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Ameriprise Financial, Inc. 10-Q 2005
UNITED STATES WASHINGTON, D.C. 20549
FORM 10-Q
For the Transition Period from to
Commission file number 1-32525
AMERIPRISE FINANCIAL, INC. (Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code (612) 671-3131
None Former name, former address and former fiscal year, if changed since last report.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (The registrant has not been subject to such filing requirements for the past 90 days.) Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
AMERIPRISE FINANCIAL, INC.
FORM 10-Q
INDEX
AMERIPRISE FINANCIAL, INC. CONSOLIDATED STATEMENTS OF INCOME (Millions, except per share amounts) (Unaudited)
See Notes to Consolidated Financial Statements.
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AMERIPRISE FINANCIAL, INC. CONSOLIDATED STATEMENTS OF INCOME (Millions, except per share amounts) (Unaudited)
See Notes to Consolidated Financial Statements.
2
AMERIPRISE FINANCIAL, INC. (Millions, except share data)
See Notes to Consolidated Financial Statements.
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AMERIPRISE FINANCIAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Millions) (Unaudited)
See Notes to Consolidated Financial Statements.
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AMERIPRISE FINANCIAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Millions) (Unaudited)
See Notes to Consolidated Financial Statements.
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AMERIPRISE FINANCIAL, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (Millions) (Unaudited)
See Notes to Consolidated Financial Statements.
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AMERIPRISE FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Separation and Distribution from American Express
Ameriprise Financial, Inc (the Company or Ameriprise) was formerly a wholly-owned subsidiary of American Express Company (American Express). On February 1, 2005, the American Express Board of Directors announced its intention to pursue the disposition of 100% of its shareholdings in the Company through a tax-free distribution to American Express Company’s shareholders. In preparation for the disposition, the Company approved a stock split of its 100 common shares entirely held by American Express into 246 million common shares. Effective as of the close of business on September 30, 2005, American Express completed the separation of Ameriprise and the distribution of the Ameriprise common shares to American Express shareholders (the Distribution). The Distribution was effectuated through a pro-rata dividend to American Express shareholders consisting of one share of Ameriprise common stock for every 5 shares of American Express common stock owned by its shareholders on September 19, 2005, the record date. Prior to August 1, 2005, Ameriprise was named American Express Financial Corporation.
In connection with the Distribution, Ameriprise entered into the following transactions with American Express.
• Effective August 1, 2005, the Company transferred its ownership interest and the related assets and liabilities of its consolidated subsidiary, American Express International Deposit Company (AEIDC), to American Express for $164 million through a non-cash dividend equal to the net book value excluding $26 million of net unrealized investment losses of AEIDC. In connection with the AEIDC transfer American Express paid the Company a $164 million capital contribution. The assets, liabilities and results of operations of AEIDC are shown as discontinued operations in the accompanying financial statements. Refer to Note 7 for further discussion.
• Effective July 1, 2005, the Company’s subsidiary, AMEX Assurance, ceded 100% of its travel and other card insurance business offered to American Express customers, to an American Express subsidiary in return for an arm’s length ceding fee. As of September 30, 2005, the Company has entered into an agreement to sell the AMEX Assurance legal entity to American Express within two years after separation for a fixed price equal to the net book value of AMEX Assurance as of the separation date, which approximates $115 million.
In connection with the Distribution, American Express provided the Company a capital contribution of approximately $1.1 billion, which is in addition to the $164 million capital contribution noted above.
As a result of the Distribution, Ameriprise has entered into an unsecured bridge loan in the amount of $1.4 billion. That loan was drawn in September 2005. Refer to Note 5 for further discussion.
Ameriprise has incurred significant non-recurring separation costs as a result of the separation from American Express. Separation costs generally consisted of expenses related to advisor retention program costs, technology costs and costs associated with establishing the Ameriprise Financial brand. During the quarter ended September 30, 2005, $92 million ($59 million after-tax) of such costs were incurred. For the nine months ended September 30, 2005 actual costs have totaled $168 million pretax ($109 million after-tax).
American Express has historically provided a variety of corporate and other support services for Ameriprise, including information technology, treasury, accounting, financial reporting, tax administration, human resources, marketing, legal, procurement and other services. American Express will continue to provide Ameriprise with many of these services pursuant to a transition services agreement for transition periods of up to two years following the separation and distribution, and Ameriprise will arrange to procure other services pursuant to arrangements with third parties or through the Company’s own employees.
Retirement plans are in the process of being segregated. See Note 11 for further discussion. The new plans are substantially consistent with old plans.
Additionally, a tax allocation agreement with American Express was signed effective September 30, 2005. See Note 12 for further discussion.
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2. Basis of Presentation and Recent Accounting Pronouncements
Basis of Presentation
The Company is a financial planning and financial services company that offers solutions for its clients’ asset accumulation, income management and protection needs. The Company has two main operating segments: (i) Asset Accumulation and Income and (ii) Protection. These two operating segments are aligned with the financial solutions the Company offers to address its clients’ needs. The Asset Accumulation and Income business offers mutual funds as well as its own annuities and other asset accumulation and income management products and services to retail clients through its advisor network. The Company offers its annuity products through outside channels, such as banks and broker-dealer networks. This operating segment also serves institutional clients in the separately managed account, sub-advisory and 401(k) markets, among others. The Protection segment offers various life, disability income, long-term care, and brokered insurance products through the Company’s advisor network. The Company offers personal auto and home insurance products on a direct basis to retail clients principally through its strategic marketing alliances.
The Company has a Corporate and Other segment, which consists of income derived from corporate level assets and unallocated corporate expenses, primarily separation costs, as well as the results of its subsidiary, Securities America Financial Corporation, which operates its own independent separately branded distribution platform.
The interim financial information in this report has not been audited. In the opinion of management, all adjustments necessary for a fair statement of the consolidated financial position and the consolidated results of operations for the interim periods have been made. All adjustments made were of a normal, recurring nature. Results of operations reported for interim periods are not necessarily indicative of results for the entire year.
Principles of Consolidation
The accompanying consolidated financial statements should be read in conjunction with the financial statements which are included in the Securities and Exchange Commission (SEC) Form 10 registration statement of Ameriprise Financial, Inc. filed on August 19, 2005. All material intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications of prior period amounts have been made to conform to the current presentation.
Recently Issued Accounting Standards
On November 3, 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” FSP FAS 115-1 and FAS 124-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary and the measurement of loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP FAS 115-1 and FAS 124-1 are effective for reporting periods beginning after December 15, 2005. The Company is currently evaluating the impact of FSP FAS 115-1 and FAS 124-1 on the Company’s results of operations and financial position.
In September 2005, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts” (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment
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contracts other than those specifically described in Statement of Financial Accounting Standards (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 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. The Company is currently evaluating the impact of SOP 05-1 on the Company’s results of operations and financial position.
Effective July 1, 2005, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123(R)). SFAS No. 123(R) requires entities to measure and recognize the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). In January 2003, the Company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), prospectively for all American Express stock options granted to the Company’s employees after December 31, 2002. Substantially all stock options for which intrinsic value accounting was continued under Accounting Principles Board (APB) Opinion No. 25 were vested as of June 30, 2005. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. The effect of adopting SFAS 123(R) on the Company’s results of operations and financial position, using a modified prospective application, was insignificant. In March 2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107 (SAB No. 107), which summarizes the staff’s views regarding share-based payment arrangements for public companies. The Company took into account the views included in SAB No. 107 in its adoption of SFAS No. 123(R).
In June 2004, the FASB issued FSP No. 97-1, “Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments (SFAS No. 97), Permit or Require Accrual of an Unearned Revenue Liability” (FSP 97-1). The implementation of the AICPA SOP 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (SOP 03-1) raised a question regarding the interpretation of the requirements of SFAS No. 97 concerning when it is appropriate to record an unearned revenue liability. FSP 97-1 clarifies that SFAS No. 97 is clear in its intent and language, and requires the recognition of an unearned revenue liability for amounts that have been assessed to compensate insurers for services to be performed over future periods. SOP 03-1 describes one situation, when assessments result in profits followed by losses, where an unearned revenue liability is required. SOP 03-1 does not amend SFAS No. 97 or limit the recognition of an unearned revenue liability to the situation described in SOP 03-1. The guidance in FSP 97-1 is effective for financial statements for fiscal periods beginning after June 18, 2004. The adoption of FSP 97-1 did not have a material impact on the Company’s consolidated financial condition or results of operations.
Effective January 1, 2004, the Company adopted SOP 03-1 which provides guidance on: (i) the classification and valuation of long-duration contract liabilities; (ii) the accounting for sales inducements; and (iii) separate account presentation and valuation. The adoption of SOP 03-1 as of January 1, 2004, resulted in a cumulative effect of accounting change that reduced first quarter 2004 results by $71 million ($109 million pretax). The cumulative effect of accounting change consisted of: (i) $43 million pretax from establishing additional liabilities for certain variable annuity guaranteed benefits ($33 million) and from considering these liabilities in valuing deferred acquisition costs (DAC) and deferred sales inducement costs associated with those contracts ($10 million) and (ii) $66 million pretax from establishing additional liabilities for certain variable universal life and single pay universal life insurance contracts under which contractual costs of insurance charges are expected to be less than future death benefits ($92 million) and from considering these liabilities in valuing DAC associated with those contracts ($26 million offset). Prior to the adoption of SOP 03-1, amounts paid in excess of contract value were expensed when payable. Amounts expensed in 2004 to establish and maintain additional liabilities for certain variable annuity guaranteed benefits were $53 million (of which $33 million was part of the adoption charges discussed earlier) as compared to amounts expensed in 2003 and 2002 of $32 million and $37 million, respectively. The Company’s accounting for separate accounts was already consistent with the provisions of SOP 03-1 and, therefore, there was no impact related to this requirement.
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The AICPA released a series of technical practice aids (TPAs) in September 2004, which provide additional guidance related to, among other things, the definition of an insurance benefit feature and the definition of policy assessments in determining benefit liabilities, as described within SOP 03-1. The TPAs did not have a material effect on the Company’s calculation of liabilities that were recorded in the first quarter of 2004 upon adoption of SOP 03-1.
3. Investments
The following is a summary of investments at September 30, 2005 and December 31, 2004:
Gross realized gains and losses on sales and losses recognized for other-than-temporary impairments of securities classified as Available-for-Sale, using the specific identification method, were as follows for the three and nine months ended September 30, 2005 and 2004:
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4. Deferred Acquisition Costs
The balances and changes in deferred acquisition costs from January 1, 2004 through September 30, 2005 were:
(a) Primarily relates to a $66 million reduction in DAC amortization expense to reflect the lengthening of the amortization periods for certain annuity and life insurance products impacted by the adoption by the Company of SOP 03-1 on January 1, 2004, partially offset by a $10 million increase in amortization expense due to a long-term care DAC valuation system conversion.
5. Short-term Debt
In September 2005, the Company entered into an unsecured bridge loan facility in the amount of $1.4 billion, which matures in September 2006. At September 30, 2005, $1.4 billion was outstanding under this facility. The interest rate is variable based on one month LIBOR plus a spread and was 4.275% at September 30, 2005. In September 2005, the Company also obtained an unsecured revolving credit facility for $750 million expiring in September 2010 from various third party financial institutions and as of September 30, 2005, the Company had drawn no balance on that line. Under the terms of the revolving credit facility, the Company may increase the amount of the facility to $1.0 billion. At September 30, 2005, the Company was in compliance with all debt covenants related to these facilities.
6. Variable Interest Entities
AMEX Assurance maintains the required licenses to offer insurance in various states and both IDS Property Casualty, a subsidiary of the Company, and American Express utilize those licenses to offer their products in exchange for a ceding fee. AMEX Assurance has entered into separate reinsurance agreements with IDS Property Casualty and American Express to transfer insurance related risks to the respective companies. As discussed in Note 1, effective September 30, 2005, the Company entered into an agreement to sell its interest in the AMEX Assurance legal entity to American Express within two years after separation for a fixed price. This transaction, combined with ceding of all travel and other card insurance business to American Express, created a variable interest entity for which the Company has a significant interest but is not the primary beneficiary based on the Company’s variability in losses and returns relative to other variable interest holders. Accordingly, the Company deconsolidated AMEX Assurance as of September 30, 2005. AMEX Assurance had $413 million of total assets as of December 31, 2004, and $215 million of total revenues and $103 million of net income for the year ended December 31, 2004. The maximum exposure to loss as a result of the Company’s interest in AMEX Assurance is represented by the agreed-upon fixed sales price, which approximates $115 million.
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7. Discontinued Operations
Effective August 1, 2005, the Company transferred its ownership interest and the related assets and liabilities of its consolidated subsidiary, AEIDC, to American Express for $164 million through a non-cash dividend equal to the net book value of AEIDC excluding net unrealized investment losses of $26 million and accordingly no gain or loss was recorded. In connection with the AEIDC transfer, American Express made a cash capital contribution of $164 million to the Company. The assets, liabilities and operations of AEIDC are shown as discontinued operations in the accompanying financial statements.
The components of earnings from discontinued operations for the three and nine months ended September 30, 2005 and 2004 are as follows:
The assets and liabilities associated with discontinued operations included in the Company’s Consolidated Balance Sheet as of December 31, 2004 consisted of the following:
8. Related Party Transactions
The Company has entered into various transactions with American Express in the normal course of business. The Company earned approximately $4 million and $10 million during the three month and nine month periods ended September 30, 2005, and approximately $2 million and $6 million during the three month and nine
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month periods ended September 30, 2004, respectively, in revenues from American Express. The Company received approximately $8 million and $26 million for the three month and nine month periods ended September 30, 2005 and $21 million and $57 million for the three month and nine month periods ended September 30, 2004, respectively, of reimbursements from American Express for the Company’s participation in certain corporate initiatives. As a result of the separation from American Express, the Company determined it appropriate to reflect certain reimbursements previously received from American Express for costs incurred related to certain American Express-related corporate initiatives, as capital contributions rather than reductions to expense amounts. These amounts were approximately $8 million and $26 million for the three month and nine month periods ended September 30, 2005 and $13 million and $32 million for the three month and nine month periods ended September 30, 2004, respectively.
9. Share-Based Compensation
The Company approved the Ameriprise Financial 2005 Incentive Compensation Plan (the Plan) as of September 30, 2005. Under the Plan, stock and cash incentive awards may be granted to employees, directors and independent contractors including stock options, restricted stock awards, restricted stock units, performance shares and similar awards designed to comply with the applicable federal regulations and laws of jurisdiction. Under the Plan, the maximum number of shares of common stock that may be covered by the stock-based awards shall generally not exceed 37.9 million shares.
At September 30, 2005, the Company also entered into an Employee Benefits Agreement (EBA) with American Express as part of the Distribution. In accordance with the EBA, all American Express stock options and restricted stock awards held by the Company’s employees and vesting on or before December 31, 2005 will remain American Express stock options or restricted stock awards. However, all American Express stock options and restricted stock awards held by the Company’s employees and not vesting on or before December 31, 2005, will be substituted by a stock option or restricted stock award issued under the Plan and subject to the terms and conditions after the Distribution that are substantially similar to the terms and conditions applicable to the original American Express stock options and restricted stock awards.
Stock options granted under the Plan must have an exercise price not less than 100% of the current fair market value of a share of common stock on the grant date and a term of no more than ten years. Options substituted pursuant to the EBA on September 30, 2005 resulted from converting the number of American Express options and strike prices to a number of the Company’s stock options and strike prices in order to maintain the same intrinsic value to the employee. The conversion was based on the pre-distribution American Express closing price relative to the post-distribution Ameriprise closing price on September 30, 2005. The stock options substituted maintain a vesting schedule which is the same as the American Express stock options. Generally, these stock options had an original vesting schedule of four years and vest ratably at 25 percent per year. A similar conversion process was completed to determine the number of the Company’s restricted stock awards granted on September 30, 2005 to replace American Express restricted stock awards. The restricted stock awards also maintain a vesting schedule which is the same as the American Express restricted stock awards and generally have an original vesting schedule of four years with 25 percent ratable vesting per year.
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A summary of the conversion of American Express stock options to the Company’s stock options under the Plan as of September 30, 2005 is presented below (shares and intrinsic value in millions):
(a) Conversion factor for number of shares is the ratio of the American Express pre-distribution closing stock price ($57.44) to the Company’s post-distribution stock price ($35.80). Conversion factor for the strike price is the ratio of the Company’s post-distribution stock price ($35.80) to the American Express pre-distribution closing stock price ($57.44).
The weighted average grant date fair value of each American Express-related option during the nine month periods ended September 30, 2005 and 2004 was $12.59 and $13.27, respectively. The fair value of each American Express option granted was estimated on the date of grant using a Black-Scholes option-pricing model with assumptions determined by American Express. The Company will compare the pre-distribution fair value of the American Express options as of September 30, 2005 to the post-distribution fair value of the Company’s options using the Company’s stock volatility and other applicable assumptions to determine whether there was any incremental value associated with the substituted awards.
A summary of the conversion of American Express non-vested shares, primarily consisting of restricted stock awards, granted to the Company’s employees to the Company’s awards under the Plan as of September 30, 2005 is presented below (shares in millions):
(a) Conversion factor for number of shares is the ratio of the American Express pre-distribution closing stock price ($57.44) to the Company’s post-distribution stock price ($35.80).
The Company expensed $15 million and $10 million for the three months ended September 30, 2005 and 2004, respectively, and $39 million and $30 million for the nine months ended September 30, 2005 and 2004, respectively, related to American Express stock options granted to the Company’s employees January 1, 2003 or later and all American Express restricted stock awards granted to the Company’s employees. The total income tax benefit recognized by the Company for American Express stock options and restricted stock awards granted to the Company’s employees was $5 million and $4 million for the three months ended September 30, 2005 and 2004, respectively, and $14 million and $11 million for the nine months ended September 30, 2005 and 2004, respectively.
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As of September 30, 2005, there was $106 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 2.6 years.
10. Commitments and Contingencies
The SEC, the National Association of Securities Dealers (NASD) and several state attorneys general have brought proceedings challenging several mutual fund industry practices, including late trading, market timing, and disclosure of revenue sharing arrangements, which are paid by fund advisors or companies to brokerage firms who agree to sell those funds. The Company has received requests for information and has been contacted by regulatory authorities concerning its practices and is cooperating fully with these inquiries.
On March 21, 2005, the Company’s broker-dealer subsidiary entered into an agreement with the NASD to settle alleged violations of NASD rules arising from the sale to customers of B mutual fund shares between January 1, 2002 and July 31, 2003. The Company’s agreement with the NASD is one of several that the NASD entered into with certain brokerage firms regarding allegedly inappropriate sales of B shares. Under the terms of the settlement, the Company consented to the payment of a fine to the NASD in the amount of $13 million. The Company established reserves in prior quarters to cover the payment of the fine. The Company also agreed to offer certain customers who purchased B shares in any fund family from January 1, 2002 through the date of the settlement and continued to hold such shares the option of converting their B shares into a number of A shares equal to (x) the number of A shares that the customer could have purchased on the date(s) that they purchased their B shares plus (y) any shares reflecting reinvestment of dividends. The Company agreed to pay cash to certain customers who have sold a portion or all of their B shares in order to put them in substantially the same financial position (based on actual fund performance and redemption value) in which such customers would have been had the customers purchased A shares instead of B shares.
In July 2005, the Company settled an action brought by the New Hampshire Bureau of Securities Regulation (the NHBSR) alleging that the Company failed to disclose revenue sharing and directed brokerage payments received from non-proprietary mutual funds, and failed to disclose incentives for advisors to sell proprietary products and other alleged conflicts of interest. The Company has completed payment of $5 million in fines and penalties to the NHBSR and the reimbursement of the costs incurred by the NHBSR for its investigation. The Company is cooperating with the NHBSR to make payment of up to $2 million in restitution to New Hampshire customers who meet specified criteria.
The Company has received requests for information from the SEC, NASD and various state regulatory authorities on a variety of activities and practices, including sales of other companies’ REIT shares, sales of its mutual funds and non-cash compensation paid to its financial advisors and is cooperating fully with the applicable regulators regarding their requests for information.
The Company has reached a comprehensive settlement regarding the consolidated securities class action lawsuit filed against the Company, its former parent and affiliates in October 2004 called, “In re American Express Financial Advisors Securities Litigation.” The settlement, under which the Company denies any liability, includes a one-time payment of $100 million to the class members. The settlement is subject to court approval. The class members include individuals who purchased mutual funds in the Company’s Preferred Provider Program, Select Group Program, or any similar revenue sharing program; purchased mutual funds sold under the American Express ® or AXP ® brand; or purchased for a fee financial plans or advice from the Company between March 10, 1999 and through the date on which a formal stipulation of settlement is signed. The Company’s litigation reserve is sufficient to cover the contingent liability for the settlement. The reserve for this litigation was increased by $70 million pretax, $46 million after-tax, at September 30, 2005 from the reserve at June 30, 2005. The impact of this reserve increase is reflected as an expense on the Company’s statement of operations for the quarter ended September 30, 2005.
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In November 2002, a suit, now captioned Haritos et al. v. American Express Financial Advisors, Inc., was filed in the United States District Court for the District of Arizona. The suit was filed by plaintiffs who purport to represent a class of all persons that have purchased financial plans from the Company’s advisors from November 1997 through July 2004. Plaintiffs allege that the sale of the plans violates the Investment Advisers Act of 1940, or the IAA. The suit seeks an unspecified amount of damages, rescission of the investment advisor plans and restitution of monies paid for such plans. In February 2005, the Court denied the Company’s motion to dismiss the Second Amended Complaint. The Company has filed a motion to stay the Haritos proceedings pending approval of the settlement in In re American Express Financial Advisors Securities Litigation. Plaintiffs have opposed the motion.
In June 2004, an action captioned John E. Gallus et al. v. American Express Financial Corp. and American Express Financial Advisors, Inc. was filed in the United States District Court for the District of Arizona. The plaintiffs allege that they are investors in several AXP mutual funds and they purport to bring the action derivatively on behalf of those funds under the Investment Company Act of 1940. The plaintiffs allege that fees allegedly paid to the defendants by the funds for investment advisory and administrative services are excessive. The plaintiffs seek remedies including restitution and rescission of investment advisory and distribution agreements. The plaintiffs voluntarily agreed to transfer this case to the United States District Court for the District of Minnesota. In response to our motion to dismiss the complaint, the Court dismissed one of plaintiffs’ four claims and granted plaintiffs limited discovery.
From time to time, the Company is involved in legal, regulatory and arbitration proceedings, including class actions concerning matters arising in connection with the conduct of its business activities. These proceedings are subject to uncertainties and, as such, the Company is unable to estimate the possible loss or range of loss that may result. An adverse outcome in one or more of these proceedings could have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.
The IRS routinely examines the Company’s federal income tax returns and recently completed its audit of the Company for the 1993 through 1996 tax years. The IRS is currently conducting an audit of the Company for the 1997 through 2002 tax years. Management does not believe there will be a material adverse effect on the Company’s consolidated financial position and results of operations as a result of these audits.
11. Retirement Plans and Other Profit Sharing Arrangements
The components of the net pension cost for all defined benefit plans are as follows:
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The net periodic postretirement benefit expense recognized for the three months ended September 30, 2005 and 2004 was $0.6 million and $0.2 million, respectively, and $1.7 million and $1.9 million for the nine months ended September 30, 2005 and 2004.
On September 30, 2005, the Company entered into an Employee Benefits Agreement (the EBA) with American Express that allocates certain liabilities and responsibilities relating to employee compensation and benefit plans and programs and other related matters in connection with the Distribution including the general treatment of outstanding American Express equity awards, certain outstanding annual and long-term incentive awards, existing deferred compensation obligations, and certain retirement and welfare benefit obligations. The EBA provides that as of the date of the Distribution, Ameriprise generally will assume, retain and be liable for all wages, salaries, welfare, incentive compensation, and employee-related obligations and liabilities for all of its current and former employees. The EBA also provides for the transfer of qualified plan assets and transfer of liabilities relating to the pre-distribution participation of Ameriprise’s employees in American Express’ various retirement, welfare, and employee benefit plans from such plans to the applicable plans Ameriprise has adopted for the benefit of its employees.
12. Income Taxes
The Company’s effective tax rate was 32.2% during the three months ended September 30, 2005 compared to 27.7% during the three months ended September 30, 2004. The increased effective tax rate reflects a $20 million tax expense applicable to prior years partially offset by a $7 million tax benefit related to the finalization of the prior year tax return, as well as relatively lower levels of pretax income compared to tax-advantaged items in 2005. The Company’s effective tax rate was 27.7% during the nine months ended September 30, 2005, which resulted from relatively lower levels of pretax income compared to tax-advantaged items in 2005, reflecting 2005 separation costs, and a $3 million tax benefit resulting from an IRS audit of previous years’ tax returns. Additionally, as noted above, there was a $20 million tax expense applicable to prior years and a $7 million tax benefit related to the finalization of the prior year tax return, as well as, non-tax deductible charges that the Company does not expect to occur in future periods. The Company’s effective tax rate was 29.7% during the nine months ended September 30, 2004, which reflects a $16 million tax expense due to required amendments to prior year tax returns.
The Company is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. Among our deferred tax assets is a significant deferred tax asset relating to capital losses realized for tax return purposes and capital losses that have been recognized for financial statement purposes but not yet for tax return purposes. Under current U.S. federal income tax law, capital losses generally must be used against capital gain income within five years of the year in which the capital losses are recognized for tax purposes. The Company has less than $50 million in capital loss carryforwards that must be utilized by December 31, 2005, as well as additional capital loss carryforwards that expire December 31, 2009. Based on analysis of the Company’s tax position, management believes it is more likely than not that the results of future operations and implementation of tax planning strategies will generate sufficient taxable income to enable the Company to utilize all of its deferred tax assets. Accordingly, no valuation allowance for deferred tax assets has been established.
As a result of our separation from American Express, the Company will be required to file a short period income tax return through September 30, 2005 which will be included as part of the American Express consolidated income tax return for the year ending December 31, 2005. The Company will also be required to file two separate short period consolidated income tax returns for the period October 1, 2005 through December 31, 2005, one including our life insurance subsidiaries and one for all of the non-life insurance companies required to be included in a consolidated income tax return.
On September 30, 2005, the Company entered into a Tax Allocation Agreement (the Tax Allocation Agreement) with American Express. The Tax Allocation Agreement governs the allocation of consolidated
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U.S. federal and applicable combined or unitary state and local income tax liability as between American Express and the Company for tax periods prior to September 30, 2005, and in addition provides for certain restrictions and indemnities in connection with the tax treatment of the Distribution and addresses other tax-related matters.
13. Earnings per Common Share
Basic and diluted earnings per share are calculated by dividing historical earnings for the three months and nine months ended September 30, 2005 and 2004 by the actual shares outstanding for all periods presented as retroactively adjusted for the stock split. The Company had no dilutive shares outstanding for all periods as all share-based compensation was granted on American Express common shares and, as a result, there were no share-based awards outstanding until the September 30, 2005 conversion discussed in Note 9. The computations of basic and diluted EPS for the three and nine months ended September 30, 2005 and 2004 are as follows:
14. Derivatives and Hedging Activities
During June 2005, the Company entered into $1.5 billion notional forward starting interest rate swaps to hedge its interest rate risk associated with the forecasted issuance of $1.5 billion of long-term debt. No portions of the swaps were excluded from the assessment of hedge effectiveness. The loss resulting from ineffectiveness associated with this cash flow hedge was not material and was reclassified out of other comprehensive income and reflected as an expense in the third quarter.
15. Segment Information
The Company has two main operating segments: (i) Asset Accumulation and Income and (ii) Protection. These two operating segments are aligned with the financial solutions the Company offers to address its clients’ needs. The Asset Accumulation and Income business offers mutual funds, annuities and other asset accumulation and income management products and services to retail clients through its advisor network. The Company also offers its annuity products through outside channels, such as banks and broker-dealer networks. This operating segment also serves institutional clients in the separately managed account, sub-advisory and 401(k) markets, among others. The Protection segment offers various life insurance, disability income and long-term care, and brokered insurance products through the Company’s advisor network. The Company also offers personal auto and home insurance products on a direct basis to retail clients principally through its strategic marketing alliances.
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The Company also has a Corporate and Other segment, which consists of income derived from corporate level assets and unallocated corporate expenses, primarily separation costs, as well as the results of its subsidiary, Securities America Financial Corporation, which operates its own independent separately branded distribution platform. The Corporate and Other segment also includes the assets representing capital that has not been allocated to any other segment. Financial results of the corporate and other segment primarily reflect the Company’s financing activities (including interest expense), income on capital not allocated to other segments, income tax risks and certain income, expenses and other after-tax adjustments not allocated to the segments based on the nature of such items.
The following is a summary of assets by operating segment:
The following is a summary of segment activity for the three months ended September 30:
(a) Represents the amortization expense for deferred acquisition costs, deferred sales inducement costs and intangible assets.
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AMERIPRISE FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
The following is a summary of segment activity for the nine months ended September 30:
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