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EX-31.2 - EXHIBIT 31.2 - GREAT WEST LIFE & ANNUITY INSURANCE COq12016gwla-exx312.htm
EX-32 - EXHIBIT 32 - GREAT WEST LIFE & ANNUITY INSURANCE COq12016gwla-exx32.htm
EX-31.1 - EXHIBIT 31.1 - GREAT WEST LIFE & ANNUITY INSURANCE COq12016gwla-ex311.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2016
 
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 333-1173
 
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
 
COLORADO
 
84-0467907
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
8515 EAST ORCHARD ROAD, GREENWOOD VILLAGE, CO 80111
(Address of principal executive offices)
 
(303) 737-3000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x         No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes x         No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company as defined in Rule 12b-2 of the Act.
 
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer x
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Act.
 
Yes ¨         No x
 
As of May 1, 2016, 7,032,000 shares of the registrant’s common stock were outstanding, all of which were owned by the registrant’s parent company.





Table of Contents
 
 
 
Page
 
 
 
Number
Part I
 
 
Item 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2
 
Item 3
 
Item 4
 
 
 
 
Part II
 
Item 1
 
Item 1A
 
Item 6
 
 
 
 
 
 


2



Part I     Financial Information
Item1.    Interim Financial Statements


 GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Balance Sheets
March 31, 2016, and December 31, 2015
(In Thousands, Except Share Amounts)
(Unaudited)
 
 
 
March 31, 2016
 
December 31, 2015
Assets
 
 

 
 

Investments:
 
 

 
 

Fixed maturities, available-for-sale, at fair value (amortized cost $19,884,469 and $20,007,462)
 
$
20,838,179

 
$
20,531,627

Fixed maturities, held-for-trading, at fair value (amortized cost $553,871 and $612,899)
 
569,611

 
615,839

Mortgage loans on real estate (net of allowances of $2,882 and $2,890)
 
3,275,312

 
3,247,704

Policy loans
 
4,069,236

 
4,092,661

Short-term investments (amortized cost $808,515 and $267,026)
 
808,515

 
267,026

Limited partnership and other corporation interests
 
37,077

 
40,980

Other investments
 
14,974

 
15,189

Total investments
 
29,612,904

 
28,811,026

 
 
 
 
 
Other assets:
 
 

 
 

Cash
 
18,708

 
34,362

Reinsurance receivable
 
609,377

 
604,946

Deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”)
 
391,883

 
414,143

Investment income due and accrued
 
316,742

 
283,183

Collateral under securities lending agreements
 
107,654

 

Due from parent and affiliates
 
78,570

 
62,596

Goodwill
 
137,683

 
137,683

Other intangible assets
 
22,846

 
23,819

Other assets
 
938,940

 
874,918

Assets of discontinued operations
 
19,951

 
21,910

Separate account assets
 
27,239,781

 
26,631,193

Total assets
 
$
59,495,039

 
$
57,899,779

 
See notes to condensed consolidated financial statements.
 
(Continued)


3



GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Balance Sheets
March 31, 2016, and December 31, 2015
(In Thousands, Except Share Amounts)
(Unaudited)
 
 
 
March 31, 2016
 
December 31, 2015
Liabilities and stockholder’s equity
 
 

 
 

Policy benefit liabilities:
 
 

 
 

Future policy benefits
 
$
27,591,907

 
$
27,110,981

Policy and contract claims
 
364,276

 
354,899

Policyholders’ funds
 
262,651

 
299,577

Provision for policyholders’ dividends
 
54,060

 
55,481

Undistributed earnings on participating business
 
19,768

 
17,024

Total policy benefit liabilities
 
28,292,662

 
27,837,962

 
 
 
 
 
General liabilities:
 
 

 
 

Due to parent and affiliates
 
544,988

 
540,310

Commercial paper
 
99,171

 
93,371

Payable under securities lending agreements
 
107,654

 

Deferred income tax liabilities, net
 
272,504

 
137,116

Other liabilities
 
783,609

 
755,651

Liabilities of discontinued operations
 
19,951

 
21,910

Separate account liabilities
 
27,239,781

 
26,631,193

Total liabilities
 
57,360,320

 
56,017,513

 
 
 
 
 
Commitments and contingencies (See Note 13)
 


 


 
 
 
 
 
Stockholder’s equity:
 
 

 
 

Preferred stock, $1 par value, 50,000,000 shares authorized; none issued and outstanding
 

 

Common stock, $1 par value, 50,000,000 shares authorized; 7,232,986 shares issued and outstanding
 
7,233

 
7,233

Additional paid-in capital
 
841,549

 
840,874

Accumulated other comprehensive income
 
459,991

 
233,438

Retained earnings
 
825,946

 
800,721

Total stockholder’s equity
 
2,134,719

 
1,882,266

Total liabilities and stockholder’s equity
 
$
59,495,039

 
$
57,899,779

 
See notes to condensed consolidated financial statements.
 
(Concluded)


4



GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Statements of Income
Three Months Ended March 31, 2016, and 2015
(In Thousands)
(Unaudited)
 
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Revenues:
 
 

 
 

Premium income
 
$
154,927

 
$
145,703

Fee income
 
225,067

 
225,277

Other revenue
 
3,149

 
1,820

Net investment income
 
331,785

 
358,856

Realized investment gains (losses), net:
 
 

 
 

Total other-than-temporary gains (losses), net
 
(536
)
 
(558
)
Other-than-temporary (gains) losses, net, transferred to other comprehensive income (loss)
 

 
108

Other realized investment gains (losses), net
 
31,806

 
18,650

Total realized investment gains (losses), net
 
31,270

 
18,200

Total revenues
 
746,198

 
749,856

Benefits and expenses:
 
 

 
 

Life and other policy benefits
 
186,636

 
149,539

(Decrease) increase in future policy benefits
 
(14,015
)
 
17,351

Interest credited or paid to contractholders
 
148,310

 
142,891

Provision for policyholders’ share of losses on participating business
 
(169
)
 
(451
)
Dividends to policyholders
 
15,981

 
18,341

Total benefits
 
336,743

 
327,671

General insurance expenses
 
276,528

 
244,484

Amortization of DAC and VOBA
 
539

 
17,556

Interest expense
 
9,724

 
9,637

Total benefits and expenses
 
623,534

 
599,348

Income before income taxes
 
122,664

 
150,508

Income tax expense
 
24,038

 
51,896

Net income
 
$
98,626

 
$
98,612

 
See notes to condensed consolidated financial statements.


5



GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2016, and 2015
(In Thousands)
(Unaudited)
 
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Net income
 
$
98,626

 
$
98,612

Components of other comprehensive income
 
 

 
 

Unrealized holding gains (losses), net, arising on available-for-sale fixed maturity investments
 
446,610

 
181,375

Unrealized holding gains (losses), net, arising on cash flow hedges
 
(1,604
)
 
17,155

Reclassification adjustment for (gains) losses, net, realized in net income
 
(22,456
)
 
(30,437
)
Net unrealized gains (losses) related to investments
 
422,550

 
168,093

Future policy benefits, DAC and VOBA adjustments
 
(76,240
)
 
(35,129
)
Employee benefit plan adjustment
 
2,234

 
2,603

Other comprehensive income before income taxes
 
348,544

 
135,567

Income tax expense related to items of other comprehensive income
 
121,991

 
47,448

Other comprehensive income(1)
 
226,553

 
88,119

Total comprehensive income
 
$
325,179

 
$
186,731

(1) Other comprehensive income includes the non-credit component of impaired gains (losses), net, on fixed maturities available-for-sale in the amounts of $(1,895) and $(2,543) for the three months ended March 31, 2016, and 2015, respectively.
 
See notes to condensed consolidated financial statements.


6



GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Statements of Stockholder’s Equity
Three Months Ended March 31, 2016, and 2015
(In Thousands)
(Unaudited)
 
 
 
Three Months Ended March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Common
stock
 
Additional
paid-in
capital
 
Accumulated
 other
comprehensive
income
 
Retained
earnings
 
Total
Balances, January 1, 2016
 
$
7,233

 
$
840,874

 
$
233,438

 
$
800,721

 
$
1,882,266

Net income
 

 

 

 
98,626

 
98,626

Other comprehensive income, net of income taxes
 

 

 
226,553

 

 
226,553

Dividends
 

 

 

 
(73,401
)
 
(73,401
)
Capital contribution - stock-based compensation
 

 
534

 

 

 
534

Income tax benefit on stock-based compensation
 

 
141

 

 

 
141

Balances, March 31, 2016
 
$
7,233

 
$
841,549

 
$
459,991

 
$
825,946

 
$
2,134,719


 
 
Three Months Ended March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Common
stock
 
Additional
paid-in
capital
 
Accumulated
other
comprehensive
income
 
Retained
earnings
 
Total
Balances, January 1, 2015
 
$
7,032

 
$
777,664

 
$
603,018

 
$
749,799

 
$
2,137,513

Net income
 

 

 

 
98,612

 
98,612

Other comprehensive income, net of income taxes
 

 

 
88,119

 

 
88,119

Dividends
 

 

 

 
(77,309
)
 
(77,309
)
Capital contribution - stock-based compensation
 

 
525

 

 

 
525

Income tax benefit on stock-based compensation
 

 
275

 

 

 
275

Balances, March 31, 2015
 
$
7,032

 
$
778,464

 
$
691,137

 
$
771,102

 
$
2,247,735

 
See notes to condensed consolidated financial statements.


7



GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2016, and 2015
(In Thousands)
(Unaudited)
 
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Net cash provided by operating activities
 
$
142,307

 
$
298,843

 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Proceeds from sales, maturities and redemptions of investments:
 
 

 
 

Fixed maturities, available-for-sale
 
1,983,974

 
3,024,890

Mortgage loans on real estate
 
92,302

 
54,923

Limited partnership interests, other corporation interests and other investments
 
2,567

 
1,174

Purchases of investments:
 
 

 
 

Fixed maturities, available-for-sale
 
(1,818,569
)
 
(1,009,516
)
Mortgage loans on real estate
 
(117,720
)
 
(131,172
)
Limited partnership interests, other corporation interests and other investments
 
(1,593
)
 
(123
)
Net change in short-term investments
 
(546,036
)
 
(2,170,798
)
Net change in policy loans
 
(29
)
 
(141
)
Purchases of furniture, equipment and software
 
(12,064
)
 
(23,451
)
Net cash used in investing activities
 
(417,168
)
 
(254,214
)
 
 
 
 
 
Cash flows from financing activities:
 
 

 
 

Contract deposits
 
851,509

 
428,073

Contract withdrawals
 
(510,660
)
 
(401,887
)
Net change in due to/from parent and affiliates
 
(11,274
)
 
16,067

Dividends paid
 
(73,401
)
 
(77,309
)
Payments for and interest paid on financing element derivatives, net
 
(3,000
)
 
(4,169
)
Net change in commercial paper borrowings
 
5,800

 
(8,600
)
Net change in book overdrafts
 
92

 
(1,722
)
Income tax benefit on share-based compensation
 
141

 
275

Net cash provided by (used in) financing activities
 
259,207

 
(49,272
)
 
 
 
 
 
Net decrease in cash
 
(15,654
)
 
(4,643
)
Cash, beginning of year
 
34,362

 
12,775

Cash, end of period
 
$
18,708

 
$
8,132

 
See notes to condensed consolidated financial statements.
 
(Continued)

8



GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2016, and 2015
(In Thousands)
(Unaudited)
 
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Supplemental disclosures of cash flow information:
 
 

 
 
Net cash paid during the year for:
 
 

 
 

Income taxes
 
$
(8,305
)
 
$
(11,488
)
Interest
 
(140
)
 
(56
)
 
 
 
 
 
Non-cash investing and financing transactions during the years:
 
 
 
 
Share-based compensation expense
 
$
534

 
$
525

 
See notes to condensed consolidated financial statements.
 
(Concluded)


9

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)





1.  Organization and Basis of Presentation
 
Organization
 
Great-West Life & Annuity Insurance Company (“GWLA”) and its subsidiaries (collectively, the “Company”) is a direct wholly-owned subsidiary of GWL&A Financial Inc. (“GWL&A Financial”), a holding company.  GWL&A Financial is a direct wholly-owned subsidiary of Great-West Lifeco U.S. Inc. (“Lifeco U.S.”) and an indirect wholly-owned subsidiary of Great-West Lifeco Inc. (“Lifeco”), a Canadian holding company.  The Company offers a wide range of life insurance, retirement, and investment products to individuals, businesses, and other private and public organizations throughout the United States. The Company is an insurance company domiciled in the State of Colorado and is subject to regulation by the Colorado Division of Insurance.
 
Basis of Presentation
 
The condensed consolidated financial statements include the accounts of the Company and the accounts of its subsidiaries over which it exercises control and are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  Intercompany transactions and balances have been eliminated in consolidation.
 
The condensed consolidated balance sheet as of December 31, 2015, which was derived from the Company’s audited financial statements, and the unaudited interim condensed consolidated financial statements as of and for the three months ended March 31, 2016, have been prepared in accordance with the instructions for Form 10-Q.  In compliance with those instructions, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.  As such, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
 
In the opinion of management, these statements include all normal recurring adjustments necessary to fairly present the Company’s condensed consolidated results of operations, financial position, and cash flows as of March 31, 2016, and for all periods presented. The condensed consolidated results of operations and condensed consolidated statement of cash flows for the three months ended March 31, 2016, are not necessarily indicative of the results or cash flows expected for the full year.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.


10

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



2.  Acquisitions
 
Putnam Retirement Business

Description of transaction

On January 1, 2015, the Company acquired the retirement business of Putnam Investments, LLC (“Putnam”), an affiliate of the Company. The transaction was accounted for as a combination between entities under common control. As such, the assets and liabilities acquired from Putnam were recorded at historical cost as of January 1, 2015. In exchange for cash paid in the amount of $4,114, the Company acquired $11,501 of other assets, assumed $7,717 of other liabilities, and recognized a dividend of $330.

3.  Application of Recent Accounting Pronouncements

Recently adopted accounting pronouncements

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (Topic 810). The update primarily amends the criteria used to evaluate whether certain variable interest entities should be consolidated. The update also modifies the criteria used to determine whether partnerships and similar entities are variable interest entities (“VIEs”). The update is effective for interim and annual periods beginning after December 15, 2015, with early adoption permitted, including in the interim periods. The adoption of this ASU did not have a material effect on the Company’s consolidated financial position or results of operations; however, the Company has additional investments that meet the definition of VIE under this update.  As such, the guidance was retrospectively applied and the December 31, 2015 carrying value and maximum exposure to loss in relation to the activities of the VIEs disclosed in Note 5 includes an additional $35,776 to conform to the current year presentation.

In April 2015, the FASB issued ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (Subtopic 350-40). The update requires the Company to determine if the cloud computing arrangement contains a software license and if so, apply the accounting requirements for other intangible assets. The update also supersedes the requirement to apply lease accounting requirements by analogy for lease classification. If the arrangement is not a software license, then the Company applies accounting requirements for a service requirement. The update is effective for interim and annual periods beginning after December 15, 2015, with early adoption permitted. The adoption of this ASU did not have a material effect on the Company’s consolidated financial position or results of operations.

Future adoption of new accounting pronouncements

In May 2014, the FASB issued ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606) (“ASU No. 2014-09”). The update outlines a comprehensive model for accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. While the update does not apply to insurance contracts within the scope of Topic 944, it does apply to other fee income earned by the Company which includes fees from assets under management, assets under administration, shareholder servicing, administration and record-keeping services, and investment advisory services. The core principle of the model requires that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. The update also requires increased disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts. In adopting ASU No. 2014-09, the Company may use either a full retrospective or a modified retrospective approach. The update is effective for public business entities for interim and annual periods beginning after December 15, 2017, based upon an update issued by the FASB in August 2015. Early adoption is permitted as of accounting periods beginning after December 15, 2016. The Company is currently evaluating the impact of this update on its consolidated financial statements.

In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance: Disclosures about Short-Duration Contracts (Topic 944). The update requires that all years in the claims development table that precede the current reporting period and the related disclosure about the history of claims duration should be presented as required supplementary information. The update also includes a disclosure objective of providing information about claim frequency along with a description of methodologies for determining claim frequency information, unless it is impracticable to do so. The update is effective for annual reporting

11

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



periods beginning after December 15, 2015, and for interim reporting periods within annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of this update on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10).  The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by requiring equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income, simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, use of exit price notion when measuring the fair value of financial instruments for disclosure purposes, separate presentation of financial assets and liabilities by measurement category and form of financial assets (i.e. securities or loans and receivables) on the balance sheet or notes to the financial statements, eliminating the requirement to disclose the method and significant assumptions used to estimate fair value of a financial instrument measured at amortized cost on the balance sheet, requiring entities to present separately in other comprehensive income the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (i.e. “own credit”) when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, and clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.  The update is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The ASU also permits early adoption of the own credit provision.  The Company is currently evaluating the impact of this update on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. This update requires organizations to recognize lease assets and lease liabilities on the balance sheet and also disclose key information about leasing arrangements. This ASU is effective for annual reporting periods beginning on or after December 15, 2018, and interim periods within those annual periods. Earlier application is permitted for all entities as of the beginning of an interim or annual period. The Company is currently evaluating the impact of this update on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-05, Derivative Contract Novations. The amendments clarify that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument in an existing hedging relationship would not, in and of itself, be considered a termination of the derivative instrument or a change in critical term of the hedging relationship. The update is effective for fiscal years and interim periods within those beginning after December 15, 2016. The Company is currently evaluating the impact of this update on its financial statements.

In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging: Contingent Put and Call Options in Debt Instruments. The amendments clarify the steps required to assess whether a call or put option meets the criteria for bifurcation as an embedded derivative. The update is effective for fiscal years and interim periods within those beginning after December 15, 2016. The Company does not expect this update to have a material impact on the Company’s financial statements.

In March 2016, the FASB issued ASU 2016-07, Investments - Equity Method and Joint Ventures. The amendments simplify the equity method of accounting by eliminating the requirement to retrospectively apply the equity method to an investment that subsequently qualifies for such accounting as a result of an increase in the level of ownership interest or degree of influence. The update is effective for fiscal years and interim periods within those beginning after December 15, 2016. The Company is currently evaluating the impact of this update on its financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations. The amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The effective date for this update is the same as the effective date for ASU 2014-09. The Company is currently evaluating the impact of this update on its financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Account. The amendments simplify several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, statutory tax withholding requirements, and cash flow statements. The update is effective for fiscal years and interim periods within those beginning after December 15, 2016. The Company is currently evaluating the impact of this update on its financial statements.

12

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)




In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing. The amendments are intended to reduce the cost and complexity of applying the guidance on identifying promised goods or services and to improve the operability and understandability of the licensing implementation guidance. The effective date for this update is the same as the effective date for ASU 2014-09. The Company is currently evaluating the impact of this update on its financial statements.

In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients. The standard amends guidance in the new revenue standard on collectibility, noncash consideration, presentation of sales tax, and transition and are intended to address implementation issues that were raised by stakeholders and provide additional practical expedients. The effective date for this update is the same as the effective date for ASU 2014-09.  The Company is currently evaluating the impact of this update on its financial statements. 

4.  Dividends
 
The maximum amount of dividends, which can be paid to stockholders by insurance companies domiciled in the State of Colorado, is subject to restrictions relating to statutory surplus and statutory net gain from operations.  Prior to the payment of any dividends, the Company seeks approval from the Colorado Insurance Commissioner.  During the three months ended March 31, 2016, and 2015, the Company paid dividends of $73,401 and $77,309, respectively, to its parent, GWL&A Financial.
 
5.  Summary of Investments
 
The following tables summarize fixed maturity investments classified as available-for-sale and the non-credit-related component of other-than-temporary impairments (“OTTI”) in accumulated other comprehensive income (loss) (“AOCI”): 
 
 
March 31, 2016
 
 
Amortized
 
Gross unrealized
 
Gross unrealized
 
Estimated fair value
 
OTTI (gain) loss
Fixed maturities:
 
cost
 
gains
 
losses
 
and carrying value
 
included in AOCI (1)
U.S. government direct obligations and U.S. agencies
 
$
2,306,623

 
$
89,965

 
$
741

 
$
2,395,847

 
$

Obligations of U.S. states and their subdivisions
 
1,942,741

 
290,203

 
1,166

 
2,231,778

 

Foreign government securities
 
2,250

 

 
3

 
2,247

 

Corporate debt securities (2)
 
12,768,568

 
652,028

 
224,945

 
13,195,651

 
(1,733
)
Asset-backed securities
 
1,627,812

 
123,351

 
15,742

 
1,735,421

 
(81,066
)
Residential mortgage-backed securities
 
105,454

 
3,808

 
880

 
108,382

 
(43
)
Commercial mortgage-backed securities
 
1,122,101

 
41,831

 
4,068

 
1,159,864

 

Collateralized debt obligations
 
8,920

 
69

 

 
8,989

 

Total fixed maturities
 
$
19,884,469

 
$
1,201,255

 
$
247,545

 
$
20,838,179

 
$
(82,842
)

(1)  Indicates the amount of any OTTI (gain) loss included in AOCI that is included in gross unrealized gains and losses.  OTTI (gain) loss included in AOCI, as presented above, includes both the initial recognition of non-credit losses and the effects of subsequent increases and decreases in estimated fair value for those fixed maturity securities with previous non-credit impairment. The non-credit loss component of OTTI (gain) loss was in an unrealized gain position due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.
(2) Includes perpetual debt investments with amortized cost of $149,062 and estimated fair value of $107,421.
 

13

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



 
 
December 31, 2015
 
 
Amortized
 
Gross unrealized
 
Gross unrealized
 
Estimated fair value
 
OTTI (gain) loss
Fixed maturities:
 
cost
 
gains
 
losses
 
and carrying value
 
included in AOCI (1)
U.S. government direct obligations and U.S. agencies
 
$
3,291,167

 
$
55,193

 
$
4,608

 
$
3,341,752

 
$

Obligations of U.S. states and their subdivisions
 
1,988,214

 
238,862

 
7,903

 
2,219,173

 
50

Foreign government securities
 
2,291

 

 
5

 
2,286

 

Corporate debt securities (2)
 
12,388,886

 
437,207

 
320,381

 
12,505,712

 
(1,810
)
Asset-backed securities
 
1,196,326

 
128,406

 
13,362

 
1,311,370

 
(86,474
)
Residential mortgage-backed securities
 
122,146

 
4,734

 
1,508

 
125,372

 
(123
)
Commercial mortgage-backed securities
 
1,009,320

 
19,117

 
11,529

 
1,016,908

 

Collateralized debt obligations
 
9,112

 

 
58

 
9,054

 

Total fixed maturities
 
$
20,007,462

 
$
883,519

 
$
359,354

 
$
20,531,627

 
$
(88,357
)

(1)  Indicates the amount of any OTTI (gain) loss included in AOCI that is included in gross unrealized gains and losses.  OTTI (gain) loss included in AOCI, as presented above, includes both the initial recognition of non-credit losses and the effects of subsequent increases and decreases in estimated fair value for those fixed maturity securities with previous non-credit impairment. The non-credit loss component of OTTI (gain) loss was in an unrealized gain position due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.
(2) Includes perpetual debt investments with amortized cost of $149,062 and estimated fair value of $116,423.
 
See Note 8 for additional discussion regarding fair value measurements.

The amortized cost and estimated fair value of fixed maturity investments classified as available-for-sale, based on estimated cash flows, are shown in the table below.  Actual maturities will likely differ from these projections because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 
 
March 31, 2016
 
Amortized cost
 
Estimated fair value
Maturing in one year or less
$
691,217

 
$
716,630

Maturing after one year through five years
3,663,240

 
3,892,707

Maturing after five years through ten years
5,699,079

 
5,940,455

Maturing after ten years
5,023,933

 
5,288,230

Mortgage-backed and asset-backed securities
4,807,000

 
5,000,157

 Total fixed maturities
$
19,884,469

 
$
20,838,179


Mortgage-backed (commercial and residential) and asset-backed securities include those issued by the U.S. government and U.S. agencies.
 
The following table summarizes information regarding the sales of securities classified as available-for-sale: 
 
Three Months Ended March 31,
 
2016
 
2015
Proceeds from sales
$
1,682,893

 
$
2,658,671

Gross realized gains from sales
19,857

 
23,351

Gross realized losses from sales
11

 
20



14

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



Included in net investment income are unrealized gains (losses) of $12,622 and $908 for the three months ended March 31, 2016, and 2015, respectively, on held-for-trading fixed maturity investments still held at period end.

Mortgage loans on real estate — The following table summarizes the carrying value of the mortgage loan portfolio by component:  
 
March 31, 2016
 
December 31, 2015
Principal
$
3,271,087

 
$
3,242,627

Unamortized premium (discount) and fees, net
7,107

 
7,967

Mortgage provision allowance
(2,882
)
 
(2,890
)
Total mortgage loans
$
3,275,312

 
$
3,247,704

 
The following table summarizes the recorded investment of the mortgage loan portfolio by risk assessment category as of March 31, 2016, and December 31, 2015, respectively. 
 
March 31, 2016
 
December 31, 2015
Performing
$
3,276,729

 
$
3,249,129

Non-performing
1,465

 
1,465

Total
$
3,278,194

 
$
3,250,594


The following table summarizes activity in the mortgage provision allowance:
 
Three Months Ended March 31, 2016
 
Year Ended
December 31, 2015
 
Commercial mortgages
 
Commercial mortgages
Beginning balance
$
2,890

 
$
2,890

Provision increases
536

 

Provision decreases
(544
)
 

Ending balance
$
2,882

 
$
2,890

 
 
 
 
Allowance ending balance by basis of impairment method:
 
 
 
Individually evaluated for impairment
$
536

 
$

Collectively evaluated for impairment
2,346

 
2,890

 
 
 
 
Recorded investment balance in the mortgage loan portfolio, gross of allowance, by basis of impairment method:
$
3,278,194

 
$
3,250,594

Individually evaluated for impairment
13,922

 
14,031

Collectively evaluated for impairment
3,264,272

 
3,236,563

 
Limited partnership and other corporation interests — At March 31, 2016, and December 31, 2015, the Company had $37,077 and $40,980, respectively, invested in limited partnership and other corporation interests. Limited partnership interests represent the Company’s minority ownership interests in pooled investment funds that primarily make private equity investments across diverse industries and geographical focuses. The Company has determined its interest in each limited partnership to be considered a variable interest entity (“VIE”). Consolidation is not required as the Company is not deemed to be the primary beneficiary of the VIEs.
 
The carrying value and maximum exposure to loss in relation to the activities of the VIEs was $34,601 and $38,504 at March 31, 2016, and December 31, 2015, respectively.

Special deposits — The Company had securities on deposit with government authorities as required by certain insurance laws with fair values of $7,014 and $14,000 at March 31, 2016, and December 31, 2015, respectively.

15

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)




Securities lending — Securities with a cost or amortized cost of $169,660 and zero, and estimated fair values of $167,578 and zero, were on loan under the program at March 31, 2016, and December 31, 2015, respectively.  The Company received cash of $107,654 and zero, and securities with a fair value of $64,776 and zero, as collateral at March 31, 2016, and December 31, 2015, respectively. The Company bears the risk of any deficiency in the amount of collateral available for return to a borrower due to a loss in an approved investment.

The following table summarizes the collateral pledged by the Company under the securities lending program, by class of investment. Under the securities lending program the collateral pledged is, by definition, the securities loaned against the assets borrowed.
 
 
 
 
March 31, 2016
 
December 31, 2015
Securities lending transactions
 
 
 
 
 
 
U.S. government direct obligations and U.S. agencies
 
 
 
$
7,091

 
$

Corporate debt securities
 
 
 
160,487

 

Total secured borrowings
 
 
 
$
167,578

 
$


The Company’s securities lending agreements are open agreements meaning the borrower can return and the Company can recall the loaned securities at any time. The assets and liabilities associated with securities lending program are not subject to master netting arrangements and are not offset in the condensed consolidated balance sheets.

Unrealized losses on fixed maturity investments classified as available-for-sale — The following tables summarize unrealized investment losses, including the non-credit-related portion of OTTI losses reported in AOCI, by class of investment:
 
 
March 31, 2016
 
 
Less than twelve months
 
Twelve months or longer
 
Total
 
 
Estimated
 
Unrealized
 
Estimated
 
Unrealized
 
Estimated
 
Unrealized
Fixed maturities:
 
fair value
 
loss and OTTI
 
fair value
 
loss and OTTI
 
fair value
 
loss and OTTI
U.S. government direct obligations and U.S. agencies
 
$
50,371


$
439


$
53,275


$
302


$
103,646


$
741

Obligations of U.S. states and their subdivisions
 
10,796


143


78,883


1,023


89,679


1,166

Foreign government securities
 
2,248


3






2,248


3

Corporate debt securities
 
2,052,304


74,189


865,541


150,756


2,917,845


224,945

Asset-backed securities
 
388,520


5,968


207,508


9,774


596,028


15,742

Residential mortgage-backed securities
 
4,858


9


18,107


871


22,965


880

Commercial mortgage-backed securities
 
143,070


2,254


61,814


1,814


204,884


4,068

Total fixed maturities
 
$
2,652,167


$
83,005


$
1,285,128


$
164,540


$
3,937,295


$
247,545

 
 

















Total number of securities in an unrealized loss position
 
 


246


 


155


 


401

 

16

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



 
 
December 31, 2015
 
 
Less than twelve months
 
Twelve months or longer
 
Total
 
 
Estimated
 
Unrealized
 
Estimated
 
Unrealized
 
Estimated
 
Unrealized
Fixed maturities:
 
fair value
 
loss and OTTI
 
fair value
 
loss and OTTI
 
fair value
 
loss and OTTI
U.S. government direct obligations and U.S. agencies
 
$
1,357,822


$
4,101


$
23,604


$
507


$
1,381,426


$
4,608

Obligations of U.S. states and their subdivisions
 
267,581


7,903






267,581


7,903

Foreign government securities
 
2,286


5






2,286


5

Corporate debt securities
 
4,412,965


202,874


552,791


117,507


4,965,756


320,381

Asset-backed securities
 
247,082


4,372


182,404


8,990


429,486


13,362

Residential mortgage-backed securities
 




18,625


1,508


18,625


1,508

Commercial mortgage-backed securities
 
429,175


11,154


44,498


375


473,673


11,529

Collateralized debt obligations
 
9,054


58






9,054


58

Total fixed maturities
 
$
6,725,965


$
230,467


$
821,922


$
128,887


$
7,547,887


$
359,354

 
 

















Total number of securities in an unrealized loss position
 
 


558


 


106


 


664

 
Fixed maturity investments — Total unrealized losses and OTTI decreased by $111,809, or 31%, from December 31, 2015, to March 31, 2016. The overall decrease in unrealized losses was across most asset classes and reflects lower interest rates at March 31, 2016, compared to December 31, 2015, resulting in generally higher valuations of these fixed maturity securities.
 
Total unrealized losses greater than twelve months increased by $35,653 from December 31, 2015, to March 31, 2016.  Corporate debt securities account for 92%, or $150,756, of the unrealized losses and OTTI greater than twelve months at March 31, 2016.  Non-investment grade corporate debt securities account for $19,440 of the unrealized losses and OTTI greater than twelve months, and $13,166 of the losses are on perpetual debt investments issued by investment grade rated banks in the United Kingdom.  Management does not have the intent to sell these assets; therefore, an OTTI was not recognized in earnings.
 
Asset-backed securities account for 6% of the unrealized losses and OTTI greater than twelve months at March 31, 2016.  The present value of the cash flows expected to be collected is not less than amortized cost and management does not have the intent to sell these assets; therefore, an OTTI was not recognized in earnings.
 
Other-than-temporary impairment recognition — The OTTI on fixed maturity securities where the loss portion is bifurcated and the credit related component is recognized in realized investment gains (losses) is summarized as follows:

 
 
Three Months Ended March 31,
 
 
2016
 
2015
Beginning balance
 
$
102,343

 
$
119,532

Initial impairments - credit loss on securities not previously impaired
 

 
450

Reductions due to increases in cash flows expected to be collected that are recognized over the remaining life of the security
 
(3,927
)
 
(4,329
)
Ending balance
 
$
98,416

 
$
115,653



17

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



6.  Derivative Financial Instruments
 
Derivative transactions are generally entered into pursuant to International Swaps and Derivatives Association (“ISDA”) Master Agreements or Master Securities Forward Transaction Agreements (“MSFTA”) with approved counterparties that provide for a single net payment to be made by one party to the other on a daily basis, periodic payment dates, or at the due date, expiration, or termination of the agreement.

The ISDA Master Agreements contain provisions that would allow the counterparties to require immediate settlement of all derivative instruments in a net liability position if the Company were to default on any debt obligations over a certain threshold.  The MSFTA contain provisions which do not stipulate a threshold for default and only apply to debt obligations between the Company and the specific counterparty.  The aggregate fair value, inclusive of accrued income and expense, of derivative instruments with credit-risk-related contingent features that were in a net liability position was $77,578 and $76,107 as of March 31, 2016, and December 31, 2015, respectively.  The Company had pledged collateral related to these derivatives of $33,155 and $45,940 as of March 31, 2016, and December 31, 2015, respectively, in the normal course of business.  If the credit-risk-related contingent features were triggered on March 31, 2016, the fair value of assets that could be required to settle the derivatives in a net liability position was $44,422.
 
At March 31, 2016, and December 31, 2015, the Company had pledged $33,155 and $50,924 of unrestricted cash collateral to counterparties in the normal course of business, while other counterparties had pledged $22,450 and $19,060 of unrestricted cash collateral to the Company to satisfy collateral netting agreements, respectively.
 
At March 31, 2016, the Company estimated $4,651 of net derivative gains related to cash flow hedges included in AOCI will be reclassified into net income within the next twelve months. Gains and losses included in AOCI are reclassified into net income when the hedged item affects earnings.

Types of derivative instruments and derivative strategies

Interest rate contracts
 
Cash flow hedges
 
Interest rate swap agreements are used to convert the interest rate on certain debt security investments and debt obligations from a floating rate to a fixed rate.  Interest rate futures are used to manage the interest rate risks of forecasted acquisitions of fixed rate maturity investments and are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities.
 
Fair value hedges
 
Interest rate swap agreements are used to convert the interest rate on certain debt securities from a fixed rate to a floating rate to manage the interest rate risk of the change in the fair value of certain fixed rate maturity investments.
 
Not designated as hedging instruments
 
The Company enters into certain transactions in which derivatives are hedging an economic risk but hedge accounting is not elected.  These derivative instruments include:  exchange-traded interest rate swap futures, over-the-counter (“OTC”) interest rate swaptions, OTC interest rate swaps, exchange-traded Eurodollar interest rate futures, and treasury interest rate futures.  Certain of the Company’s OTC derivatives are cleared and settled through a central clearing counterparty while others are bilateral contracts between the Company and a counterparty.
 
The derivative instruments mentioned above are economic hedges and used to manage risk.  These transactions are used to offset changes in liabilities including those in variable annuity products, hedge the economic effect of a large increase in interest rates, manage the potential variability in future interest payments due to a change in credited interest rates and the related change in cash flows due to increased surrenders, and manage interest rate risks of forecasted acquisitions of fixed rate maturity investments and forecasted liability pricing.

18

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)




Cross-currency contracts
 
Cross-currency swaps are used to manage the foreign currency exchange rate risk associated with investments denominated in other than U.S. dollars.  The Company uses cross-currency swaps to convert interest and principal payments on foreign denominated debt instruments into U.S. dollars.  Cross-currency swaps may be designated as cash flow hedges; however, hedge accounting is not always elected.

Equity contracts
 
The Company uses futures on equity indices to offset changes in guaranteed lifetime withdrawal benefit liabilities; however, hedge accounting is not elected.

Other forward contracts
 
The Company uses forward settling to be announced (“TBA”) securities to gain exposure to the investment risk and return of agency mortgage-backed securities (pass-throughs). These transactions enhance the return on the Company’s investment portfolio and provide a more liquid and cost effective method of achieving these goals than purchasing or selling individual agency mortgage-backed pools.  As the Company does not regularly accept delivery of such securities, they are accounted for as derivatives but hedge accounting is not elected. 

The following tables summarize the notional amount and fair value of derivative financial instruments, excluding embedded derivatives:
 
March 31, 2016
 
 
 
Net derivatives
 
Asset derivatives
 
Liability derivatives
 
Notional amount
 
Fair value
 
Fair value (1)
 
Fair value (1)
Hedge designation/derivative type:
 


 


 


 

Derivatives designated as hedges:
 


 


 


 

Cash flow hedges:
 


 


 


 

Interest rate swaps
$
419,800


$
11,443


$
13,867


$
2,424

Cross-currency swaps
389,294


25,518


29,992


4,474

Total cash flow hedges
809,094


36,961


43,859


6,898

 











Total derivatives designated as hedges
809,094


36,961


43,859


6,898

 











Derivatives not designated as hedges:
 


 


 


 

Interest rate swaps
361,100


13,850


21,619


7,769

Futures on equity indices
32,259







Interest rate futures
137,500







Interest rate swaptions
144,704


179


179



Other forward contracts
1,687,650


3,056


4,161


1,105

Cross-currency swaps
662,935


(38,149
)

21,716


59,865

Total derivatives not designated as hedges
3,026,148


(21,064
)

47,675


68,739

Total derivative financial instruments
$
3,835,242


$
15,897


$
91,534


$
75,637


(1) The estimated fair value excludes accrued income and expense. The estimated fair value of all derivatives in an asset position is reported within other assets and the estimated fair value of all derivatives in a liability position is reported within other liabilities in the condensed consolidated balance sheets.


19

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



 
December 31, 2015
 
 
 
Net derivatives
 
Asset derivatives
 
Liability derivatives
 
Notional amount
 
Fair value
 
Fair value (1)
 
Fair value (1)
Hedge designation/derivative type:
 


 


 


 

Derivatives designated as hedges:
 


 


 


 

Cash flow hedges:
 


 


 


 

Interest rate swaps
$
143,800


$
11,843


$
11,843


$

Cross-currency swaps
380,873


28,714


28,736


22

Total cash flow hedges
524,673


40,557


40,579


22

 











Total derivatives designated as hedges
524,673


40,557


40,579


22

 











Derivatives not designated as hedges:
 


 


 


 

Interest rate swaps
303,600


3,240


8,295


5,055

Futures on equity indices
29,310







Interest rate futures
117,200







Interest rate swaptions
151,204


189


189



Cross-currency swaps
662,935


(51,759
)

19,537


71,296

Total derivatives not designated as hedges
1,264,249


(48,330
)

28,021


76,351

Total derivative financial instruments
$
1,788,922


$
(7,773
)

$
68,600


$
76,373


(1) The estimated fair value excludes accrued income and expense. The estimated fair value of all derivatives in an asset position is reported within other assets and the estimated fair value of all derivatives in a liability position is reported within other liabilities in the condensed consolidated balance sheets.
 
Notional amounts are used to express the extent of the Company’s involvement in derivative transactions and represent a standard measurement of the volume of its derivative activity.  Notional amounts represent those amounts used to calculate contractual flows to be exchanged and are not paid or received. The average notional outstanding during the three months ended March 31, 2016, was $620,400, $1,050,124, $165,772, $146,329, and $1,324,717 for interest rate swaps, cross-currency swaps, futures, swaptions, and other forward contracts, respectively. The average notional outstanding during the year ended December 31, 2015, was $443,589, $937,242, $111,801, $212,299, and $5,014,845 for interest rate swaps, cross-currency swaps, futures, swaptions, and other forward contracts, respectively.

The following tables present the effect of derivative instruments in the condensed consolidated statements of income reported by cash flow hedges, fair value hedges, and economic hedges, excluding embedded derivatives: 

Gain (loss) recognized in OCI on derivatives (Effective portion)
 
Gain (loss) reclassified from OCI
into net income (Effective portion)
 
 
Three Months Ended March 31,
 
Three Months Ended March 31,
 
 
2016
 
2015
 
2016
 
2015
 
Cash flow hedges:
 

 
 

 
 

 
 

 
Interest rate swaps
$
525

 
$
3,141

 
$
1,494

 
$
1,856

(A)
Cross-currency swaps
(2,129
)
 
14,014

 
992

 
423

(A)
Interest rate futures

 

 

 
(21
)
(A)
Total cash flow hedges
$
(1,604
)
 
$
17,155

 
$
2,486

 
$
2,258

 

(A) Net investment income.
 
 
 
 
 
 
 
 
 

20

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



 
Gain (loss) on derivatives
recognized in net income
 
Gain (loss) on hedged assets
recognized in net income
 
 
Three Months Ended March 31,
 
Three Months Ended March 31,
 
 
2016
 
2015
 
2016
 
2015
 
Fair value hedges:
 

 
 

 
 

 
 

 
Interest rate swaps
$

 
$
(1,438
)
(A)
$

 
$

 
Interest rate swaps

 
630

(B)

 

 
Items hedged in interest rate swaps

 

 

 
1,443

(A)
Items hedged in interest rate swaps

 

 

 
(630
)
(B)
Total fair value hedges
$

 
$
(808
)
 
$

 
$
813

 

(A) Net investment income.
(B) Represents realized gains (losses) on closed positions recorded in realized investment gains (losses), net.
 
 
 
 
 
 
 
 
 
 
Gain (loss) on derivatives recognized in net income
 
 
Three Months Ended March 31,
 
 
2016
 
2015
 
Derivatives not designated as hedging instruments:
 

 
 

 
Futures on equity indices
$
(230
)
(A)
$
147

(A)
Futures on equity indices
(1,441
)
(B)
(723
)
(B)
Interest rate swaps
10,622

(A)
2,822

(A)
Interest rate futures
(204
)
(A)
(151
)
(A)
Interest rate futures
(32
)
(B)
135

(B)
Interest rate swaptions
134

(A)
910

(A)
Interest rate swaptions
(195
)
(B)
(987
)
(B)
Other forward contracts
3,056

(A)
16,825

(A)
Other forward contracts
2,938

(B)
(9,340
)
(B)
Cross-currency swaps
12,199

(A)
45,046

(A)
Total derivatives not designated as hedging instruments
$
26,847

 
$
54,684

 

(A) Net investment income.
(B) Represents realized gains (losses) on closed positions recorded in realized investment gains (losses), net.
 
 
 
 
 

Embedded derivative - Guaranteed Lifetime Withdrawal Benefit

The Company offers a guaranteed lifetime withdrawal benefit (“GLWB”) through a variable annuity or a contingent deferred annuity. The GLWB is deemed to be an embedded derivative. The GLWB is recorded at fair value within future policy benefits on the condensed consolidated balance sheets. Changes in fair value of GLWB are recorded in net investment income in the condensed consolidated statements of income.

The estimated fair value of the GLWB was $21,707 and $11,257 at March 31, 2016, and December 31, 2015, respectively. The changes in fair value of the GLWB were $10,450 and $2,770 for the three months ended March 31, 2016, and 2015, respectively.

21

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



7.  Summary of Offsetting Assets and Liabilities
 
The Company enters into derivative transactions with several approved counterparties. The Company’s derivative transactions are generally governed by MSFTA or ISDA Master Agreements which provide for legally enforceable set-off and close-out netting in the event of default or bankruptcy of the Company’s counterparties.  The Company’s MSFTA and ISDA Master Agreements generally include provisions which require both the pledging and accepting of collateral in connection with its derivative transactions. These provisions have the effect of securing each party’s position to the extent of collateral held. The following tables summarize the effect of master netting arrangements on the Company’s financial position in the normal course of business and in the event of default or bankruptcy of the Company’s counterparties: 
 

March 31, 2016
 

 
 
Gross fair value not offset
 
 
 

 
 
in balance sheets
 
 
 

Gross fair value of
 
Financial
 
Cash collateral
 
Net
Financial instruments:

recognized assets/liabilities (1)
 
instruments
 
received
 
fair value
Derivative instruments (assets) (2)

$
77,202


$
(48,039
)

$
22,217


$
6,946

Derivative instruments (liabilities) (3)
 
69,160

 
(48,039
)
 
(20,817
)
 
304


(1) The gross fair value of derivative instrument assets is not netted against offsetting liabilities for presentation on the condensed consolidated balance sheets.
(2) The estimated fair value of derivative instrument assets is reported in other assets in the condensed consolidated balance sheets. Derivative transactions entered into under ISDA master agreements include income and expense accruals.
(3) The estimated fair value of derivative instrument liabilities is reported in other liabilities in the condensed consolidated balance sheets. Derivative transactions entered into under ISDA master agreements include income and expense accruals.
 
 

December 31, 2015
 

 
 
Gross fair value not offset
 
 
 

 
 
in balance sheets
 
 
 

Gross fair value of
 
Financial
 
Cash collateral
 
Net
Financial instruments:

recognized assets/liabilities (1)
 
instruments
 
received/(pledged)
 
fair value
Derivative instruments (assets) (2)

$
66,435


$
(38,236
)

$
19,060


$
9,139

Derivative instruments (liabilities) (3)

76,107


(38,236
)

(37,871
)



(1) The gross fair value of derivative instrument assets is not netted against offsetting liabilities for presentation on the condensed consolidated balance sheets.
(2) The estimated fair value of derivative instrument assets is reported in other assets in the condensed consolidated balance sheets. Derivative transactions entered into under ISDA master agreements include income and expense accruals.
(3) The estimated fair value of derivative instrument liabilities is reported in other liabilities in the condensed consolidated balance sheets. Derivative transactions entered into under ISDA master agreements include income and expense accruals.
 

22

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



8.  Fair Value Measurements
 
Recurring fair value measurements
 
The following tables present the Company’s financial assets and liabilities carried at fair value on a recurring basis by fair value hierarchy category:

Assets and liabilities measured at
fair value on a recurring basis
 
March 31, 2016
 
Quoted prices
 
Significant
 
 
 
 
 
in active
markets for
identical assets
(Level 1)
 
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets
 

 
 

 
 

 
 

Fixed maturities available-for-sale:
 

 
 

 
 

 
 

U.S. government direct obligations and U.S. agencies
$


$
2,395,847


$


$
2,395,847

Obligations of U.S. states and their subdivisions


2,231,778




2,231,778

Foreign government securities


2,247




2,247

Corporate debt securities


13,180,109


15,542


13,195,651

Asset-backed securities


1,735,421




1,735,421

Residential mortgage-backed securities


108,382




108,382

Commercial mortgage-backed securities


1,159,864




1,159,864

Collateralized debt obligations


8,989




8,989

Total fixed maturities available-for-sale


20,822,637


15,542


20,838,179

Fixed maturities held-for-trading:
 


 


 


 

U.S. government direct obligations and U.S. agencies


511,509




511,509

Corporate debt securities


56,991




56,991

Commercial mortgage-backed securities


1,111




1,111

Total fixed maturities held-for-trading


569,611




569,611

Short-term investments
369,283


439,232




808,515

Collateral under securities lending agreements
107,654






107,654

Collateral under derivative counterparty collateral agreements
55,605






55,605

Derivative instruments designated as hedges:
 


 


 


 

Interest rate swaps


13,867




13,867

Cross-currency swaps

 
29,992

 

 
29,992

Derivative instruments not designated as hedges:
 


 


 


 

Interest rate swaps


21,619




21,619

Interest rate swaptions


179




179

Other forward contracts


4,161




4,161

Cross-currency swaps


21,716




21,716

Total derivative instruments


91,534




91,534

Separate account assets
15,170,321


12,069,460




27,239,781

Total assets
$
15,702,863


$
33,992,474


$
15,542


$
49,710,879

 











Liabilities
 


 


 


 

Payable under securities lending agreements
$
107,654


$


$


$
107,654

Collateral under derivative counterparty collateral agreements
22,450

 

 

 
22,450

Derivative instruments designated as hedges:
 


 


 


 

Interest rate swaps


2,424




2,424

Cross-currency swaps


4,474




4,474

Derivative instruments not designated as hedges:
 


 


 


 

Interest rate swaps


7,769




7,769

Other forward contracts


1,105




1,105

Cross-currency swaps


59,865




59,865

Total derivative instruments


75,637




75,637

Embedded derivatives - GLWB

 

 
21,707

 
21,707

Separate account liabilities (1)
38


256,885




256,923

Total liabilities
$
130,142


$
332,522


$
21,707


$
484,371

 (1) Includes only separate account instruments which are carried at the fair value of the underlying liabilities owned by the separate accounts.

23

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)




Assets and liabilities measured at
fair value on a recurring basis
 
December 31, 2015
 
Quoted prices
 
Significant
 
 
 
 
 
in active
markets for
identical assets
(Level 1)
 
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets
 


 


 


 

Fixed maturities available-for-sale:
 


 


 


 

U.S. government direct obligations and U.S. agencies
$


$
3,341,752


$


$
3,341,752

Obligations of U.S. states and their subdivisions


2,219,173




2,219,173

Foreign government securities


2,286




2,286

Corporate debt securities


12,501,174


4,538


12,505,712

Asset-backed securities


1,311,370




1,311,370

Residential mortgage-backed securities


125,372




125,372

Commercial mortgage-backed securities


1,016,908




1,016,908

Collateralized debt obligations


9,054




9,054

Total fixed maturities available-for-sale


20,527,089


4,538


20,531,627

Fixed maturities held-for-trading:
 


 


 


 

U.S. government direct obligations and U.S. agencies


558,208




558,208

Corporate debt securities


56,566




56,566

Commercial mortgage-backed securities


1,065




1,065

Total fixed maturities held-for-trading


615,839




615,839

Short-term investments
132,288


134,738




267,026

Collateral under derivative counterparty collateral agreements
69,984






69,984

Derivative instruments designated as hedges:
 


 


 


 

Interest rate swaps


11,843




11,843

Cross-currency swaps

 
28,736

 

 
28,736

Derivative instruments not designated as hedges:
 


 


 


 

Interest rate swaps


8,295




8,295

Interest rate swaptions


189




189

Cross-currency swaps


19,537




19,537

Total derivative instruments


68,600




68,600

Separate account assets
15,249,966


11,381,227




26,631,193

Total assets
$
15,452,238


$
32,727,493


$
4,538


$
48,184,269

 











Liabilities
 


 


 


 

Collateral under derivative counterparty collateral agreements
$
19,060

 
$

 
$

 
$
19,060

Derivative instruments designated as hedges:
 


 


 


 

Cross-currency swaps


22




22

Derivative instruments not designated as hedges:
 


 


 


 

Interest rate swaps


5,055




5,055

Cross-currency swaps


71,296




71,296

Total derivative instruments


76,373




76,373

Embedded derivatives - GLWB

 

 
11,257

 
11,257

Separate account liabilities (1)
24


290,293




290,317

Total liabilities
$
19,084


$
366,666


$
11,257


$
397,007


 (1) Includes only separate account instruments which are carried at the fair value of the underlying liabilities owned by the separate accounts.


24

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The methods and assumptions used to estimate the fair value of the Company’s financial assets and liabilities carried at fair value on a recurring basis are as follows:

Fixed maturity investments
 
The fair values for fixed maturity investments are generally based upon market prices from independent pricing services.  In cases where market prices are not readily available, fair values are estimated by the Company.  To determine estimated fair value for these instruments, the Company generally utilizes discounted cash flows models with market observable pricing inputs such as spreads, average life, and credit quality.  Fair value estimates are made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty.
 
Short-term investments and securities lending agreements
 
The amortized cost of short-term investments, collateral under securities lending agreements, and payable under securities lending agreements is a reasonable estimate of fair value due to their short-term nature and high credit quality of the issuers.
 
Collateral under derivative counterparty collateral agreements
 
Included in other assets is cash collateral received from or pledged to derivative counterparties and included in other liabilities is the obligation to return the cash collateral to the counterparties.  The carrying value of the collateral is a reasonable estimate of fair value.
 
Derivative instruments
 
Included in other assets and other liabilities are derivative financial instruments. The estimated fair values of OTC derivatives, primarily consisting of cross-currency swaps, interest rate swaps, interest rate swaptions, and other forward contracts, are the estimated amounts the Company would receive or pay to terminate the agreements at the end of each reporting period, taking into consideration current interest rates and other relevant factors.

Embedded derivative - GLWB

Significant unobservable inputs used in the fair value measurements of GLWB include long-term equity and interest rate implied volatility, mortality, and policyholder behavior assumptions, such as benefit utilization, lapses, and partial withdrawals.

Separate account assets and liabilities
 
Separate account assets and liabilities primarily include investments in mutual fund, fixed maturity, and short-term securities.  Mutual funds are recorded at net asset value, which approximates fair value, on a daily basis.  The fixed maturity and short-term investments are valued in the same manner, and using the same pricing sources and inputs as the fixed maturity and short-term investments of the Company.
 

25

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The following tables present additional information about assets and liabilities measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

 
Recurring Level 3 financial assets and liabilities

Three Months Ended March 31, 2016
 
Assets
 
Liabilities
 
Fixed maturities  available-for-sale
 
Embedded
 
Corporate
 
derivatives
 
debt securities
 
- GLWB
Balances, January 1, 2016
$
4,538


$
11,257

Realized and unrealized gains (losses) included in:
 


 
Net income

 
10,450

Other comprehensive income
366



Settlements
(598
)


Transfers into Level 3 (1)
11,236

 

Balances, March 31, 2016
$
15,542


$
21,707

Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets and liabilities held at March 31, 2016
$


$
10,450


 (1) Transfers into Level 3 are due primarily to decreased observability of inputs in valuation methodologies.


Recurring Level 3 financial assets and liabilities

Three Months Ended March 31, 2015
 
Assets
 
Liabilities
 
Fixed maturities 
available-for-sale
 
 
 
Embedded
 
Corporate
 
Asset-backed
 
 
 
derivatives
 
debt securities
 
securities
 
Total
 
- GLWB
Balances, January 1, 2015
$
5,842


$
36

 
$
5,878

 
$
6,407

Realized and unrealized gains (losses) included in:
 


 

 
 

 
 
Net income (loss)

 

 

 
2,770

Other comprehensive income (loss)
(28
)


 
(28
)
 

Settlements
(485
)

(3
)
 
(488
)
 

Balances, March 31, 2015
$
5,329


$
33

 
$
5,362

 
$
9,177

Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets and liabilities held at March 31, 2015
$


$

 
$

 
$
2,770




26

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The following tables present significant unobservable inputs used during the valuation of certain liabilities categorized within Level 3 of the recurring fair value measurements table:
 
 
March 31, 2016
 
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range
Embedded derivatives - GLWB
 
$
21,707

 
Risk neutral stochastic valuation methodology
 
Equity volatility
 
15% - 28%
 
 
 
 
 
 
Swap curve
 
0.85% - 2.50%
 
 
 
 
 
 
Mortality rate
 
Based on the Annuity 2000 Mortality Table
 
 
 
 
 
 
Lapse rate
 
1% - 15%

 
 
December 31, 2015
 
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range
Embedded derivatives - GLWB
 
$
11,257

 
Risk neutral stochastic valuation methodology
 
Equity volatility
 
15% - 28%
 
 
 
 
 
 
Swap curve
 
0.75% - 3.00%
 
 
 
 
 
 
Mortality rate
 
Based on the Annuity 2000 Mortality Table
 
 
 
 
 
 
Lapse rate
 
1% - 15%

Fair value of financial instruments
 
The following tables summarize the carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on a recurring basis:
 
March 31, 2016
 
December 31, 2015
 
Carrying
 
Estimated
 
Carrying
 
Estimated
 
amount
 
fair value
 
amount
 
fair value
Assets
 

 
 

 
 

 
 

Mortgage loans on real estate
$
3,275,312

 
$
3,463,079

 
$
3,247,704

 
$
3,362,496

Policy loans
4,069,236

 
4,069,236

 
4,092,661

 
4,092,661

Limited partnership interests
33,372

 
32,725

 
35,039

 
34,882

Other investments
14,459

 
44,723

 
14,596

 
44,723

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Annuity contract benefits without life contingencies
$
11,428,441

 
$
11,492,552

 
$
11,104,721

 
$
10,839,205

Policyholders’ funds
262,651

 
262,651

 
299,577

 
299,577

Commercial paper
99,171

 
99,171

 
93,371

 
93,371

Notes payable
541,840

 
562,486

 
532,575

 
563,633

 

27

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The methods and assumptions used to estimate the fair value of financial instruments not carried at fair value on a recurring basis are summarized as follows: 

Mortgage loans on real estate

Mortgage loan fair value estimates are generally based on discounted cash flows.  A discount rate matrix is used where the discount rate valuing a specific mortgage generally corresponds to that mortgage’s remaining term and credit quality.  Management believes the discount rate used is comparable to the credit, interest rate, term, servicing costs, and risks of loans similar to the portfolio loans that the Company would make today given its internal pricing strategy.  The estimated fair value is classified as Level 2.
 
Policy loans
 
Policy loans are funds provided to policy holders in return for a claim on the policy. The funds provided are limited to the cash surrender value of the underlying policy. The nature of policy loans is to have a negligible default risk as the loans are fully collateralized by the value of the policy. Policy loans do not have a stated maturity and the balances and accrued interest are repaid either by the policyholder or with proceeds from the policy. Due to the collateralized nature of policy loans and unpredictable timing of repayments, the Company believes the fair value of policy loans approximates carrying value. The estimated fair value is classified as Level 2.
 
Limited partnership interests
 
Limited partnership interests, accounted for using the cost method, represent the Company’s minority ownership interests in pooled investment funds.  These funds employ varying investment strategies that primarily make private equity investments across diverse industries and geographical focuses.  The estimated fair value was determined using the partnership financial statement reported capital account or net asset value adjusted for other relevant information which may impact the exit value of the investments.  Distributions by these investments are generated from investment gains, from operating income generated by the underlying investments of the funds, and from liquidation of the underlying assets of the funds which are estimated to be liquidated over the next 1 to 10 years.  The estimated fair value is classified as Level 3.

Other investments
 
Other investments primarily include real estate held for investment.  The estimated fair value for real estate is based on the unadjusted annual appraised value which includes factors such as comparable property sales, property income analysis, and capitalization rates.  The estimated fair value is classified as Level 2.

Annuity contract benefits without life contingencies
 
The estimated fair value of annuity contract benefits without life contingencies is estimated by discounting the projected expected cash flows to the maturity of the contracts utilizing risk-free spot interest rates plus a provision for the Company’s credit risk.  The estimated fair value is classified as Level 2.
 
Policyholders’ funds
 
The carrying amount of policyholders’ funds approximates the fair value since the Company can change the interest credited rates with 30 days notice. The estimated fair value is classified as Level 2.
 
Commercial paper
 
The amortized cost of commercial paper is a reasonable estimate of fair value due to its short-term nature and the high credit quality of the obligor.  The estimated fair value is classified as Level 2.

28

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)




Notes payable
 
The estimated fair value of the notes payable to GWL&A Financial is based upon quoted market prices from independent pricing services of securities with characteristics similar to those of the notes payable.  The estimated fair value is classified as Level 2. 

9.  Other Comprehensive Income
 
The following tables present the accumulated balances for each classification of other comprehensive income (loss):
 
 
Three Months Ended March 31, 2016
 
Unrealized
holding gains
/ losses
arising on
fixed
maturities,
available-for-
sale
 
Unrealized
holding gains
/ losses
arising on
cash flow
hedges
 
Future policy
benefits, DAC
and VOBA
adjustments
 
Employee
benefit plan
adjustment
 
Total
Balances, January 1, 2016
$
339,520

 
$
45,284

 
$
(65,785
)
 
$
(85,581
)
 
$
233,438

Other comprehensive income (loss) before reclassifications
290,296

 
(1,043
)
 
(49,556
)
 

 
239,697

Amounts reclassified from AOCI
(12,980
)
 
(1,616
)
 

 
1,452

 
(13,144
)
Net current period other comprehensive income (loss)
277,316

 
(2,659
)
 
(49,556
)
 
1,452

 
226,553

Balances, March 31, 2016
$
616,836

 
$
42,625

 
$
(115,341
)
 
$
(84,129
)
 
$
459,991

 
 
Three Months Ended March 31, 2015
 
Unrealized
holding gains
/ losses
arising on
fixed
maturities,
available-for-
sale
 
Unrealized
holding gains
/ losses
arising on
cash flow
hedges
 
Future policy
benefits, DAC
and VOBA
adjustments
 
Employee
benefit plan
adjustment
 
Total
Balances, January 1, 2015
$
784,183

 
$
33,141

 
$
(108,194
)
 
$
(106,112
)
 
$
603,018

Other comprehensive income (loss) before reclassifications
117,894

 
11,151

 
(22,834
)
 
(215
)
 
105,996

Amounts reclassified from AOCI
(18,316
)
 
(1,468
)
 

 
1,907

 
(17,877
)
Net current period other comprehensive income (loss)
99,578

 
9,683

 
(22,834
)
 
1,692

 
88,119

Balances, March 31, 2015
$
883,761

 
$
42,824

 
$
(131,028
)
 
$
(104,420
)
 
$
691,137

 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 


29

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The following tables present the composition of other comprehensive income (loss):
 
 
Three Months Ended March 31, 2016
 
Before-tax
 
Tax (expense)
 
Net-of-tax
 
amount
 
benefit
 
amount
Unrealized holding gains (losses), net, arising on fixed maturities, available-for-sale
$
446,610

 
$
(156,314
)
 
$
290,296

Unrealized holding gains (losses), net, arising on cash flow hedges
(1,604
)
 
561

 
(1,043
)
Reclassification adjustment for (gains) losses, net, realized in net income
(22,456
)
 
7,860

 
(14,596
)
Net unrealized gains (losses) related to investments
422,550

 
(147,893
)
 
274,657

Future policy benefits, DAC and VOBA adjustments
(76,240
)
 
26,684

 
(49,556
)
Net unrealized gains (losses)
346,310

 
(121,209
)
 
225,101

Employee benefit plan adjustment
2,234

 
(782
)
 
1,452

Other comprehensive income (loss)
$
348,544

 
$
(121,991
)
 
$
226,553

 
 
Three Months Ended March 31, 2015
 
Before-tax
 
Tax (expense)
 
Net-of-tax
 
amount
 
benefit
 
amount
Unrealized holding gains (losses), net, arising on fixed maturities, available-for-sale
$
181,375

 
$
(63,481
)
 
$
117,894

Unrealized holding gains (losses), net, arising on cash flow hedges
17,155

 
(6,004
)
 
11,151

Reclassification adjustment for (gains) losses, net, realized in net income
(30,437
)
 
10,653

 
(19,784
)
Net unrealized gains (losses) related to investments
168,093

 
(58,832
)
 
109,261

Future policy benefits, DAC and VOBA adjustments
(35,129
)
 
12,295

 
(22,834
)
Net unrealized gains (losses)
132,964

 
(46,537
)
 
86,427

Employee benefit plan adjustment
2,603

 
(911
)
 
1,692

Other comprehensive income (loss)
$
135,567

 
$
(47,448
)
 
$
88,119


 
 
 
 
 
 

 
 
 
 
 
 


30

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The following tables presents the reclassifications out of accumulated other comprehensive income (loss):
 
 
 
Three Months Ended March 31,
 
 
 
 
2016
 
2015
 
 
Details about accumulated other 
comprehensive income (loss) components
 
Amount reclassified from accumulated other comprehensive income (loss)
 
Affected line item in the statement where net income is presented
Unrealized holding (gains) losses, net, arising on fixed maturities, available-for-sale
 
$
(19,970
)
 
$
(28,179
)
 
Other realized investment (gains) losses, net
 
 
(19,970
)
 
(28,179
)
 
Total before tax
 
 
(6,990
)
 
(9,863
)
 
Tax expense or benefit
 
 
$
(12,980
)
 
$
(18,316
)
 
Net of tax
 
 
 
 
 
 
 
Unrealized holding (gains) losses, net, arising on cash flow hedges
 
$
(2,486
)
 
$
(2,258
)
 
Net investment income
 
 
(2,486
)
 
(2,258
)
 
Total before tax
 
 
(870
)
 
(790
)
 
Tax expense or benefit
 
 
$
(1,616
)
 
$
(1,468
)
 
Net of tax
 
 
 
 
 
 
 
Amortization of employee benefit plan items
 
 
 
 
 
 
Prior service (benefits)
 
$
(151
)
(1) 
$
(181
)
(1) 
 
Actuarial (gains)
 
2,385

(1) 
3,115

(1) 
 
 
 
2,234

 
2,934

 
Total before tax
 
 
782

 
1,027

 
Tax expense or benefit
 
 
$
1,452

 
$
1,907

 
Net of tax
 
 
 
 
 
 
 
Total reclassification
 
$
(13,144
)
 
$
(17,877
)
 
Net of tax

(1) These accumulated other comprehensive income components are included in the computation of net periodic (benefit) cost of employee benefit plans (see Note 10 for additional details).

 
 
 
 
 
 
 





31

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



10.  Employee Benefit Plans
 
Net periodic cost (benefit) of the Defined Benefit Pension, Post-Retirement Medical, and Supplemental Executive Retirement plans included in general insurance expenses in the accompanying condensed consolidated statements of income includes the following components:
 
 
Three Months Ended March 31,
 
Defined Benefit 
Pension Plan
 
Post-Retirement 
Medical Plan
 
Supplemental Executive
Retirement Plan
 
Total
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Components of net periodic cost (benefit):
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
Service cost
$
1,335

 
$
1,509

 
$
293

 
$
264

 
$
73

 
$
70

 
$
1,701

 
$
1,843

Interest cost
6,282

 
5,997

 
175

 
126

 
444

 
531

 
6,901

 
6,654

Expected return on plan assets
(6,278
)
 
(7,087
)
 

 

 

 

 
(6,278
)
 
(7,087
)
Amortization of unrecognized prior service costs (benefits)

 
3

 
(276
)
 
(417
)
 
125

 
233

 
(151
)
 
(181
)
Amortization of losses (gains) from earlier periods
2,485

 
3,106

 
(85
)
 
(157
)
 
(15
)
 
166

 
2,385

 
3,115

Net periodic cost (benefit)
$
3,824

 
$
3,528

 
$
107

 
$
(184
)
 
$
627

 
$
1,000

 
$
4,558

 
$
4,344

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
On January 1, 2015, the Company acquired the retirement business of Putnam, an affiliate of the Company. See Note 2 for additional discussion regarding the acquisition. Per the terms of the Asset Transfer Agreement, the Company was required to give each Putnam employee full credit for the employee’s service period with Putnam prior to the closing date for the purpose of eligibility to participate, vesting and level of benefits under the Post-Retirement Medical Plan.  As a result, approximately 150 individuals became eligible participants of the Post-Retirement Medical Plan at January 1, 2015.  The transaction was recorded as a prior service cost, which resulted in a $339 increase before tax to other liabilities and expenses and a decrease to accumulated other comprehensive income.

The Company expects to make payments of approximately $816 with respect to its Post-Retirement Medical Plan and $3,337 with respect to its Supplemental Executive Retirement Plan during the year ended December 31, 2016.  The Company expects to make contributions of zero to its Defined Benefit Pension Plan during the year ended December 31, 2016.  A December 31 measurement date is used for the employee benefit plans.
 
The following table summarizes contributions to the Defined Benefit Pension Plan and payments made to the Post-Retirement Medical Plan and the Supplemental Executive Retirement Plan:
 
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Payments to the Post-Retirement Medical Plan
 
204

 
133

Payments to the Supplemental Executive Retirement Plan
 
834

 
2,335




32

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



11.  Income Taxes
 
The provision for income taxes is comprised of the following:
 
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Current
 
$
10,640


$
28,094

Deferred
 
13,398

 
23,802

Total income tax provision
 
$
24,038

 
$
51,896


The following table presents a reconciliation between the statutory federal income tax rate and the Company’s effective income tax rate:
 
 
Three Months Ended March 31,
 
 
2016
 
2015
Statutory federal income tax rate
 
35.0
 %
 
35.0
 %
Income tax effect of:
 
 

 
 

Investment income not subject to federal tax
 
(2.3
)%
 
(2.0
)%
Tax credits
 
(16.3
)%
 
(0.2
)%
State income taxes, net of federal benefit
 
2.3
 %
 
1.3
 %
Other, net
 
0.9
 %
 
0.4
 %
Effective income tax rate
 
19.6
 %
 
34.5
 %
 
During the three months ended March 31, 2016, and 2015, the Company recorded an increase in unrecognized tax benefits in the amount of $1,843 and $2,695, respectively. The Company anticipates additional increases to its unrecognized tax benefits of $5,000 to $7,000 in the next twelve months. The Company expects that the majority of the increase in its unrecognized tax benefits will not impact the effective tax rate.
 
The Company files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal income tax examinations by tax authorities for years 2011 and prior.  Tax years 2012 through 2014 are open to federal examination by the Internal Revenue Service (“IRS”).  The Company does not expect significant increases or decreases to unrecognized tax benefits relating to federal, state, or local audits.
 

33

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



12.  Segment Information
 
The Chief Operating Decision Maker (“CODM”) of the Company is also the Chief Executive Officer (“CEO”) of the Company and Lifeco U.S. The CODM reviews the financial information for the purposes of assessing performance and allocating resources based upon the results of Lifeco U.S. and other U.S. affiliates prepared in accordance with International Financial Reporting Standards. The CODM, in his capacity as CEO of the Company, reviews the Company’s financial information only
in connection with the quarterly and annual reports that are filed with the Securities and Exchange Commission (“SEC”).
Consequently, the Company does not provide its discrete financial information to the CODM to be regularly reviewed to make
decisions about resources to be allocated or to assess performance. For purposes of SEC reporting requirements, the Company
has chosen to present its financial information in three segments, notwithstanding the above. The three segments are: Individual Markets, Empower Retirement (formerly known as “Retirement Services”), and Other. 

Individual Markets
 
The Individual Markets reporting and operating segment distributes life insurance, annuity, and retirement products to both individuals and businesses through various distribution channels.  Life insurance products in-force include participating and non-participating term life, whole life, universal life, and variable universal life.
 
Empower Retirement
 
The Empower Retirement reporting and operating segment provides various retirement plan products (including individual retirement accounts (“IRAs”)) and investment options as well as comprehensive administrative and record-keeping services for financial institutions and employers, which include educational, advisory, enrollment, and communication services for employer-sponsored defined contribution plans and associated defined benefit plans.
 
Other
 
The Company’s Other reporting segment is substantially comprised of activity under the assumption of reinsurance between Great-West Life & Annuity Insurance Company of South Carolina (“GWSC”), a wholly owned subsidiary, and The Canada Life Assurance Company (“CLAC”), corporate items not directly allocated to the other operating segments, and interest expense on long-term debt.
 
The accounting principles used to determine segment results are the same as those used in the consolidated financial statements.  Inter-segment transactions and balances have been eliminated in consolidation.  The Company’s operations are not materially dependent on one or a few customers, brokers, or agents.
 

34

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



The following tables summarize segment financial information:
 
 
 
Three Months Ended March 31, 2016
 
 
Individual
 
Empower
 
 
 
 
 
 
Markets
 
Retirement
 
Other
 
Total
Revenue:
 
 

 
 

 
 

 
 

Premium income
 
$
133,286

 
$
346

 
$
21,295

 
$
154,927

Fee income
 
22,724

 
200,923

 
1,420

 
225,067

Other revenue
 

 
3,149

 

 
3,149

Net investment income
 
207,693

 
110,534

 
13,558

 
331,785

Realized investment gains (losses), net
 
11,806

 
19,471

 
(7
)
 
31,270

Total revenues
 
375,509

 
334,423

 
36,266

 
746,198

Benefits and expenses:
 
 

 
 

 
 

 
 

Policyholder benefits
 
267,497

 
49,917

 
19,329

 
336,743

Operating expenses
 
37,223

 
231,640

 
17,928

 
286,791

Total benefits and expenses
 
304,720

 
281,557

 
37,257

 
623,534

Income (loss) before income taxes
 
70,789

 
52,866

 
(991
)
 
122,664

Income tax expense (benefit)
 
23,834

 
651

 
(447
)
 
24,038

Net income (loss)
 
$
46,955

 
$
52,215

 
$
(544
)
 
$
98,626

 
 
 
Three Months Ended March 31, 2015
 
 
Individual
 
Empower
 
 
 
 
 
 
Markets
 
Retirement
 
Other
 
Total
Revenue:
 
 

 
 

 
 

 
 

Premium income
 
$
124,962

 
$

 
$
20,741

 
$
145,703

Fee income
 
21,502

 
202,821

 
954

 
225,277

Other revenue
 

 
1,820

 

 
1,820

Net investment income
 
217,653

 
127,730

 
13,473

 
358,856

Realized investment gains (losses), net
 
8,400

 
9,800

 

 
18,200

Total revenues
 
372,517

 
342,171

 
35,168

 
749,856

Benefits and expenses:
 
 

 
 

 
 

 
 

Policyholder benefits
 
256,323

 
49,045

 
22,303

 
327,671

Operating expenses
 
35,941

 
221,030

 
14,706

 
271,677

Total benefits and expenses
 
292,264

 
270,075

 
37,009

 
599,348

Income (loss) before income taxes
 
80,253

 
72,096

 
(1,841
)
 
150,508

Income tax expense (benefit)
 
28,222

 
24,380

 
(706
)
 
51,896

Net income (loss)
 
$
52,031

 
$
47,716

 
$
(1,135
)
 
$
98,612

 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 

35

GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
Notes to Condensed Consolidated Financial Statements
(Dollars in Thousands)
(Unaudited)



13.  Commitments and Contingencies
 
Commitments

The Company has a revolving credit facility agreement in the amount of $50,000 for general corporate purposes.  The credit facility expires on March 1, 2018.  Interest accrues at a rate dependent on various conditions and terms of borrowings.  The agreement requires, among other things, the Company to maintain a minimum adjusted net worth of $1,100,000, as defined in the credit facility agreement (compiled on the statutory accounting basis prescribed by the National Association of Insurance Commissioners), at anytime.  The Company was in compliance with all covenants at March 31, 2016, and December 31, 2015.  At March 31, 2016, and December 31, 2015, there were no outstanding amounts related to the credit facility.

GWSC and CLAC are parties to a reinsurance agreement pursuant to which GWSC assumes term life insurance from CLAC.  GWL&A Financial obtained two letters of credit for the benefit of the Company as collateral under the GWSC and CLAC reinsurance agreement for policy liabilities and capital support.  The first letter of credit is for $1,169,670 and renews annually until it expires on July 3, 2027.  The second letter of credit is for $70,000 and renews annually until it expires on December 31, 2017.  At March 31, 2016, and December 31, 2015, there were no outstanding amounts related to the letters of credit.
 
In addition, the Company has other letters of credit with a total amount of $9,095, renewable annually for an indefinite period of time. At March 31, 2016, and December 31, 2015, there were no outstanding amounts related to those letters of credit.

The Company makes commitments to fund partnership interests, mortgage loans on real estate, and other investments in the normal course of its business.  The amounts of these unfunded commitments at March 31, 2016, and December 31, 2015, were $205,160 and $50,692, of which $28,010 and $8,692 were related to cost basis limited partnership interests, respectively, all of which is due within one year from the dates indicated.
 
Contingencies
 
From time to time, the Company may be threatened with, or named as a defendant in, lawsuits, mediations, arbitrations, and administrative claims. Any such claims that are decided against the Company could harm the Company’s business. The Company is also subject to periodic regulatory audits and inspections which could result in fines or other disciplinary actions. Unfavorable outcomes in such matters may result in a material impact on the Company's financial position, results of operations, or cash flows.
 
The Company is defending a lawsuit related to a motor vehicle accident involving an employee. It received a $20,000 demand from the plaintiff’s attorney during the fourth quarter of 2014.  The amount is fully indemnified by a third-party insurer.

The Company is defending lawsuits relating to the administration of its staff retirement plan, or to the costs and features of certain of its retirement or fund products. These actions are at their early stages. Management believes the claims are without merit and will defend these actions. Based on the information known, these actions will not have a material adverse effect on the consolidated financial position of the Company.

The Company is involved in other various legal proceedings that arise in the ordinary course of its business.  In the opinion of management, after consultation with counsel, the likelihood of loss from the resolution of these proceedings is remote and/or the estimated loss is not expected to have a material effect on the Company’s consolidated financial position, results of its operations, or cash flows.

14.  Subsequent Events

On April 28, 2016, the Company’s Board of Directors declared a dividend of $31,430, payable on June 15, 2016, to its sole shareholder, GWL&A Financial.

36



Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
General
 
As used in this Form 10-Q, the “Company” refers to Great-West Life & Annuity Insurance Company, a stock life insurance company originally organized on March 28, 1907 and domiciled in the state of Colorado, and its subsidiaries.
 
This Form 10-Q contains forward-looking statements.  Forward-looking statements are statements not based on historical information and that relate to future operations, strategies, financial results, or other developments.  In particular, statements using words such as “may,” “would,” “could,” “should,” “estimates,” “expected,” “anticipate,” “believe,” or words of similar import generally involve forward-looking statements.  Without limiting the foregoing, forward-looking statements include statements that represent the Company’s beliefs concerning future or projected levels of sales of its products, investment spreads or yields, or the earnings or profitability of the Company’s activities.
 
Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond the Company’s control and many of which, with respect to future business decisions, are subject to change.  Some of these risks are described in “Risk Factors” in Item 1A of this report.  These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company.  Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be global or national in scope, such as general economic conditions and interest rates, some of which may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation, and others of which may relate to the Company specifically, such as credit, volatility, and other risks associated with its investment portfolio and other factors. 

Readers should also consider other matters, including any risks and uncertainties, discussed in documents filed by the Company and certain of its subsidiaries with the Securities and Exchange Commission. The following discussion addresses the Company’s results of operations for the three months ended March 31, 2016, compared with the same period in 2015. The discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” to which the reader is directed for additional information.

Recent Events

Empower Retirement continues to incur strategic and business development expenses as it focuses on enhancements, which will improve the client-facing experience as well as streamline the back-office processing over the next several years. The Company anticipates investing approximately $150 million in total on this multi-year initiative, with over $126 million already invested by March 31, 2016. In 2015, these costs decreased net earnings by $34 million and are expected to decrease net earnings by approximately $20 million in 2016. For the three months ended March 31, 2016, these costs have decreased net earnings by $6 million.

The Company has set an annual costs savings target of $40 to $50 million pre-tax.  Integration activities are expected to be completed by the second quarter of 2017 with the annual reduction of operating costs fully reflected upon the completion of the business transformation in the next three to four years.  These synergies are expected to be achieved through efficiencies from the conversion of business onto a single back-office platform, increased utilization of Great-West Global, which launched in the third quarter of 2015, with over 350 professionals based in India, as well as scale-driven cost improvements. Ongoing operations will include amortization expense from system and infrastructure enhancements. The Company expects that these enhancements will increase market share by driving future sales and improving the retention of participants and assets.

On April 6, 2016, the U.S. Department of Labor issued a new rule redefining and expanding who is a fiduciary by reason of providing investment advice to a retirement plan or holder of an individual retirement account.  Compliance with the rule will generally be required by April 10, 2017 (certain parts by January 1, 2018).  The Company is in the process of analyzing the rule against current business practices in its Empower Retirement and Individual Markets businesses.  The rule may require changes to certain aspects of product and service delivery but management does not expect that it will prevent the Company from executing on its overall business strategy and growth objectives.



37



Current Market Conditions
 
The financial markets strengthened during the three months ended March 31, 2016.  The S&P 500 index as at March 31, 2016 was up by less than 1% compared to January 1, 2016. The S&P 500 index at March 31, 2015 was up by less than 1% when compared to January 1, 2015.  The average of the S&P 500 index during the three months ended March 31, 2016, was down by 5% when compared to the same period in 2015.
 
 
2016
 
2015
S&P 500 Index
 
Close
 
Average in Quarter
 
Close
 
Average in Quarter
March 31
 
2,060

 
1,952

 
2,068

 
2,064

January 1
 
2,044

 
 
 
2,059

 
 

Variable asset-based fees earned by the Company fluctuate with changes in participant account balances. Participant account balances change due to cash flow and unrealized market gains and losses, which are primarily associated with changes in the U.S. equities market. Fee income remained constant for the three months ended March 31, 2016, when compared to the same period in 2015, as a result of higher average account balances partially offset by decreased average performance of the U.S. equities market.
 
Interest rates decreased during the three months ended March 31, 2016. The 10-year U.S. Treasury rate as at March 31, 2016, was down by 49 basis points as compared to January 1, 2016. The rate at March 31, 2015 was down by 23 basis points as compared to January 1, 2015. The average of the 10-year U.S. Treasury rate during the three months ended March 31, 2016, was down by 6 basis points when compared to the same period in 2015.

 
 
2016
2015
10-Year Treasury Rate
 
Close
 
Average in Quarter
 
Close
 
Average in Quarter
March 31
 
1.78
%
 
1.91
%
 
1.94
%
 
1.97
%
January 1
 
2.27
%
 
 
 
2.17
%
 
 

The Company employs hedging strategies for the purpose of managing the interest rate, foreign currency exchange rate and equity market risks impacting the Company’s business.  For those derivative instruments when hedge accounting is not elected, all gains or losses are recorded in the consolidated statement of income.  As a result, fluctuations in interest rates, foreign currencies, or equity markets may cause the Company to experience volatility in its earnings.  For three months ended March 31, 2016, the Company recorded unfavorable changes in unrealized gains (losses), net, of $14 million, on forward settling to be announced (“TBA”) securities as compared to the same period in 2015. Additionally, the realized gains (losses), net, on forward settling TBA securities had favorable changes of $12 million for the three months ended March 31, 2016, as compared to the same period in 2015.

Unrealized gains on fixed maturity investments fluctuate with changes in the prevailing interest rates.  When interest rates rise, market values of fixed maturity investments generally fall.  During the three months ended March 31, 2016, fixed maturity investments' unrealized investment gains (losses), net, recognized in net income, had a favorable change of $14 million, as compared to the same period in 2015. The Company also recorded in other comprehensive income favorable changes in unrealized gains (losses), net, on fixed maturity investments, of $430 million for the three months ended March 31, 2016, and favorable changes of $156 million for the three months ended March 31, 2015, respectively. The realized gains (losses), net, on fixed maturity investments had an unfavorable change of $1 million for the three months ended March 31, 2016, as compared to the same period in 2015.

Reconciliation of Net Income to Operating Income

The Company uses the same accounting policies and procedures to measure operating income as it uses to measure consolidated net income. The Company employs hedging strategies for the purpose of managing the interest rate, foreign currency exchange rate, and equity market risks impacting the Company’s business.  For some derivative instruments, hedge accounting is not elected; therefore all gains or losses from these transactions are recorded in the consolidated statement of income.  As a result, fluctuations in interest rates, foreign currencies, or equity markets may cause the Company to experience volatility in net income. As such, the Company has defined operating income as net income, excluding realized and unrealized gains and losses on investments and derivatives and their related tax effect. Operating income should not be viewed as a

38



substitute for net income prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP). In addition, the Company’s operating income measures may not be comparable to similarly titled measures reported by other companies.
 
Three months ended March 31, 2016, compared with the three months ended March 31, 2015
 
The Company believes that the presentation of operating income enhances the understanding of the Company’s performance by highlighting the results of operations and the underlying profitability drivers of the business. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a summary of the contributions of each segment to the net income and a reconciliation of net income to operating income:
 
 
Three Months Ended March 31,
 
Increase
 
Percentage
Income statement data (In millions)
 
2016
 
2015
 
(decrease)
 
change
Net (loss) income
 
 
 
 
 
 
 
 
Individual Markets segment
 
$
47

 
$
52

 
$
(5
)
 
(10
)%
Empower Retirement segment
 
52

 
48

 
4

 
8
 %
Other segment
 
(1
)
 
(1
)
 

 
 %
Total net (loss) income
 
98

 
99

 
(1
)
 
(1
)%
Adjustments to net (loss) income
 
 
 
 
 
 
 
 
Unrealized investment gains (losses), net
 
28

 
62

 
(34
)
 
(55
)%
Realized investment gains (losses), net
 
31

 
18

 
13

 
72
 %
Pro-rata tax (expense) benefit (1)
 
(21
)
 
(28
)
 
7

 
(25
)%
Operating income
 
$
60

 
$
47

 
$
13

 
28
 %
(1) Calculated utilizing estimated tax rate of 35%.

Unrealized investment gains (losses), net, had an unfavorable change of $34 million, or 55%, to $28 million during the three months ended March 31, 2016, when compared to the same period in 2015. The primary driver of the change was a $34 million unfavorable change from derivatives in addition to a $14 million unfavorable change from forward settling TBA securities, partially offset by a $14 million favorable change from bonds.

Realized investment gains (losses), net, had a favorable change of $13 million, or 72%, to $31 million during the three months ended March 31, 2016, when compared to the same period in 2015. The change was primarily driven by a $12 million favorable change from forward settling TBA securities in addition to a $2 million favorable change from mortgage gains, partially offset by a $1 million unfavorable change from other investments.

Pro-rata tax expense decreased by $7 million, from $28 million in 2015 to $21 million in 2016 resulting from the unfavorable change in total unrealized and realized investment gains (losses), net.




39



Company Results of Operations
 
Three months ended March 31, 2016, compared with the three months ended March 31, 2015
 
The following is a summary of certain financial data of the Company:
  
 
 
Three Months Ended March 31,
 
Increase
 
Percentage
Income statement data (In millions)
 
2016
 
2015
 
(decrease)
 
change
Premium income
 
$
155

 
$
146

 
$
9

 
6
 %
Fee income
 
225

 
225

 

 
 %
Other revenue
 
3

 
2

 
1

 
50
 %
Net investment income
 
304

 
297

 
7

 
2
 %
Total revenues
 
687

 
670

 
17

 
3
 %
Policyholder benefits
 
337

 
328

 
9

 
3
 %
Operating expenses
 
287

 
272

 
15

 
6
 %
Total benefits and expenses
 
624

 
600

 
24

 
4
 %
Income before income taxes
 
63

 
70

 
(7
)
 
(10
)%
Income tax (benefit) expense
 
3

 
23

 
(20
)
 
(87
)%
Operating income
 
$
60

 
$
47

 
$
13

 
28
 %

The Company’s consolidated operating income increased by $13 million, or 28%, to $60 million for the three months ended March 31, 2016, when compared to the same period in 2015. The increase was primarily due to lower income tax expense.
 

Premium income increased by $9 million, or 6%, to $155 million for the three months ended March 31, 2016, when compared to the same period in 2015. This increase was primarily related to the Company’s Individual Markets segment which had an increase of $9 million due to lower group health and group life refunds.

Net investment income increased by $7 million, or 2%, to $304 million during the three months ended March 31, 2016, when compared to the same period in 2015. The primary driver of the change was higher investment income on bonds, mortgages, and policy loans as a result of higher volume partially offset by lower rates.
 
Policyholder benefits increased by $9 million, or 3%, to $337 million for the three months ended March 31, 2016, when compared to the same period in 2015, primarily due to the Company’s Individual Markets segment which had an increase of $11 million. The increase was primarily driven by an increase in death claims of $36 million, partially offset by reserve released on death claims of $25 million.

Operating expenses increased by $15 million, or 6%, to $287 million for the three months ended March 31, 2016, when compared to the same period in 2015 primarily due to the Company’s Empower Retirement segment which had an increase of $11 million. The increase was primarily attributable to a $24 million increase in operating expenses primarily from increased salaries and benefits as a result of increased headcount due to business growth. This increase was partially offset by a $13 million decrease in DAC amortization primarily due to higher expected future profits.
 
Income tax expense had a favorable change of $20 million, from $23 million in 2015 to $3 million in 2016 primarily due to lower income taxes as a result of a management election to claim foreign tax credits in addition to decrease in operating income before tax.


40



Individual Markets Segment Results of Operations
 
Three months ended March 31, 2016, compared with the three months ended March 31, 2015
 
The following is a summary of certain financial data of the Individual Markets segment:

 
 
Three Months Ended March 31,
 
Increase
 
Percentage
Income statement data (In millions)
 
2016
 
2015
 
(decrease)
 
change
Premium income
 
$
134

 
$
125

 
$
9

 
7
 %
Fee income
 
23

 
22

 
1

 
5
 %
Net investment income
 
186

 
186

 

 
 %
Total revenues
 
343

 
333

 
10

 
3
 %
Policyholder benefits
 
268

 
257

 
11

 
4
 %
Operating expenses
 
37

 
36

 
1

 
3
 %
Total benefits and expenses
 
305

 
293

 
12

 
4
 %
Income before income taxes
 
38

 
40

 
(2
)
 
(5
)%
Income tax expense
 
11

 
14

 
(3
)
 
(21
)%
Operating income
 
$
27

 
$
26

 
$
1

 
4
 %
 
Operating income for the Individual Markets segment increased by $1 million, or 4%, to $27 million, during the three months ended March 31, 2016, when compared to the same period in 2015. The increase was primarily due to higher premiums and lower income tax expense partially offset by higher policyholder benefits.
 
Premium income increased by $9 million, or 7%, to $134 million for the three months ended March 31, 2016, when compared to the same period in 2015. This increase was primarily related to lower group health and group life refunds.
 
Policyholder benefits increased by $11 million, or 4%, to $268 million for the three months ended March 31, 2016, when compared to the same period in 2015, primarily driven by an increase in death claims of $36 million, partially offset by reserve released on death claims of $25 million.

Income tax expense decreased by $3 million, or 21%, to $11 million during the three months ended March 31, 2016, when compared to the same period in 2015, primarily as a result of a management election to claim foreign tax credits.


41



Empower Retirement Segment Results of Operations
 
Three months ended March 31, 2016, compared with the three months ended March 31, 2015
 
The following is a summary of certain financial data of the Empower Retirement segment:
 
 
 
Three Months Ended March 31,
 
Increase
 
Percentage
Income statement data (In millions)
 
2016
 
2015
 
(decrease)
 
change
Fee income
 
$
201

 
$
202

 
$
(1
)
 
 %
Other revenue
 
3

 
2

 
1

 
50
 %
Net investment income
 
104

 
98

 
6

 
6
 %
Total revenues
 
308

 
302

 
6

 
2
 %
Policyholder benefits
 
50

 
49

 
1

 
2
 %
Operating expenses
 
232

 
221

 
11

 
5
 %
Total benefits and expenses
 
282

 
270

 
12

 
4
 %
Income before income taxes
 
26

 
32

 
(6
)
 
(19
)%
Income tax (benefit) expense
 
(8
)
 
10

 
(18
)
 
(180
)%
Operating income
 
$
34

 
$
22

 
$
12

 
55
 %
  
Operating income for the Empower Retirement segment increased by $12 million, or 55%, to $34 million for the three months ended March 31, 2016, when compared to the same period in 2015.  The increase was primarily due to favorable income tax expense and higher net investment income partially offset by higher operating expenses.

Net investment income increased by $6 million, or 6%, to $104 million for the three months ended March 31, 2016, when compared to the same period in 2015. The primary driver of the change was higher investment income on bonds, mortgages, and policy loans as a result of higher volume partially offset by lower rates.

Operating expenses increased by $11 million, or 5%, to $232 million for the three months ended March 31, 2016, when compared to the same period in 2015. The increase was primarily attributable to a $24 million increase in operating expenses primarily from increased salaries and benefits as a result of increased headcount due to business growth. This increase was partially offset by a $13 million decrease in DAC amortization primarily due to expected higher future profits.
 
Income tax expense had a favorable change of $18 million from an expense of $10 million in 2015 to a benefit of $8 million in 2016, primarily as a result of a management election to claim foreign tax credits in addition to decrease in operating income before tax.


 


42



Other Segment Results of Operations
 
Three months ended March 31, 2016, compared with the three months ended March 31, 2015
 
The following is a summary of certain financial data of the Company’s Other segment:
 
 
 
Three Months Ended March 31,
 
Increase
 
Percentage
Income statement data (In millions)
 
2016
 
2015
 
(decrease)
 
change
Premium income
 
$
21

 
$
21

 
$

 
 %
Fee income
 
1

 
1

 

 
 %
Net investment income
 
14

 
13

 
1

 
8
 %
Total revenues
 
36

 
35

 
1

 
3
 %
Policyholder benefits
 
19

 
22

 
(3
)
 
(14
)%
Operating expenses
 
18

 
15

 
3

 
20
 %
Total benefits and expenses
 
37

 
37

 

 
 %
Income before income taxes
 
(1
)
 
(2
)
 
1

 
(50
)%
Income tax benefit
 

 
(1
)
 
1

 
(100
)%
Operating loss
 
$
(1
)
 
$
(1
)
 
$

 
 %
  
Operating loss for the Company’s Other segment remained the same for the three months ended March 31, 2016 and 2015.

Investment Operations
 
The Company’s primary investment objective is to acquire assets with duration and cash flow characteristics reflective of its liabilities, while meeting industry, size, issuer, and geographic diversification standards.  Formal liquidity and credit quality parameters have also been established.

The Company follows rigorous procedures to control interest rate risk and observes strict asset and liability matching guidelines.  These guidelines ensure that even under changing market conditions, the Company’s assets should meet the cash flow and income requirements of its liabilities. Using dynamic modeling to analyze the effects of a range of possible market changes upon investments and policyholder benefits, the Company works to ensure that its investment portfolio is appropriately structured to fulfill financial obligations to its policyholders.
 
The following table presents the percentage distribution of the carrying values of the Company’s general account investment portfolio: 
(In millions)

March 31, 2016

December 31, 2015
Fixed maturities, available-for-sale

$
20,838


70.4
%

$
20,532


71.3
%
Fixed maturities, held-for-trading

570


1.9
%

616


2.1
%
Mortgage loans on real estate

3,275


11.1
%

3,248


11.3
%
Policy loans

4,069


13.7
%

4,093


14.2
%
Short-term investments

809


2.7
%

266


0.9
%
Limited partnership and other corporation interests

37


0.1
%

41


0.1
%
Other investments

15


0.1
%

15


0.1
%
Total investments

$
29,613


100.0
%

$
28,811


100.0
%
 
Fixed Maturity Investments
 
Fixed maturity investments include public and privately placed corporate bonds, government bonds, and mortgage-backed and asset-backed securities.  Included in available-for-sale fixed maturities are perpetual debt investments which primarily consist of junior subordinated debt instruments that have no stated maturity date but pay fixed or floating interest in perpetuity.  The Company’s strategy related to mortgage-backed and asset-backed securities is to focus on those investments with low prepayment risk and minimal credit risk.
 

43



Private placement investments are generally less marketable than publicly traded assets, yet they typically offer enhanced covenant protection that allows the Company, if necessary, to take appropriate action to protect its investment.  The Company believes that the cost of the additional monitoring and analysis required by private placement investments is more than offset by their enhanced yield.
 
One of the Company’s primary objectives is to ensure that its fixed maturity portfolio is maintained at a high average credit quality to limit credit risk.  All securities are internally rated by the Company on a basis intended to be similar to that of the rating agencies.  The Company’s internal rating methodology generally takes into account ratings from Standard & Poor’s Ratings Services, Fitch Ratings, and Moody’s Investor Services, Inc.  In addition, the National Association of Insurance Commissioners (“NAIC”) implemented a ratings methodology for residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”), and other structured securities.  The Company may also utilize inputs from this ratings process to develop its internal rating.

The percentage distribution of the estimated fair value of the Company’s fixed maturity portfolio by the Company’s internal credit rating is summarized as follows:
Credit Rating
 
March 31, 2016
 
December 31, 2015
AAA
 
25.8
%
 
27.8
%
AA
 
15.2
%
 
14.8
%
A
 
30.1
%
 
29.5
%
BBB
 
27.8
%
 
26.9
%
BB and below (Non-investment grade)
 
1.1
%
 
1.0
%
Total
 
100.0
%
 
100.0
%
 
The percentage distribution of the estimated fair value of the corporate sector fixed maturity portfolio, calculated as a percentage of fixed maturities, is summarized as follows:
Sector
 
March 31, 2016
 
December 31, 2015
Utility
 
18.8
%
 
17.6
%
Finance
 
10.4
%
 
10.2
%
Consumer
 
10.0
%
 
9.3
%
Natural resources
 
6.8
%
 
6.5
%
Transportation
 
3.4
%
 
3.2
%
Other
 
14.2
%
 
13.0
%
 
Mortgage Loans on Real Estate
 
The Company’s mortgage loans on real estate are comprised exclusively of domestic commercial collateralized real estate loans.  The mortgage loan portfolio is diversified with regard to geographical markets and commercial real estate property types within the United States.  The Company originates, directly or through correspondents, real estate mortgages with the intent to hold to maturity.  The Company’s portfolio includes loans which are fully amortizing, amortizing with a balloon balance at maturity, interest only to maturity, and interest only for a number of years followed by an amortizing period.

Derivatives
 
The Company uses certain derivatives, such as futures, swaps, and interest rate swaptions, for purposes of managing the interest rate, foreign currency exchange rate, and equity market risks impacting the Company’s business.  These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, since used for hedging purposes, these instruments are intended to reduce risk.  For derivative instruments where hedge accounting is not elected, changes in interest rates, foreign currencies, or equity markets may generate derivative gains or losses which may cause the Company to experience volatility in net income.  The Company also uses forward settling TBA securities to gain exposure to the investment risk and return of agency mortgage-backed securities (pass-throughs).  These transactions enhance the return on the Company’s investment portfolio and provide a more liquid and cost effective method of achieving these goals than purchasing or selling individual agency mortgage-backed pools.  The Company controls the credit risk of its over-the-counter derivative contracts through credit approvals, limits, monitoring procedures and in most cases, requiring collateral.  Risk of loss is generally limited to the portion of the fair value of derivative instruments that exceeds the value of the collateral held and not to the notional or contractual amounts of the derivatives. 

44



Summary of Critical Accounting Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires the Company’s management to adopt accounting policies to enable them to make a significant variety of accounting and actuarial estimates and assumptions.  These estimates and assumptions are evaluated on an ongoing basis based on historical developments, market conditions, industry trends, and other information that is reasonable given the facts and circumstances for the Company. These critical estimates and assumptions affect, among other things, the reported amounts of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses.  Actual results can differ from the amounts previously estimated, which were based on information available at the time the estimates were made.
 
The Company has identified the following accounting policies, judgments, and estimates as critical in that they involve a higher degree of judgment and are subject to a significant degree of variability:
 
·             Valuation of investments;
·             Impairment of investments;
·             Valuation of derivatives and related hedge accounting;
·             Valuation of DAC and related amortization (including unlocking of assumptions); and
·             Valuation of policy benefit liabilities
 
A discussion of each of these critical accounting policies may be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Application of Recent Accounting Pronouncements
 
See Note 3 to the accompanying condensed consolidated financial statements for a discussion of the application of recent accounting pronouncements.
 
Liquidity and Capital Resources
 
Liquidity refers to a company’s ability to generate sufficient cash flows to meet the short-term needs of its operations.  The Company manages its operations to create stable, reliable, and cost-effective sources of cash flows to meet all of its obligations.
 
The principal sources of the Company’s liquidity are premiums and contract deposits, fees, investment income, and investment maturities and sales.  Funds provided from these sources are reasonably predictable and normally exceed liquidity requirements for payment of policy benefits, payments to policy and contractholders in connection with surrenders and withdrawals, and general expenses.  However, since the timing of available funds cannot always be matched precisely to commitments, imbalances may arise when demands for funds exceed those on hand.  A primary liquidity concern regarding cash flows from operations is the risk of early policyholder and contractholder withdrawals.  A primary liquidity concern regarding investment activity is the risk of defaults and market volatility.

In addition, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities.  The sources of the funds that may be required in such situations include the issuance of commercial paper or other debt instruments.

Management believes that the liquidity profile of its assets is sufficient to satisfy the short-term liquidity requirements of reasonably foreseeable scenarios.
 
Generally, the Company has met its operating requirements by utilizing cash flows from operations and maintaining appropriate levels of liquidity in its investment portfolio.  Liquidity for the Company has remained strong, as evidenced by the amounts of short-term investments and cash that totaled $649 million and $301 million as of March 31, 2016, and December 31, 2015, respectively.  The March 31, 2016, and December 31, 2015, short-term investments included above exclude any amounts held to settle TBA forward contracts.  In addition, 99% of the fixed maturity portfolio carried an investment grade rating at March 31, 2016, and December 31, 2015, which provides significant liquidity to the Company’s overall investment portfolio.
 
The Company continues to be well capitalized, with sufficient borrowing capacity.  Additionally, the Company anticipates that cash on hand and expected net cash generated by operating activities will exceed the forecasted needs of the business over the next 12 months.  The Company’s financial strength provides the capacity and flexibility to enable it to raise funds in the capital

45



markets through the issuance of commercial paper.  The Company had $99 million and $93 million of commercial paper outstanding as of March 31, 2016, and December 31, 2015, respectively.  The commercial paper has been given a rating of A-1+ by Standard & Poor’s Ratings Services and a rating of P-1 by Moody’s Investors Service, each being the highest rating available.  Through the recent financial market volatility, the Company continued to have the ability to access the capital markets for funds.  The loss of this access in the future would not have a significant impact to the Company’s liquidity as commercial paper is not used to fund daily operations and is an insignificant amount in relation to total invested assets.
 
The Company also has available a revolving credit facility agreement with U.S. Bank, which expires on March 1, 2018, in the amount of $50 million for general corporate purposes.  The Company had no borrowings under this credit facility as of or during the three months ended March 31, 2016.  The Company does not anticipate the need for borrowings under this facility and the loss of its availability would not significantly impact its liquidity.
 
Capital resources provide protection for policyholders and financial strength to support the underwriting of insurance risks and allow for continued business growth.  The amount of capital resources that may be needed is determined by the Company’s senior management and Board of Directors, as well as by regulatory requirements.  The allocation of resources to new long-term business commitments is designed to achieve an attractive return, tempered by considerations of risk and the need to support the Company’s existing business.
 
Off-Balance Sheet Arrangements
 
The Company makes commitments to fund partnership interests, mortgage loans on real estate, and other investments in the normal course of its business.  The amounts of these unfunded commitments at March 31, 2016, and December 31, 2015, were $205 million and $51 million, respectively.  The precise timing of the fulfillment of the commitment cannot be predicted; however, these amounts are due within one year of the dates indicated.  There are no other obligations or liabilities arising from such arrangements that are reasonably likely to become material.
 
The Company participates in a securities lending program in which the Company lends securities that are held as part of its general account investment portfolio to third parties for the purpose of enhancing the total return on its investment portfolio.  The Company generally requires initial collateral in an amount greater than or equal to 102% of the fair value of domestic securities loaned and 105% of foreign securities loaned.  The Company received securities with a fair value of $65 million and zero as collateral at March 31, 2016, and December 31, 2015, respectively, which have not been recorded on the condensed consolidated balance sheets as the Company does not have effective control.

Item 3.         Quantitative and Qualitative Disclosures about Market Risk
 
The Company has established processes and procedures to effectively identify, monitor, measure, and manage the risks associated with its invested assets and its interest rate sensitive insurance and annuity products.  Management has identified investment portfolio management, including the use of derivative instruments, insurance and annuity product design, and asset/liability management as three critical means to accomplish a successful risk management program.
 
The major risks to which the Company is exposed include the following: 

Market risk - the potential of loss arising from adverse fluctuations in interest rates and equity market prices and the levels of their volatility.
Insurance risk - the potential of loss resulting from claims, persistency, and expense experience exceeding that assumed in the liabilities held.
Credit risk - the potential of loss arising from an obligator’s inability or unwillingness to meet its obligations to the Company.
Operational and corporate risk - the potential of direct or indirect loss resulting from inadequate or failed internal processes, people and systems, or from other external events.
  
A discussion of each of these risk factors may be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, under Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
 

46



Item 4.         Controls and Procedures
 
Disclosure Controls and Procedures
 
The Company’s management, with the participation of its President and Chief Executive Officer and its Principal Accounting Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (“Exchange Act”).  The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in reports it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and to ensure that the information required to be disclosed by the Company in reports that it files under the Exchange Act is accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, the President and Chief Executive Officer and Principal Accounting Officer have concluded that the Company’s disclosure controls and procedures are effective as of March 31, 2016.

Changes in Internal Control over Financial Reporting
 
As disclosed in Item 9A, “Controls and Procedures,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, management concluded that the Company maintained effective internal control over financial reporting. There has been no change in the control environment for the three months ended March 31, 2016. Management is committed to continuing to improve its internal control processes and will continue to review its financial reporting controls and procedures.

Part II          Other Information
 
Item 1.         Legal Proceedings
 
From time to time, the Company may be threatened with, or named as a defendant in, lawsuits, mediations, arbitrations, and administrative claims. Any such claims that are decided against the Company could harm the Company’s business. The Company is also subject to periodic regulatory audits and inspections which could result in fines or other disciplinary actions. Unfavorable outcomes in such matters may result in a material impact on the Company's financial position, results of operations, or cash flows.
 
The Company is defending a lawsuit related to a motor vehicle accident involving an employee. It received a $20 million demand letter from the plaintiff’s attorney during the fourth quarter of 2014.  The amount is fully indemnified by a third-party insurer.

The Company is defending lawsuits relating to the administration of its staff retirement plan, or to the costs and features of certain of its retirement or fund products. These actions are at their early stages. Management believes the claims are without merit and will defend these actions. Based on the information known, these actions will not have a material adverse effect on the consolidated financial position of the Company.

The Company is involved in other various legal proceedings that arise in the ordinary course of its business.  In the opinion of management, after consultation with counsel, the likelihood of loss from the resolution of these proceedings is remote and/or

47



the estimated loss is not expected to have a material effect on the Company’s consolidated financial position, results of its operations or cash flows.

Item 1A. Risk Factors
 
In the normal course of its business, the Company is exposed to certain operational, regulatory, and financial risks and uncertainties.  The most significant risks include the following:

Competition could negatively affect the ability of the Company to maintain or increase market share or profitability.

The insurance and financial services industries are heavily regulated and changes in regulation may reduce profitability.
 
A downgrade or potential downgrade in the Company’s financial strength or claims paying ratings could result in a loss of business and negatively affect results of operations and financial condition.

Deviations from assumptions regarding future persistency, mortality, and interest rates used in calculating liabilities for future policyholder benefits and claims could adversely affect the Company’s results of operations and financial condition.

The Company may be required to accelerate the amortization of DAC or VOBA, or recognize impairment in the value of goodwill or other intangible assets, which could adversely affect its results of operations and financial condition.

If the companies that provide reinsurance default or fail to perform or the Company is unable to obtain adequate reinsurance for some of the risks underwritten, the Company could incur significant losses adversely affecting results of operations and financial condition.

Interest rate fluctuations could have a negative impact on results of operations and financial condition.
  
Market fluctuations and general economic conditions may adversely affect results of operations and financial condition.

Changes in U.S. federal income tax law could make some of the Company’s products less attractive to consumers and increase its tax costs.

The Company may be subject to litigation resulting in substantial awards or settlements and this may adversely affect its reputation and results of operations.

The Company’s risk management policies and procedures may leave it exposed to unidentified or unanticipated risk, which could adversely affect its business, results of operations, and financial condition.

The Company may experience difficulty in marketing and distributing products through its current and future distribution channels.

A failure in cyber or information security systems could result in a loss or disclosure of confidential information, damage the Company’s reputation, and could impair its ability to conduct business effectively.

The Company could face difficulties, unforeseen liabilities, or asset impairments arising from business acquisitions or integrations and managing growth of such businesses.


48



Item 6.         Exhibits
 
The documents identified below are filed as a part of this report:
 
Index to Exhibits
 
Exhibit Number
Title
31.1
Rule 13a-14(a)/15-d14(a) Certification
31.2
Rule 13a-14(a)/15-d14(a) Certification
32
18 U.S.C. 1350 Certification
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
Great-West Life & Annuity Insurance Company
 
By:
/s/
Kara Roe
 
Date:
May 11, 2016
 
 
Kara Roe
 
 
 
 
 
Vice President, Controller, and Principal Accounting Officer
 
 
 


49