10-Q 1 idsl10q.txt IDS LIFE INSURANCE UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 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 33-28976 IDS LIFE INSURANCE COMPANY -------------------------------------------------------------- (Exact name of registrant as specified in its charter) MINNESOTA 41-0823832 ------------------------------------ ----------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 227 AXP FINANCIAL CENTER, MINNEAPOLIS, MINNESOTA 55474 ------------------------------------------------ ------------- (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (612) 671-3131 -------------- 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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes _____ No __X__ THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT. IDS LIFE INSURANCE COMPANY FORM 10-Q INDEX Page No. Part I. Financial Information: Item 1. Financial Statements Consolidated Statements of Income - Three months ended September 30, 2003 and 2002 1 Consolidated Statements of Income - Nine months ended September 30, 2003 and 2002 2 Consolidated Balance Sheets - September 30, 2003 and December 31, 2002 3 Consolidated Statements of Cash Flows - Nine months ended September 30, 2003 and 2002 4-5 Notes to Consolidated Financial Statements 6-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-19 Item 4. Controls and Procedures 20 Part II. Other Information 22 Item 1. Legal Proceedings 22 Item 6. Exhibits and Reports on Form 8-K 22 Signatures 23 Exhibit Index E-1 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME (thousands) (unaudited) Three months ended September 30, ------------------------------------ 2003 2002 ----------- ---------- Revenues: Premiums: Traditional life insurance $ 16,021 $ 17,549 Disability income and long-term care insurance 71,433 69,893 -------- -------- Total premiums 87,454 87,442 Policyholder and contractholder charges 130,320 132,140 Management and other fees 101,980 93,723 Net investment income 427,603 385,490 Net realized (loss) gain on investments (10,665) 11,619 -------- -------- Total revenues 736,692 710,414 -------- -------- Benefits and expenses: Death and other benefits: Traditional life insurance 11,063 9,213 Universal life-type insurance and investment contracts 56,620 54,956 Disability income and long-term care insurance 14,877 13,636 (Decrease) increase in liabilities for future policy benefits: Traditional life insurance (2,374) (2,373) Disability income and long-term care insurance 36,398 34,104 Interest credited on universal life-type insurance and investment contracts 308,675 287,046 Amortization of deferred policy acquisition costs 74,234 96,443 Other insurance and operating expenses 107,627 115,537 --------- -------- Total benefits and expenses 607,120 608,562 --------- -------- Income before income tax (benefit) provision 129,572 101,852 Income tax (benefit) provision (3,592) 15,681 --------- -------- Net income $133,164 $ 86,171 ========= ======== See Notes to Consolidated Financial Statements.
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IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME (thousands) (unaudited) Nine months ended September 30, ---------------------------------- 2003 2002 ----------- ---------- Revenues: Premiums: Traditional life insurance $ 48,406 $ 50,213 Disability income and long-term care insurance 210,814 201,613 ----------- ---------- Total premiums 259,220 251,826 Policyholder and contractholder charges 397,287 386,969 Management and other fees 284,430 313,728 Net investment income 1,246,136 1,167,344 Net realized gain (loss) on investments 12,655 (33,695) ----------- ---------- Total revenues 2,199,728 2,086,172 ----------- ---------- Benefits and expenses: Death and other benefits: Traditional life insurance 30,916 27,413 Universal life-type insurance and investment contracts 155,015 143,353 Disability income and long-term care insurance 42,224 38,414 (Decrease) increase in liabilities for future policy benefits: Traditional life insurance (2,733) 2,039 Disability income and long-term care insurance 102,237 98,121 Interest credited on universal life-type insurance and investment contracts 919,558 842,647 Amortization of deferred policy acquisition costs 228,292 264,114 Other insurance and operating expenses 341,660 321,679 ----------- ---------- Total benefits and expenses $1,817,169 $1,737,780 ----------- ---------- Income before income tax provision 382,559 348,392 Income tax provision 42,974 62,262 ----------- ---------- Net income $ 339,585 $ 286,130 =========== ========== See Notes to Consolidated Financial Statements.
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IDS LIFE INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS (thousands) September 30, December 31, 2003 2002 ----------------- -------------- (unaudited) Assets Investments: Available-for-sale: Fixed maturity investments, at fair value (amortized cost: 2003, $27,149,933; 2002, $23,209,226) $28,073,453 $24,052,104 Mortgage loans on real estate (less reserves: 2003, $47,947; 2002, $30,103) 3,235,521 3,417,651 Policy loans 579,401 591,126 Other investments 1,112,785 752,579 ------------ ------------ Total investments 33,001,160 28,813,460 Cash and cash equivalents 79,970 4,424,061 Amounts recoverable from reinsurers 723,093 633,510 Amounts due from brokers 433,108 25,835 Other accounts receivable 58,503 56,245 Accrued investment income 340,498 277,279 Deferred policy acquisition costs 3,523,189 3,309,783 Other assets 121,905 117,788 Separate account assets 24,996,574 21,980,674 ------------ ------------ Total assets $63,278,000 $59,638,635 ============ ============ Liabilities and Stockholder's Equity Liabilities: Future policy benefits: Fixed annuities $26,311,665 $23,411,314 Universal life-type insurance 3,566,598 3,515,010 Traditional life insurance 251,344 247,441 Disability income and long-term care insurance 1,653,495 1,466,171 Policy claims and other policyholders' funds 83,230 85,400 Amounts due to brokers 464,918 3,342,989 Deferred income taxes 214,643 182,059 Other liabilities 413,182 463,326 Separate account liabilities 24,996,574 21,980,674 ------------ ------------ Total liabilities 57,955,649 54,694,384 ------------ ------------ Stockholder's equity: Capital stock, $30 par value per share; 100,000 shares authorized, issued and outstanding 3,000 3,000 Additional paid-in capital 1,088,327 1,088,327 Retained earnings 3,694,426 3,354,841 Other comprehensive income, net of tax: Net unrealized securities gains 535,380 497,319 Net unrealized derivative gains 1,218 764 ------------ ------------ Accumulated other comprehensive income 536,598 498,083 ------------ ------------ Total stockholder's equity 5,322,351 4,944,251 ------------ ------------ Total liabilities and stockholder's equity $63,278,000 $59,638,635 ============ ============ See Notes to Consolidated Financial Statements.
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IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands) (unaudited) Nine months ended September 30, 2003 2002 ---------- ---------- Cash Flows from Operating Activities Net income $ 339,585 $ 286,130 Adjustments to reconcile net income to net cash provided by operating activities: Policy loans, excluding universal life-type insurance Issuance (25,868) (28,126) Repayment 33,403 37,939 Change in amounts recoverable from reinsurers (89,583) (72,869) Change in other accounts receivable (2,258) (7,164) Change in accrued investment income (72,249) (1,655) Change in deferred policy acquisition costs, net (233,646) (195,873) Change in liabilities for future policy benefits for traditional life, disability income and long-term care insurance 191,227 178,522 Change in policy claims and other policyholders' funds (2,170) 25,363 Deferred income taxes 11,800 53,671 Change in other assets (4,117) 9,637 Change in other liabilities (50,144) (63,075) Amortization of premium, net 136,950 48,874 Net realized (gain) loss on investments (12,655) 33,695 Net realized gains on trading securities (19,079) (6,993) Contractholder charges, non-cash (175,764) (172,811) Other, net (4,168) 5,123 ---------- ---------- Net cash provided by operating activities 21,264 130,388 ---------- ---------- See Notes to Consolidated Financial Statements.
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IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands) (unaudited) Nine months ended September 30, 2003 2002 ---------------- ----------------- Cash Flows from Investing Activities Available-for-Sale investments: Sales $ 9,205,312 $ 6,581,196 Maturities, sinking fund payments and calls 3,546,041 2,276,303 Purchases (16,738,868) (10,031,715) Other investments, excluding policy loans: Sales, maturities, sinking fund payments and calls 471,588 355,323 Purchases (697,042) (362,979) Change in amounts due to and from brokers, net (3,285,344) (1,344,862) -------------- ------------- Net cash used in investing activities (7,498,313) (2,526,734) -------------- ------------- Cash Flows from Financing Activities Activity related to universal life-type insurance and investment contracts: Considerations received 3,701,940 3,315,296 Interest credited to account balances 919,558 842,647 Surrenders and death benefits (1,492,730) (1,205,070) Universal life-type insurance policy loans: Repayment 66,085 71,752 Issuance (61,895) (57,875) Cash dividends to parent -- (70,000) Capital contribution from parent -- 250,000 -------------- ------------- Net cash provided by financing activities 3,132,958 3,146,750 -------------- ------------- Net (decrease) increase in cash and cash equivalents (4,344,091) 750,404 Cash and cash equivalents at beginning of period 4,424,061 1,150,251 -------------- ------------- Cash and cash equivalents at end of period $ 79,970 $ 1,900,655 ============== ============= See Notes to Consolidated Financial Statements.
-5- IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The accompanying Consolidated Financial Statements should be read in conjunction with the financial statements in the Annual Report on Form 10-K of IDS Life Insurance Company (the Company) for the year ended December 31, 2002. Certain reclassifications of prior period amounts have been made to conform to the current presentation. The interim financial information in this report has not been audited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position and the consolidated results of operations for the interim periods have been made. All adjustments made were of a normal, recurring nature. See Note 4., Taxes and Interest, regarding the Company's third quarter 2003 income tax benefit. Results of operations reported for interim periods are not necessarily indicative of results for the entire year. Recently Issued Accounting Standards In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which addresses consolidation by business enterprises of variable interest entities (VIEs). In October 2003, the FASB issued a statement delaying the effective date of the consolidation provisions of FIN 46 from July 1, 2003 to December 31, 2003 for VIEs created prior to February 1, 2003. An entity is subject to consolidation according to the provisions of FIN 46, if, by design, either (i) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or, (ii) as a group, the holders of the equity investment at risk lack: (a) direct or indirect ability to make decisions about an entity's activities; (b) the obligation to absorb the expected losses of the entity if they occur; or (c) the right to receive the expected residual returns of the entity if they occur. In general, FIN 46 requires a VIE to be consolidated when an enterprise has a variable interest that will absorb a majority of the VIE's expected losses or receive a majority of the VIE's expected residual return. The entities primarily impacted by FIN 46, which the Company may consolidate, relate to structured investments, including collateralized debt obligations (CDOs) and secured loan trusts (SLTs), which are partially owned by the Company. FIN 46 does not impact the accounting for qualified special purpose entities as defined by SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Debt," such as the Company's CDO-related securitization trust established in 2001. That trust contains a majority of the Company's rated CDOs whose retained interests in the trust had a carrying value of $548 million at -6- IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) September 30, 2003, of which $411 million is considered investment grade. Separately, FIN 46 is not expected to impact the accounting for an additional $24 million of rated CDO tranches managed by a third party. The CDO entities impacted by FIN 46 contain debt issued to investors which is non-recourse to the Company and solely supported by portfolios of high-yield bonds and loans. From time-to-time, the Company invests in the residual and rated debt tranches of the CDO structures that are either managed by a related party or a third-party. The SLTs provide returns to investors primarily based on the performance of an underlying portfolio of high-yield loans, which are managed by a related party. Detailed interpretations of FIN 46 continue to emerge and the FASB's statement delaying its implementation indicated the FASB intends to issue further interpretations over the next few months. Accordingly, the Company decided to delay its planned third quarter 2003 adoption of FIN 46 until the revised effective date of December 31, 2003. The Company will record a cumulative effect of accounting change with the consolidation of up to $450 million of additional assets. The impact of adopting FIN 46 will be dependent upon further interpretations of FIN 46 and market factors at December 31, 2003. Taken together, over the lives of the structures subject to FIN 46 through their maturity, the Company's maximum cumulative exposure to pre-tax loss as a result of its investment in these entities is represented by the carrying values at September 30, 2003. Those carrying values include CDO residual tranches having an adjusted cost basis of $4 million and SLTs having an adjusted cost basis of $652 million. The initial impact related to the application of FIN 46 will have no cash flow effect on the Company. Ongoing valuation adjustments specifically related to the application of FIN 46 to the CDOs, if consolidated, would also be non-cash items, and would be reflected in the Company's quarterly results until maturity. Subsequent to the December 31, 2003 FIN 46 adoption, if required, these ongoing valuation adjustments, which will be reflected in operating results over the then remaining lives of the structures subject to FIN 46 and which will be dependent upon market factors during such time, will result in periodic gains or losses. The Company expects, in the aggregate, such gains or losses, including the December 31, 2003 implementation amount, if CDOs are required to be consolidated, to reverse themselves over time as the structures mature, because the debt issued to the investors in the CDOs is non-recourse to the Company and the further reductions in the value of the related assets will be absorbed by the third party investors. To the extent losses are incurred in the SLT portfolio, future charges could be incurred under FIN 46. In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" -7- IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (SOP 03-1). The Company is currently evaluating its impact, which, among other provisions, requires reserves related to guaranteed minimum death benefits (GMDBs) and guaranteed minimum income benefits (GMIBs) included within the variable annuity contracts offered by the Company. SOP 03-1 is required to be adopted on January 1, 2004. 2. Investment Securities Gross realized gains on sales of securities classified as Available-for-Sale, using the specific identification method, were $26.3 million and $93.9 million for the three months ended September 30, 2003 and 2002, respectively. Gross realized losses on sales of securities classified as Available-for-Sale were $36.6 million and $49.7 million for the three months ended September 30, 2003 and 2002, respectively. The Company also recognized other-than-temporary impairment losses on Available-for-Sale securities of $33.1 million for the three months ended September 30, 2002. Gross realized gains on sales of securities classified as Available-for-Sale, using the specific identification method, were $217.3 million and $176.6 million for the nine months ended September 30, 2003 and 2002, respectively. Gross realized losses on sales of securities classified as Available-for-Sale were $91.4 million and $78.0 million for the nine months ended September 30, 2003 and 2002, respectively. The Company also recognized other-than-temporary impairment losses on Available-for-Sale securities of $102.6 million and $119.8 million for the nine months ended September 30, 2003 and 2002, respectively. 3. Comprehensive Income Comprehensive income is defined as the aggregate change in stockholders' equity, excluding changes in ownership interests. It is the sum of net income and changes in unrealized gains or losses on Available-for-Sale securities and applicable deferred policy acquisition costs, net of related tax and unrealized gains or losses on derivatives, net of related tax. Total comprehensive (loss) income was ($61) million and $402 million for the three months ended September 30, 2003 and 2002, respectively. Total comprehensive income was $390 million and $721 million for the nine months ended September 30, 2003 and 2002, respectively. The difference between net income and total comprehensive income for these periods primarily reflects the change in net unrealized gains on Available-for-Sale securities. -8- IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 4. Taxes and Interest Net income taxes paid during the nine months ended September 30, 2003 and 2002, were $58.8 million and $80.4 million, respectively. The income tax benefit in the third quarter of 2003 reflects a $29 million reduction in the tax provision resulting from adjustments related to the finalization of the 2002 tax return filed during the quarter and publication of favorable technical guidance related to the taxation of dividend income. Interest paid on borrowings during the nine months ended September 30, 2003 and 2002, were $2.3 million and $6.3 million, respectively. 5. Commitments and Contingencies Commitments to fund mortgage loans on real estate at September 30, 2003 were $86.2 million. The maximum amount of life insurance risk retained by the Company is $750,000 on any policy insuring a single life and $1.5 million on any policy insuring a joint-life combination. The Company generally retains 10 percent of the mortality risk on new life insurance policies. Risk not retained is reinsured with other life insurance companies. Risk on universal life and variable universal life policies are reinsured on a yearly renewable term basis. Risk on term insurance and long-term care policies is reinsured on a coinsurance basis. The Company retains all accidental death benefit, disability income and waiver of premium risk. Reinsurance contracts do not relieve the Company from its primary obligation to policyholders. The majority of the variable annuity contracts offered by the Company contain guaranteed minimum death benefit (GMDB) provisions. The standard guaranteed minimum death benefit in the current "flagship" annuity offered by the Company, American Express Retirement Advisor Advantage Variable Annuity, provides that if the contract owner and annuitant are age 80 or younger on the date of death, the beneficiary will receive the greatest of (i) the contract value on the date of death, (ii) purchase payments minus adjusted partial surrenders, or (iii) the contract value as of the most recent sixth contract anniversary, plus purchase payment and minus adjusted partial surrenders since that anniversary. To the extent that the GMDB is higher than the current account value at the time of death, a cost is incurred by the issuer of the policy. Current accounting literature does not prescribe advance recognition of the projected future net costs associated with these guarantees, and accordingly, the Company currently does not record a liability corresponding to these future obligations for death benefits in excess of annuity account value. At present, the amount paid in excess of contract -9- IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) value is expensed when payable. Amounts expensed for the three months ended September 30, 2003 and 2002, were $7 million and $10 million, respectively. Amounts expensed for the nine months ended September 30, 2003 and 2002, were $26 million and $23 million, respectively. The Company also issues certain variable annuity contracts that contain a guaranteed minimum income benefit (GMIB) feature which, if elected by the contract owner and after a stipulated waiting period from contract issuance, guarantees a minimum lifetime annuity based on predetermined annuity purchase rates. To date, the Company has not expensed any amount related to GMIBs as all terms on GMIB features are within the stipulated waiting periods. As discussed in Note 1, SOP 03-1, which was issued by the AICPA in July 2003 with a required adoption date of January 1, 2004, will require reserves related to GMDBs and GMIBs. The impact of that requirement, as well as other provisions of SOP 03-1, is being evaluated. The Company's life and annuity products all have minimum interest rate guarantees in their fixed accounts. These guarantees range from 3 percent to 5 percent. To the extent the yield on the Company's invested asset portfolio declines below its target spread plus the minimum guarantee, the Company's profitability would be negatively affected. The IRS routinely examines the Company's federal income tax information and is currently conducting an audit for the 1993 through 1996 tax years. Management does not believe there will be a material adverse effect on the Company's consolidated financial position as a result of these audits. The Company is a party to litigation and arbitration proceedings in the ordinary course of its business. The outcome of any litigation or threatened litigation cannot be predicted with any certainty. However, in the aggregate, the Company does not consider any lawsuits in which it is named as a defendant to have a material impact on the Company's financial position or operating results. -10- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IDS Life Insurance Company ("the Company") is a stock life insurance company organized under the laws of the State of Minnesota. The Company is a wholly owned subsidiary of American Express Financial Corporation ("AEFC") and serves all states except New York. AEFC is a wholly-owned subsidiary of American Express Company. The Company distributes its fixed and variable insurance and annuities products exclusively through the American Express Financial Advisors' ("AEFA") retail sales force. The Company has four wholly owned subsidiaries that distribute their products through the various AEFA distribution channels. IDS Life Insurance Company of New York ("IDS Life of New York"), a New York corporation, is a wholly owned subsidiary of the Company and serves New York State residents. IDS Life of New York distributes its fixed and variable insurance and annuity products exclusively through AEFA's retail sales force. The Company also owns American Enterprise Life Insurance Company ("American Enterprise Life"), an Indiana corporation, which primarily issues fixed and variable annuity contracts for sale through non-affiliated representatives and agents of third party distributors. American Centurion Life Assurance Company ("American Centurion Life"), a New York corporation, is also a subsidiary of the Company. American Centurion Life offers fixed and variable annuities to American Express(R) Cardmembers and others in New York, as well as fixed and variable annuities for sale through non-affiliated representatives and agents of third party distributors, in New York. The Company owns American Partners Life Insurance Company ("American Partners Life"), an Arizona corporation which offers fixed and variable annuity contracts to American Express(R) Cardmembers and others who reside in states other than New York. The Company also owns IDS REO 1, LLC; IDS REO 2, LLC; and American Express Corporation. These subsidiaries hold real estate, mortgage loans on real estate and/or affordable housing investments. The Company follows accounting principles generally accepted in the United States (GAAP). Results of Operations for the Three Months Ended September 30, 2003 and 2002 Net income increased 55 percent to $133.2 million from $86.2 million. This increase reflects: (i) a $29 million reduction in income tax provision due to adjustments related to the finalization of the 2002 tax return filed during the third quarter of 2003 and the publication of favorable technical guidance related to the taxation of dividend income; (ii) net realized loss on investments of $10.7 million in the third quarter of 2003 compared to a net realized gain on investments of $11.6 million in the third quarter of 2002; (iii) increased revenues from management and other fees; and (iv) substantially increased net investment income. Management and other fees revenue increased $8.3 million or 9 percent. This was primarily due to a higher average value of separate account assets, reflecting the -11- recent improvement in equity market conditions. As of September 30, 2003, the Company provides investment management services for many of the mutual funds used as investment options for variable annuities and variable life insurance. The Company also receives a mortality and expense risk fee from the separate accounts based on asset levels. Net investment income increased $42.1 million or 11 percent as higher levels of invested assets were partially offset by lower average yields on the investment portfolio. Net realized (loss) gain on investments was a $10.7 million net loss for the three months ended September 30, 2003 compared to an $11.6 million net gain for the three months ended September 30, 2002. For the three months ended September 30, 2003, $26.4 million of investment gains were more than offset by $37.1 million of impairments and losses. Included in these total investment gains and losses are $26.3 million of gross realized gains and $36.6 million of gross realized losses from sales of securities, classified as Available-for-Sale. For the three months ended September 30, 2002, $96.9 million of investment gains were partially offset by $85.3 million of impairments and losses. Included in these total investment gains and losses are $93.9 million of gross realized gains and $49.7 million of gross realized losses from sales of securities, as well as $33.1 million of other-than-temporary investment impairment losses, classified as Available-for-Sale. Interest credited expenses on universal life-type insurance and investment contracts increased 8 percent due to higher average in force levels across annuity and life products and the effect of appreciation in the S&P 500 on equity indexed annuities this period versus depreciation in the same period a year ago, partially offset by lower crediting rates on both annuities and life insurance products. Total death and other benefits increased slightly by $4.8 million. These two increases were substantially offset by lower DAC amortization expense together with a 7 percent decrease in other insurance and operating expenses. Amortization of deferred policy acquisition costs (DAC) decreased $22.2 million or 23 percent reflecting a net $18 million increase in DAC amortization expense in the third quarter of 2002, and a net $2 million decrease in DAC amortization expense in the third quarter of 2003, both as a result of the Company's annual third quarter review of various DAC assumptions and practices. See the DAC section below for further discussion of DAC and related adjustments. The income tax benefit in the third quarter of 2003 reflects a $29 million reduction in the tax provision resulting from adjustments related to the finalization of the 2002 tax return filed during the quarter and publication of favorable technical guidance related to the taxation of dividend income. Partially offsetting this expense reduction were realized losses from sales of mortgage-backed securities as the Company made adjustments in the level of these investments, such that mortgage-backed securities were 39 percent of the Company's overall portfolio at September 30, 2003 compared to 44 percent at December 31, 2002. -12- Results of Operations for the Nine Months Ended September 30, 2003 and 2002 Net income increased 19 percent to $339.6 million from $286.1 million. This increase reflects the third quarter 2003 $29 million reduction in income tax provision discussed above and a net realized gain on investments of $12.7 million compared to a net realized loss on investments of $33.7 million in the third quarter of 2002, partially offset by lower revenues from management and other fees and higher total benefits and expenses. Management and other fees decreased to $284 million for the nine months ended September 30, 2003 compared with $314 million for the nine months ended September 30, 2002. This was primarily due to a decrease in average value of separate account assets. While equity markets rose in the third quarter of 2003, average asset values for the nine months ended September 30, 2003 remained below 2002 levels. As of September 30, 2003, the Company provides investment management services for many of the mutual funds, which are used as investment options for variable annuities and variable life insurance. The Company also receives a mortality and expense risk fee from the separate accounts based on asset levels. Net investment income increased 7 percent to $1.2 billion for the nine months ended September 30, 2003 reflecting higher invested asset amounts in 2003, partially offset by lower average yields on the investment portfolio as a result of the relatively low interest rate environment. Net realized gain (loss) on investments was a $12.7 million net gain for the nine months ended September 30, 2003 compared to a $33.7 million net loss for the nine months ended September 30, 2002. For the nine months ended September 30, 2003, $218.4 million of total investment gains were partially offset by $205.7 million of impairments and losses. Included in these total investment gains and losses are $217.3 million of gross realized gains and $91.4 million of gross realized losses from sales of securities, as well as $102.6 million of other-than-temporary investment impairment losses, classified as Available-for-Sale. For the nine months ended September 30, 2002, $180 million of investment gains were partially offset by $213.7 million of impairments and losses. Included in these total investment gains and losses are $176.6 million of gross realized gains, $78 million of gross realized losses from sales of securities, as well as $119.8 million of other-than-temporary investment impairment losses, classified as Available-for-Sale. Total benefits and expenses were $1.8 billion for the nine months ended September 30, 2003, an increase of 5 percent from the same period in 2002. This increase reflects a 9 percent increase in interest credited expenses on universal life-type insurance and investment contracts, which was primarily due to higher levels of annuities and insurance products in force, partially offset by lower crediting rates. Total death and other benefits increased 9 percent reflecting the $7 million release of reserves in the 2002 period, which was related to the September 11, 2001 terrorist attacks. -13- DAC amortization expense decreased to $228.3 million for the nine months ended September 30, 2003 compared to $264.1 million for the nine months ended September 30, 2002. The decrease in DAC amortization reflects the impact of annual third quarter DAC-related adjustments discussed above together with the recently improved equity market performance in 2003 as compared with 2002. Faster-than-assumed growth in customer asset values associated with the Company's variable annuity and insurance products resulted in a deceleration of DAC amortization during the nine months ended September 30, 2003, whereas declines in variable annuity and insurance customer asset values resulted in an acceleration of DAC amortization during the nine months ended September 30, 2002. Other insurance and operating expenses increased 6 percent, reflecting, during the six months ended June 30, 2003, the impact of fewer capitalized costs, which was primarily the result of a comprehensive review of the DAC-related practices completed during the third quarter of 2002 and which is more fully described below. The income tax provision for the nine months ended September 30, 2003 reflects a $29 million reduction in the tax expense during the third quarter of 2003 resulting from adjustments related to the finalization of the 2002 tax return filed during the quarter and publication of favorable technical guidance related to the taxation of dividend income. Partially offsetting this expense reduction were realized losses from sales of mortgage-backed securities as the Company made adjustments in the level of these investments, such that mortgage-backed securities were 39 percent of the Company's overall portfolio at September 30, 2003 compared to 44 percent at December 31, 2002. Deferred Policy Acquisition Costs The costs of acquiring new business, including for example, direct sales commissions, related sales incentive bonuses and awards, underwriting costs, policy issue costs and other related costs, have been deferred on the sale of insurance and annuity contracts. The deferred policy acquisition costs (DAC) for universal life and variable universal life insurance and certain installment annuities are amortized as a percentage of the estimated gross profits expected to be realized on the policies. DAC for other annuities are amortized using the interest method. For traditional life, disability income and long-term care insurance policies, the costs are amortized in proportion to premium revenue. Amortization of DAC requires the use of certain assumptions including interest margins, mortality rates, persistency rates, maintenance expense levels and customer asset value growth rates for variable products. The customer asset value growth rate is the rate at which contract values are assumed to appreciate in the future. This rate is net of asset fees, and anticipates a blend of equity and fixed income investments. Management routinely monitors a wide variety of trends in the business, including comparisons of actual and assumed experience. Management reviews and, where appropriate, adjusts its assumptions with respect to customer asset value growth rates on a quarterly basis. -14- Management monitors other principal DAC assumptions, such as persistency, mortality rate, interest margin and maintenance expense level assumptions, each quarter. Unless management identifies a material deviation over the course of the quarterly monitoring, management reviews and updates these DAC assumptions annually in the third quarter of each year. When assumptions are changed, the percentage of estimated gross profits or portion of interest margins used to amortize DAC may also change. A change in the required amortization percentage is applied retrospectively; an increase in amortization percentage will result in an acceleration of DAC amortization while a decrease in amortization percentage will result in a deceleration of DAC amortization. The impact on results of operations of changing assumptions with respect to the amortization of DAC can be either positive or negative in any particular period, and is reflected in the period that such changes are made. As a result of these reviews, the Company took actions in both 2003 and 2002 that impacted the DAC balance and expenses. In the third quarter 2003, these actions resulted in a net $2 million in DAC amortization expense reduction reflecting: o A $106 million DAC amortization reduction resulting from extending 10 - 15 year amortization periods for certain Flex Annuity contracts to 20 years. The Flex Annuity is an advisor-distributed variable annuity product sold from 1986 - 1996. In reviewing the persistency of this business in recent years, the Company had observed significant volumes persisting beyond the end of the 10- and 15-year amortization periods. The Company had maintained these amortization periods, however, due to uncertainty over the impact of a program launched in April 2002 under which eligible Flex Annuity contracts can be exchanged for new variable annuity contracts offered by the Company. Exchange rates to date under this program have been less than those expected, and the Company concluded in the third quarter it would be appropriate to measure the meaningful life of this business without anticipating future exchanges. This is consistent with the measurement made for other Company products, and the resulting 20-year period is the same as that used for other advisor-distributed variable annuity products. o A $92 million DAC amortization increase resulting from the recognition of a premium deficiency on the Company's Long-Term Care (LTC) business. The Company has monitored this business closely in recent periods as claim and persistency experience have developed adversely. The Company discontinued sales of its proprietary LTC product in the first quarter of 2003, and outsourced claims administration on the existing book in the second quarter. On the basis of updated analysis completed in the third quarter, the Company concluded that the associated DAC was not fully recoverable at current premium levels. The associated DAC remaining after this $92 million reduction is $162 million. o A $12 million net DAC amortization increase across the Company's Universal Life, Variable Universal Life and fixed and variable annuity products. The Company updated a number of DAC assumptions resulting in increases in amortization totaling $26 million and decreases in amortization totaling $14 -15- million. The largest single item was a $16 million increase in amortization from reflecting lower than previously assumed spreads on fixed contract values. In the third quarter 2002, these actions resulted in a net $37 million increase in expenses reflecting: o A $173 million DAC amortization expense increase resulting from resetting the customer asset value growth rate assumptions for variable annuity and variable life products to anticipate near-term and long-term growth at an annual rate of 7 percent; and o A $155 million DAC amortization expense reduction from revising certain mortality and persistency assumptions for universal and variable universal life insurance products and fixed and variable annuity products to better reflect actual experience and future expectations. o These two items resulted in a net increase in expenses of $18 million as compared to the net decrease in expenses of $2 million in 2003. o In addition, 2002 expenses increased $19 million from the revision of the types and amounts of costs deferred, in part to reflect the impact of advisor platform changes and the effects of related reengineering. This revision, which resulted in an increase in ongoing expenses, continues to impact the 2003 quarterly results. DAC of $3.5 billion was on the Company's balance sheet at September 30, 2003. This balance consisted of $1.6 billion related to life and health insurance and $1.9 billion related to annuities. The DAC balance at December 31, 2002 was $3.3 billion and consisted of $1.7 billion related to life and health insurance and $1.6 billion related to annuities. Impact of Market-Volatility on Results of Operations Various aspects of the Company business are impacted by equity market levels and other market-based events. Three areas in particular involve DAC, asset management fees and structured investments. The direction and magnitude of the changes in equity markets can increase or decrease DAC expense levels and asset management fees and correspondingly affect results of operations in any particular period. Similarly, the value of the Company's structured investment portfolio is impacted by various market factors. Persistency of, or increases in, bond and loan default rates, among other factors, could result in negative adjustments to the market values of these investments in the future, which would adversely impact results of operations. See Liquidity and Capital Resources section of Management Discussion and Analysis for a further discussion of structured investments. Another area impacted by market-based events is guaranteed minimum death benefits (GMDBs). The majority of the variable annuity contracts offered by the Company contain GMDB provisions. The standard guaranteed minimum death benefit in the current "flagship" annuity offered by the Company, American -16- Express Retirement Advisor Advantage Variable Annuity, provides that if the contract owner and annuitant are age 80 or younger on the date of death, the beneficiary will receive the greatest of (i) the contract value on the date of death, (ii) purchase payments minus adjusted partial surrenders, or (iii) the contract value as of the most recent sixth contract anniversary, plus purchase payment and minus adjusted partial surrenders since that anniversary. To the extent that the GMDB is higher than the current account value at the time of death, a cost is incurred by the issuer of the policy. Current accounting literature does not prescribe advance recognition of the projected future net costs associated with these guarantees, and accordingly, the Company currently does not record a liability corresponding to these future obligations for death benefits in excess of annuity account value. At present, the amount paid in excess of contract value is expensed when payable. Amounts expensed for the three months ended September 30, 2003 and 2002, were $7 million and $10 million, respectively. Amounts expensed for the nine months ended September 30, 2003 and 2002, were $26 million and $23 million, respectively. The Company also issues certain variable annuity contracts that contain a guaranteed minimum income benefit (GMIB) feature which, if elected by the contract owner and after a stipulated waiting period from contract issuance, guarantees a minimum lifetime annuity based on predetermined annuity purchase rates. To date, the Company has not expensed any amount related to GMIBs as all terms on GMIB features are within the stipulated waiting periods. In July 2003, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" (SOP 03-1) which requires reserves related to GMDBs and GMIBs. The impact of that requirement, as well as other provisions of SOP 03-1, are currently being evaluated. The Company's life and annuity products all have minimum interest rate guarantees in their fixed accounts. These guarantees range from 3 percent to 5 percent. To the extent the yield on the Company's invested asset portfolio declines below its target spread plus the minimum guarantee, the Company's profitability would be negatively affected. Liquidity and Capital Resources The liquidity requirements of the Company are generally met by funds provided by premiums, investment contract deposits, investment income, proceeds from sales of investments as well as maturities, periodic repayments of investment principal and capital contributions. The primary uses of funds are policy benefits, commissions and operating expenses, policy loans, dividends and investment purchases. The Company routinely reviews its sources and uses of funds in order to meet its ongoing obligations. The Company has an available line of credit with AEFC of $200 million ($100 million committed and $100 million uncommitted). This line of credit is used strictly as a short-term source of funds. There were no borrowings outstanding under this line of credit at September 30, 2003. The Company also uses reverse -17- repurchase agreements for short-term liquidity needs. Reverse repurchase agreements outstanding at September 30, 2003 were $130 million. At September 30, 2003 and 2002, based on amortized cost, approximately 7 percent of the Company's fixed maturity investments were below-investment-grade bonds. These investments may be subject to a higher degree of risk than the investment grade issues because of the borrowers' generally greater sensitivity to adverse economic conditions, such as recession or increasing interest rates, and in certain instances the lack of an active secondary market. Expected returns on below-investment-grade bonds reflect consideration of such factors. The Company has identified those fixed maturities for which a decline in fair value is determined to be other than temporary, and has written them down to fair value with a charge to earnings. Additionally, the Company had a reserve for losses on mortgage loans of $48 million at September 30, 2003. The Company holds investments in collateralized debt obligations (CDOs) and secured loan trusts (SLTs) (backed by high-yield bonds and bank loans), some of which are also managed by a related party. The Company invested in CDOs and SLTs as part of its investment strategy in order to pay a competitive rate to contractholders' accounts. The Company's exposure as an investor is limited solely to its aggregate investment in the CDOs and SLTs, and it has no obligations or commitments, contingent or otherwise, that could require any further funding of such investments. As of September 30, 2003, the carrying values of the CDO residual tranches and SLT notes were $4 million and $652 million, respectively. The Company also has an interest in a CDO securitization trust described below as well as $24 million in rated CDO tranches managed by a third party. CDOs and SLTs are illiquid investments. As an investor in the residual tranche of CDOs, the Company's return correlates to the performance of portfolios of high-yield bonds and/or bank loans. As a noteholder of SLTs, the Company's return is based on a reference portfolio of loans. The carrying value of the CDO and SLT investments and the Company's projected return are based on discounted cash flow projections that require a significant degree of management judgment as to assumptions primarily related to default and recovery rates of the high-yield bonds and/or bank loans either held directly by the CDO or in the reference portfolio of the SLT and, as such, are subject to change. Generally, the SLTs are structured such that the principal amount of the loans in the reference portfolio may be up to five times that of the par amount of the notes held by the Company. Although the exposure associated with the Company's investment in CDOs and SLTs is limited to the carrying value of such investments, they have additional risk associated with them because the amount of the initial value of the loans and/or other debt obligations in the related portfolios is significantly greater than the Company's exposure. Deterioration in the value of the high-yield bonds or bank loans would likely result in deterioration of the Company's investment return with respect to the relevant CDO or SLT, as the case may be. In the event of significant deterioration of a portfolio, the relevant CDO or SLT may be subject to early liquidation, which could result in further deterioration of the investment return or, in severe cases, loss of the carrying amount. See Note 1 to the Consolidated Financial Statements. -18- During 2001, the Company placed a majority of its rated CDO securities and related accrued interest, as well as a relatively minor amount of other liquid securities, (collectively referred to as transferred assets), having an aggregate book value of $675 million, into a securitization trust. In return, the Company received $90 million in cash (excluding transaction expenses) relating to sales to unaffiliated investors and retained interests in the trust with allocated book amounts aggregating $586 million. As of September 30, 2003, the retained interests had a carrying value of $548 million, of which $411 million is considered investment grade. The Company has no obligations, contingent or otherwise, to such unaffiliated investors. One of the results of this transaction is that increases or decreases in future cash flows of the individual CDOs are combined into one overall cash flow for purposes of determining the carrying value of the retained interests and related impact on results of operations. OTHER REPORTING MATTERS Accounting Developments In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which addresses consolidation by business enterprises of variable interest entities (VIEs). In October 2003, the FASB issued a statement delaying the effective date of the consolidation provisions of FIN 46 from July 31, 2003 to December 31, 2003 for VIEs created prior to February 1, 2003. Certain disclosures are addressed in Note 1 to the Consolidated Financial Statements. The impact of adopting FIN 46 on the Consolidated Financial Statements is dependent upon further interpretations of FIN 46 and market conditions at December 31, 2003. In July 2003, the AICPA issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" (SOP 03-1). The Company is currently evaluating its impact, which, among other provisions, requires reserves related to guaranteed minimum death benefits and guaranteed minimum income benefits included within its variable annuity contracts. SOP 03-1 is required to be adopted on January 1, 2004. See Impact of Recent Market-Volatility on Results of Operations section of MD&A for further discussion. -19- ITEM 4. CONTROLS AND PROCEDURES (a) Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective. (b) Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Forward-Looking Statements This report includes forward-looking statements, which are subject to risks and uncertainties. The words "believe," "expect," "anticipate," "optimistic," "intend," "plan," "aim," "will," "should," "could," "likely," and similar expressions are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to update or revise any forward-looking statements. Factors that could cause actual results to differ materially from these forward-looking statements include, but are not limited to: the Company's ability to successfully implement a business model that allows for significant earnings growth based on revenue growth that is lower than historical levels, including the ability to improve its operating expense to revenue ratio both in the short-term and over time, which will depend in part on the effectiveness of reengineering and other cost control initiatives, as well as factors impacting the Company's revenues; the Company's ability to grow its business over time, which will depend on the Company's ability to manage its capital needs and the effect of business mix, and rating agency requirements; the ability to increase investment spending, which will depend in part on the equity markets and other factors affecting revenues, and the ability to capitalize on such investments to improve business metrics; the accuracy of certain critical accounting estimates, including, the fair value of the assets in the Company's investment portfolio (including those investments that are not readily marketable); fluctuation in the equity and fixed income markets, which can affect the amount and types of investment products sold, the market value of its managed assets, management, distribution and other fees received based on the value of those assets, the Company's ability to recover DAC as well as the timing of such DAC -20- amortization, in connection with the sale of annuity and insurance products, and the level of guaranteed minimum death benefits paid to clients; changes in assumptions relating to DAC, which could impact the amount of DAC amortization; potential deterioration in the Company's high-yield and other investments, which could result in further losses in the investment portfolio; the ability to sell certain high-yield investments at expected values and within anticipated timeframes and to maintain its high-yield portfolio at certain levels in the future; the types and value of certain death benefit features on variable annuity contracts; the affect of assessments and other surcharges for guaranty funds; the response of reinsurance companies under reinsurance contracts; the impact of reinsurance rates and the availability and adequacy of reinsurance to protect the Company against losses; a downturn in the Company's business and/or negative changes in the Company's and its subsidiaries' claims-paying ability and other ratings, which could negatively impact sales; increasing competition in all of the Company's major lines of business; fluctuations in interest rates, which impact the Company's spreads, credit trends and the rate of bankruptcies, which can affect returns on the Company's investment portfolios; changes in laws or government regulations, including tax laws affecting the Company's business or that may affect the sales of the Company's products, and regulatory activity in the areas of customer privacy, consumer protection, business continuity and data protection; the adoption of recently issued accounting rules related to the consolidation of variable interest entities, including those involving CDOs and SLTs that the Company invests in, which could affect both the Company's balance sheet and results of operations; and outcomes and costs associated with litigation and compliance and regulatory matters. -21- PART II - OTHER INFORMATION IDS LIFE INSURANCE COMPANY Item 1. Legal Proceedings In November 2002, a suit, captioned HARITOS ET AL. V. AMERICAN EXPRESS FINANCIAL CORPORATION AND IDS LIFE INSURANCE COMPANY, was filed in the United States District Court for the District of Arizona. The suit was filed by plaintiffs who purport to represent a class of all persons that have purchased financial plans from AEFA advisors during an undefined class period. Plaintiffs allege that the sale of the plans violate the Investment Advisors Act of 1940. The suit seeks an unspecified amount of damages, rescission and injunction relief. The Company believes that it has meritorious defenses to this suit and intends to defend this case vigorously. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits See Exhibit Index on page E-1 hereof. (b) Reports on Form 8-K. There were no reports on Form 8-K filed by the Company during the quarterly period ended September 30, 2003. -22- SIGNATURES 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. IDS LIFE INSURANCE COMPANY (Registrant) Date: November 14, 2003 By /s/ Barbara H. Fraser ----------------------- Barbara H. Fraser Chief Executive Officer Date: November 14, 2003 By /s/ John T. Sweeney ------------------- John T. Sweeney Executive Vice President - Finance and Chief Financial Officer -23- EXHIBIT INDEX The following exhibits are filed as part of this Quarterly Report: Exhibit Description 31.1 Certification of Barbara H. Fraser pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 31.2 Certification of John T. Sweeney pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 32.1 Certification of Barbara H. Fraser and John T. Sweeney pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. E-1