10-Q 1 gfi10q.txt GWLAFINANCIAL UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 -------------------------- OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from To ------------------- ------------------ Commission file number 333-64473 ------------------ GWL&A FINANCIAL INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Colorado 84-1474245 ------------------------------------------------------------- ---------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number) 8515 East Orchard Road, Greenwood Village, CO 80111 ------------------------------------------------------ (Address of principal executive offices) (Zip Code) (303) 737-4128 ------------------------------------------------------ (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----------------- ----------------- Indicate by check mark whether the registrant is an accelerated filer as defined in ss.240.12(b)-2 of this chapter. Yes No X ----------------- ----------------- The public may read and copy any of the registrant's reports filed with the SEC at the SEC's Public Reference Room, 450 Fifth Street NW, Washington DC 20549, telephone 1-800-SEC-0330 or online at (http://www.sec.gov). As of August 1, 2003, 50,025 shares of the registrant's common stock were outstanding, all of which were owned by the registrant's parent company. 25 TABLE OF CONTENTS Part I FINANCIAL INFORMATION Page ----------- Item 1 Financial Statements 3 Consolidated Statements of Income 3 Consolidated Balance Sheets 4 Consolidated Statements of Cash Flows 6 Consolidated Statements of Stockholder's Equity 8 Notes to Consolidated Financial Statements 9 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3 Quantitative and Qualitative Disclosures About Market Risk 20 Item 4 Controls and Procedures 21 Part II OTHER INFORMATION Item 1 Legal Proceedings 22 Item 6 Exhibits and Reports on Form 8-K 22 Signature 22

PART I FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS GWL&A FINANCIAL INC. CONSOLIDATED STATEMENTS OF INCOME [Dollars in Thousands] ==================================================================================================================================== [Unaudited] Three Months Ended Six Months Ended June 30, June 30, ---------------------------------- -- ---------------------------------- REVENUES: 2003 2002 2003 2002 --------------- --------------- --------------- --------------- Premium (net of premiums ceded totaling $35,689, $33,516, $44,240, and $41,895) $ 233,693 $ 259,488 $ 507,596 $ 549,009 Fee income 206,601 233,264 422,475 460,008 Net investment income 206,116 234,585 420,748 462,505 Net realized gains on investments 24,535 1,667 50,850 7,908 --------------- --------------- --------------- --------------- 670,945 729,004 1,401,669 1,479,430 --------------- --------------- --------------- --------------- BENEFITS AND EXPENSES: Life and other policy benefits (net of reinsurance recoveries totaling $12,006, $12,744, $22,410, and $25,487) 189,274 240,856 376,681 451,184 Increase (decrease) in reserves 1,157 (14,367) 54,169 25,227 Interest paid or credited to contractholders 129,914 125,129 244,591 251,029 Provision for policyholders' share of earnings (loss) on participating business 3,285 (7) 5,646 922 Dividends to policyholders 15,726 16,088 40,529 40,290 --------------- --------------- --------------- --------------- 339,356 367,699 721,616 768,652 --------------- --------------- --------------- --------------- Commissions 40,207 59,102 80,107 98,539 Operating expenses 164,016 175,083 335,305 371,070 Premium taxes 8,554 9,547 15,216 15,348 --------------- --------------- --------------- --------------- 552,133 611,431 1,152,244 1,253,609 --------------- --------------- --------------- --------------- INCOME BEFORE INCOME TAXES 118,812 117,573 249,425 225,821 PROVISION FOR INCOME TAXES: Current 34,281 37,307 61,354 44,165 Deferred 5,180 80 22,781 28,592 --------------- --------------- --------------- --------------- 39,461 37,387 84,135 72,757 --------------- --------------- --------------- --------------- NET INCOME $ 79,351 $ 80,186 $ 165,290 $ 153,064 =============== =============== =============== ===============

See notes to consolidated financial statements. GWL&A FINANCIAL INC. CONSOLIDATED BALANCE SHEETS [Dollars in Thousands] ==================================================================================================================================== June 30, December 31, ASSETS 2003 2002 ------ -------------------- --------------------- [unaudited] INVESTMENTS: Fixed Maturities available-for-sale, at fair value (amortized cost $10,228,529 and $9,910,662) $ 10,789,279 $ 10,371,152 Mortgage loans on real estate (net of allowances of $49,462 and $55,654) 347,246 417,412 Common stock, at fair value (cost $103,969, and $102,862) 109,085 90,188 Real estate, net 1,721 3,735 Policy loans 2,986,381 2,964,030 Short-term investments, available-for-sale (amortized cost $676,322 and $710,085) 676,322 710,297 -------------------- --------------------- Total investments 14,910,034 14,556,814 Cash 273,989 154,631 Reinsurance receivable 229,083 241,153 Deferred policy acquisition costs 266,302 267,846 Investment income due and accrued 108,592 133,166 Amounts receivable related to uninsured accident and health plan claims (net of allowances of $47,454 and $42,144) 97,900 86,228 Other assets 993,946 754,869 Premiums in course of collection (net of allowances of $10,275 and $12,011) 45,235 54,494 Deferred income taxes 27,240 71,206 Separate account assets 12,300,781 11,338,376 -------------------- --------------------- TOTAL ASSETS $ 29,253,102 $ 27,658,783 ==================== ===================== (continued)

GWL&A FINANCIAL INC. CONSOLIDATED BALANCE SHEETS [Dollars in Thousands] ==================================================================================================================================== [unaudited] June 30, December 31, LIABILITIES AND STOCKHOLDER'S EQUITY 2003 2002 ------------------------------------ -------------------- --------------------- [unaudited] POLICY BENEFIT LIABILITIES: Policy reserves $ 12,312,551 $ 12,251,214 Policy and contract claims 362,723 378,995 Policyholders' funds 315,815 299,730 Provision for policyholders' dividends 78,264 76,983 Undistributed earnings on participating business 179,112 170,456 GENERAL LIABILITIES: Due to GWL 25,966 33,766 Repurchase agreements 187,921 323,200 Commercial paper 102,032 96,645 Other liabilities 1,390,529 849,370 Separate account liabilities 12,300,781 11,338,376 -------------------- --------------------- Total liabilities 27,255,694 25,818,735 -------------------- --------------------- GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S JUNIOR SUBORDINATED DEBENTURES 175,000 175,000 STOCKHOLDER'S EQUITY: Preferred stock, $1 par value, 50,000,000 shares authorized; 0 shares issued and outstanding Common stock, $0 par value; 500,000 shares authorized; 50,025 shares issued and outstanding 250 250 Additional paid-in capital 727,516 726,741 Accumulated other comprehensive income 187,610 150,616 Retained earnings 907,032 787,441 -------------------- --------------------- Total stockholder's equity 1,822,408 1,665,048 -------------------- --------------------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 29,253,102 $ 27,658,783 ==================== ===================== See notes to consolidated financial statements. (Concluded)

GWL&A FINANCIAL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS [Dollars in Thousands] ==================================================================================================================================== [Unaudited] Six Months Ended June 30, --------------------------------------------- OPERATING ACTIVITIES: 2003 2002 -------------------- --------------------- Net income $ 165,290 $ 153,064 Adjustments to reconcile net income to net cash provided by operating activities: Gain allocated to participating policyholders 5,646 922 Amortization of investments (33,728) (37,991) Realized gains on disposal of investments and write-downs of mortgage loans and real estate (50,850) (7,908) Amortization 17,907 19,834 Deferred income taxes 22,781 28,592 Changes in assets and liabilities: Policy benefit liabilities 256,797 197,437 Reinsurance receivable 12,070 (30,149) Accrued interest and other receivables 22,161 52,892 Other, net (35,636) 1,200 -------------------- --------------------- Net cash provided by operating activities 382,438 377,893 -------------------- --------------------- INVESTING ACTIVITIES: Proceeds from sales, maturities, and redemptions of investments: Fixed maturities available-for-sale Sales 1,887,963 3,013,838 Maturities and redemptions 4,154,422 699,609 Mortgage loans 77,751 102,047 Real estate 3,000 1,800 Common stock 7,638 7,347 Purchases of investments: Fixed maturities held-to-maturity (6,248,831) (3,701,476) Mortgage loans Real estate (496) (2,243) Common stock (7,948) (15,372) Other, net 311,847 (63,390) -------------------- --------------------- Net cash provided by investing activities 185,346 42,160 -------------------- --------------------- (continued)

GWL&A FINANCIAL INC. CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2003 [Dollars in Thousands] ==================================================================================================================================== [Unaudited] Accumulated Other Comprehensive Income (Loss) ------------------------ Unrealized Minimum Additional Gains Pension Preferred Stock Common Stock Paid-in (Losses) on Liability Retained --------------- ------------------ Shares Amount Shares Amount Capital Securities Adjustment Earnings Total ------- ------- --------- -------- ----------- ------------ ------------ ----------- ----------- BALANCES, JANUARY 1, 2003 0 $ 0 50,025 $ 250 $ 726,741 $ 163,500 $ (12,884) $ 787,441 $ 1,665,048 Net income 165,290 165,290 Other comprehensive income Change in unrealized gains 36,994 36,994 ----------- Total comprehensive income 202,284 ----------- Dividends (45,699) (45,699) Income tax benefit on stock compensation 775 775 ------- ------- --------- -------- ----------- ------------ ------------ ----------- ----------- BALANCES, JUNE 30, 2003 0 $ 0 50,025 $ 250 $ 727,516 $ 200,494 $ (12,884) $ 907,032 $ 1,822,408 ======= ======= ========= ======== =========== ============ ============ =========== ===========

See notes to consolidated financial statements. GWL&A FINANCIAL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [Amounts in Thousands] ================================================================================ [Unaudited] 1. BASIS OF PRESENTATION The consolidated financial statements and related notes of GWL&A Financial Inc. (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to interim financial reporting and do not include all of the information and footnotes required for complete financial statements. However, in the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the results. These financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes included in the Company's latest annual report on Form 10-K for the year ended December 31, 2002. Operating results for the six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2003. At June 30, 2003, the Company has a stock option plan that provides for the granting of options on common shares of Great-West Lifeco Inc. (Lifeco), of which the Company is an indirect wholly-owned subsidiary, to certain officers and employees of Lifeco and its subsidiaries, including the Company. The Company accounts for the plan under recognition and measurement principles of APB Opinion No. 25 "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation" to stock-based employee compensation. For the three months ended For the six months ended Proforma Disclosures June 30, June 30, ------------------------------ ------------------------------ [Thousands] 2003 2002 2003 2002 ------------------------------------ ------------- ------------- ------------- ------------- Net income as reported $ 79,351 $ 80,186 $ 165,290 $ 153,064 Less compensation for fair value of stock options, net of related tax effects 742 582 1,401 1,148 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Proforma net income $ 78,609 $ 79,604 $ 163,889 $ 151,916 ============= ============= ============= =============

2. NEW ACCOUNTING PRONOUNCEMENTS In April 2002, the FASB issued Statement No. 145 "Rescission of FASB No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" (SFAS No. 145). FASB No. 4 required all gains or losses from extinguishment of debt to be classified as extraordinary items net of income taxes. SFAS No. 145 requires that gains and losses from extinguishment of debt be evaluated under the provision of Accounting Principles Board Opinion No. 30, and be classified as ordinary items unless they are unusual or infrequent or meet the specific criteria for treatment as an extraordinary item. SFAS No. 145 was adopted January 1, 2003 without a material impact on the Company's financial position or results of operations. In July 2002, the FASB issued Statement No. 146 "Accounting for Costs Associated With Exit or Disposal Activities" (SFAS No. 146). This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred, as opposed to when the entity commits to an exit plan under EITF 94-3. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material impact on the Company's financial position or results of operations. In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" to clarify accounting and disclosure requirements relating to a guarantor's issuance of certain types of guarantees. FIN 45 requires entities to disclose additional information about certain guarantees, or groups of similar guarantees, even if the likelihood of the guarantor's having to make any payments under the guarantee is remote. The disclosure provisions are effective for financial statements for fiscal years ended after December 15, 2002. For certain guarantees, the interpretation also requires that guarantors recognize a liability equal to the fair value of the guarantee upon its issuance. This initial recognition and measurement provision is to be applied only on a prospective basis to guarantees issued or modified after December 31, 2002. In the normal course, the Company may enter into agreements which may contain features which meet the FIN 45 definition of a guarantee, and while the maximum guarantee cannot always be determined, given the nature of the future events which may or may not occur, any such arrangements that were material have been previously disclosed by the Company. In January 2003, FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities", an interpretation of Accounting Research Bulletin (ARB) No. 51. This Interpretation addresses consolidation by business enterprises of variable interest entities (VIE), which have one or both of the following characteristics: a) insufficient equity investment at risk, or b) insufficient control by equity investors. This guidance is effective for VIEs created after January 31, 2003, and for existing VIEs as of July 1, 2003. An entity with variable interests in VIEs created before February 1, 2003, shall apply the guidance no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003. In conjunction with the issuance of this guidance, the Company conducted a review of its involvement with VIEs and does not have any investments or ownership in VIEs. In April 2003, the FASB issued Statement No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain implementation guidance that is incorporated in SFAS No. 149 and already effective, SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The Company does not expect SFAS No. 149 to have a significant impact on the Company's financial position or results of operation. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with characteristics of both Liabilities and Equity" (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), many of which were previously classified as equity. The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003 and with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003. As a result of the adoption of SFAS 150 the Guaranteed Preferred Beneficial Interests in the Company's Junior Subordinate Debentures will be reported as a liability effective July 1, 2003. 3. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S JUNIOR SUBORDINATED DEBENTURES On May 4, 1999, Great-West Life & Annuity Insurance Capital I (the Trust), the Company's wholly-owned subsidiary trust created under the laws of the State of Delaware, issued $175,000 of Subordinated Capital Income Securities. The sole assets of the Trust are the $180,412 aggregate principal amount of the Company's 7.25% Junior Subordinated Debentures due June 30, 2048. The obligations of the Trust related to its Junior Subordinated Debentures are fully and unconditionally guaranteed by the Company. 4. OTHER On July 10, 2003, Lifeco completed its acquisition of Canada Life Financial Corporation. Canada Life is a Canadian based insurance company with business principally in Canada, the United Kingdom, the United States and Ireland. In the United States, Canada Life sells individual and group insurance and annuity products. Canada Life's U.S. operations represented approximately $1.6 billion in annual revenue in 2002 and $7.4 billion in assets as of December 31, 2002. Canada Life's U.S. operations are being integrated with the Company's operations. As of July 10, 2003, the Company will provide, with respect to Canada Life's U.S. operations, certain corporate services, and operational administrative services with respect to Canada Life's individual life and annuity business. On July 21, 2003 the Company announced a new name for the Employee Benefit divisions of the Company and its subsidiaries: Alta Health & Life Insurance Company, First Great-West Life & Annuity Insurance Company, and the One Health Plan HMO companies. Great-West Healthcare is the new name designed to unify all the employee benefit products and services under one brand name. The name change is intended to eliminate potential market confusion over different carriers and networks. The Company is involved in various legal proceedings that arise in the ordinary course of its business. In the opinion of management, after consultation with counsel, the resolution of these proceedings should not have a material adverse effect on its financial position or results of operations. Certain reclassifications have been made to the 2002 financial statements to conform to the 2003 presentation. These changes in classification had no effect on previously reported stockholder's equity or net income. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Three Months Ended Six Months Ended Operating Summary June 30, June 30, ------------------------------- ---------------------------------- [Millions] 2003 2002 2003 2002 ---------------------------------- ------------- ------------- ------------- ---------------- Premium income $ 234 $ 260 $ 507 $ 549 Fee income 207 233 422 460 Net investment income 206 234 421 462 Realized investment gains 24 2 51 8 ------------- ------------- ------------- ---------------- Total revenues 671 729 1,401 1,479 Total benefits and expenses 552 611 1,152 1,253 Income tax expenses 40 38 84 73 ------------- ------------- ------------- ---------------- Net income $ 79 $ 80 $ 165 $ 153 ============= ============= ============= ================ Deposits for investment- type contracts $ 122 $ 162 $ 269 $ 312 Deposits to separate accounts 480 589 1,050 1,388 Self-funded premium equivalents 1,205 1,294 2,402 2,642

Balance Sheet June 30, December 31, [Millions] 2003 2002 ------------------------------------------------------------------- -------------- ------------------ Investment assets $ 14,910 $ 14,557 Separate account assets 12,301 11,338 Total assets 29,253 27,659 Total policy benefit liabilities 13,248 13,177 Due to GWL 26 34 Guaranteed preferred beneficial interests in the Company's junior subordinated debentures 175 175 Total stockholder's equity 1,822 1,665

GENERAL This Form 10-Q contains forward-looking statements. Forward-looking statements are statements not based on historical information and that relate to future operations, strategies, financial results, or other developments. In particular, statements using verbs such as "expect", "anticipate", "believe", or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company's beliefs concerning future or projected levels of sales of the Company's products, investment spreads or yields, or the earnings or profitability of the Company's activities. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates, some of which may be related to the insurance industry generally, such as pricing competition, regulatory developments, and industry consolidation, and others of which may relate to the Company specifically, such as credit, volatility, and other risks associated with the Company's investment portfolio, and other factors. Readers are also directed to consider other risks and uncertainties discussed in documents filed by the Company and certain of its subsidiaries with the Securities and Exchange Commission. The following discussion addresses the financial condition of the Company as of June 30, 2003, compared with December 31, 2002, and its results of operations for the quarter and six months ended June 30, 2003, compared with the same periods in 2002. The discussion should be read in conjunction with the Management's Discussion and Analysis section included in the Company's report on Form 10-K for the year ended December 31, 2002 to which the reader is directed for additional information. CONSOLIDATED RESULTS The Company's consolidated net income decreased $1 million or 1% for the second quarter of 2003 when compared to the same period of 2002. The net income decrease reflects a $3 million decrease in the Financial Services segment offset by a $2 million increase in the Employee Benefits segment. The net income decrease of $1 million reflects lower investment income offset by improved aggregate and specific stop loss morbidity and an increase in realized gains on the sale of fixed maturities. The Company's consolidated net income increased $12 million or 8% for the first six months of 2003 when compared to the same period of 2002. The net income increase reflects a $12 million increase in the Employee Benefits segment as a result of improved morbidity and increases in realized investment gains on the sale of fixed maturities offset by reduced revenues primarily resulting from the decline in membership. Total revenues decreased $58 million or 8% and $78 million or 5% for the second quarter and first six months of 2003 when compared to the same periods of 2002. The decreases were primarily due to a $52 million or 11% decrease and a $80 million or 8% decrease in premium and fee income in the second quarter and first six months of 2003 when compared to the second quarter and first six months of 2002. The decreases are primarily in the Employee Benefits segment reflecting lower membership levels mainly associated with contract terminations resulting from pricing actions taken during 2002. The decreases in net investment income for the second quarter and the first six months of 2003 when compared to the same periods in 2002 were primarily the result of decreasing interest rates. The actual earned rate at June 30, 2003 was 6.35% compared to 6.67% at March 31, 2003; 6.99% at March 31, 2002 and 6.87% at June 30, 2002. Realized investment gains increased $22 million and $43 million for the second quarter and the first six months of 2003 when compared to the same periods in 2002 primarily due to an increase in the gains on the sale of fixed maturities as a result of the declining interest rate environment. Benefits and expenses decreased $59 million or 10% and $101 million or 8% for the second quarter and the first six months of 2003 when compared to the same periods of 2002. The decrease in benefits and expenses was primarily in the Employee Benefits segment and was a combination of higher deficit recoveries resulting from the pricing actions taken in 2002 and lower operating expenses resulting from a reduction in staff. In evaluating its results of operations, the Company also considers net changes in deposits received for investment-type contracts, deposits to separate accounts and self-funded equivalents. Self-funded equivalents represent paid claims under minimum premium and administrative services only contracts. These amounts approximate the additional premiums which would have been earned under such contracts if they had been written as traditional indemnity or HMO programs. Deposits received for investment-type contracts decreased $40 million or 25% and $43 million or 14% for the second quarter and the first six months of 2003 when compared to the same periods of 2002. The decreases were due to the net decrease in participant accounts in the retirement products area in 2003. Deposits for separate accounts decreased $109 million or 19% and $338 million or 24% for the second quarter and the first six months of 2003 when compared to the same periods of 2002. The second quarter decrease was due to lower 401k premium deposits associated with a decrease in participant accounts and fewer individual insurance Business Owned Life Insurance (BOLI) sales. The decrease for the first six months of 2003 when compared to the same period last year was due primarily to a decrease in group annuity single premium deposits. Self-funded premium equivalents decreased $89 million or 7% and $240 million or 9% for the second quarter and the first six months of 2003 when compared to the same periods of 2002. The decreases were due to improved morbidity as well as the decrease in membership. SEGMENT RESULTS Employee Benefits The following is a summary of certain financial data of the Employee Benefits segment: Three Months Ended Six Months Ended Operating Summary June 30, June 30, ------------------------------- ------------------------------- [Millions] 2003 2002 2003 2002 ------------------------------------ ------------- -------------- ------------- ------------- Premium income $ 191 $ 222 $ 426 $ 465 Fee income 151 175 310 346 Net investment income 15 17 31 34 Realized investment gains 5 1 10 1 ------------- -------------- ------------- ------------- Total revenues 362 415 777 846 Total benefits and expenses 296 352 640 728 Income tax expenses 22 21 46 39 ------------- -------------- ------------- ------------- Net income $ 44 $ 42 $ 91 $ 79 ============= ============== ============= ============= Self-funded premium equivalents $ 1,205 $ 1,294 $ 2,402 $ 2,642

The increase in earnings for the second quarter and the first six months of 2003 compared to the same periods of 2002 is primarily due to improved aggregate and specific stop loss morbidity. Premium and fee income decreased $55 million or 14% for the second quarter of 2003 and decreased $75 million or 9% for the first six months of 2003, when compared to the same periods of 2002. The decreases are primarily due to lower membership levels. There was an 11% decrease in total health care membership from 2,174,000 at December 31, 2002 to 1,926,900 at June 30, 2003. There was a 17% decrease in total health care membership from 2,321,400 at June 30, 2002 to 1,926,900 at June 30, 2003. Much of the health care decline can be attributed to contract terminations resulting from pricing actions taken during 2002. The decline in membership is also due to a decrease in the employee base for existing group health care customers and the general decline in the economy. Total benefits and expenses decreased $56 million or 16% and $88 million or 12% for the second quarter and first six months of 2003 when compared to the same periods of 2002. The decreases are due primarily to higher deficit recoveries resulting from the pricing actions taken and lower operating expenses resulting from a reduction in staff. Self-funded premium equivalents decreased $89 million and $240 million for the second quarter and first six months of 2003 compared to the same periods of 2002. The decrease was due to improved morbidity, as well as the decrease in membership. The Company recorded $14.0 million ($9.1 million, net of tax) and $4.5 million ($2.9 million, net of tax) of restructuring costs in the first quarter of 2002 and in the second quarter of 2002 related to the costs associated with the consolidation of benefit payment offices and sales offices throughout the United States. The charges relate to severance of $2.8 million and $1.5 million, disposal of furniture and equipment of $4.4 million and $0.5 million, and termination of leasing agreements of $6.8 million and $2.5 million. The Company established a premium deficiency reserve on the Alta block of business in 2001. The Company had released premium deficiency reserves of $6.2 million in the first quarter of 2002 and $2.1 million in the second quarter of 2002 to offset underwriting losses incurred on the under priced block of business. In addition, the premium deficiency reserve was reduced by $15.0 million ($9.8 million net of tax) during the first quarter of 2002 and was reduced by $4.0 million ($2.6 million, net of tax) during the second quarter of 2002 based on an analysis of emerging experience which was more favorable than originally estimated. The premium deficiency reserve was $0 at June 30, 2002. Financial Services The following is a summary of certain financial data of the Financial Services segment. Three Months Ended Six Months Ended Operating Summary June 30, June 30, ------------------------------- ------------------------------- [Millions] 2003 2002 2003 2002 ------------------------------------ ------------- -------------- ------------- ------------- Premium income $ 43 $ 38 $ 81 $ 84 Fee income 56 58 112 114 Net investment income 191 217 390 428 Realized investment gains 19 1 41 7 ------------- -------------- ------------- ------------- Total revenues 309 314 624 633 Total benefits and expenses 256 259 512 525 Income tax expenses 18 17 38 34 ------------- -------------- ------------- ------------- Net income $ 35 $ 38 $ 74 $ 74 ============= ============== ============= ============= Deposits for investment-type contracts $ 122 $ 162 $ 269 $ 312 Deposits to separate accounts 480 589 1,050 1,388

The decrease in Financial Services earnings for the second quarter of 2003 compared to the same period in 2002 is primarily due to lower interest margins, which were partially offset by realized investment gains. Earnings for the first six months of 2003 have remained relatively unchanged compared to the same period in 2002, as lower interest margins were largely offset by realized investment gains. Premium income and deposits to investment-type contracts and separate accounts have decreased $146 million or 17% for the second quarter of 2003 and decreased $386 million or 20% for the first six months of 2003 when compared to the same periods in 2002. Some of the decrease is associated with the net decrease in participant accounts in the retirement products area in 2003. The remaining decrease from 2002 relates to individual insurance sales of the BOLI product that have been negligible in 2003. Retirement participant accounts including third-party administration and institutional accounts decreased 3% in 2003 from 2,160,000 at December 31, 2002 to 2,091,000 at June 30, 2003. There was a 4% decrease in participant accounts from 2,186,000 at June 30, 2002 to 2,091,000 at June 30, 2003. A large part of the decrease is related to one large case termination of 117,000 participant accounts. Fee income has decreased $2 million or 3% for the second quarter of 2003 and decreased $2 million or 2% for the first six months of 2003 when compared to the same periods of 2002. Retirement products variable asset-based fees fluctuate with fluctuations in the participant account values. Account values change due to cash flow and unrealized market gains and losses associated with fluctuations in the U.S. equities market. Investment income decreased $26 million or 12% for the second quarter of 2003 and decreased $38 million or 9% for the first six months of 2003 when compared to the same periods of 2002. The decrease in investment income is offset by positive realized investment gains in the first six months of 2003. Total benefits and expenses have decreased $3 million or 1% for the second quarter of 2003 and decreased $13 million or 2% for the first six months of 2003 when compared to the same periods of 2002. . A reduction in expenses and positive mortality experience on the individual insurance lines have contributed to these reductions. GENERAL ACCOUNT INVESTMENTS The Company's primary investment objective is to acquire assets whose duration and cash flow reflect the characteristics of the Company's liabilities, while meeting industry, size, issuer, and geographic diversification standards. Formal liquidity and credit quality parameters have also been established. The Company follows rigorous procedures to control interest rate risk and observes strict asset and liability matching guidelines. These guidelines ensure that even in changing market conditions, the Company's assets will meet the cash flow and income requirements of its liabilities. Using dynamic modeling to analyze the effects of a range of possible market changes upon investments and policyholder benefits, the Company ensures that its investment portfolio is appropriately structured to fulfill financial obligations to its policyholders. Fixed Maturities Fixed maturities investments include public and privately placed corporate bonds, government bonds, and mortgage-backed and asset-backed securities. The Company's strategy related to structured assets is to focus on those investments with lower volatility and minimal credit risk. The Company does not invest in higher risk mortgage obligations such as interest-only and principal-only strips, and currently has no plans to invest in such securities. Private placement investments are generally less marketable than publicly traded assets, yet they typically offer covenant protection that allows the Company, if necessary, to take appropriate action to protect its investment. The Company believes that the cost of the additional monitoring and analysis required by private placements is more than offset by their enhanced yield. One of the Company's primary objectives is to ensure that its fixed maturity portfolio is maintained at a high average quality, so as to limit credit risk. If not externally rated, the securities are rated by the Company on a basis intended to be similar to that of rating agencies. The distribution of the fixed maturity portfolio by credit rating is summarized as follows: June 30, December 31, 2003 2002 ---------------------- ----------------------- AAA 60.8 % 58.9 % AA 8.7 % 8.9 % A 14.3 % 15.2 % BBB 13.7 % 14.4 % BB and Below (non-investment grade) 2.5 % 2.6 % ---------------------- ----------------------- TOTAL 100.0 % 100.0 % ====================== =======================

During the first six months of 2003, net unrealized gains on fixed maturities included in stockholder's equity, which is net of policyholder-related amounts and deferred income taxes, increased stockholder's equity by $37 million. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company's management to make a variety of estimates and assumptions. These estimates and assumptions affect, among other things, the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results can differ from the amounts previously estimated, which were based on the information available at the time the estimates were made. The critical accounting policies described below are those that the Company believes are important to the portrayal of the Company's financial condition and results, and which require management to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. The Company believes that critical accounting policies include policy reserves, allowances for credit losses, deferred policy acquisition costs, and valuation of privately placed fixed maturities. Policy Reserves Life Insurance and Annuity Reserves - Life insurance and annuity policy reserves with life contingencies are computed on the basis of estimated mortality, investment yield, withdrawals, future maintenance and settlement expenses, and retrospective experience rating premium refunds. Annuity contract reserves without life contingencies are established at the contractholder's account value. Reinsurance - Policy reserves ceded to other insurance companies are carried as a reinsurance receivable on the balance sheet. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding risks to other insurance enterprises under excess coverage and co-insurance contracts. The Company retains a maximum of $1.5 million of coverage per individual life. Policy and Contract Claims - Policy and contract claims include provisions for reported life and health claims in process of settlement, valued in accordance with the terms of the related policies and contracts, as well as provisions for claims incurred and unreported based primarily on prior experience of the Company. Allowance For Credit Losses The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb credit losses on its amounts receivable related to uninsured accident and health plan claims paid on behalf of policyholders and premiums in course of collection, and to absorb credit losses on its impaired loans. Management's judgement is based on past loss experience and current and projected economic conditions, and extensive situational analysis of each individual loan. The measurement of impaired loans is based on the fair value of the collateral. Deferred Policy Acquisition Costs Policy acquisition costs, which primarily consist of sales commissions and costs associated with the Company's group sales representatives related to the production of new business, have been deferred to the extent recoverable. These costs are variable in nature and are dependent upon sales volume. Deferred costs associated with the annuity products are being amortized over the life of the contracts in proportion to the emergence of gross profits. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits. Deferred costs associated with traditional life insurance are amortized over the premium paying period of the related policies in proportion to premium revenues recognized. Valuation Of Privately Placed Fixed Maturities The estimated fair values of financial instruments have been determined using available information and appropriate valuation methodologies. However, considerable judgement is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. To determine fair value for fixed maturities not actively traded, the Company utilizes discounted cash flows calculated at current market rates on investments of similar quality and term. LIQUIDITY AND CAPITAL RESOURCES The Company's operations have liquidity requirements that vary among the principal product lines. Life insurance and pension plan reserves are primarily long-term liabilities. Accident and health reserves, including long-term disability, consist of both short-term and long-term liabilities. Life insurance and pension plan reserve requirements are usually stable and predictable, and are supported primarily by long-term, fixed income investments. Accident and health claim demands are stable and predictable but generally shorter term, requiring greater liquidity. Generally, the Company has met its operating requirements by maintaining appropriate levels of liquidity in its investment portfolio. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash that totaled $950.3 million and $864.9 million as of June 30, 2003 and December 31, 2002, respectively. Funds provided from premiums and fees, investment income and maturities of investment assets are reasonably predictable and normally exceed liquidity requirements for payment of claims, benefits, and expenses. However, since the timing of available funds cannot always be matched precisely to commitments, imbalances may arise when demands for funds exceed those on hand. Also, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities. The Company's capital resources represent funds available for long-term business commitments and primarily consist of retained earnings and proceeds from the issuance of equity securities. Capital resources provide protection for policyholders and the financial strength to support the underwriting of insurance risks, and allow for continued business growth. The amount of capital resources that may be needed is determined by the Company's senior management and Board of Directors, as well as by regulatory requirements. The allocation of resources to new long-term business commitments is designed to achieve an attractive return, tempered by considerations of risk and the need to support the Company's existing business. Additional liquidity is available through the Company's participation in repurchase agreements with third party brokers and the issuance of commercial paper. The Company had $187.9 million of repurchase agreements at June 30, 2003, compared to $323.2 at December 31, 2002. The Company's participation in repurchase agreements depends on current market conditions, and as a result, fluctuations may occur. The Company's financial strength provides the capacity and flexibility to enable it to raise funds in the capital markets through the issuance of commercial paper. The Company continues to be well capitalized, with sufficient borrowing capacity to meet the anticipated needs of its business. The Company had $102.0 million and $96.6 million of commercial paper outstanding at June 30, 2003, and December 31, 2002, respectively. The commercial paper has been given a rating of A-1 + by Standard & Poor's Corporation and a rating of P-1 by Moody's Investors Service, each being the highest rating available. OBLIGATIONS RELATING TO DEBT AND LEASES AT MARCH 31, 2003 ARE AS FOLLOWS: 2003 2004 2005 2006 2007 Thereafter ---------- --------- ---------- ---------- --------- ------------- Subordinated debentures $ $ $ $ $ $ 175.0 Related party note 25.0 Operating leases 19.3 23.3 22.0 20.1 18.1 39.4 ---------- --------- ---------- ---------- --------- ------------- Total contractual obligations $ 19.3 $ 23.3 $ 22.0 $ 45.1 $ 18.1 $ 214.4 ========== ========= ========== ========== ========= =============

Item 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The Company's assets are purchased to fund future benefit payments to its policyholders and contractholders. The primary risk of these assets is exposure to rising interest rates. The Company's exposure to foreign currency exchange rate fluctuations is minimal as only nominal foreign investments are held. To manage interest rate risk, the Company invests in assets that are suited to the products that it sells. For products with fixed and highly predictable benefit payments such as certificate annuities and payout annuities, the Company invests in fixed income assets with cash flows that closely match the liability product cash flows. The Company is then protected against interest rate changes, as any change in the fair value of the assets will be offset by a similar change in the fair value of the liabilities. For products with uncertain timing of benefit payments such as portfolio annuities and life insurance, the Company invests in fixed income assets with expected cash flows that are earlier than the expected timing of the benefit payments. The Company can then react to changing interest rates sooner as these assets mature for reinvestment. The Company also manages risk with interest rate derivatives such as interest rate caps that pay the Company investment income if interest rates rise above the level specified in the cap. The Company also uses interest rate swaps to convert cash flow from variable-rate investments to fixed amounts to match such cash flows to expected cash flows on its liabilities to policyholders. These derivatives are only used to reduce risk and are not used for speculative purposes. To manage foreign currency exchange risk, the Company uses currency swaps to convert foreign currency back to United States dollars. These swaps are purchased each time a foreign currency denominated asset is purchased. There are no significant changes to the Company's risk from December 31, 2002. Item 4. CONTROLS AND PROCEDURES Based on their evaluation as of June 30, 2003, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in ensuring that information relating to the Company and its subsidiaries which is required to be disclosed in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported in a timely manner; and (ii) accumulated and communicated to the Company's senior management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, so that timely decisions may be made regarding disclosure. The Chief Executive Officer and Chief Financial Officer hereby confirm that there were no significant changes in the Company's internal controls over financial reporting that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) INDEX TO EXHIBITS Exhibit Number Title Page -------------- ----- ---- 31 Rule 13a-14 and 15d-14 Certifications 23 32 Rule 13a-14 and 15d-14 Certifications 25

(b) REPORTS ON FORM 8-K A report on Form 8-K, dated July 31, 2003, was filed disclosing the Company's second quarter results as of June 30, 2003. SIGNATURE Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GWL&A FINANCIAL INC. BY: /s/ Glen R. Derback DATE: August 13, 2003 ------------------------------------------------------ --------------- Glen R. Derback, Senior Vice President and Controller (Duly authorized officer and chief accounting officer)

GWL&A FINANCIAL INC 10-Q