10-Q 1 a2063258z10-q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2001 ------------------ Commission file number 33-81010 -------- AETNA INSURANCE COMPANY OF AMERICA -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Florida 06-1286272 -------------------------------------------------------------------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 5100 West Lemon Street, Suite 213, Tampa, Florida 33609 -------------------------------------------------------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) Registrant's telephone number, including area code (860) 273-0123 ----------------------------- None -------------------------------------------------------------------------------- (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR IF CHANGED SINCE LAST REPORT) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------------- ------------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Shares Outstanding Title of Class at November 9, 2001 -------------- ------------------- Common Capital Stock, par value $100 25,500 The registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced disclosure format. AETNA INSURANCE COMPANY OF AMERICA (A wholly owned subsidiary of Aetna Life Insurance and Annuity Company) TABLE OF CONTENTS

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AETNA INSURANCE COMPANY OF AMERICA (A wholly owned subsidiary of Aetna Life Insurance and Annuity Company) STATEMENTS OF INCOME (Unaudited) (millions)

See Condensed Notes to Financial Statements. 3 AETNA INSURANCE COMPANY OF AMERICA (A wholly owned subsidiary of Aetna Life Insurance and Annuity Company) BALANCE SHEETS (millions, except share data)

See Condensed Notes to Financial Statements. 4 AETNA INSURANCE COMPANY OF AMERICA (A wholly owned subsidiary of Aetna Life Insurance and Annuity Company) STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY (Unaudited) (millions)

See Condensed Notes to Financial Statements. 5 AETNA INSURANCE COMPANY OF AMERICA (A wholly owned subsidiary of Aetna Life Insurance and Annuity Company) STATEMENTS OF CASH FLOWS (Unaudited) (millions)

See Condensed Notes to Financial Statements. 6 CONDENSED NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION Aetna Insurance Company of America (the "Company") is a stock life insurance company organized in 1990 under the insurance laws of the state of Connecticut. Effective January 5, 2000, the Company changed its state of domicile from Connecticut to Florida. The Company is a wholly owned subsidiary of Aetna Life Insurance and Annuity Company ("ALIAC"). ALIAC is a wholly owned subsidiary of Aetna Retirement Holdings, Inc. ("HOLDCO"). HOLDCO is a wholly owned subsidiary of Aetna Retirement Services, Inc. ("ARSI"), whose ultimate parent is ING Groep N.V. ("ING"). The Company has one operating segment and all revenue reported by the Company comes from external customers. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and are unaudited. Certain reclassifications have been made to the 2000 financial information to conform to the 2001 presentation. These interim statements necessarily rely heavily on estimates, including assumptions as to annualized tax rates. In the opinion of management, all adjustments necessary for a fair statement of results for the interim periods have been made. All such adjustments are of a normal, recurring nature. The accompanying financial statements should be read in conjunction with the financial statements and related notes as presented in the Company's 2000 Annual Report on Form 10-K. Certain financial information that is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America, but that is not required for interim reporting purposes, has been condensed or omitted. Operating results for the three and nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. 2. NEW ACCOUNTING STANDARD As of January 1, 2001, the Company adopted FAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted by FAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, FAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133. and certain FAS No. 133 implementation issues. This standard, as amended, requires companies to record all derivatives on the balance sheet as either assets or liabilities and measure those instruments at fair value. The manner in which companies are to record gains or losses resulting from changes in the fair values of those derivatives depends on the use of the derivative and whether it qualifies for hedge accounting. Adoption of FAS No. 133 did not have a material effect on the Company's financial position or results of operations due to the Company's limited derivative and embedded derivative holdings. 7 The Company may utilize futures contracts, options, interest rate swap agreements and warrants in order to manage interest rate and price risk (collectively, market risk). These financial exposures are monitored and managed by the Company as an integral part of its overall risk management program. Derivatives are recognized on the balance sheet at fair value. The Company does not designate its derivative instruments as part of hedge transactions. Therefore changes in the fair value of the Company's derivative instruments are recorded immediately in the consolidated statements of income as part of realized capital gains and losses. Warrants are instruments that give the holder the right, but not the obligation, to buy or sell a fixed amount of an underlying asset at a fixed price in the future. Warrants are carried at fair value and are recorded as either derivative instruments or FAS No. 115 available for sale securities. Warrants that are considered derivatives are carried at fair value if they are readily convertible to cash. The values of these warrants can fluctuate given that the companies which underlie the warrants are non public companies. Warrants, considered to be derivatives, will be revalued each quarter and the change in the value of the warrants will be included in the consolidated statements of income. As of September 30, 2001, the Company had no warrants. The Company, at times, may own warrants on common stock which are not readily convertible to cash as they contain certain conditions which preclude their convertibility and therefore, will not be included in assets or liabilities as derivatives. If conditions are satisfied and the underlying stocks become marketable, the warrants would be reclassified as derivatives and recorded at fair value as an adjustment through current period results of operations. The Company occasionally purchases a financial instrument that contains a derivative that is "embedded" in the instrument. In addition, the Company's insurance products are reviewed to determine whether they contain an embedded derivative. To the extent a financial instrument or insurance product (host instrument) contains an embedded derivative, the Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the host contract and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and that a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract and carried at fair value. However, in cases where the host contract is measured at fair value, with changes in fair value reported in current period earnings or the Company is unable to reliably identify and measure the embedded derivative for separation from its host contract, the entire contract is carried on the balance sheet at fair value and is not designated as a hedging instrument. The Company had no material amounts of embedded derivatives at September 30, 2001. 8 3. FUTURE ACCOUNTING STANDARD ACCOUNTING FOR GOODWILL AND INTANGIBLE ASSETS In July 2001, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standard ("FAS") No. 142, Accounting for Goodwill and Intangible Assets. Under the new standard, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the new standard. Other intangible assets will continue to be amortized over their useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the new standard is expected to result in an increase in net income; however, the Company is still assessing the impact of the new standard. During 2002, the Company will perform the required impairment tests of goodwill as of January 1, 2002 and has not yet determined what the effect of these tests will be on the earnings and financial position of the Company. 4. SALE OF AETNA FINANCIAL SERVICES AND AETNA INTERNATIONAL On December 13, 2000, ING America Insurance Holdings, Inc., an indirect wholly owned subsidiary of ING, acquired Aetna Inc., comprised of the Aetna Financial Services business, of which the Company is a part, and the Aetna International business, for approximately $7.7 billion. The purchase price was comprised of approximately $5.0 billion in cash and the assumption of $2.7 billion of outstanding debt and other net liabilities. In connection with the acquisition, Aetna Inc. was renamed Lion Connecticut Holdings Inc. ("Lion"). At the time of the sale, Lion entered into certain transition services agreements with a former related party, Aetna U.S. Healthcare, which was renamed Aetna Inc. ("former Aetna"). For accounting purposes, the acquisition was accounted for as of November 30, 2000 using the purchase method. The application of the purchase method, including the recognition of goodwill, was pushed down and reflected on the financial statements of certain ARSI subsidiaries, including the Company. The purchase price was allocated to assets and liabilities based on their respective fair values. This revaluation resulted in a net increase to assets, excluding the effects of goodwill, of $3.2 million and a net increase to liabilities of $1.1 million. Additionally, the Company established goodwill of $98.9 million. Goodwill is being amortized over a period of 40 years. The allocation of the purchase price to assets and liabilities is subject to further refinement. Unaudited pro forma consolidated net income of the Company for the nine months ended September 30, 2000, assuming that the acquisition of the Company occurred at the beginning of 2000, would each have been approximately $1.9 million. The pro forma adjustments, which do not affect revenues, reflect primarily goodwill amortization. 9 5. REVISION OF PRELIMINARY ALLOCATION OF PURCHASE PRICE ING America Insurance Holdings, Inc., an indirect wholly owned subsidiary of ING, acquired Aetna Inc., comprised of the Aetna Financial Services business, of which the Company is a part, and the Aetna International business, on December 13, 2000. The preliminary allocation of the purchase price did not reflect any market value adjustments related to the Company's investment portfolios. The Company, after giving consideration to certain exposures in the general market place which, while existing prior to the acquisition, subsequently took on more significance, determined that a reduction in carrying value was warranted. The amount of the reductions in the carrying values of the investment portfolios were accounted for as components of the purchase price and the amounts assigned to the Company's assets and liabilities in the allocation of the purchase price were adjusted appropriately. That adjustment was generally reflected as an adjustment to goodwill. 6. ADDITIONAL INFORMATION - ACCUMULATED OTHER COMPREHENSIVE INCOME Changes in accumulated other comprehensive income related to changes in unrealized gains on securities (excluding those related to experience-rated contractholders) were as follows:

(1) Pretax unrealized holding gains arising during the period were $3.2 million and $0.8 million for 2001 and 2000, respectively. (2) Pretax reclassification adjustments for gains (losses) and other items included in net income were $0.3 million and $(0.8) million for 2001 and 2000, respectively. 10 7. VALUE OF BUSINESS ACQUIRED Value of business acquired ("VOBA") is an asset and represents the present value of estimated net cash flows embedded in the Company's contracts indirectly acquired by ING. VOBA is amortized in proportion to estimated gross profits and is adjusted to reflect actual gross profits over the life of the contracts (up to 30 years for annuity contracts and pension contracts). Activity for the nine months ended September 30, 2001 within VOBA was as follows:

8. LITIGATION The Company is not currently involved in any material litigation. 11 INDEPENDENT ACCOUNTANTS' REVIEW REPORT The Board of Directors Aetna Insurance Company of America We have reviewed the accompanying condensed balance sheet of Aetna Insurance Company of America (the "Company") as of September 30, 2001, and the related condensed statements of income, changes in stockholder's equity and cash flows for the three-month and nine-month periods then ended. These financial statements are the responsibility of the Company's management. The financial statements of the Company for the three and nine-month periods ended September 30, 2000 were reviewed by other accountants whose report (dated October 31, 2000) stated that they were not aware of any material modifications that should be made to those statements for them to be in conformity with accounting principles generally accepted in the United States. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed financial statements at September 30, 2001, and for the three-month and nine-month periods then ended for them to be in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Hartford, Connecticut November 8, 2001 12 ITEM 2. MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS The following analysis presents a review of the Company for the three months and nine months ended September 30, 2001 and 2000. This review should be read in conjunction with the financial statements and other data presented herein as well as in the "Management's Analysis of the Results of Operations" section of the Company's 2000 Annual Report on Form 10-K. OVERVIEW Sale of Aetna Financial Services and Aetna International On December 13, 2000, ING America Insurance Holdings, Inc., an indirect wholly owned subsidiary of ING Groep N.V. ("ING"), acquired Aetna Inc., comprised of the Aetna Financial Services business, of which the Company is a part, and the Aetna International business, for approximately $7.7 billion. The purchase price was comprised of approximately $5.0 billion in cash and the assumption of $2.7 billion of outstanding debt and other net liabilities. In connection with the acquisition, Aetna Inc. was renamed Lion Connecticut Holdings Inc. ("Lion"). At the time of the sale, Lion entered into certain transition services agreements with a former related party, Aetna U.S. Healthcare, which was renamed Aetna Inc. ("former Aetna"). Refer to Note 4 of Condensed Notes to Financial Statements for more information on the acquisition. 13 RESULTS OF OPERATIONS

(1) Excludes net unrealized capital gains of $5.9 million at September 30, 2001 and net unrealized capital losses of $2.3 million at September 30, 2000. (2) Includes $66.7 million and $72.7 million at September 30, 2001 and September 30, 2000, respectively, related to the assets supporting a guaranteed interest option. (3) Includes $533.9 million and $802.9 million at September 30, 2001 and September 30, 2000, respectively, of assets invested through the Company's products in unaffiliated mutual funds. (4) Includes $267.3 million and $310.2 million at September 30, 2001 and September 30, 2000, respectively, of assets managed by an affiliate of the Company, and includes $57.6 million and $122.3 million at September 30, 2001 and September 30, 2000, respectively, of assets managed by the Company's parent, ALIAC. Net income for the three months ended September 30, 2001 decreased $2.2 million compared to the same period in 2000. Excluding goodwill amortization and net realized capital gains and losses, results for the three months ended September 30, 2001 decreased $1.1 million, or 41%, compared to the same period in 2000. Net income for the nine months ended September 30, 2001 decreased by $3.4 million compared to the same period in 2000. Excluding goodwill amortization and net realized capital gains and losses, results for the nine months ended September 30, 2001 decreased $2.2 million, or 34%, compared to the same period in 2000. 14 The decreases in earnings for the three months and nine months ended September 30, 2001 are due primarily to a decrease in charges assessed against policyholders partially offset by a decrease in operating expenses. Substantially all of the charges assessed against policyholders reported by the Company are derived from assets under management. For the quarter ended September 30, 2001, assets under management decreased $376.6 million, or 30%, compared to the same period in 2000 primarily due to a decline in the stock market. Annuity deposits relate to annuity contracts not containing life contingencies. Deposits increased by $2.7 million and $19.7 million for the three months and nine months ended September 30, 2001, respectively, compared to the same periods in 2000 primarily due to an increase in employer sponsored annuity sales partially offset by a decrease in individual annuity sales. The increase in employer sponsored sales and decrease in individual annuity sales is primarily the result of the Company's decision to focus its marketing efforts on expanding its employer sponsored business and to not actively market its annuity products to individuals. Refer to the "Outlook" section of Management's Analysis of the Results of Operations in the Company's 2000 Annual Report on Form 10-K. Lower operating expenses for the three months and nine months ended September 30, 2001 are primarily the result of the Company's decision to not actively market its annuity products to individuals. The effective tax rate decreased for the three months ended September 30, 2001 and increased for the nine months ended September 30, 2001 when compared to the same periods a year ago. Relative to the amount of pretax income in all periods, a decrease in the deduction for dividends received and the disallowance of goodwill amortization as a deduction principally contributed to the decrease and increase in the effective tax rate. GENERAL ACCOUNT INVESTMENTS Effective April 1, 2001, ING Investment Management, LLC, an affiliate of the Company, became the advisor of the Company's general account investments replacing Aeltus Investment Management, Inc, another affiliate of the Company. The Company's invested assets were comprised of the following:

(1) Includes $10.5 million and $5.8 million of debt securities pledged to creditors at September 30, 2001 and December 31, 2000, respectively. (2) Includes $2.3 million of short-term investments pledged to creditors at December 31, 2000. 15 Debt Securities At September 30, 2001 and December 31, 2000, the Company's carrying value of available for sale debt securities including debt securities pledged to creditors (herein after referred to as "total debt securities") represented 100% and 97%, respectively, of the total general account invested assets. For the same periods, debt securities equal to $125.0 million (93% of the total debt securities) and $119.1 million (90% of the total debt securities), respectively, supported experience-rated contracts. Total debt securities reflected net unrealized capital gains of $5.9 million and $0.8 million at September 30, 2001 and December 31, 2000, respectively. It is management's objective that the portfolio of debt securities be of high quality and be well diversified by market sector. The debt securities in the Company's portfolio are generally rated by external rating agencies, and, if not externally rated, are rated by the Company on a basis believed to be similar to that used by the rating agencies. The average quality rating of the Company's debt security portfolio was AA- at September 30, 2001 and December 31, 2000. The percentage of total debt securities by quality rating category is as follows:

The percentage of total debt securities by market sector is as follows:

(1) Primarily U.S. dollar denominated. FORWARD-LOOKING INFORMATION/RISK FACTORS The "Forward-Looking Information/Risk Factors" section of AICA's 2000 Annual Report on Form 10-K contains discussions of important risk factors related to the Company's businesses. 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not currently involved in any material litigation. ITEM 5. OTHER INFORMATION RATINGS The Company's financial strength ratings at November 9, 2001 and August 9, 2001 are as follows:

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) Reports on Form 8-K None 17 SIGNATURE 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. AETNA INSURANCE COMPANY OF AMERICA ---------------------------------- (Registrant) November 13, 2001 By /s/ Deborah Koltenuk ----------------- ----------------------------------------- (Date) Deborah Koltenuk Vice President and Corporate Controller (Chief Accounting Officer) 18

AETNA INSURANCE CO OF AMERICA 10-Q