News Column

GREAT WEST LIFE & ANNUITY INSURANCE CO - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 13, 2014

General

As used in this Form 10-Q, the "Company" refers to Great-West Life & Annuity Insurance Company, a stock life insurance company originally organized on March 28, 1907 and domiciled in the state of Colorado, and its subsidiaries.

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 words such as "may," "would," "could," "should," "estimates," "expected," "anticipate," "believe," or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements that represent the Company's beliefs concerning future or projected levels of sales of its 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. Some of these risks are described in "Risk Factors" in Item 1A of this report. 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 global or 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 its investment portfolio and other factors. Readers should also consider other matters, including any 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 Company's results of operations for the three and six months ended June 30, 2014 compared with the same period in 2013. The discussion should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2013, under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," to which the reader is directed for additional information.

On January 1, 2013, the Company terminated its reinsurance agreement with an affiliate, The Canada Life Assurance Company ("CLAC"), pursuant to which it had ceded certain participating life business on a coinsurance basis. As a result of that termination, on January 1, 2013, the Company recorded the following increases (decreases) in its statement of income in connection with the termination of the reinsurance agreement: (In millions) Premium income $ 42 Other revenue 7 Total 49 Increase in future policy benefits 41 Dividends to policyholders 1 Total 42 Participating policyholders' net income before income taxes 7 Income tax expense (benefit) 2 Participating policyholders' income 5



Provision for policyholders' share of (losses) earnings on participating business

5 Net income available to shareholder $ -



Participating policyholders share in the financial results of the participating business in the form of policyholder dividends. The policyholder dividends can be distributed directly to the policyholders in the form of cash or through an increase in benefits such as paid-up additions. The participating policyholder earnings that cannot be distributed to the Company's

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shareholder and have not been distributed to participating policyholders are not included in the Company's net income and are reflected in liabilities in undistributed earnings on participating business in the Company's balance sheets. As such, the transaction above had no impact on net income available to the Company's shareholder.

On March 20, 2014, Great-West Lifeco Inc. announced its intent to combine the retirement business of Putnam Investments, an affiliate of the Company, with the retirement business of the Company. Management is still assessing the form of the combination. The Putnam Investments retirement business comprises 375 clients with approximately 199,000 participants and $15 billion in assets under administration.

On April 3, 2014, the Company announced it has reached an agreement to acquire the J.P. Morgan Retirement Plan Services large-market recordkeeping business. The transaction is expected to close during the third quarter pending regulatory approval. The J.P. Morgan Retirement Plan Services business comprises 200 clients with approximately 1.9 million participants and $167 billion in assets under administration. It also includes the more than 1,000 personnel affiliated with J.P. Morgan Retirement Plan Services, including sales staff, consultant relations, relationship managers and client service specialists.

The Company employs hedging strategies for the purpose of managing the interest rate, foreign currency exchange rate and equity market risks impacting the Company's business. For some derivative instruments, hedge accounting is not elected; therefore all gains or losses from these transactions are recorded in the consolidated statement of income. As a result, fluctuations in interest rates, foreign currencies or equity markets may cause the Company to experience volatility in net income.

Company Results of Operations

Three months ended June 30, 2014 compared with the three months ended June 30, 2013

The following is a summary of certain financial data of the Company:

Three Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 62 $ 66 Fee income 172 154 Net investment income 320 250 Realized investment gains (losses), net 37 (24 ) Total revenues 591 446 Policyholder benefits 263 265 Operating expenses 213 189 Total benefits and expenses 476 454 Income (loss) before income taxes 115 (8 ) Income tax expense (benefit) 40 (4 ) Net income (loss) $ 75 $ (4 )



The Company's consolidated net income increased by $79 million from a loss of $4 million in 2013 to a gain of $75 million in 2014. The increase in earnings is due to net investment income and realized investment gains (losses), net, attributable to realized and unrealized gains on forward settling to be announced ("TBA") security transactions as a result of decreasing interest rates. Additionally, the Company had higher fee income due to increased average asset levels driven by higher average equity market levels. These increases in earnings were partially offset by higher operating expenses.

Premium income decreased by $4 million, or 6%, to $62 million for the three months ended June 30, 2014 when compared to 2013. This decrease is primarily related to the Company's Other segment which had a decrease of $12 million due to lapses on a block of 10-year term insurance policies whose original term ended in 2013. The decrease was partially offset by an increase of $8 million in the Individual Markets segment which is driven by increased sales.

Fee income increased by $18 million, or 12%, to $172 million for the three months ended June 30, 2014 when compared to 2013. The increase is primarily related to a $16 million, or 18%, increase in asset-based variable fee income resulting from increased average asset levels driven by sales growth and higher average equity market levels. The equity market performance

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is evidenced by the 18% increase in the average S&P 500 index during the three months ended June 30, 2014 as compared to the three months ended June 30, 2013.

Net investment income increased by $70 million, or 28%, to $320 million during the three months ended June 30, 2014 when compared to 2013. The primary driver of the change is a $57 million increase in unrealized gains from forward settling TBA securities as a result of decreasing interest rates. Additionally, there was a $17 million increase in investment income earned on bonds, mortgages and policy loans as a result of higher invested assets balances partially offset by lower yields and a $12 million increase in unrealized gains from derivatives. The increase in net investment income was partially offset by a $17 million decrease in investment income earned on derivatives.

Realized investment gains (losses), net, increased by $61 million to $37 million during the three months ended June 30, 2014 when compared to 2013. The fluctuation is driven primarily by an increase in gains of $55 million on forward settling TBA security transactions and an increase in gains of $10 million on bonds as a result of decreasing interest rates, offset by a decrease in gains of $5 million on mortgages.

Total benefits and expenses increased by $22 million, or 5%, to $476 million for the three months ended June 30, 2014 when compared to 2013 primarily due to higher operating expenses. The increase in benefits and expenses is primarily attributable to a $29 million increase in the Company's Retirement Services segment as a result of higher asset based commissions, higher incentive compensation and higher executive compensation. Additionally, the Company had higher deferred acquisition cost ("DAC") amortization as a result of realized gains in 2014 as compared to realized losses in 2013. The Individual Markets segment had an increase of $7 million primarily driven by higher interest credited or paid to contractholders due to higher average liabilities and also driven by higher incentive compensation and higher executive compensation. Offsetting the increases was a decrease of $14 million in the Other segment as a result of actual surrenders coming in lower than previously estimated and lower commissions due to higher lapses.

Income tax expense increased by $44 million from a benefit of $4 million in 2013 to an expense of $40 million in 2014 primarily due to an increase in net income before tax.

Six months ended June 30, 2014 compared with the six months ended June 30, 2013

The following is a summary of certain financial data of the Company:

Six Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 194$ 245 Fee income 339 301 Other revenue - 7 Net investment income 620 534 Realized investment gains (losses), net 64 (9 ) Total revenues 1,217 1,078 Policyholder benefits 569 610 Operating expenses 387 371 Total benefits and expenses 956 981 Income before income taxes 261 97 Income tax expense 91 34 Net income $ 170$ 63



The Company's consolidated net income increased by $107 million to $170 million for the six months ended June 30, 2014 when compared to 2013. The increase in earnings is due to net investment income and realized investment gains (losses), net, attributable to realized and unrealized gains on forward settling TBA security transactions as a result of decreasing interest rates. Additionally, the Company had higher fee income due to increased average asset levels driven by higher average equity market levels. These increases in earnings were partially offset by higher operating expenses.

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Premium income decreased by $51 million, or 21%, to $194 million for the six months ended June 30, 2014 when compared to 2013. This decrease is primarily related to the Company's Individual Markets segment which is driven by the $42 million received in 2013 in conjunction with the termination of the reinsurance agreement with CLAC, partially offset by a $7 million increase driven by higher sales. The Other segment had a decrease of $18 million due to lapses on a block of 10-year term insurance policies whose original term ended in 2013.

Fee income increased by $38 million, or 13%, to $339 million for the six months ended June 30, 2014 when compared to 2013. The increase is primarily related to a $32 million, or 18%, increase in asset-based variable fee income resulting from increased average asset levels driven by sales growth and higher average equity market levels. The equity market performance is evidenced by the 20% increase in the average S&P 500 index during the six months ended June 30, 2014 as compared to the six months ended June 30, 2013.

Other revenue decreased by $7 million for the six months ended June 30, 2014 when compared to 2013 as a result of the termination of the reinsurance agreement with CLAC in 2013.

Net investment income increased by $86 million, or 16%, to $620 million during the six months ended June 30, 2014 when compared to 2013. The primary driver of the change is a $45 million increase in unrealized gains from forward settling TBA securities as a result of decreasing interest rates and a $28 million increase in investment income earned on bonds, mortgages and policy loans as a result of higher invested assets balances partially offset by lower yields. Additionally, there was an $18 million and $8 million increase in unrealized gains from derivatives and bonds, respectively, and a $5 million increase in investment income earned on other investments. The increase in net investment income was partially offset by an $18 million decrease in investment income earned on derivatives.

Realized investment gains (losses), net, increased by $73 million to $64 million during the six months ended June 30, 2014 when compared to 2013. The fluctuation is driven primarily by an increase in gains of $72 million on forward settling TBA security transactions and an increase in gains of $7 million on bonds as a result of decreasing interest rates, offset by a decrease in gains of $5 million on mortgages.

Total benefits and expenses decreased by $25 million, or 3%, to $956 million for the six months ended June 30, 2014 when compared to 2013 primarily due to lower policyholder benefits. The decrease in benefits and expenses is attributable to a $32 million decrease in the Company's Individual Markets segment driven by benefits expense incurred in 2013 in conjunction with the termination of the reinsurance agreement with CLAC. The Other segment had a decrease of $17 million as a result of actual surrenders coming in lower than previously estimated and lower commissions due to fewer renewals. Offsetting the decreases was an increase of $25 million in the Retirement Services segment, of which $18 million is driven by operating expenses as a result of higher asset based commissions, higher incentive compensation and higher executive compensation. Additionally, the Company had higher policyholder benefits due to higher interest credited or paid to contractholders as a result of increased average liabilities.

Income tax expense increased by $57 million to $91 million for the six months ended June 30, 2014 when compared to 2013 primarily due to an increase in net income before tax.

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Individual Markets Segment Results of Operations

Three months ended June 30, 2014 compared with the three months ended June 30, 2013

The following is a summary of certain financial data of the Individual Markets segment:

Three Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 37 $ 29 Fee income 27 24 Net investment income 187 173 Realized investment gains (losses), net 10 7 Total revenues 261 233 Policyholder benefits 178 176 Operating expenses 42 37 Total benefits and expenses 220 213 Income before income taxes 41 20 Income tax expense 14 6 Net income $ 27 $ 14



Net income for the Individual Markets segment increased by $13 million, or 93%, to $27 million million during the three months ended June 30, 2014 when compared to 2013. The increase in earnings is primarily due to higher net investment income driven by higher invested assets and higher unrealized gains from forward settling TBA securities as a result of decreasing interest rates.

Premium income increased by $8 million, or 28%, to $37 million for the three months ended June 30, 2014 when compared to 2013. This increase is primarily driven by higher sales in 2014.

Fee income increased by $3 million, or 13%, to $27 million for the three months ended June 30, 2014 when compared to 2013. The increase is primarily related to fees earned in the executive benefits market due to increased assets resulting from growing sales.

Net investment income increased by $14 million, or 8%, to $187 million for the three months ended June 30, 2014 when compared to 2013. The primary driver of the change is a $13 million increase in unrealized gains from forward settling TBA securities as a result of decreasing interest rates. Additionally, there was a $6 million increase in investment income earned on bonds, mortgages and policy loans as a result of higher invested assets balances partially offset by lower yields and a $6 million increase in unrealized gains from derivatives. The increase in net investment income was partially offset by an $11 million decrease in investment income earned on derivatives.

Realized investment gains (losses), net, increased by $3 million, or 43%, to $10 million during the three months ended June 30, 2014 when compared to 2013. The fluctuation is driven primarily by an increase in gains of $13 million on forward settling TBA security transactions as a result of decreasing interest rates, offset by a decrease in gains of $6 million and $5 million on bonds and mortgages, respectively.

Total benefits and expenses increased by $7 million, or 3%, to $220 million during the three months ended June 30, 2014 when compared to 2013. The change in benefits and expenses is primarily driven by higher interest credited or paid to contractholders as a result of increased average liabilities and also driven by higher incentive compensation and higher executive compensation.

Income tax expense increased by $8 million to $14 million during the three months ended June 30, 2014 when compared to 2013 primarily due to an increase in net income before tax.

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Six months ended June 30, 2014 compared with the six months ended June 30, 2013

The following is a summary of certain financial data of the Individual Markets segment:

Six Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 150 $ 183 Fee income 51 47 Other revenue - 7 Net investment income 372 350 Realized investment gains (losses), net 17 16 Total revenues 590 603 Policyholder benefits 418 454 Operating expenses 77 73 Total benefits and expenses 495 527 Income before income taxes 95 76 Income tax expense 33 28 Net income $ 62 $ 48



Net income for the Individual Markets segment increased by $14 million, or 29%, to $62 million during the six months ended June 30, 2014 when compared to 2013. The increase in earnings is primarily due to higher net investment income driven by higher invested assets and higher unrealized gains from forward settling TBA securities as a result of decreasing interest rates, partially offset by a decrease in other revenues.

Premium income decreased by $33 million, or 18%, to $150 million for the six months ended June 30, 2014 when compared to 2013. This decrease is primarily driven by the $42 million received in 2013 in conjunction with the termination of the reinsurance agreement with CLAC, partially offset by a $7 million increase driven by higher sales.

Fee income increased by $4 million, or 9%, to $51 million for the six months ended June 30, 2014 when compared to 2013. The increase is primarily related to fees earned in the executive benefits market due to increased assets resulting from growing sales.

Other revenue decreased by $7 million for the six months ended June 30, 2014 when compared to 2013 as a result of the termination of the reinsurance agreement with CLAC in 2013.

Net investment income increased by $22 million, or 6%, to $372 million for the six months ended June 30, 2014 when compared to 2013. The primary driver of the change is a $12 million increase in unrealized gains from forward settling TBA securities as a result of decreasing interest rates and an $11 million increase in investment income earned on bonds, mortgages and policy loans as a result of higher invested assets balances partially offset by lower yields. Additionally, there was an $8 million and $4 million increase in unrealized gains from derivatives and bonds, respectively. The increase in net investment income was partially offset by a $14 million decrease in investment income earned on derivatives.

Realized investment gains (losses), net, increased by $1 million, or 6%, to $17 million during the six months ended June 30, 2014 when compared to 2013. The fluctuation is driven primarily by an increase in gains of $16 million on forward settling TBA security transactions as a result of decreasing interest rates, offset by a decrease in gains of $9 million and $5 million on bonds and mortgages, respectively.

Total benefits and expenses decreased by $32 million, or 6%, to $495 million during the six months ended June 30, 2014 when compared to 2013. The change in benefits and expenses is primarily attributable to a $41 million benefits expense incurred in 2013 in conjunction with the termination of the reinsurance agreement with CLAC, partially offset by a $9 million increase in interest credited or paid to contractholders as a result of increased average liabilities and increased incentive compensation and executive compensation.

Income tax expense increased by $5 million, or 18%, to $33 million during the six months ended June 30, 2014 when compared to 2013 primarily due to an increase in net income before tax.

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Retirement Services Segment Results of Operations

Three months ended June 30, 2014 compared with the three months ended June 30, 2013

The following is a summary of certain financial data of the Retirement Services segment:

Three Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ - $ 1 Fee income 144 129 Net investment income 119 65 Realized investment gains (losses), net 27 (32 ) Total revenues 290 163 Policyholder benefits 51 48 Operating expenses 156 130 Total benefits and expenses 207 178 Income (loss) before income taxes 83 (15 ) Income tax expense (benefit) 29 (5 ) Net income (loss) $ 54$ (10 )



Net income (loss) for the Retirement Services segment increased by $64 million from a loss of $10 million in 2013 to a gain of $54 million in 2014. The increase in earnings is primarily due to increases in net investment income and realized investment gains (losses), net, attributable to realized and unrealized gains on forward settling TBA security transactions as a result of decreasing interest rates. Additionally, the Company had higher fee income due to increased average asset levels driven by higher average equity market levels. These increases in earnings were partially offset by higher operating expenses.

Fee income increased by $15 million, or 12%, to $144 million for the three months ended June 30, 2014 when compared to 2013. The increase is primarily related to a $16 million, or 18%, increase in asset-based variable fee income due to increased average asset levels driven by sales growth and higher average equity market levels. The equity market performance is evidenced by an 18% increase in the average S&P 500 index during the three months ended June 30, 2014 as compared to the three months ended June 30, 2013.

Net investment income increased by $54 million, or 83%, to $119 million for the three months ended June 30, 2014 when compared to 2013. The primary driver of the change is a $44 million increase in unrealized gains from forward settling TBA securities as a result of decreasing interest rates. Additionally, there was a $10 million increase in investment income earned on bonds, mortgages and policy loans as a result of higher invested assets balances partially offset by lower yields.

Realized investment gains (losses), net, increased by $59 million to $27 million for the three months ended June 30, 2014 when compared to 2013. The fluctuation is driven primarily by an increase in gains of $42 million on forward settling TBA security transactions and an increase in gains of $16 million on bonds as a result of decreasing interest rates.

Total benefits and expenses increased by $29 million, or 16%, to $207 million for the three months ended June 30, 2014 when compared to 2013. The increase in benefits and expenses is primarily attributable to a $26 million increase in operating expenses as a result of higher asset based commissions due to increased average asset levels, higher incentive compensation due to larger plan sales in 2014 and higher executive compensation. Additionally, the Company had higher DAC amortization as a result of realized gains in 2014 as compared to realized losses in 2013.

Income tax expense increased by $34 million from a benefit of $5 million to an expense of $29 million. The increase is primarily due to an increase in net income before income taxes.

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Six months ended June 30, 2014 compared with the six months ended June 30, 2013

The following is a summary of certain financial data of the Retirement Services segment:

Six Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 1 $ 1 Fee income 286 252 Net investment income 220 161 Realized investment gains (losses), net 47 (26 ) Total revenues 554 388 Policyholder benefits 100 93 Operating expenses 280 262 Total benefits and expenses 380 355 Income before income taxes 174 33 Income tax expense 60 11 Net income $ 114 $ 22



Net income for the Retirement Services segment increased by $92 million to $114 million for the six months ended June 30, 2014 when compared to 2013. The increase in earnings is primarily due to increases in net investment income and realized investment gains (losses), net, attributable to realized and unrealized gains on forward settling TBA security transactions as a result of decreasing interest rates. Additionally, the Company had higher fee income due to increased average asset levels driven by higher average equity market levels. These increases in earnings were partially offset by higher operating expenses.

Fee income increased by $34 million, or 13%, to $286 million for the six months ended June 30, 2014 when compared to 2013. The increase is primarily related to a $32 million, or 18%, increase in asset-based variable fee income due to increased average asset levels driven by sales growth and higher average equity market levels. The equity market performance is evidenced by a 20% increase in the average S&P 500 index during the six months ended June 30, 2014 as compared to the six months ended June 30, 2013.

Net investment income increased by $59 million, or 37%, to $220 million for the six months ended June 30, 2014 when compared to 2013. The primary driver of the change is a $33 million increase in unrealized gains from forward settling TBA securities as a result of decreasing interest rates. Additionally, there was a $16 million increase in investment income earned on bonds, mortgages and policy loans as a result of higher invested assets balances partially offset by lower yields and a $10 million increase in unrealized gains from derivatives.

Realized investment gains (losses), net, increased by $73 million to $47 million for the six months ended June 30, 2014 when compared to 2013. The fluctuation is driven primarily by an increase in gains of $56 million on forward settling TBA security transactions and an increase in gains of $16 million on bonds as a result of decreasing interest rates.

Total benefits and expenses increased by $25 million, or 7%, to $380 million for the six months ended June 30, 2014 when compared to 2013. The increase in benefits and expenses is primarily attributable to an $18 million increase in operating expenses as a result of higher asset based commissions due to increased average asset levels, higher incentive compensation due to larger plan sales in 2014 and higher executive compensation. Additionally, the Company had higher policyholder benefits due to higher interest credited or paid to contractholders as a result of increased average liabilities.

Income tax expense increased by $49 million to $60 million during the six months ended June 30, 2014 when compared to 2013. The increase is primarily due to an increase in net income before income taxes.

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Other Segment Results of Operations

Three months ended June 30, 2014 compared with the three months ended June 30, 2013

The following is a summary of certain financial data of the Company's Other segment:

Three Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 24$ 36 Fee income 1 1 Net investment income 14 12 Total revenues 39 49 Policyholder benefits 32 41 Operating expenses 16 21 Total benefits and expenses 48 62 Loss before income taxes (9 ) (13 ) Income tax benefit (3 ) (5 ) Net loss $ (6 )$ (8 )



Net loss for the Company's Other segment decreased by $2 million, or 25%, to $6 million for the three months ended June 30, 2014. Policyholder benefits decreased by $9 million as a result of lower surrenders in 2014 than expected as compared to 2013 and operating expenses decreased by $5 million as a result of lower commissions due to fewer policy renewals on 10-year term insurance policies. Offsetting the decrease was a $12 million decrease in premium due to lapses on a block of 10-year term insurance policies whose original term ended in 2013.

Six months ended June 30, 2014 compared with the six months ended June 30, 2013

The following is a summary of certain financial data of the Company's Other segment:

Six Months Ended June 30, Income statement data (In millions) 2014 2013 Premium income $ 43$ 61 Fee income 2 2 Net investment income 27 24 Total revenues 72 87 Policyholder benefits 51 63 Operating expenses 31 36 Total benefits and expenses 82 99 Loss before income taxes (10 ) (12 ) Income tax benefit (3 ) (4 ) Net loss $ (7 )$ (8 )



Net loss for the Company's Other segment decreased by $1 million, or 13%, to $7 million for the six months ended June 30, 2014. Policyholder benefits decreased by $12 million as a result of fewer surrenders in 2014 than expected as compared to 2013 and operating expenses decreased by $5 million as a result of lower commissions due to fewer policy renewals on 10-year term insurance policies. Offsetting the decrease was a $18 million decrease in premium due to lapses on a block of 10-year term insurance policies whose original term ended in 2013.

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Investment Operations

The Company's primary investment objective is to acquire assets with duration and cash flow characteristics reflective of its 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 should 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 works to ensure that its investment portfolio is appropriately structured to fulfill financial obligations to its policyholders.

A summary of the Company's general account investment assets and the assets as a percentage of total general account investments follows: (In millions)

June 30, 2014 December 31, 2013 Fixed maturities, available-for-sale $ 17,246 62.3 % $ 18,470 69.6 % Fixed maturities, held for trading 117 0.4 % 336 1.3 % Mortgage loans on real estate 3,096 11.2 % 3,134 11.8 % Policy loans 4,239 15.3 % 4,185 15.8 % Short-term investments, available-for-sale 2,925 10.5 % 294 1.1 % Limited partnership and other corporation interests 63 0.2 % 79 0.3 % Other investments 17 0.1 % 18 0.1 % Total investments $ 27,703 100.0 % $ 26,516 100.0 %



The June 30, 2014 fixed maturities, available-for-sale amount decreased as compared to December 31, 2013 as the Company sold government agency mortgage-backed security ("MBS") pools to enter into forward settling TBA contracts which are treated as derivatives. There is a corresponding increase in short-term investments, available-for-sale as the Company holds these investments in order to settle the forward settling TBA contracts.

Fixed Maturity Investments

Fixed maturity investments include public and privately placed corporate bonds, government bonds and mortgage-backed and asset-backed securities. Included in available-for-sale fixed maturities are perpetual debt investments which primarily consist of junior subordinated debt instruments that have no stated maturity date but pay fixed or floating interest in perpetuity. 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.

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 placement investments 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 credit quality to limit credit risk. All securities are internally rated by the Company on a basis intended to be similar to that of the rating agencies. The Company's internal rating methodology generally takes into account ratings from Standard & Poor's Ratings Services, Fitch Ratings and Moody's Investor Services, Inc. In addition, the National Association of Insurance Commissioners ("NAIC") implemented a ratings methodology for residential mortgage-backed securities ("RMBS"), commercial mortgage-backed securities ("CMBS") and other structured securities. The Company may also utilize inputs from this ratings process to develop its internal rating.

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The distribution of the Company's fixed maturity portfolio by the Company's internal credit rating is summarized as follows: Credit Rating June 30, 2014 December 31, 2013 AAA 18.1 % 28.4 % AA 17.4 % 15.3 % A 31.8 % 26.5 % BBB 31.5 % 28.6 % BB and below (Non-investment grade) 1.2 % 1.2 % Total 100.0 % 100.0 %



The June 30, 2014 AAA rating percentage decreased as compared to December 31, 2013 as the Company sold AAA rated government agency MBS pools to enter into forward settling TBA contracts which are treated as derivatives.

The following table contains the sector distribution of the Company's corporate fixed maturity investment portfolio, calculated as a percentage of fixed maturities: Sector June 30, 2014 December 31, 2013 Utility 20.9 % 18.5 % Finance 11.8 % 10.0 % Consumer 11.2 % 9.9 % Natural resources 5.9 % 5.2 % Transportation 3.6 % 3.0 % Other 12.8 % 11.1 %



Fair Value Measurement of Fixed Maturity Investments Classified as Available-for-Sale

Each fixed maturity investment is categorized in a hierarchy based on the observability of inputs into the valuation methodology with Level 3 being the least observable. Management uses some judgment in determining the observability of valuation inputs. Level 3 assets at June 30, 2014 were $227 million, or 1%, of total net assets and liabilities carried at fair value compared to Level 3 assets of $260 million, or 1%, at December 31, 2013. The decrease in Level 3 assets is primarily due to principal reductions.

Securities Lending, Reverse Repurchase Agreements and Cash Collateral Reinvestment Practices

Cash collateral related to the securities lending program and reverse repurchase agreements is invested in U.S. Government or U.S. Government Agency securities. In addition, the securities lending agent indemnifies the Company against borrower risk, meaning that the lending agent agrees contractually to replace securities not returned due to a borrower default. As of June 30, 2014 and December 31, 2013, the Company had $38 million and $27 million, respectively, of securities out on loan and $600 million and zero, respectively, in short-term reverse repurchase agreements, all of which are fully collateralized as described above. The Company does not enter into these types of transactions for liquidity purposes, but rather for yield enhancement on its investment portfolio.

Mortgage Loans on Real Estate

The Company's mortgage loans on real estate are comprised exclusively of domestic commercial collateralized real estate loans. The mortgage loan portfolio is diversified with regard to geographical markets and commercial real estate property types within the United States. The Company originates, directly or through correspondents, real estate mortgages with the intent to hold to maturity. The Company's portfolio includes loans which are fully amortizing, amortizing with a balloon balance at maturity, interest only to maturity and interest only for a number of years followed by an amortizing period.

Derivatives

The Company uses certain derivatives, such as futures, swaps and interest rate swaptions, for purposes of managing the interest rate, foreign currency exchange rate and equity market risks impacting the Company's business. These derivatives, when taken alone, may subject the Company to varying degrees of market and credit risk; however, since used for hedging purposes, these instruments are intended to reduce risk. For derivative instruments where hedge accounting is not elected, changes in interest rates, foreign currencies or equity markets may generate derivative gains or losses which may cause the Company to experience

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volatility in net income. The Company also uses forward settling TBA securities to gain exposure to the investment risk and return of agency mortgage-backed securities (pass-throughs). These transactions enhance the return on the Company's investment portfolio and provide a more liquid and cost effective method of achieving these goals than purchasing or selling individual agency mortgage-backed pools. The Company controls the credit risk of its over-the-counter derivative contracts through credit approvals, limits, monitoring procedures and in most cases, requiring collateral. Risk of loss is generally limited to the portion of the fair value of derivative instruments that exceeds the value of the collateral held and not to the notional or contractual amounts of the derivatives.

Summary of Critical Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires the Company's management to adopt accounting policies to enable them to make a significant variety of accounting and actuarial 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 information available at the time the estimates were made.

Critical accounting estimates are those that management believes are important to the portrayal of the Company's results of operations and financial condition and which require them to make difficult, subjective and/or complex judgments. Critical accounting estimates cover accounting and actuarial matters that are inherently uncertain because the future resolution of such matters is unknown. Many of these policies, estimates and related judgments are common in the insurance and financial services industries. The Company believes that its most critical accounting estimates include the following:

Valuation of investments and derivatives in the absence of quoted market

values;

Impairment of investments;

Accounting for derivative financial instruments;

Valuation of policy benefit liabilities; and

Valuation of DAC (deferred acquisition costs)

A discussion of each of these critical accounting policies may be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Application of Recent Accounting Pronouncements

See Note 3 to the accompanying condensed consolidated financial statements for a discussion of the application of recent accounting pronouncements.

Liquidity and Capital Resources

Liquidity refers to a company's ability to generate sufficient cash flows to meet the needs of its operations. The Company manages its operations to create stable, reliable and cost-effective sources of cash flows to meet all of its obligations.

The principal sources of the Company's liquidity are premiums and contract deposits, fees, investment income and investment maturities and sales. Funds provided from these sources are reasonably predictable and normally exceed liquidity requirements for payment of policy benefits, payments to policy and contractholders in connection with surrenders and withdrawals and general 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. A primary liquidity concern regarding cash flows from operations is the risk of early policyholder and contractholder withdrawals. A primary liquidity concern regarding investment activity is the risk of defaults and market volatility. In addition, 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 or other debt instruments. Management believes that the liquidity profile of its assets is sufficient to satisfy the liquidity requirements of reasonably foreseeable scenarios.

Generally, the Company has met its operating requirements by utilizing cash flows from operations and maintaining appropriate levels of liquidity in its investment portfolio. Liquidity for the Company has remained strong, as evidenced by the amounts of short-term investments and cash that totaled $434 million and $302 million as of June 30, 2014 and December 31, 2013, respectively. The June 30, 2014 short-term investments included above exclude amounts held to settle TBA forward

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contracts. In addition, 99% of the fixed maturity portfolio carried an investment grade rating at June 30, 2014 and December 31, 2013, thereby providing significant liquidity to the Company's overall investment portfolio.

The Company continues to be well capitalized, with sufficient borrowing capacity. Additionally, the Company anticipates that cash on hand and expected net cash generated by operating activities will exceed the forecasted needs of the business over the next 12 months. 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 had $100 million and $99 million of commercial paper outstanding at June 30, 2014 and December 31, 2013, respectively. The commercial paper has been given a rating of A-1+ by Standard & Poor's Ratings Services and a rating of P-1 by Moody's Investors Service, each being the highest rating available. Through the recent financial market volatility, the Company continued to have the ability to access the capital markets for funds. The loss of this access in the future would not have a significant impact to the Company's liquidity as commercial paper is not used to fund daily operations and is an insignificant amount in relation to total invested assets.

The Company also has available a revolving credit facility agreement, which expires on March 1, 2018, in the amount of $50 million for general corporate purposes. The Company had no borrowings under this credit facility as of or during the six months ended June 30, 2014. The Company does not anticipate the need for borrowings under this facility and the loss of its availability would not significantly impact its liquidity.

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.

Off-Balance Sheet Arrangements

The Company makes commitments to fund partnership interests, mortgage loans on real estate and other investments in the normal course of its business. The amounts of these unfunded commitments at June 30, 2014 and December 31, 2013 were $234 million and $197 million, respectively. The precise timing of the fulfillment of the commitment cannot be predicted; however, these amounts are due within one year of the dates indicated. There are no other obligations or liabilities arising from such arrangements that are reasonably likely to become material.

The Company participates in a short-term reverse repurchase program for the purpose of enhancing the total return on its investment portfolio. This type of transaction involves the purchase of securities with a simultaneous agreement to sell similar securities at a future date at an agreed-upon price. In exchange, the financial institutions put non-cash collateral on deposit with a third-party custodian on behalf of the Company. The amount of securities purchased in connection with these transactions was $600 million and zero at June 30, 2014 and December 31, 2013, respectively. Non-cash collateral on deposit with the third-party custodian on the Company's behalf was $612 million and zero at June 30, 2014 and December 31, 2013, respectively, which cannot be sold or re-pledged and which has not been recorded on the condensed consolidated balance sheets.

The Company participates in a securities lending program in which the Company lends securities that are held as part of its general account investment portfolio to third parties for the purpose of enhancing the total return on its investment portfolio. The Company generally requires initial collateral in an amount greater than or equal to 102% of the fair value of domestic securities loaned and 105% of foreign securities loaned. The Company received securities with a fair value of $7 million and $9 million as collateral at June 30, 2014 and December 31, 2013, respectively, which have not been recorded on the condensed consolidated balance sheets.

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