ITEM 1. BUSINESS
OWNERSHIP
Great Northern Insured Annuity Corporation (GNA or the Company) was incorporated as a stock life insurance company organized under the laws of the State of Washington on June 4, 1980 and began writing business pursuant to licensing on October 15, 1980. On June 30, 1983, The Weyerhaeuser Company (Weyerhaeuser) acquired a controlling interest in GNA.
Pursuant to a Stock Purchase Agreement dated January 5, 1993, by and between Weyerhaeuser and General Electric Capital Corporation (GE Capital), 100% of the outstanding capital stock of GNA Corporation was sold to GE Capital effective April 1, 1993.
Effective July 14, 1993, GE Capital acquired 100% of the outstanding capital stock of United Pacific Life Insurance Company (United Pacific Life). GE Capital transferred controlling ownership of United Pacific Life to GNA. Subsequently, United Pacific Life's name was changed to General Electric Capital Assurance Company (GE Capital Assurance). GE Capital Assurance, a Delaware life insurer, is licensed in the District of Columbia, and all states except Maine and New York.
On February 1, 1990, GNA acquired 100% of the outstanding stock of First GNA Life Insurance Company of New York (First GNA). Subsequent to the acquisition of United Pacific Life, GNA merged First GNA with United Pacific Reliance Life Insurance Company of New York, a wholly-owned subsidiary of United Pacific Life. The merged company is 48% owned by GNA and 52% by GE Capital Assurance. Effective February 1, 1996, First GNA's name was changed to GE Capital Life Assurance Company of New York (GE Capital Life). GE Capital Life issues deferred and immediate annuities and life insurance in the state of New York.
Effective October 1, 1995, GNA was party to a reorganization involving GNA Corporation and certain of its life insurance company subsidiaries (herein referred to as the Reorganization). As part of the Reorganization, GNA became a wholly-owned subsidiary of GE Capital Assurance, and GE Capital Assurance became a wholly-owned subsidiary of GNA Corporation. Previously, all of GE Capital Assurance's voting common stock was owned by GNA. The Reorganization allows all life insurance company subsidiaries of GNA Corporation to file a consolidated federal tax return.
On January 1, 1999, GNA merged with and into its parent company, GE Capital Assurance, pursuant to an Agreement and Plan of Merger between the GNA and GE Capital Assurance dated May 18, 1998. Prior regulatory approval of the merger was obtained from the Delaware Department of Insurance and from the Washington Department of Insurance. This merger was also approved by the U.S. Securities & Exchange Commission. As a result of the merger, GNA will no longer file financial information on Forms 10-Q nor 10-K. The merger will be treated on an as-if-pooled basis; accordingly, the resulting consolidated financial statements will include the accounts and operations of GNA and GE Capital Assurance.
MARKETING
GNA is licensed in the District of Columbia and all states except New Hampshire and New York. GNA markets fixed-rate deferred annuities, immediate annuities and structured settlement immediate annuities primarily through banks, thrifts and other financial institutions.
DEFERRED FIXED RATE ANNUITIES. The predominant form of deferred annuities require either single premium or flexible premium payments and have a minimum annual guaranteed crediting rate. After the initial guarantee period, the crediting rate may be changed periodically. The policy owner is permitted to withdraw all or part of the premium paid plus interest credited, less a surrender charge for withdrawals during the initial penalty period of one to eight years. The surrender charge is initially 5% to 8% of the contract value and decreases over the penalty period. Some deferred annuities provide for penalty-free partial withdrawals of the accumulated interest credited or up to 10% annually of the accumulation value. In
1998, the Company issued $33.0 million in deferred annuities. At December 31, 1998, deferred annuities comprised $4,436.7 million of total liabilities for future annuity and contract benefits.
IMMEDIATE ANNUITIES. The Company's immediate annuities are designed to provide a series of periodic payments for a fixed length of time or for life, according to the annuitant's choice at the time of issue. Once the payments have begun, the amount, frequency and length of time for which they are payable are fixed. A primary form of immediate annuities, the structured settlement annuity, is usually sold as part of a settlement resulting from a personal injury or wrongful death claim to provide scheduled payments to an injured person or their dependents. Structured settlement annuities are generally long-term and cannot be surrendered. In 1998, the Company issued $55.7 million in immediate annuities. At December 31, 1998, immediate annuities comprised $777.9 million of total liabilities for future annuity and contract benefits.
COMPETITION
The Company is engaged in a business that is highly competitive because of the large number of stock and mutual life insurance companies and other entities marketing insurance and investment products. There are numerous stock, mutual and other types of insurers in the life insurance business in the United States, a significant number of which are substantially larger than GNA.
A.M. Best has currently assigned to GNA an A + (Superior) rating and Standard & Poor's has assigned an AA (Excellent) rating based on the Company's high claims paying ability and excellent asset quality.
GOVERNMENT REGULATION
GNA is subject to the laws of the State of Washington governing insurance companies and to the regulations of the Washington Insurance Department. In addition, GNA is subject to regulation under the insurance laws of other jurisdictions in which the Company operates. Regulation by other supervisory agencies includes licensing to transact business, overseeing trade practices, licensing agents, approving policy forms, establishing reserve requirements, fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values, prescribing the form and content of required financial statements and regulating the type and amounts of investments permitted. The Company's books and accounts are subject to review by each Insurance Department and other supervisory agencies at all times, and GNA files annual statements with these agencies. A full examination of the Company's operations is conducted periodically by various Insurance Departments and may include the participation of the insurance departments of other states in which GNA conducts business. Recent examinations have not resulted in significant findings.
In addition, many states regulate affiliated groups of insurers (including GNA) under insurance holding company legislation. Under such laws, intercompany transactions, including transfers of assets and dividend payments from insurance subsidiaries, may be subject to prior notice or approval, depending on the size of the transfers and payments in relation to the financial positions of the companies involved. Due to the Company's volume of California business, GNA is considered a California commercially domiciled insurer under California insurance holding company law.
The National Association of Insurance Commissioners (NAIC) uses Risk-Based Capital (RBC) requirements to evaluate the adequacy of statutory capital and surplus in relation to risks associated with: (i) asset quality, (ii) insurance risk (iii) interest rate risk, and (iv) other business factors. The RBC formula is designed as an early warning tool for the states to identify possible under-capitalized companies for the purpose of initiating regulatory action. In the course of its operations, the Company monitors the level of its RBC and it exceeds the minimum required levels.
Under insurance guaranty fund laws in most states, insurers doing business therein can be assessed (up to prescribed limits) for policyholder losses incurred by insolvent companies. GNA has estimated assessments related to known insolvencies, primarily Executive Life Insurance Company, and has recorded a liability of $25.6 million at December 31, 1998 related to this estimated liability. The amount of any future assessments related to future insolvencies under these laws, however, cannot be reasonably estimated. Most
of these laws do provide that an assessment may be excused or deferred if it would threaten an insurer's own financial strength.
Although the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include employee benefit regulation, removal of barriers preventing banks from engaging in the insurance business, tax law changes affecting the taxation of insurance companies and the tax treatment of insurance products and the taxation impact on the relative desirability of various investment vehicles.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases office space in Seattle, Washington. The Company is reimbursed by its affiliates for rent based on direct and indirect allocation methods.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in various cases of litigation considered to be in the normal course of business. The Company believes that the outcome of such litigation will not have a material effect on its financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is owned entirely by GE Capital Assurance and, therefore, there is no trading market in such stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the financial statements and notes thereto included in this Form 10-K.
(1) Unaudited pro forma results reflect the Reorganization as if it had occurred at the beginning of the period.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
GNA derives substantially all its income from earnings on investments offset by interest credited to policyholders of predominantly deferred and immediate annuities, operating expenses, acquisition costs and taxes. Funds received for the purchase of immediate annuities with life contingencies, including options elected under annuity contracts, are reported as premium income. Other income is primarily surrender fees on deferred annuity policies.
GNA's results of operations for the years ended December 31, 1998 and 1997 include the accounts of GNA, as well as the Company's investment in GE Capital Life of New York, accounted for under the equity method.
As a result of a continued shift in marketing focus to GE Capital Assurance for sales of life contingent structured settlement products, premium revenues, benefits and changes in policy reserves, commissions, general expenses and change in deferred acquisition costs, net were lower in 1998 as compared to 1997.
1998 Compared to 1997 - ---------------------
NET INVESTMENT INCOME decreased $33.6 million to $441.7 million. This decrease is primarily attributed to a decrease in average investments during the period and the impact of lower weighted average yields due to a lower interest rate environment in 1998.
NET REALIZED INVESTMENT GAINS (LOSSES) - Net realized investment gains were $9.0 million during 1998, compared to a $19.7 million in 1997. This change is related to the Company's asset/liability risk management and varies with market and economic conditions.
PREMIUMS decreased $43.6 million to $17.5 million. This decrease is due to lower sales of life contingent structured settlement product primarily related to a shift in marketing focus to GE Capital Assurance products.
INTEREST CREDITED on policyholder deposits decreased $40.3 million to $253.6 million primarily due to lower future annuity and contract benefit liabilities during 1998.
BENEFITS AND OTHER CHANGES IN POLICY RESERVES decreased $42.9 million to $54.8 million. This decrease was largely due to a reduction in sales of life contingent structured settlement products and reserve reduction associated with the payout of benefits.
COMMISSIONS decreased $9.4 million to $5.3 million. This decrease is due to continued shift in marketing focus to GE Capital Assurance products.
GENERAL EXPENSES decreased $9.4 million to $17.5 million due to GNA's continued shift in marketing focus to GE Capital Assurance products.
AMORTIZATION OF INTANGIBLES, NET decreased $1.3 million to $31.3 million. The Company established goodwill and present value of future profits (PVFP) assets in connection with GNA's acquisition. The decrease is primarily related to lower PVFP amortization in 1998 versus 1997, due to a normal PVFP amortization pattern.
CHANGE IN DEFERRED ACQUISITION COSTS, NET increased $23.0 million to $14.8 million primarily as a result of lower deferrable commissions as discussed above and higher amortization of previously capitalized deferred acquisition costs due to a continuing runoff of the underlying business.
PROVISION FOR INCOME TAXES. The effective tax rate for 1998 decreased to 32.8% from 33.2% primarily due to the recognition of equity income in earnings of GE Capital Life of New York.
1997 Compared to 1996
NET INVESTMENT INCOME decreased $12.8 million to $475.3 million. This increase is primarily attributable to purchase of higher yield securities, dividends from other invested assets and an increase in average investments during the period.
NET REALIZED INVESTMENT GAINS (LOSSES) - Net realized investment gains were $19.7 million during 1997, compared to $3.1 million in 1996. This change is related to the Company's asset/liability risk management and varies with market and economic conditions.
PREMIUMS decreased $138.9 million to $61.1 million. This decrease is due to lower sales of life contingent structured settlement product primarily related to a shift in marketing focus to GE Capital Assurance products.
INTEREST CREDITED on policyholder deposits decreased $1.8 million to $293.9 million primarily due to lower future annuity and contract benefit liabilities during 1997.
BENEFITS AND OTHER CHANGES IN POLICY RESERVES decreased $133.2 million to $97.7 million. Change in policy reserves decreased largely due to a reduction in sales of life contingent structured settlement products and reserve reduction associated with the payout of benefits.
COMMISSIONS decreased $12.7 million to $14.7 million. This decrease is due to a continued shift in marketing focus to GE Capital Assurance products.
GENERAL EXPENSES decreased $9.6 million to $26.9 million due to the GNA's continued shift in marketing focus to GE Capital Assurance products.
AMORTIZATION OF INTANGIBLES, NET decreased $1.3 million to $32.6 million. The Company established goodwill and present value of future profits (PVFP) assets in connection with GNA's acquisition. The decrease is primarily related to lower PVFP amortization in 1997 versus 1996, due to a normal PVFP amortization pattern.
CHANGE IN DEFERRED ACQUISITION COSTS, NET decreased $18.5 million to $8.2 million primarily as a result of lower deferrable commissions, as discussed above.
PROVISION FOR INCOME TAXES. The effective tax rate for 1997 increased to 33.2% from 32.8% primarily due to the recognition of equity income in earnings of GE Capital Life of New York.
INVESTMENTS
The Company manages its investment portfolio to meet the diversification, credit quality, yield and liquidity requirements of its policy liabilities by investing primarily in fixed maturity instruments, including government and corporate bonds, mortgage-backed securities, and mortgage loans on real estate. At December 31, 1998, the Company held $5.8 billion, or 95.1% of its investment portfolio, in fixed maturity instruments and mortgage loans. The Company's investment philosophy focuses on purchasing assets the durations of which approximate policyholder obligations. To match some of its longer term policy liabilities, the Company has followed a strategy of buying bonds with adequate call protection. The Company also invests in policy loans, short-term securities and other investments, which comprised the remaining 4.9% of its investment portfolio at December 31, 1998.
The Company primarily purchases investment-grade (BBB-/Baa3 or above) bonds. At December 31, 1998, $4,269.2 million, or 90.2% of the fixed maturity securities held by the Company were bonds rated by a rating agency (S&P or Moody's), or were government/agency bonds. Fixed maturity securities of $462.7 million, or 9.8%, were comprised primarily of private placement bonds not rated by either rating agency. At December 31, 1998, the Company held $66.4 million of bonds rated below investment grade (excluding split-rated bonds). In addition, the Company held $41.5 million of "not-rated" bonds which the Company believes are below investment grade. Below investment grade bonds include those bonds originally
purchased as investment grade but subsequently downgraded in rating, as well as bonds purchased as below investment grade. The Company holds this small percentage of below investment grade bonds in order to enhance the yield on its investment portfolio.
Investments in mortgage-backed securities include $1,288.3 million in collateralized mortgage obligations (CMOs) and asset-backed securities and $311.1 million of pass-through securities. These securities are secured primarily by pools of residential mortgages and generally carry high credit ratings. Approximately 41% of the mortgage-backed securities are backed by securities issued by Government National Mortgage Association, Federal Home Loan Mortgage Corporation, or Federal National Mortgage Association. In aggregate, the mortgage-backed securities had an average rating of AAA/Aaa at December 31, 1998. Most CMO and pass-through securities are subject to prepayment and extension risk (i.e., principal can be received earlier or later than anticipated, based on the rate of mortgage prepayments in the underlying residential mortgage pools).
The Company has classified all of its fixed maturity investments available-for-sale. Such securities are carried on the balance sheet at current fair values and marked to market quarterly. Changes in market value, net of the effect on present value of future profits, deferred policy acquisition costs and deferred income taxes, are recorded as unrealized appreciation or depreciation directly in shareholder's interest and, accordingly, have no effect on net income, but are shown as a component of accumulated non-owner changes in equity. At December 31, 1998, the amortized cost basis of the Company's fixed maturity securities was $4,580.4 million, representing net unrealized gains of $151.5 million.
The Company's mortgage loan portfolio consisted of 870 loans at December 31, 1998. The loans, which are originated through a network of mortgage bankers, are made only on completed, leased properties and have a maximum loan-to-value ratio of 75% at the date of origination. Commercial loans comprise the majority of the portfolio, with $558.0 million (51.4%), $255.9 million (23.6%) and $139.3 million (12.8%) attributable to the retail, industrial and office sectors, respectively. The remainder of the loans are attributable to the residential and other miscellaneous sectors. The mortgage loans are secured by property throughout the U.S., with concentrations in the Pacific region (42.1%) and the South Atlantic region (21.0%).
Other invested assets of $277.1 million at December 31, 1998 were comprised of several type of assets. These include investments in mutual funds offered by the Company's mutual fund and variable annuity distribution channels ($55.2 million) in order to provide seed money for these funds; and pursuant to a periodic review of its asset allocation strategy, the Company has also made investments in limited partnerships ($80.0 million) and an investment in affiliate ($127.9 million).
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements are met by funds from operations and investment activity. Premiums and policyholder deposits are invested in assets that generally have durations similar to the Company's liabilities. Funds from investment activity included principal and interest payments from the bond and mortgage portfolio as well as sales, calls and maturities of certain securities. As of December 31, 1998, investments subject to certain call provisions totaled $185.5 million; and mortgage-backed securities subject to prepayment risk totaled $1,599.4 million.
The Company is restricted by Washington State as to the amount of dividends it may pay within a given calendar year to its parent without regulatory consent. That restriction is the greater of statutory net gain from operations for the year or 10% of the statutory surplus at the end of the year, subject to a maximum equal to statutory earned surplus. As of December 31, 1998, approximately $89.4 million was available for dividend payments in 1999.
YEAR 2000
Year 2000 will test the capability of business processes to function correctly. The Company, with the assistance of its parent, has undertaken an effort to identify and mitigate Year 2000 issues in its information systems, products, facilities and suppliers. The Company has a Year 2000 leader who oversees a multi-functional remediation project team responsible for applying a Six Sigma quality approach in four phases: (1) define/measure- identify and inventory possible sources of Year 2000 issues; (2) analyze- determine the
nature and extent of Year 2000 issues and develop project plans to address those issues; (3) improve- execute project plans and per-form a majority of the testing; and (4) control - complete testing, continue monitoring readiness and complete necessary contingency plans. The progress of this program is monitored and reviews with senior management are conducted monthly. The first three phases of the program have been completed for a substantial majority of mission-critical activities. Management plans to have nearly all significant information systems, products and facilities through the control phase of the program by mid-1999.
The scope of the Year 2000 effort encompasses many hundreds of applications and computer programs; as well as products and services; facilities and facilities-related equipment; suppliers and customers. Business operations are also affected by the Year 2000 readiness of customers, distribution channels and infrastructure suppliers in areas such as utilities, communications and other services. In this environment, there will likely be instances of failure that could cause disruptions in business processes for the Company's business. The likelihood and effects of failures in the customer base, infrastructure systems, distribution channels and in the supply chain cannot be estimated. However, with respect to operations under its direct control, management does not expect, in view of its Year 2000 program efforts and the diversity of its products, suppliers, distribution channels and customers, that occurrences of Year 2000 failures will have a material adverse effect on the financial position, results of operations or liquidity of the Company.
Total Year 2000 remediation expenditures, to be incurred by the Company and its affiliated carriers, are expected to be approximately $47 million, of which approximately 80% was spent by the end of 1998. Substantially all of the remainder is expected to be spent in 1999. The activities involved in the Year 2000 effort necessarily involve estimates and projections of activities and resources that will be required in the future. These estimates and projections could change as work progresses.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Item omitted pursuant to General Instructions J(2) (c) of Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Item omitted pursuant to General Instructions J(2) (c) of Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Item omitted pursuant to General Instructions J(2) (c) of Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item omitted pursuant to General Instructions J(2) (c) of Form 10-K.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K