of July 1, 2004 for the paragraphs of the guidance
surrounding steps two and three of the impairment model introduced. The
delay is in effect until a final consensus can be reached on such guidance.
Despite the delay of the implementation of steps two and three, other than
temporary impairments are still to be recognized as required by existing
guidance.
10
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 03-1 reached in March 2004 included additional disclosure requirements
that are effective for annual financial statements for fiscal years ending
after June 15, 2004.
Accounting for Derivative Instruments and Hedging Activities
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, did 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.
11
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 September 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 $ 3,188.3 $ 3,321.1
Foreign Securities - US VIE subsidiaries of
foreign companies Investment Holdings 556.1 587.6
Commercial Mortgage Obligations (CMO) Investment Holdings 3,051.7 3,101.4
Collateralized Debt Obligations (CDO) Investment Holdings and/or
Collateral Manager 73.7 69.3
Asset-Backed Securities (ABS) Investment Holdings 153.2 152.8
Commercial Mortgage Backed Securities (CMBS) Investment Holdings 1,027.3 1,066.0
(1) Represents maximum exposure to loss except for those structures for
which the Company also receives asset management fees.
New Accounting Pronouncements
In September 2004, the AICPA issued Technical Practice Aid 6300.05 -
6300.08 "Q&As Related to the Implementation of SOP 03-1, Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" (the "TPA"). The TPA provides
additional guidance regarding certain implicit assessments that may be used
in testing of the base mortality function on contracts, which is performed
to determine whether additional liabilities are required in conjunction
with SOP 03-1. In addition, the TPA provides additional guidance
surrounding the allowed level of aggregation of additional liabilities
determined under the SOP. The Company is currently evaluating the impact of
the TPA on the cumulative effect of a change in accounting principle
recognized on January 1, 2004, and anticipates a potential decrease in the
net liability established as part of the accounting change. The TPA will be
fully implemented during the fourth quarter 2004 and will be reported as a
cumulative effect of a change in accounting principle applied retroactively
to January 1, 2004.
12
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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.
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 EITF Issue No.
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.
13
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 fixed
maturities and the offsetting collateral liability is included in borrowed
money on the Condensed Balance Sheets.
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 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.
14
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 which do
not qualify for hedge accounting treatment under FAS 133. 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. Derivatives are included in Other investments on
the Condensed Balance Sheets.
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
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").
15
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 September 30, 2004 and 2003 within VOBA was
as follows:
(Millions)
Balance at December 31, 2002 $ 134.5
Adjustment for FAS No. 115 (0.2)
Interest accrued at 5% - 7% 5.0
Amortization (23.3)
--------------
Balance at September 30, 2003 $ 116.0
==============
Balance at December 31, 2003 $ 111.5
Adjustment for FAS No. 115 (5.8)
Interest accrued at 4% - 6% 5.2
Amortization (5.6)
--------------
Balance at September 30, 2004 $ 105.3
==============
The estimated amount of VOBA to be amortized, net of interest, over the
next five years is $2.7 million, $13.6 million, $13.4 million, $9.5 million
and $9.8 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.
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 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 and liabilities are carried at fair value and shown
as separate captions in the Condensed Balance Sheets. Deposits, investment
income and net realized and unrealized capital gains and losses of the
Separate Accounts are not reflected in the Condensed Financial Statements.
The Condensed 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 (primarily guaranteed interest options), and
revenue and expenses related to such arrangements, are consolidated in the
financial statements with the general account. At September 30, 2004 and
2003, unrealized gains of $107.5 million and $143.4 million, respectively,
after taxes, on assets supporting a guaranteed interest option are
reflected in shareholder's equity.
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 0.0% to 10.0%
for all periods presented) net of adjustments for investment experience
that the Company is entitled to reflect in future credited interest.
17
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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
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 27% 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 $12.3 million and $12.8 million were
incurred during the nine months ended September 30, 2004 and 2003,
respectively.
18
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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.
2. Investments
Fixed maturities and equity securities available for sale as of September
30, 2004 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- -------------- -------------- ---------------
Fixed maturities:
U.S. government and government
agencies and authorities $ 172.4 $ 1.5 $ 0.3 $ 173.6
State, municipalities and political
subdivisions 20.7 - 0.9 19.8
U.S. corporate securities:
Public utilities 1,794.6 78.2 8.6 1,864.2
Other corporate securities 7,309.4 298.4 27.9 7,579.9
--------------- -------------- -------------- ---------------
Total U.S. corporate securities 9,104.0 376.6 36.5 9,444.1
--------------- -------------- -------------- ---------------
Foreign securities:
Government 525.5 17.7 2.8 540.4
Other 2,423.4 95.2 11.5 2,507.1
--------------- -------------- -------------- ---------------
Total foreign securities 2,948.9 112.9 14.3 3,047.5
--------------- -------------- -------------- ---------------
Mortgage-backed securities 3,451.3 61.0 19.2 3,493.1
Other asset-backed securities 1,901.9 19.3 16.5 1,904.7
Total fixed maturities, including fixed
maturities pledged to creditors 17,599.2 571.3 87.7 18,082.8
Less: fixed maturities pledged to creditors 1,427.1 31.1 3.9 1,454.3
--------------- -------------- -------------- ---------------
Fixed maturities 16,172.1 540.2 83.8 16,628.5
Equity securities 24.4 0.9 0.1 25.2
--------------- -------------- -------------- ---------------
Total investments available for sale $ 16,196.5 $ 541.1 $ 83.9 $ 16,653.7
=============== ============== ============== ===============
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 and equity securities available for sale as of December
31, 2003 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- --------------- -------------- --------------
Fixed maturities:
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 555.5 6.4 2.8 559.1
--------------- --------------- -------------- --------------
Fixed maturities 15,025.0 628.2 114.5 15,538.7
Equity securities 115.5 4.7 - 120.2
--------------- --------------- -------------- --------------
Total investments available for sale $ 15,140.5 $ 632.9 $ 114.5 $ 15,658.9
=============== =============== ============== ==============
At September 30, 2004 and December 31, 2003, net unrealized appreciation is
$484.4 million and $522.0 million, respectively, on total fixed maturities,
including fixed maturities pledged to creditors, and equity securities.
20
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The aggregate unrealized losses and related fair values of total fixed
maturities, including fixed maturities pledged to creditors, and equity
securities with unrealized losses as of September 30, 2004, are shown below
by duration:
Unrealized Fair
Loss Value
------------ -------------
(Millions)
Duration category:
Less than six months below cost $ 13.2 $ 1,505.0
More than six months and less than
twelve months below cost 35.0 2,481.6
More than twelve months below cost 39.6 764.4
------------ -------------
Total $ 87.8 $ 4,751.0
============ =============
Of the unrealized losses less than 6 months in duration of $13.2 million,
there were $12.6 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 $0.6 million as of September 30, 2004, related to
securities 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 $259.2 million.
Of the unrealized losses more than 6 months and less than 12 months in
duration of $35.0 million, there were $30.1 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 unrealized losses of $4.9 million
as of September 30, 2004, included the following significant items:
|X| $3.7 million of unrealized losses related to securities 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 $243.1 million.
|X| $1.2 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $22.7 million.
Of the unrealized losses more than 12 months in duration of $39.6 million,
there were $33.7 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 unrealized losses of $5.9 million as of September 30, 2004
included the following significant items:
|X| $3.4 million of unrealized losses related to securities 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 $115.8 million.
21
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
|X| $1.1 million of unrealized losses relating to the airlines industry,
for which the carrying amount was $4.9 million.
|X| $1.4 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $5.6 million.
The amortized cost and fair value of total fixed maturities as of September
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 $ 303.6 $ 310.0
After one year through five years 3,772.7 3,880.5
After five years through ten years 3,954.5 4,146.5
After ten years 3,159.7 3,252.6
Mortgage-backed securities 4,506.8 4,588.5
Other asset-backed securities 1,901.9 1,904.7
Less: fixed maturities pledged
to creditors 1,427.1 1,454.3
----------------- -----------------
Fixed maturities $ 16,172.1 $ 16,628.5
================= =================
At September 30, 2004 and December 31, 2003, fixed maturities with fair
values of $13.4 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 September 30, 2004.
The Company enters into dollar repurchase agreement and repurchase
agreement transactions to increase its return on investments and improve
liquidity. At September 30, 2004 and December 31, 2003, the carrying value
of the securities pledged in dollar rolls and repurchase agreement
transactions was $663.0 million and $536.8 million, respectively. The
carrying value of the securities pledged in dollar rolls and repurchase
agreement transactions is included in pledged securities on the Condensed
Balance Sheets. The repurchase obligation totaled $691.2 million and $534.2
million at September 30, 2004 and December 31, 2003, respectively.
22
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 September 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 September 30, 2004, the Company determined
that 47 fixed maturities had an other than temporary impairment. As a
result, for the three months ended September 30, 2004, the Company
recognized a pre-tax loss of $4.8 million to reduce the carrying value of
the fixed maturities to their fair value at the time of impairment. During
the three months ended September 30, 2003, the Company determined that 42
fixed maturities had other than temporary impairments. As a result, for the
three months ended September 30, 2003, the Company recognized a pre-tax
loss of $12.5 million to reduce the carrying value of the fixed maturities
to their fair value at the time of impairment.
During the nine months ended September 30, 2004, the Company determined
that 86 fixed maturities had an other than temporary impairment. As a
result, for the nine months ended September 30, 2004, the Company
recognized a pre-tax loss of $17.9 million to reduce the carrying value of
the fixed maturities to their fair value at the time of impairment. During
the nine months ended September 30, 2003, the Company determined that 188
fixed maturities had other than temporary impairments. As a result, for the
nine months ended September 30, 2003, the Company recognized a pre-tax loss
of $99.5 million to reduce the carrying value of the fixed maturities to
their fair value at the time of impairment.
The fair value of the remaining impaired fixed maturities at September 30,
2004 and 2003 is $173.4 million and $219.5 million, respectively.
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
23
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. Also considered
are 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. Using this data, the model generates estimated market values, which
the Company considers reflective of the fair value of each privately placed
bond.
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.
24
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 September 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 $ 18,082.8 $ 18,082.8 $ 16,097.8 $ 16,097.8
Equity securities 25.2 25.2 120.2 120.2
Mortgage loans on real estate 3,706.2 3,853.9 3,388.7 3,581.4
Real estate 1.8 2.0 4.5 4.8
Policy loans 171.4 171.4 177.1 177.1
Cash and short-term investments 896.9 896.9 88.3 88.3
Other investments 168.0 168.0 56.0 56.0
Assets held in separate accounts 21,708.7 21,708.7 18,220.1 18,220.1
Liabilities:
Notes to affiliates 35.0 49.7 35.0 57.3
Investment contract liabilities:
Deferred annuities 17,333.5 16,210.9 16,072.4 15,069.0
Supplementary contracts and
immediate annuities 865.9 865.9 840.1 840.1
Liabilities related to separate accounts 21,708.7 21,708.7 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
25
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 of the Company's open interest rate caps
as of September 30, 2004 was $736.2 million. Carrying value and estimated
fair value of the open interest rate caps was minimal. 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 September 30, 2004 were $2,263.1 million, $26.9
million and $26.9 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 September 30, 2004, were
$(1,165.2) million, $(1.9) million and $(1.9) 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
26
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
estimated fair value of the Company's open foreign exchange rate swaps as
of September 30, 2004 were $146.7 million, $(22.3) million and $(22.3)
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 September 30, 2004 were $2,047.8 million, $109.7
million, and $109.7 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 September 30, 2004 and December 31, 2003 was $(2.6)
thousand and $(1,055.9) thousand, respectively. The estimated fair value of
the embedded derivatives within retail annuity products as of September 30,
2004 and December 31, 2003, was $384.8 million and $238.9 million,
respectively.
27
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
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Fixed maturities $ 249.8 $ 239.3
Equity securities 0.1 0.1
Mortgage loans 54.0 50.9
Policy loans 1.2 3.5
Short-term investments and cash equivalents 0.5 0.7
Other (21.4) (5.3)
------------------ -----------------
Gross investment income 284.2 289.2
Less: investment expenses (18.2) (17.0)
------------------ -----------------
Net investment income $ 266.0 $ 272.2
================== =================
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Fixed maturities $ 722.5 $ 724.2
Equity securities 0.2 2.7
Mortgage loans 164.3 153.1
Real estate 0.2 0.5
Policy loans 6.1 7.3
Short-term investments and cash equivalents 1.1 2.0
Other (12.0) (4.8)
------------------ -----------------
Gross investment income 882.4 885.0
Less: investment expenses (52.5) (46.8)
------------------ -----------------
Net investment income $ 829.9 $ 838.2
================== =================
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 September 30, 2004 or the year
ended December 31, 2003.
28
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 was $68.0 million and $24.1 million, for the three
months ended September 30, 2004 and 2003, respectively. Statutory net
income (loss) was $55.4 million and $(36.3) million, for the nine months
ended September 30, 2004 and 2003, respectively. Statutory capital and
surplus was $1,224.8 million and $1,071.0 million as of September 30, 2004
and 2003, respectively.
As of September 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:
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
----------------- -----------------
Fixed maturities $ 30.7 $ 98.3
Equity securities 5.4 (1.0)
Derivatives (1.3) (83.5)
Real estate - (2.7)
Other (2.1) (0.3)
----------------- -----------------
Pretax realized capital gains 32.7 10.8
================= =================
After-tax realized capital gains $ 21.3 $ 7.0
================= =================
Proceeds from the sale of total fixed maturities and equity securities and
the related gross gains and losses were as follows:
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Proceeds on sales $ 8,536.5 $ 11,295.6
Gross gains 115.9 257.0
Gross losses 52.2 49.0
29
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:
Nine months Nine months
ended ended
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Fixed maturities $ (33.7) $ 35.5
Equity securities (4.4) 7.4
DAC/VOBA (67.1) 101.1
Derivatives 4.6 3.0
Sales inducements (8.7) -
Other 0.1 (0.1)
------------------ -----------------
Subtotal (109.2) 146.9
Decrease (increase) in deferred
income taxes 12.0 (40.3)
------------------ -----------------
Net changes in accumulated other
comprehensive income $ (97.2) $ 106.6
================== =================
Shareholder's equity included the following accumulated other comprehensive
income:
September 30, September 30,
(Millions) 2004 2003
------------------ -----------------
Net unrealized capital gains (losses):
Fixed maturities $ 483.5 $ 643.3
Equity securities 0.9 4.0
DAC/VOBA (277.7) (260.8)
Derivatives (9.4) (24.7)
Sales inducements (8.7) -
Other 0.1 0.2
------------------ -----------------
Subtotal 188.7 362.0
Less: deferred income taxes 95.9 120.3
------------------ -----------------
Net accumulated other comprehensive income $ 92.8 $ 241.7
================== =================
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 accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities, were as follows:
Nine months ended
September 30,
(Millions) 2004 2003
----------------- -----------------
Unrealized holding gains (losses) arising
during the year (1) $ (37.2) $ 197.9
Less: reclassification adjustment for gains
and other items included in net income (2) 60.0 91.3
----------------- -----------------
Net unrealized gains (losses) on securities $ (97.2) $ 106.6
================= =================
(1) Pretax unrealized holding gains (losses) arising during the period
were $(57.2) million and $304.5 million for the nine months ended
September 30, 2004 and 2003, respectively.
(2) Pretax reclassification adjustments for gains and other items included
in net income were $92.3 million and $140.5 million for the nine
months ended September 30, 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.
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.
31
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 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 September 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 6.0%, 60.0%, 75.0%, 75.0% of the 90-95
ultimate mortality table for standard,
rachet, rolup 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 September
30, 2004, are consistent with those used for the calculating the additional
MGDB liability. In addition, the calculation of the GMIB liability assumes
dynamic surrenders and dynamic annuitization reflecting the extent to which
the benefit, at the time of payment, has a positive value.
32
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 September 30, 2004, and the paid and incurred
amounts by type for the nine months ended September 30, 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 $ 21,708.7 $ 1,544.6 $ 7,371.0
============== ===================== ==============
Additional liability balance:
Balance at January 1, 2004 $ 56.5 $ 14.5 $ 13.6
Incurred guaranteed benefits 39.8 5.5 17.1
Paid guaranteed benefits (24.8) - -
-------------- --------------------- --------------
Balance at September 30, 2004 $ 71.5 $