10-Q 1 gfi10qform.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q

PART I FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS

See notes to consolidated financial statements.

GWL&A FINANCIAL INC. CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2004 [Dollars and Shares in Thousands] ================================================================================ [Unaudited] Accumulated Other Comprehensive Income (Loss) -------------------------- Unrealized Minimum Preferred Stock Common Stock Additional Gains Pension ------------------- ------------------- Paid-in (Losses)on Liability Retained Shares Amount Shares Amount Capital Securities Adjustment Earnings Total -------- -------- --------- -------- ---------- ----------- ---------- ---------- --------- BALANCE, JANUARY 1, 2004 0 $ 0 50,025 $ 250 $ 729,397 $ 137,122 $ (9,311) $ 1,029,755 $ 1,887,213 Net income 152,707 152,707 Other comprehensive income (120,639) (120,639) --------- Total comprehensive income 32,068 --------- Dividends (47,888) (47,888) Income tax benefit on stock compensation 1,434 1,434 -------- -------- --------- -------- ---------- ----------- ---------- ---------- --------- BALANCE, JUNE 30, 2004 0 $ 0 50,025 $ 250 $ 730,831 $ 16,483 $ (9,311) $ 1,134,574 $ 1,872,827 ======== ======== ========= ======== ========== =========== ========== ========== =========

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, 2003. Operating results for the six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2004. The Company has two reportable segments: Great-West Healthcare and Financial Services. The Great-West Healthcare segment markets group life and health insurance to small and mid-sized corporate employers. The Financial Services segment markets and administers savings products to public and not-for-profit employers, corporations, and individuals and offers life insurance products to individuals and businesses. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately as each segment has unique distribution channels. At June 30, 2004, 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 as allowed by FASB Statement No. 123, "Accounting for Stock-Based Compensation" (FASB No. 123). 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 No.123 to stock-based employee compensation. For the three months ended For the six months ended Proforma Disclosures June 30, June 30, ------------------------------ ------------------------------ [Thousands] 2004 2003 2004 2003 ------------------------------------ ------------- ------------- ------------- ------------- Net income as reported $ 54,768 $ 79,351 $ 152,707 $ 165,290 Less compensation for fair value of stock options, net of related tax effects 900 742 1,920 1,401 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Proforma net income $ 53,868 $ 78,609 $ 150,787 $ 163,889 ============= ============= ============= =============

2. NEW ACCOUNTING PRONOUNCEMENTS In January 2004, FASB reissued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities" as FIN 46R. 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, as reissued, is effective for VIEs created after January 31, 2003, and for pre-existing VIEs as of March 31, 2004. In conjunction with the issuance of this guidance, the Company conducted a review of its involvement with VIEs and confirmed it does not have any investments or ownership in VIEs. In July 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 03-01, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." AcSEC developed the SOP to address the evolution of product designs since the issuance of SFAS No. 60, "Accounting and Reporting by Insurance Enterprises," and SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." SOP 03-1 provides guidance related to the reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits, such as guaranteed minimum death benefits, and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1 addresses certain issues related to the presentation and reporting of separate accounts, as well as rules concerning the capitalization and amortization of sales inducements. SOP 03-1 was effective January 1, 2004. The adoption of SOP 03-1 did not have a material effect on the Company's consolidated financial statements. In January 2004, FASB issued Emerging Issues Task Force ("EITF") Issue No. 03-1, The Meaning of Other-Than Temporary Impairment and It's Application to Certain Investments ("EITF 03-1"). EITF 03-1 provides guidance on the disclosure requirements for other-than-temporary impairments of debt and marketable equity investments that are accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"). The adoption of EITF 03-1 would require the Company to include certain quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS 115 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The Company does not anticipate that the adoption of this issue would have a material impact on the Company's financial position or results of operations. 3. 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 $175.0 million of subordinated capital income securities. The sole assets of the Trust are the $180.4 million 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. As discussed in note 2 above, the Trust is not consolidated in accordance with FIN 46R. 4. RELATED-PARTY TRANSACTIONS On August 31, 2003, the Company and The Canada Life Assurance Company (CLAC), a wholly owned subsidiary of Canada Life Financial Corporation, entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured 80% (45% coinsurance and 35% coinsurance with funds withheld) of certain United States life, health and annuity business of CLAC's U.S. branch. On February 29, 2004, CLAC recaptured the group life and health business from the Company associated with the original Indemnity Reinsurance Agreement dated August 31, 2003. The Company recorded $256 million of negative premium income and decrease in reserves associated with these policies. The Company recorded, at fair value, the following at February 29, 2004 as a result of this transaction: Assets (millions) Liabilities and Stockholder's Equity (millions) -------------------------------------------------------- ------------------------------------------------ Cash $ (126) Policy reserves $ (280) Reinsurance receivable (148) Policy and contract claims (33) Deferred ceding commission (24) Premiums in course of collection (15) ------------------- ----------------- $ (313) $ (313) =================== =================

5. REINSURANCE In addition to the Indemnity Reinsurance Agreement entered into with CLAC (see 4 above), the Great-West Healthcare division of the Company entered into a reinsurance agreement during 2003 with Allianz Risk Transfer (Bermuda) Limited (Allianz) to cede 90% in 2003 and 75% in 2004 of direct written group health stop-loss and excess loss activity. 6. COMPONENTS OF NET PERIODIC BENEFIT COST The cost of employee benefit plans, included in operating expenses, is as follows: Post-Retirement Pension Benefits Medical Plan --------------------- --------------------- For the Second Quarter Ended June 30, [Thousands] 2004 2003 2004 2003 ---------------------------------------- -------- --------- --------- --------- Service cost $ 2,144 $ 2,067 $ 722 $ 512 Interest cost 3,329 3,069 684 567 Expected return on plan assets obligation (3,733) (3,238) Amortization of transition (379) (379) Amortization of unrecognized prior service cost 158 158 (178) (178) Amortization of gain from earlier periods 688 872 166 65 -------- --------- --------- --------- Net periodic cost $ 2,207 $ 2,549 $ 1,394 $ 966 ======== ========= ========= ========= Post-Retirement Pension Benefits Medical Plan --------------------- --------------------- For the Six Months Ended June 30, [Thousands] 2004 2003 2004 2003 ---------------------------------------- -------- --------- --------- --------- Service cost $ 4,288 $ 4,134 $ 1,444 $ 1,022 Interest cost 6,658 6,138 1,368 1,136 Expected return on plan assets (7,466) (6,478) Amortization of transition obligation (758) (758) Amortization of unrecognized prior service cost 316 316 (356) (356) Amortization of gain from earlier periods 1,376 1,746 332 130 -------- --------- --------- --------- Net periodic cost $ 4,414 $ 5,098 $ 2,788 $ 1,932 ======== ========= ========= =========

The Company previously disclosed in its consolidated financial statements for the year ended December 31, 2003, that it expected to contribute $4.8 million to fund its pension plan in 2004. As of June 30, 2004, no contributions have been made. The Company anticipates contributing $4.8 million to fund its pension plan in 2004. 7. OTHER 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 consolidated financial position or results of operations. Certain reclassifications have been made to the 2003 consolidated financial statements to conform to the 2004 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 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, 2004, compared with December 31, 2003, and its results of operations for the quarter and six months ended June 30, 2004, compared with the same periods in 2003. 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, 2003, to which the reader is directed for additional information. Operating Summary Three Months Ended June 30, Six Months Ended June 30, -------------------------------- ------------------------------ [Millions] 2004 2003 2004 2003 --------------------------------------- -------------- ------------- ------------- ------------ Premium income $ 161 $ 234 $ 203 $ 507 Fee income 230 207 441 422 Net investment income 239 206 520 421 Realized investment (losses) gains (20) 24 17 51 -------------- ------------- ------------- ------------ Total revenues 610 671 1,181 1,401 Total benefits and expenses 531 552 953 1,152 Income tax expenses 24 40 75 84 -------------- ------------- ------------- ------------ Net income $ 55 $ 79 $ 153 $ 165 ============== ============= ============= ============ Deposits for investment- type contracts $ 174 $ 122 $ 344 $ 269 Deposits to separate accounts 456 480 992 1,050 Self-funded premium equivalents 1,158 1,205 2,325 2,402

Balance Sheet June 30, December 31, [Millions] 2004 2003 ----------------------------------------------------------- --------------- ---------------- Investment assets $ 19,316 $ 19,707 Separate account assets 13,390 13,175 Total assets 36,312 36,520 Total policy benefit liabilities 19,283 19,703 Due to GWL 29 31 Junior subordinated debentures 180 180 Total stockholder's equity 1,873 1,887

CONSOLIDATED RESULTS The Company's consolidated net income decreased $24 million or 30% for the second quarter of 2004 when compared to the same period in 2003. The net income decrease reflects a $10 million decrease as a result of the July 2003 purchase of Canada Life Insurance Company of America (CLICA) and Canada Life Insurance Company of New York (CLNY) and the August 2003 Indemnity Reinsurance Agreement with CLAC discussed in Note 3 to the condensed consolidated financial statements (collectively referred to as Canada Life activity), a $1 million increase in the Financial Services segment excluding the impact of the Canada Life activity and an $15 million decrease in the Great-West Healthcare segment excluding the Canada Life activity. The $10 million decrease in the Canada Life activity net income is primarily due to $9.8 million of losses, net of tax, resulting from the change in fair value of the derivative financial instrument discussed in Item 3 - Qualitative and Quantitative Disclosures About Market Risk. The Company's consolidated net income decreased $12 million or 7% for the first six months of 2004 when compared to the same period in 2003. The net income decrease reflects a $23 million decrease in the Great-West Healthcare segment excluding the Canada Life activity and a $6 million decrease in the Financial Services segment excluding the impact of the Canada Life activity, offset by a $17 million increase as a result of the Canada Life activity. Included in the Canada Life activity net income is $7.1 million of losses, net of tax, resulting from the change in fair value of the derivative financial instrument discussed in Item 3 - Qualitative and Quantitative Disclosures About Market Risk. Total revenues decreased $61 million or 9% for the second quarter of 2004 when compared to the same period in 2003. The decrease in total revenue in the second quarter was primarily due to a $73 million decrease in premium income and a $44 million decrease in realized gains on investments offset by a $23 million increase in fee income and a $33 million increase in net investment income. Total revenues decreased $220 million or 16% for the first six months of 2004 when compared to 2003. The decrease in total revenue in the first six months was primarily due to a $304 million decrease in premium income partially offset by a $99 million increase in net investment income. A $394 million decrease in premium income in the Great-West Healthcare segment primarily resulting from the negative premiums associated with the recapture of group life and health premiums by CLAC was offset by a $90 million increase in premium income in the Financial Services segment. A $104 million increase in the net investment income in the Financial Services segment was primarily due to $128 million of Canada Life activity offset by a $24 million decrease primarily resulting from the decline in investment earned rates. Benefits and expenses decreased $21 million or 4% for the second quarter of 2004 when compared to the same period in 2003. The decrease in benefits and expenses is primarily due to a $74 million decrease in the Great-West Healthcare segment primarily resulting from the Allianz reinsurance cession, offset by a $53 million increase in the Financial Services segment primarily as a result of the Canada Life activity. Benefits and expenses decreased $199 million or 17% for the first six months of 2004 when compared to the first six months in 2003. The decrease in benefits and expenses results from a $379 million decrease in the Great-West Healthcare segment primarily resulting from the recapture of benefit expense by CLAC, offset by a $180 million increase in the Financial Services segment primarily as a result of the Canada Life activity. Income tax expense decreased $9 million or 11% for the first six months of 2004 when compared to the same period in 2003 reflecting the decrease in pretax income. 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 for investment-type contracts increased $52 million or 43% and $75 million or 28% for the second quarter and the first six months of 2004 when compared to the same periods in 2003. These increases resulted from increases in the 401(k) line of business and the Canada Life activity. Deposits for separate accounts decreased $24 million or 5% and $58 million or 6% for the second quarter and the first six months of 2004 when compared to the same periods in 2003. The decrease is due to the net decrease in contributions in the 401(k) and individual annuity lines of business. Self-funded premium equivalents decreased $47 million or 4% and $77 million or 3% for the second quarter and the first six months of 2004 when compared to the same periods in 2003. The decreases are due to lower membership. SEGMENT RESULTS Great-West Healthcare The following is a summary of certain financial data of the Great-West Healthcare segment: Operating Summary Three Months Ended June 30, Six Months Ended June 30, -------------------------------- -------------------------------- [Millions] 2004 2003 2004 2003 ---------------------------------------- -------------- ------------- --------------- ------------- Premium income $ 92 $ 191 $ 32 $ 426 Fee income 164 151 308 310 Net investment income 10 15 26 31 Realized investment (losses) gains (7) 5 10 -------------- ------------- --------------- ------------- Total revenues 259 362 366 777 Total benefits and expenses 222 296 261 640 Income tax expenses 12 22 35 46 -------------- ------------- --------------- ------------- Net income $ 25 $ 44 $ 70 $ 91 ============== ============= =============== ============= Self-funded premium equivalents $ 1,158 $ 1,205 $ 2,325 $ 2,402

The decrease in earnings for the second quarter and first six months of 2004 compared to the same periods of 2003 is primarily due to lower aggregate stop loss recoveries on prior year deficits. Excluding premium and fee income of negative $85 million associated with the Allianz reinsurance cession, premium and fee income remained relatively unchanged for the second quarter of 2004 when compared to the same period of 2003. Excluding premium and fee income of negative $208 million associated with Canada Life activity and excluding negative $158 million associated with the Allianz reinsurance cession, premium and fee income decreased $30 million or 4% for the first six months of 2004 when compared to the same period of 2003. The decrease is primarily due to a decline in membership from June 30, 2003 to June 30, 2004. Including 39,000 Canada Life stop loss members which renewed in the first six months of 2004, the Great-West Healthcare segment experienced a 3.1% increase in total health care membership from 1.856 million at December 31, 2003 to 1.913 million at June 30, 2004. There was a .8% decrease in total health care membership from 1.929 million at June 30, 2003 to 1.913 million at June 30, 2004. The decline in membership during the 12-month period is due to terminations resulting from pricing action related to target margins. However, there was membership growth in the first six months of 2004. Canada Life premiums of negative $208 million are primarily the result of $256 million of premiums related to a recapture of life and health premiums by CLAC associated with the original Indemnity Reinsurance Agreement dated August 31, 2003, offset by $48 million of normal business activity recorded before the February 29, 2004 recapture. Excluding total benefits and expenses of negative $85 million associated with the Allianz reinsurance cession, total benefits and expenses increased $11 million or 4% for the second quarter of 2004 when compared to the same period of 2003. The increase is primarily due to lower stop loss recoveries of prior year deficits. Excluding total benefits and expenses of negative $211 million associated with Canada Life activity and excluding negative $158 million associated with the Allianz reinsurance cession, total benefits and expenses decreased $10 million or 2% for the first six months when compared to the same period of 2003. The decrease is due primarily to decreased benefits associated with lower membership offset by lower stop loss recoveries of prior year deficits. Canada Life total benefits and expenses of negative $211 million are primarily the result of $256 million of change in reserves as a result of the recapture discussed above offset by $45 million of normal business activity before the February 29, 2004 recapture. Self-funded premium equivalents decreased $47 million or 4% and $77 million or 3% for the second quarter and the first six months when compared to the same periods of 2003. The decrease is due to lower membership. Financial Services The following is a summary of certain financial data of the Financial Services segment. Operating Summary Three Months Ended June 30, Six Months Ended June 30, -------------------------------- -------------------------------- [Millions] 2004 2003 2004 2003 --------------------------------------- -------------- ------------- ------------- -------------- Premium income $ 69 $ 43 $ 171 $ 81 Fee income 66 56 133 112 Net investment income 229 191 494 390 Realized investment (losses) gains (13) 19 17 41 -------------- ------------- ------------- -------------- Total revenues 351 309 815 624 Total benefits and expenses 309 256 692 512 Income tax expenses 12 18 40 38 -------------- ------------- ------------- -------------- Net income $ 30 $ 35 $ 83 $ 74 ============== ============= ============= ============== Deposits for investment- type contracts $ 174 $ 122 $ 344 $ 269 Deposits to separate accounts 456 480 992 1,050

Net income for Financial Services decreased $5 million or 14% and increased $9 million or 12% in the second quarter and first six months of 2004 when compared to the same periods of 2003. Effective July 10, 2003 the Company acquired CLICA and CLNY. The results of operations for the life insurance and annuity business areas for these subsidiaries have been included in the Income Statement data above for the second quarter and the first six months of 2004. In addition, the Company has entered into an Indemnity Reinsurance Agreement with CLAC pursuant to which the Company reinsured 80% (45% coinsurance and 35% coinsurance with funds withheld) of certain United States life, health and annuity business of CLAC's U.S. branch as of August 31, 2003. The life insurance and annuity reinsurance transactions related to this agreement have also been included in the Income Statement data above for the second quarter and the first six months of 2004. The impact of both of these transactions (Canada Life activity) on the Financial Services Division results for the second quarter and the first six months of 2004 is as follows: Three Months Ended Six Months Ended June 30 June 30 ------------------------- --------------------------- Premiums $ 29 $ 88 Fee income 2 4 Net investment income 43 128 Net realized gains (losses) on Investment (11) 6 ---- - Total revenues 63 226 Policyholder benefits 59 170 Operating expenses 13 32 -- -- Total benefits and expenses 72 202 -- Income (loss) from operations (9) 24 Income taxes (3) 9 --- - Net income (loss) (6) 15

The $6.0 million net loss for the second quarter of 2004 in the Canada Life activity is primarily due to $9.8 million of losses, net of tax, resulting from the change in fair value of the derivative financial instrument discussed in Item 3 - Qualitative and Quantitative Disclosures About Market Risk. The $15.0 million net income for the first six months of 2004 in the Canada Life activity includes $7.1 million of losses, net of tax, resulting from the change in fair value of the derivative financial instrument discussed in Item 3 - Qualitative and Quantitative Disclosures About Market Risk. Net income for the Financial Services division (excluding the Canada Life activity discussed above) has increased $1 million or 3% and decreased $6 million or 8% for the second quarter and first six months of 2004 when compared the same periods of 2003. The decrease is due to a decrease in investment income and realized investment gains. The net earned rate decreased from 6.35% in June 2003 to 6.02% in June 2004. Excluding Canada Life activity, total premiums including deposits to investment-type contracts and deposits to separate accounts decreased $4 million or .3% for the first six months of 2004 when compared to the same period of 2003. Premiums and deposits have decreased $27 million or 11% in the Individual Markets area where sales were lower for the first six months of 2004 when compared to the first six months of 2003. The lower sales were partially due to a $16 million sale in 2003 which was not repeated in 2004. The decrease in the Individual Markets area was offset by a $23 million increase in the Retirement Services area, which is primarily due to premiums on new cases which came in at the end of 2003. Retirement participant accounts including third-party administration and institutional accounts increased 4% in 2004 from 2,265,713 at December 31, 2003 to 2,354,535 at June 30, 2004. Fee income has increased $17 million or 15%, excluding fee income associated with Canada Life, for the first six months of 2004 when compared to the same period of 2003. 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. Excluding investment income of $128 million associated with Canada Life, investment income decreased $24 million or 6% for the first six months of 2004 when compared to the same period of 2003. The net earned rate decreased from 6.35% in June 2003 to 6.02% in June 2004. Excluding total benefits and expenses of $202 million associated with Canada Life, total benefits and expenses decreased $22 million or 4% for the first six months of 2004 when compared to the same period of 2003 due primarily to a decrease in the interest crediting rates on the in force block of business and the surrender of a large case in the prior year. GENERAL ACCOUNT INVESTMENTS The Company's primary investment objective is to acquire assets with duration and cash flow characteristics reflective 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 under 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 strives to ensure that its investment portfolio is appropriately structured to fulfill financial obligations to its policyholders. Fixed Maturities Fixed maturity investments include public and privately placed corporate bonds, government bonds, and mortgage-backed and asset-backed securities. The Company's strategy related to mortgage-backed and asset-backed securities is to focus on those investments with low prepayment risk and minimal credit risk. The Company does not invest in higher-risk collateralized 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 enhanced covenant protection that allows the Company, if necessary, to take appropriate action to protect its investment. The Company believes that the cost of the additional monitoring and analysis required by private 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 the rating agencies. The distribution of the fixed maturity portfolio by Standard & Poor's credit rating is summarized as follows: June 30, December 31, 2004 2003 ---------------------- ----------------------- AAA 55.1 % 54.3 % AA 8.5 % 8.7 % A 14.6 % 16.0 % BBB 19.1 % 18.4 % BB and below (non-investment grade) 2.7 % 2.6 % ----------------- ---- ------------------ ---- TOTAL 100.0 % 100.0 % ================= ==== ================== ====

During the first six months of 2004, net unrealized gains on fixed maturities included in stockholder's equity, which is net of policyholder-related amounts and deferred income taxes, decreased stockholder's equity by $120.6 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 on direct business written and up to $2.8 million on business reinsured from CLAC. 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 judgment 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 sales representatives related to the production of new business, have been deferred to the extent deemed 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 judgment 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 its 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 and utilizing positive cash flows from operations. Liquidity for the Company has remained strong, as evidenced by significant amounts of short-term investments and cash that totaled $1.3 billion and $1.0 billion as of June 30, 2004 and December 31, 2003, respectively. In addition, 97% of the bond portfolio carried an investment grade rating as of June 30, 2004 and December 31, 2003, thereby providing significant liquidity to the Company's overall investment portfolio. Funds provided by 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 sources of the funds that may be required in such situations include the issuance of commercial paper and equity securities. 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 $97.3 million and $96.4 million of commercial paper outstanding at June 30, 2004 and December 31, 2003, respectively. The commercial paper has been given a rating of A-1+ by Standard & Poor's and a rating of P-1 by Moody's Investors Services, each being the highest rating available. Capital resources provide protection for policyholders and financial strength to support the underwriting of insurance risks, and allow for continued business growth. The amount of capital resources that may be needed is determined by the Company's senior management and Board of Directors, as well as by regulatory requirements. The allocation of resources to new long-term business commitments is designed to achieve an attractive return, tempered by considerations of risk and the need to support the Company's existing business. The Company entered into a line of credit agreement on March 26, 2004, which provides for loans up to $200 million to be used for general corporate purposes. The agreement expires March 26, 2005. At June 30, 2004, the Company had notified the lender of its intent to borrow $164.2 million effective July 2, 2004. 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. 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 these product's liability 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 also manages risk with interest rate derivatives such as interest rate caps that would pay the Company investment income if interest rates rise above the level specified in the cap. 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 or forecasted to be purchased. As a result of the coinsurance with funds withheld element of the Company's reinsurance of business of CLAC's US branch, the Company has recorded a derivative financial instrument to account for the different credit risks and other characteristics of the reinsurance receivable and the investment assets of CLAC that underlie that receivable. This derivative is carried at fair value and changes in fair value are included in net investment income as a non-cash charge or credit. Therefore, the Company's operating results are exposed to volatility, reflecting changes in the fair value of the underlying investment portfolio, which is exposed to interest rate, market and credit risk. Losses of $9.8 million and $7.1 million, net of tax were included in net income for the second quarter and the first six months of 2004, respectively, as a result of this derivative. Item 4. CONTROLS AND PROCEDURES Based on their evaluation as of June 30, 2004, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective at the reasonable assurance level 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 is (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 control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are 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

SIGNATURES 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 10-Q