Item 1. Business
IDS Certificate Company (IDSC) is incorporated under the laws of Delaware. Its principal executive offices are located in the IDS Tower, Minneapolis, Minnesota, and its telephone number is (612) 671-3131. American Express Financial Corporation (formerly know as IDS Financial Corporation), a Delaware corporation, IDS Tower 10, Minneapolis, Minnesota 55440-0010, owns 100% of the outstanding voting securities of IDSC. As of January 1, 1995, IDS Financial Corporation changed its name to American Express Financial Corporation. American Express Financial Corporation is a wholly owned subsidiary of American Express Company (American Express), a New York Corporation, with headquarters at American Express Tower, World Financial Center, New York, New York.
IDSC is a face-amount certificate investment company registered under the Investment Company Act of 1940 (1940 Act). IDSC is in the business of issuing face-amount certificates. Face-amount certificates issued by IDSC entitle the certificate holder to receive, at maturity, a stated amount of money and interest or credits declared from time to time by IDSC, in its discretion.
IDSC is continuously engaged in new product development. IDSC currently offers seven certificates to the public: "IDS Future Value Certificate", "IDS Cash Reserve Certificate", "IDS Flexible Savings Certificate" (formerly "IDS Variable Term Certificate"), "IDS Installment Certificate", "IDS Stock Market Certificate", "IDS Investors Certificate" and "IDS Special Deposits". The IDS Special Deposits is only offered for sale in London, England, and is not registered for sale in the United States. All certificates are currently sold without a sales charge. The IDS Installment Certificate, the IDS Flexible Savings Certificate, the IDS Stock Market Certificate, the IDS Investors Certificate and the IDS Special Deposits currently bear surrender charges for premature surrenders. All of the above described certificates, except the IDS Special Deposits, are distributed pursuant to a Distribution Agreement with American Express Financial Advisors Inc. (formerly known as IDS Financial Services Inc.), an affiliate of IDSC. With respect to the IDS Investors Certificate and the IDS Stock Market Certificate, American Express Financial Advisors Inc., in turn, has Selling Agent Agreements with American Express Bank International (AEBI), a subsidiary of American Express, and Coutts & Co. (USA) International (Coutts), a subsidiary of NatWest PLC, for selling the certificates. American Express Financial Advisors Inc. also distributes the IDS Stock Market Certificate. With respect to the IDS Special Deposits, IDSC has a Marketing Agreement with American Express Bank Ltd. (AEB), a subsidiary of American Express, for marketing the certificate.
AEBI and Coutts are Edge Act corporations organized under the provisions of Section 25(a) of the Federal Reserve Act. American Express Financial Advisors Inc. has entered into a consulting agreement with AEBI under which AEBI provides consulting services related to any selling agent agreements between American Express Financial Advisors Inc. and other Edge Act corporations.
IDSC also offers one certificate in connection with certain employee benefit plans available to eligible American Express Financial Corporation employees, financial advisors and retirees. This certificate is called the Series D-1 Investment Certificate.
Except for the IDS Investors Certificate and the IDS Special Deposits, all of the certificates are available as qualified investments for Individual Retirement Accounts (IRAs), or 401(k) plans and other qualified retirement plans.
The specified maturities of the certificates range from four to twenty years. Within that maturity period, most certificates have terms ranging from three to thirty-six months. Interest rates change and certificateholders can surrender their certificates without penalty at term end.
The IDS Future Value Certificate is a single payment certificate on which IDSC guarantees interest in advance for a 4, 5, 6, 7, 8, 9 or 10-year maturity, at the buyer's option.
The IDS Cash Reserve Certificate is a single pay certificate that permits additional investments and on which IDSC guarantees interest in advance for a three-month term.
The IDS Flexible Savings Certificate is a single payment certificate that permits a limited amount of additional payments and on which IDSC guarantees interest in advance for a term of 6, 12, 18, 24, 30 or 36 months, and potentially other terms, at the buyer's option.
The IDS Installment Certificate is an installment payment certificate that declares interest in advance for a three-month period and offers bonuses in the third through sixth years for regular investments.
The IDS Stock Market Certificate is a single payment certificate that offers the certificate holder the opportunity to have all or part of his/her interest tied to stock market performance, as measured by a broad stock market index, with return of principal guaranteed by IDSC. The holder can also choose to earn a fixed rate of interest. In addition to being sold to clients of American Express Financial Advisors Inc. pursuant to a Distribution Agreement with American Express Financial Advisors Inc., this certificate is sold by AEBI and Coutts under Selling Agent Agreements with American Express Financial Advisors Inc. to AEBI's clients and certain of Coutts' clients, respectively, who are neither citizens nor residents of the United States.
The IDS Investors Certificate is a single payment certificate that generally permits additional payments within 15 days of term renewal. Interest rates are guaranteed in advance by IDSC for a term of 1, 2, 3, 6, 12, 24 or 36 months, at thebuyer's option. This certificate is currently sold by AEBI and Coutts, through Selling Agent Agreements with American Express Financial Advisors Inc., only to AEBI's clients and certain of Coutts' clients, respectively, who are neither citizens nor residents of the United States.
The IDS Special Deposits is a single payment certificate that permits additional payments within 15 days of term renewal. Interest rates are guaranteed in advance by IDSC for a term of 1, 2, 3, 6, 12, 24 or 36 months, at the buyer's option. This certificate is currently marketed by AEB in the London office, through a Marketing Agreement with IDSC, only to AEB's clients who are neither citizens nor residents of the United States. This certificate is not registered for sale in the United States.
IDSC is by far the largest issuer of face-amount certificates in the United States. However, such certificates compete with many other investments offered by banks, savings and loan associations, mutual funds, broker-dealers and others, which may be viewed by potential clients as offering a comparable or superior combination of safety and return on investment. In particular, some of IDSC's products are designed to be competitive with the types of investment offered by banks and thrifts. Since IDSC's face-amount certificates are securities, their offer and sale are subject to regulation under federal and state securities laws. IDSC's certificates are backed by its qualified assets on deposit and are not insured by any governmental agency or other entity.
For all of the certificates, except for the IDS Investors Certificate and the IDS Special Deposits, IDSC's current policy is to re-evaluate the certificate rates weekly to respond to marketplace changes. For the IDS Investors Certificate and the IDS Special Deposits, IDSC's current policy is to re-evaluate the rates on a daily basis. For each product, IDSC refers to an independent index to set the rates for new sales. Except for IDS Special Deposits, IDSC must set the rates for an initial purchase of the certificate within a specified range of the rate from such index. For renewals, IDSC uses such rates as an indication of the competitors' rates, but is not required to set rates within a specified range.
For the IDS Flexible Savings Certificate, IDS Cash Reserve Certificate and the IDS Series D-1 Investment Certificate, the published rates of the BANK RATE MONITOR Top 25 Market Averagetm for various length bank certificates of deposit are used as the guide in setting rates. For the IDS Installment Certificate, the average interest rate for money market deposit accounts, as published by the BANK RATE MONITOR Top 25 Market Average (the BRM Average), is used as a guide in setting rates. For the IDS Future Value Certificate, the average quoted yields of certain U.S. Treasury Bonds for similar maturities, as published in the Wall Street Journal and the New York Times, are currently used as a guide in setting rates. IDSC is developing an alternative guide for Future Value certificates using the published rates of the BANK RATE MONITOR Top 25 Market Averagetm . For the IDS Investors Certificate and IDS Special Deposits, the published average rates for comparable length dollar deposits available on an interbank basis, referred to as the London Interbank Offered Rates (LIBOR), are used as a guide in setting rates. To compete with popular short-term investment vehicles such as certificates of deposit, money market certificates and money market mutual funds that offer comparable yields, liquidity and safety of principal, IDSC offers the IDS Cash Reserve Certificate and the IDS Flexible Savings Certificate. The yields and features on these products are designed to be competitive with such short-term products. The IDS Investors Certificate and IDS Special Deposits also compete with short-term products but use LIBOR rates. The IDS Future Value Certificate has certain features similar to those of zero coupon bonds and is intended to compete with that type of investment as well as with intermediate to long-term certificates of deposit. The IDS Installment Certificate is intended to help clients save systematically and may compete with passbook savings and NOW accounts. The IDS Stock Market Certificate is designed to offer interest tied to a major stock market index and principal guaranteed by IDSC. Certain banks offer certificates of deposit that have features similar to the Stock Market Certificate.
IDSC's gross income is derived principally from interest and dividends generated by its investments. IDSC's net income is determined by deducting from such gross income its provision for certificate reserves, and other expenses, including taxes, the fee paid to American Express Financial Corporation for advisory and other services, the distribution fees paid to American Express Financial Advisors Inc., and marketing fees paid to AEB.
The following table shows IDSC's certificate payments received and certificate surrenders for the three years ended December 31, 1994:
1994 1993 1992 Single Payment Certificates ($ in millions) Non-Qualified Payments through American Express Financial Advisors Inc. $ 802.4 $ 581.5 $ 613.4 AEBI, AEB and Coutts 436.0 243.0 442.5 Surrenders through American Express Financial Advisors Inc. 753.6 882.8 1,004.5 AEBI, AEB and Coutts 429.2 395.3 507.3
Qualified Through American Express Financial Advisors Inc. Payments 264.9 166.8 217.1 Surrenders 238.5 276.7 352.9
Installment Payment Certificates Through American Express Financial Advisors Inc.
Non-Qualified Payments 107.6 108.2 102.5 Surrenders 116.6 103.6 99.9
Qualified Payments 2.9 3.9 4.8 Surrenders 7.8 8.0 18.4 In 1994, approximately 29% of single payment certificate payments were through AEBI, AEB and Coutts and approximately 18% of single payment certificate payments and 3% of installment certificate payments were of tax-qualified certificates for use in IRAs, 401(k) plans and other qualified retirement plans.
The certificates offered by American Express Financial Advisors Inc. are sold pursuant to a distribution agreement which is terminable on 60 days' notice and is subject to annual approval by IDSC's Board of Directors, including a majority of the directors who are not "interested persons" of American Express Financial Advisors Inc. or IDSC as that term is defined in the 1940 Act. The agreement provides for the payment of distribution fees to American Express Financial Advisors Inc. for services provided thereunder. American Express Financial Advisors Inc. is a wholly owned subsidiary of American Express Financial Corporation. For the distribution of the IDS Investors Certificate, American Express Financial Advisors Inc., in turn, has Selling Agent Agreements with AEBI and Coutts. For marketing IDS Special Deposits, IDSC has a Marketing Agreement with AEB. These agreements are terminable upon 60 days' notice and subject to annual review by the directors who are not "interested persons" of American Express Financial Advisors Inc. or IDSC.
IDSC receives advice, statistical data and recommendations with respect to the acquisition and disposition of securities for its portfolio from American Express Financial Corporation, under an investment management agreement which is subject to annual renewal by IDSC's Board of Directors, including a majority of the directors who are not "interested persons" of American Express Financial Corporation or IDSC.
IDSC is required to maintain "qualified investments" meeting the standards of Section 28(b) of the 1940 Act. The amortized cost of said investments must be at least equal to IDSC's net liabilities on all outstanding face-amount certificates plus $250,000. IDSC's qualified assets consist of cash and cash equivalents, first mortgage loans on real estate, U.S. government and government agency securities, municipal bonds, corporate bonds, preferred stocks and other securities meeting specified standards. IDSC is subject to annual examination and supervision by the State of Minnesota, Department of Commerce (Banking Division).
Distribution fees on sales of certain certificates are deferred and amortized over the estimated lives of the related certificates, which is approximately 10 years. Upon surrender, unamortized deferred distribution fees are charged against income. Thus, these certificates must remain in effect for a period of time to permit IDSC to recover such costs.
Item 2.
Item 2. Properties
None.
Item 3.
Item 3. Legal Proceedings
Registrant has no material pending legal proceedings other than ordinary routine litigation incidental to its business.Item 4.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
There is no market for the Registrant's common stock since it is a wholly owned subsidiary of American Express Financial Corporation and, indirectly, of American Express. Frequency and amount of dividends declared during the past two years are as follows:
Dividend Payable Date Cash
For year ended December 31, 1994: February 10, 1994 $12,400,000 May 10, 1994 12,400,000 August 10, 1994 12,400,000 December 29, 1994 3,000,000 Total $40,200,000
Dividend Payable Date Cash
For year ended December 31, 1993: February 9, 1993 $11,000,000 May 13, 1993 13,000,000 August 10, 1993 13,000,000 November 10, 1993 12,500,000 December 31, 1993 15,000,000 Total $64,500,000
Restriction on the Registrant's present or future ability to pay dividends:
Certain series of installment certificates outstanding provide that cash dividends may be paid by IDSC only in calendar years for which additional credits of at least 1/2 of 1% on such series of certificates have been authorized by IDSC. This restriction has been removed for 1995 and 1996 by action of IDSC on additional credits in excess of this requirement.
Appropriated retained earnings resulting from the predeclaration of additional credits to IDSC's certificate holders are not available for the payment of dividends by IDSC. In addition, IDSC will discontinue issuance of certificates subject to the predeclaration of additional credits and will make no further predeclaration as to outstanding certificates if at any time the capital and unappropriated retained earnings of IDSC should be less than 5% of net certificate reserves (certificate reserves less certificate loans). At December 31, 1994, the capital and unappropriated retained earnings amounted to 5.18% of net certificate reserves. Item 6.
Item 6. Selected Financial Data
Summary of selected financial information
The following selected financial information has been derived from the audited financial statements and should be read in conjunction with those statements and the related notes to financial statements. Also see Management's Discussion and Analysis of Financial Condition and Results of Operations for additional comments.
IDS Certificate Company (IDSC) is 100% owned by American Express Financial Corporation (Parent) formerly IDS Financial Corporation.
(a) Consisted of an investment security at amortized cost in 1992 and a reduction in the note receivable from Parent in 1991. Item 7.
Item 7.
Management's discussion and analysis of financial condition and results of operations
Results of operations:
IDS Certificate Company's (IDSC) earnings are derived primarily from the after-tax yield on invested assets less investment expenses and interest credited on certificate reserve liabilities. Changes in earnings' trends occur largely due to changes in the margin between rates of return on investments and rates of interest credited to certificate holder accounts and also, the mix of fully taxable and tax-advantaged investments in the IDSC portfolio.
During the years 1991 through 1993, total assets and certificate reserve liabilities decreased due to certificate maturities and surrenders exceeding certificate sales. The excess of certificate maturities and surrenders over certificate sales in 1993, 1992 and 1991 primarily reflected lower accrual rates declared by IDSC in those years, which in turn, reflected lower interest rates available in the marketplace.
During 1994, total assets and certificate reserves increased due to certificate sales exceeding certificate maturities and surrenders. The excess of certificate sales over certificate maturities and surrenders resulted primarily from higher accrual rates declared by IDSC during the last six months of 1994, reflecting rising interest rates in the marketplace. The increase in total assets in 1994 was tempered by $23 million of net unrealized depreciation on investment securities classified as available for sale, net of deferred taxes of $13 million.
1994 Compared to 1993:
Gross investment income decreased 12% due primarily to a lower average balance of invested assets.
The 10% decrease in investment expenses resulted primarily from lower amortization of the cost of interest rate caps and $2.3 million of reimbursement under cap agreements in 1994. Lower amortization of deferred distribution fees, and lower investment advisory and services fees due to a lower average asset base on which the fee is calculated contributed also, to the decrease in investment expenses.
Net provision for certificate reserves decreased 13% reflecting lower accrual rates during the first six months of the year and a lower average balance of certificate reserves.
The decrease in income tax benefit resulted primarily from lower tax-advantaged income.
1993 Compared to 1992:
Gross investment income decreased 20% due to a lower average balance of invested assets and lower investment yields.
The 6.1% decrease in investment expenses resulted primarily from lower amortization of deferred distribution fees, and lower investment advisory and services fee due to a lower average asset base on which the fee is calculated. These decreases were partially offset by higher amortization of the cost of interest rate caps. The higher amortization reflects additional purchases and accelerated amortization of certain interest rate caps in 1993.
Net provision for certificate reserves decreased 31% reflecting lower accrual rates and a lower average balance of certificate reserves.
The $7.1 million decrease in income tax benefit resulted primarily from lower tax-advantaged income in 1993. The impact of the change in Federal statutory income tax rate in 1993 was an increase in income tax benefit of $.6 million of which $.4 million reflects the increase in rate on the Dec. 31, 1992 balance of temporary differences.
Liquidity and cash flow:
IDSC's principal sources of cash are reserve payments from sales of face-amount certificates and cash flows from investments. In turn, IDSC's principal uses of cash are payments to certificate holders for matured and surrendered certificates, purchase of investments and payments of dividends to the Parent.
Certificate sales volume increased 86% in 1994, reflecting higher accrual rates and clients' ongoing desire for safety of principal. Sales of certificates totaled $1.1 billion compared to $.6 billion in 1993 and $.7 billion during 1992.
IDSC, as an issuer of face-amount certificates, is affected whenever there is a significant change in interest rates. In view of the uncertainty in the investment markets and due to the short-term repricing nature of certificate reserve liabilities, IDSC continues to invest in securities with relatively short maturities and in securities that provide for more immediate, periodic interest/principal payments, resulting in improved liquidity. To accomplish this, IDSC continues to invest much of its cash flow in mortgage-backed securities and in intermediate- term bonds.
IDSC's investment program is designed to maintain an investment portfolio that will produce the highest possible after-tax yield within acceptable risk standards with additional emphasis on liquidity. The program considers investment securities as investments acquired to meet anticipated certificate holder obligations.
Effective Jan.1, 1994, IDSC adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Under the SFAS 115, debt securities that IDSC has both the positive intent and ability to hold to maturity are carried at amortized cost. Debt securities IDSC does not have the positive intent to hold to maturity, as well as all marketable equity securities, are classified as available for sale and carried at fair value. The available-for-sale classification does not mean that IDSC expects to sell these securities, but that under SFAS No. 115 positive intent criteria, these securities are available to meet possible liquidity needs should there be significant changes in market interest rates or certificate holder demand. See notes 1 and 3 to the financial statements for additional information relating to SFAS No. 115.
At Dec. 31, 1994, securities classified as held to maturity and securities classified as available for sale were $1.3 billion and $1.2 billion, respectively. These securities, which comprise 84% of IDSC's total invested assets, are well diversified. Of these securities, 96% are of investment grade and, other than U.S. Government Agency mortgage-backed securities, no one issuer represents more than 1% of these securities. See note 3 to financial statements for additional information on ratings and diversification.
In 1994, in reaction to the rising interest rate environment, IDSC continued to restructure a portion of its investment security portfolio by selling $275 million of available-for sale securities. Gross gains of $.4 million and gross losses of $10.1 million were realized on the sales.
During 1992, IDSC charged earnings with $23.7 million of write-downs in the value of certain interest-only, mortgage-backed securities that resulted from high prepayments due to refinancing and additional payment activity on the underlying pool of mortgages due to declining interest rates. At Dec. 31, 1992, the carrying value of these securities was $30.2 million. During 1993, additional write-downs of $.6 million were recorded and all of these securities with a carrying value of $27.4 million were sold for $14.3 million. At Dec. 31, 1994, IDSC held no investments in interest-only or principal-only mortgage-backed securities.
During 1994, IDSC's reserve for possible losses on its below investment grade securities was reduced from $2.0 million at Dec. 31, 1993, to $1.0 million. The reduction reflects sales and exchanges of certain of these issues in 1994. IDSC does not generally invest in below investment grade securities and is limited by regulation as to the amount of such securities it can hold. IDSC's holdings in these securities result principally from the downgrading of the securities subsequent to purchase by IDSC. Management reviews these securities on a case-by-case basis to determine whether it is appropriate to hold them in IDSC's portfolio. Management believes that reserves for possible losses on securities owned at Dec. 31, 1994, are adequate, however, future economic factors could impact the ratings of securities owned and additional reserves for losses may need to be recognized.
Derivative financial instruments:
IDSC enters into transactions involving interest rate caps, and purchased and written call options to manage its exposure to rising interest rates. IDSC does not enter into such transactions for trading purposes. There is a possibility that the value of these instruments will change due to fluctuations in a factor from which the instrument derives its value. IDSC is not subject to this market risk because these instruments are largely used to hedge such risks, and therefore, the cash flow and income effects of the instruments are inverse to the effects of of the underlying transactions. See note 8 to financial statements for additional information regarding derivative financial instruments.
Impact of new accounting standards:
The Financial Accounting Standards Board's SFAS No. 114 "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118 "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures", are effective Jan. 1, 1995. These statements apply to collateralized and uncollateralized loans except for large groups of homogeneous loans. A loan is considered impaired if, based on current information, it is probable that principal and interest due under the loan agreement will not be collected. The amount of impairment is the excess of the loan's carrying value over the present value of expected future cash flows discounted at the loan's effective rate, or if more practical, the loan's observable market price, or the fair value of collateral if the loan is collateral dependent. The new rules are not expected to have a material impact on IDSC's results of operations or financial condition.
Capital Contributions:
To manage its regulatory capital requirements, IDSC received a capital contribution from the Parent of $3.0 million in 1994.
Due to the decrease in IDSC's assets in 1992, IDSC felt its holding in Fund America Companies, Inc. preferred stock was too large an exposure to a single credit risk, resulting in IDSC's dividend- in-kind of the issue to Parent. Parent subsequently contributed capital to IDSC of $52 million. The contribution was necessary to manage IDSC's regulatory capital requirements.
Ratios:
The ratio of stockholder's equity, excluding net unrealized holding gains and losses on investment securities, to total assets less certificate loans at Dec. 31, 1994, was 5.54%, compared to 5.59% in 1993. IDSC intends to maintain a ratio of at least 5.0% in 1995, which meets current regulatory requirements.
IDS CERTIFICATE COMPANY
Item 8.
Item 8. Financial Statements and Supplementary Data
1. Financial Statements and Schedules Required under Regulation S-X
Index to Financial Statements and Schedules Page
Financial Statements:
Report of Independent Auditors 21
Responsibility for Preparation of Financial Statements 22
Balance Sheets, Dec. 31, 1994 and 1993 23-24
Statements of Operations, year ended Dec. 31, 1994, 1993 and 1992 25-26
Statements of Stockholder's Equity, year ended Dec. 31, 1994, 1993 and 1992 27
Statements of Cash Flows, year ended Dec. 31, 1994, 1993 and 1992 28-29
Notes to Financial Statements 30-44
Schedules:
I - Investments in Securities of Unaffiliated Issuers, Dec. 31, 1994
II - Investments in and Advances to Affiliates and Income Thereon, Dec. 31, 1994, 1993 and 1992
III - Mortgage Loans on Real Estate and Interest earned on Mortgages, year ended Dec. 31, 1994
V - Qualified Assets on Deposit, Dec. 31, 1994
VI - Certificate Reserves, year ended Dec. 31, 1994
VII - Valuation and Qualifying Accounts, year ended Dec. 31, 1994, 1993 and 1992
Schedules III and Schedule VI (formerly Schedule XI) for the year ended Dec. 31, 1993 and Schedule VI (formerly Schedule XI) for the year ended Dec. 31, 1992 are included in Registrant's Annual Reports on Form 10-K for the fiscal years ended Dec. 31, 1993 and Dec. 31, 1992, respectively, Commission file 2-23772, and are incorporated herein by reference.
2. Supplementary Data None
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
PART III
Items omitted pursuant to General Instructions J(1)(a) and (b) of Form 10-K.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) List the following documents filed as a part of the report:
1. All financial statements. See Item 8.
2. Financial statement schedules. See Item 8.
3. Exhibits
(1)a. The Distribution Agreement dated November 18, 1988, between Registrant and IDS Financial Services Inc., filed electronically as Exhibit 1(a) to the Registration Statement for the American Express International Investment Certificate (now called the IDS Investors Certificate), is incorporated herein by reference.
(1)b. Selling Agent Agreement dated June 1, 1990, between American Express Bank International and IDS Financial Services Inc., for the IDS Investors and IDS Stock Market Certificates, filed electronically as Exhibit 1(c) to the Post-Effective Amendment No. 5 to Registration Statement No. 33-26844 for the IDS Investors Certificate, is incorporated herein by reference.
(1)c. Marketing Agreement dated October 10, 1991, between Registrant and American Express Bank Ltd., filed electronically as Exhibit 1(d) to Post-Effective Amendment No. 31 to Registration Statement No. 2-55252 for the Series D-1 Investment Certificate, is incorporated herein by reference.
(1)d. Amendment to the Selling Agent Agreement dated December 12, 1994 between IDS Financial Services Inc. and American Express Bank International filed electronically as Exhibit 16(d) to Post-Effective Amendment No. 13 to Registration Statement No. 2-95577, is incorporated herein by reference.
(1)e. Selling Agent Agreement dated December 12, 1994 between IDS Financial Services Inc. and Coutts & Co. (USA) International filed electronically as Exhibit 16(e) to Post-Effective Amendment No. 13 to Registration Statement No. 2-95577, is incorporated herein by reference.
(1)f. Consulting Agreement dated December 12, 1994 between IDS Financial Services Inc. and American Express Bank International filed electronically as Exhibit 16(f) Post-Effective No. 13 to Registration Statement No. 2- 95577, is incorporated herein by reference.
(3)a. The ISA Certificate of Incorporation and ISA By- Laws, filed electronically as Exhibit 3(a) and 3(c) to Post-Effective Amendment No. 2 to Registration Statement No. 2-95577 are incorporated herein by reference.
(3)c. Certificate of Amendment, dated April 2, 1984, to ISA's Certificate of Incorporation filed electronically as Exhibit 3(b) to Post-Effective Amendment No. 2 to Registration Statement No. 2-95577 is incorporated herein by reference.
(10)a. The Investment Advisory and Services Agreement between ISA and IDS/American Express Inc. dated January 12, 1984 filed electronically as Exhibit 10(a) to Post- Effective Amendment No. 2 to Registration Statement No. 2-95577 is incorporated herein by reference.
(10)b. Depository and Custodial Agreement dated September 30, 1985 between IDS Certificate Company and IDS Trust Company, filed electronically as Exhibit 10(b) to Registrant's Post-Effective Amendment No. 2 to Registration Statement No. 2-95577 is incorporated herein by reference.
(10)c. Loan Agreement between Registrant and Investors Syndicate Development Corporation dated October 13, 1970, filed electronically as Exhibit 10(c) to Post- Effective Amendment No. 2 to Registration Statement No. 2-95577 is incorporated herein by reference.
(10)d. Agreement for the servicing of Residential Mortgage Loans between ISA and Advance Mortgage Company, Ltd., dated August 31, 1980, filed electronically as Exhibit 10(d) to Post-Effective Amendment No. 2 to Registration Statement No. 2-95577 is incorporated herein by reference.
(10)e. Agreement for the servicing of Commercial Mortgage Loans between ISA and FBS Mortgage Corporation, dated October 1, 1980, filed electronically as Exhibit 10(e) to Post-Effective Amendment No. 2 to Registration Statement No. 2-95577 is incorporated herein by reference.
(10)f. Agreement by and between registrant and IDS/American Express Inc. ("IDS") providing for the purchase by IDS of a block of portfolio securities from registrant, filed as Exhibit 10.5 to the September 30, 1981 Quarterly Report on Form 10-Q of Alleghany Corporation, is incorporated herein by reference.
(10)g. Transfer Agent Agreements for the servicing of the American Express Savings Certificate, filed electronically as Exhibit 10(g) to Pre-Effective Amendment No. 1 to Registration Statement No. 33-25385, are incorporated herein by reference.
(10)h. Foreign Deposit Agreement dated November 21, 1990, between IDS Certificate Company and IDS Bank & Trust, filed electronically as Exhibit 10(h) to Post- Effective Amendment No. 5 to Registration Statement No. 33-26844, is incorporated herein by reference.
(25)a. Officers' Power of Attorney dated May 17, 1994, 1994, filed as Exhibit 25(a) to Post-Effective Amendment No. 13 to Registration Statement No. 2-95577, is incorporated herein by reference.
(25)b. Directors' Power of Attorney dated May 13, 1994, 1994, filed as Exhibit 25(b) to Post-Effective Amendment No. 13 to Registration Statement No. 2-95577, is incorporated herein by reference.
(b) Reports on Form 8-K filed during the last quarter of the period covered by this report.
None SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
REGISTRANT IDS CERTIFICATE COMPANY
/s/ Stuart A. Sedlacek BY BRUCE A. KOHN NAME AND TITLE Stuart A. Sedlacek* President DATE March 30, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
BY BRUCE A. KOHN NAME AND TITLE Stuart A. Sedlacek* ** President and Director (Principal Executive Officer) DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE Jay C. Hatlestad,* Vice President and Controller (Principal Accounting Officer) DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE Morris Goodwin,* Vice President and Treasurer (Principal Financial Officer) DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE David R. Hubers,** Director DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE Charles W. Johnson,** Director DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE Edward Landes,** Director DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE John V. Luck,** Director DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE James A. Mitchell,** Director DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE Harrison Randolph,** Director DATE March 30, 1995
BY BRUCE A. KOHN NAME AND TITLE Gordon H. Ritz,** Director DATE March 30, 1995
* Signed pursuant to Officers' Power of Attorney dated May 17, 1994 filed as Exhibit 25(a) to Post-Effective Amendment No. 13 to Registration Statement No. 2-95577, incorporated herein by reference.
_______________________ Bruce A. Kohn
** Signed pursuant to Directors' Power of Attorney dated May 13, 1994 filed as Exhibit 25(b) to Post-Effective Amendment No. 13 to Registration Statement No. 2-95577, incorporated herein by reference.
_______________________ Bruce A. Kohn
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Security Holders IDS Certificate Company:
We have audited the accompanying balance sheets of IDS Certificate Company, a wholly owned subsidiary of American Express Financial Corporation (formerly IDS Financial Corporation), as of December 31, 1994 and 1993, and the related statements of operations, stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedules listed in the index at Item 8. These financial statements and schedules are the responsibility of the management of IDS Certificate Company. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. Our procedures included confirmation of investments owned as of December 31, 1994 and 1993 by correspondence with custodians and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of IDS Certificate Company at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in note 1 to the financial statements, IDS Certificate Company changed its method of accounting for certain investments in debt and equity securities in 1994.
ERNST & YOUNG LLP Minneapolis, Minnesota February 2, 1995 IDS Certificate Company
Responsibility for Preparation of Financial Statements
The management of IDS Certificate Company (IDSC) is responsible for the preparation and fair presentation of its financial statements. The financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances, and include amounts based on the best judgment of management. IDSC's management is also responsible for the accuracy and consistency of other financial information included in this Form 10-K.
In recognition of its responsibility for the integrity and objectivity of data in the financial statements, IDSC maintains a system of internal control over financial reporting. The system is designed to provide reasonable, but not absolute, assurance with respect to the reliability of IDSC's financial statements. The concept of reasonable assurance is based on the notion that the cost of the internal control system should not exceed the benefits derived.
The internal control system is founded on an ethical climate and includes an organizational structure with clearly defined lines of responsibility, policies and procedures, and the careful selection and training of employees. Internal auditors monitor and assess the effectiveness of the internal control system and report their findings to management throughout the year. IDSC's independent auditors are engaged to express an opinion on the year-end financial statements and, with the coordinated support of the internal auditors, review the financial records and related data and test the internal control system over financial reporting.
Balance Sheets, Dec. 31,
Notes to Financial Statements ($ in thousands unless indicated otherwise)
1. Summary of significant accounting policies
IDS Certificate Company (IDSC) is a wholly owned subsidiary of American Express Financial Corporation (Parent) (formerly IDS Financial Corporation), which is a wholly owned subsidiary of American Express Company.
IDSC is in the business of issuing face-amount investment certificates.
Described below are certain accounting policies that are important to an understanding of the accompanying financial statements.
Basis of financial statement presentation
The accompanying financial statements are presented in accordance with generally accepted accounting principles, except only the accounts of IDSC are included. IDSC uses the equity method of accounting for its wholly owned unconsolidated subsidiary, which is the method prescribed by the Securities and Exchange Commission (SEC) for issuers of face-amount certificates. Certain amounts from prior years have been reclassified to conform to the current year presentation.
Fair values of financial instruments
The fair values of financial instruments disclosed in the notes to financial statements are estimates based upon current market conditions and perceived risks, and require varying degrees of management judgment.
Preferred stock dividend income
IDSC recognizes dividend income from cumulative redeemable preferred stocks with fixed maturity amounts on an accrual basis similar to that used for recognizing interest income on debt securities.
Securities
Cash equivalents are carried at amortized cost, which approximates fair value. IDSC has defined cash and cash equivalents as cash in banks and highly liquid investments with a maturity of three months or less at acquisition and are not interest rate sensitive.
In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which IDSC adopted as of Jan. 1, 1994. Under the new rules, debt securities that IDSC has both the positive intent and ability to hold to maturity are carried at amortized cost. Debt securities IDSC does not have the positive intent to hold to maturity, as well as all marketable equity securities, are classified as available for sale and carried at fair value. Unrealized holding gains and Notes to Financial Statements (continued)
losses on securities classified as available for sale are carried, net of deferred income taxes, as a separate component of stockholder's equity. The opening balance of stockholder's equity was increased by $8,827 (net of $4,752 in deferred income taxes) to reflect the net unrealized holding gains on securities classified as available for sale previously carried at amortized cost or the lower of cost or market.
The basis for determining cost in computing realized gains and losses on securities is specific identification. When there is a decline in value that is other than temporary, the securities are carried at estimated realizable value with the amount of adjustment included in income.
First mortgage loans on real estate
Mortgage loans are carried at amortized cost, less reserves for losses, which is the basis for determining any realized gains or losses. When economic evaluations of the underlying real estate indicate a loss on a loan is likely to occur, an allowance for loss is recorded. IDSC generally stops accruing interest on loans for which interest is delinquent more than three months.
Certificates
Investment certificates may be purchased either with a lump-sum payment or by installment payments. Certificate holders are entitled to receive at maturity a definite sum of money. Payments from certificate holders are credited to investment certificate reserves. Investment certificate reserves accumulate at specified percentage rates. Reserves also are maintained for advance payments made by certificate holders, accrued interest thereon, and for additional credits and accrued interest thereon. On certificates allowing for the deduction of a surrender charge, the cash surrender values may be less than accumulated investment certificate reserves prior to maturity dates. Cash surrender values on certificates allowing for no surrender charge are equal to certificate reserves. The payment distribution, reserve accumulation rates, cash surrender values, reserve values and other matters are governed by the Investment Company Act of 1940 ("the 1940 Act").
Deferred distribution fee expense
On certain series of certificates, distribution fees are deferred and amortized over the estimated lives of the related certificates, which is approximately 10 years. Upon surrender, unamortized deferred distribution fees are charged against income.
Federal income taxes
IDSC's taxable income or loss is included in the consolidated federal income tax return of American Express Company. IDSC provides for income taxes on a separate return basis, except that, under an agreement between Parent and American Express Company, tax Notes to Financial Statements (continued)
benefits are recognized for losses to the extent they can be used in the consolidated return. It is the policy of Parent and its subsidiaries that Parent will reimburse a subsidiary for any tax benefits recorded.
2. Deposit of assets and maintenance of qualified assets
A) Under the provisions of its certificates and the 1940 Act, IDSC was required to have qualified assets (as that term is defined in Section 28(b) of the 1940 Act) in the amount of $2,895,226 and $2,767,057 at Dec. 31, 1994 and 1993, respectively. IDSC had qualified assets of $3,040,416 at Dec. 31, 1994 and $2,931,737 at Dec. 31, 1993, excluding net unrealized depreciation on available-for-sale securities of $35,627 at Dec. 31, 1994.
Qualified assets are valued in accordance with such provisions of the Code of the District of Columbia as are applicable to life insurance companies. Qualified assets for which no provision for valuation is made in such code are valued in accordance with rules, regulations or orders prescribed by the SEC. These values are the same as financial statement carrying values, except for debt securities classified as available for sale and all marketable equity securities, which are carried at fair value in the financial statements but are valued at amortized cost for qualified asset and deposit maintenance purposes.
B) Pursuant to provisions of the certificates, the 1940 Act, the central depositary agreement and to requirements of various states, qualified assets of IDSC were deposited as follows:
Dec. 31, 1994
Required Deposits deposits Excess Deposits to meet certificate liability requirements: States $417 $388 $29 Central Depositary 2,939,538 2,817,716 121,822
Total $2,939,955 $2,818,104 $121,851
Dec. 31, 1993
Required Deposits deposits Excess Deposits to meet certificate liability requirements: States $421 $393 $28 Central Depositary 2,814,553 2,695,884 118,669
Total $2,814,974 $2,696,277 $118,697
Notes to Financial Statements (continued)
The assets on deposit at Dec. 31, 1994 and 1993 consisted of securities having a deposit value of $2,659,676 and $2,500,790, respectively; mortgage loans of $252,263 and $276,711, respectively; and other assets of $28,016 and $37,473, respectively. Mortgage loans on deposit include an affiliated mortgage loan.
American Express Trust Company (formerly IDS Trust Company) is the central depositary for IDSC. See note 6C.
3. Investments
A) Fair values of investments in securities represent market prices and estimated fair values when quoted prices are not available. Estimated fair values are determined by IDSC using established procedures, involving review of market indexes, price levels of current offerings and comparable issues, price estimates and market data from independent brokers and financial files. The procedures are reviewed annually. IDSC's vice president - investments reports to the board of directors on an annual basis regarding such pricing sources and procedures to provide assurance that fair value is being achieved.
The following is a summary of securities held to maturity and securities available for sale at Dec. 31, 1994 and securities carried at amortized cost at Dec. 31, 1993.
Notes to Financial Statements (continued)
The amortized cost and fair value of securities held to maturity and available for sale, by contractual maturity, at Dec. 31, 1994, are shown below. Cash flows will differ from contractual maturities because issuers may have the right to call or prepay obligations.
Amortized Fair cost value HELD TO MATURITY Due within 1 year $142,206 $144,388 Due after 1 through 5 years 491,017 497,199 Due after 5 years through 10 years 384,200 383,699 Due after 10 years 163,269 160,794 1,180,692 1,186,080 Mortgage-backed securities 65,101 66,329
$1,245,793 $1,252,409 AVAILABLE FOR SALE Due within 1 year $78,018 $77,683 Due after 1 through 5 years 315,279 306,508 Due after 5 years through 10 years 70,698 65,590 Due after 10 years 52,038 51,978 516,033 501,759 Mortgage-backed securities 745,513 724,276 Common stock 755 639
$1,262,301 $1,226,674
During the year ended Dec. 31, 1994, there were no securities classified as trading securities.
During the year ended Dec. 31, 1994, securities classified as available for sale were sold with proceeds of $265,008 and gross realized gains on such sales of $363 and gross realized losses on such sales of $10,140.
During the year ended Dec. 31, 1994, a held-to-maturity security was sold with an amortized cost of $3,158. A gain of $5 was realized on the sale. The security was sold due to deterioration in the issuer's creditworthiness.
There were no transfers from securities classified as held to maturity during the year ended Dec. 31, 1994.
B) Investments in securities with fixed maturities comprised 84% and 85% of IDSC's total invested assets at Dec. 31, 1994 and 1993, respectively. Securities are rated by Moody's and Standard & Poors (S&P), or by Parent's internal analysts, using criteria similar to Moody's and S&P, when a public rating does not exist. A summary of investments in securities with fixed maturities by rating of investment is as follows:
Rating 1994 1993 Aaa/AAA 36% 35% Aa/AA 5 4 Aa/A 3 1 A/A 25 22 A/BBB 3 3 Baa/BBB 24 31 Below investment grade 4 4
100% 100%
Of the securities rated Aaa/AAA, 88% at Dec. 31, 1994 and 87% at Dec. 31, 1993, are U.S. Government Agency mortgage-backed securities that are not rated by a public rating agency. Approximately 17% at Dec. 31, 1994 and 23% at Dec. 31, 1993 of other securities with fixed maturities are rated by Parent's internal analysts. No investment in any one issuer at Dec. 31, 1994 and 1993, is greater than 1% and 2%, respectively, of IDSC's total investment in securities with fixed maturities.
At Dec. 31, 1994 and 1993, approximately 9% and 10%, respectively, of IDSC's invested assets were first mortgage loans on real estate. A summary of first mortgage loans by region and by type of real estate is as follows:
Region 1994 1993
East North Central 25% 23% South Atlantic 24 23 West North Central 18 21 Middle Atlantic 16 14 Mountain 6 6 West South Central 5 8 Pacific 3 3 New England 3 2 100% 100%
Property Type 1994 1993
Apartments 41% 40% Retail/shopping centers 30 28 Industrial buildings 12 13 Office buildings 8 10 Retirement homes 1 1 Hotels/motels - 1 Other 8 7
100% 100%
The carrying amounts and fair values of first mortgage loans on real estate are as follows at Dec. 31. The fair values are estimated using discounted cash flow analysis, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Dec. 31, 1994 Dec. 31, 1993 Carrying Fair Carrying Fair amount value amount value
Residential $48 $43 $53 $59 Commercial 254,531 246,874 282,773 289,726 254,579 246,917 282,826 289,785 Reserve for losses (611) - (961) -
Net first mortgage loans on real estate $253,968 $246,917 $281,865 $289,785
At Dec. 31, 1994 and 1993, there were no commitments for fundings of first mortgage loans. If there were any commitments, IDSC employs policies and procedures to ensure the creditworthiness of the borrowers and that funds will be available on the funding date. IDSC's first mortgage loan fundings are restricted to 75% or less of the market value of the real estate at the time of the loan funding.
C) IDSC reserves freedom of action with respect to its acquisition of restricted securities that offer advantageous and desirable investment opportunities. In a private negotiation, IDSC may purchase for its portfolio all or part of an issue of restricted securities. Since IDSC would intend to purchase such securities for investment and not for distribution, it would not be "acting as a distributor" if such securities are resold by IDSC at a later date.
The fair values of restricted securities are determined by the board of directors using the procedures and factors described in paragraph A of note 3.
In the event IDSC were to be deemed to be a distributor of the restricted securities, it is possible that IDSC would be required to bear the costs of registering those securities under the Securities Act of 1933, although in most cases such costs would be borne by the issuer of the restricted securities.
4. Certificate reserves
Reserves maintained on outstanding certificates have been computed in accordance with the provisions of the certificates and Section 28 of the 1940 Act. The average rates of accumulation on certificate reserves at Dec. 31, 1994 and 1993 were:
A) There is no minimum rate of accrual on these reserves. Interest is declared periodically, quarterly or annually, in accordance with the terms of the separate series of certificates.
B) On certain series of single payment certificates, additional interest is predeclared for periods greater than one year. At Dec. 31, 1994, $18,398 of retained earnings had been appropriated for the predeclared additional interest, which represents the difference between certificate reserves on these series, calculated on a statutory basis, and the reserves maintained per books.
C) Certain series of installment certificates guarantee accrual of interest on advance payments at an average of 3.08%. IDSC has increased the rate of accrual to 5.00% through April 30, 1996. An appropriation of retained earnings amounting to $50 has been made, which represents the estimated additional accrual that will result from the increase granted by IDSC.
D) IDS Stock Market Certificate enables the certificate holder to participate in any relative rise in a major stock market index without risking loss of principal. Generally the certificate has a term of 12 months and may continue for up to 14 successive terms. The reserve balance at Dec. 31, 1994 and 1993 was $263,494 and $402,801, respectively.
E) The carrying amounts and fair values of certificate reserves consisted of the following at Dec. 31, 1994 and 1993. Fair values of certificate reserves with interest rate terms of one year or less approximated the carrying values less any applicable surrender charges. The fair values for other certificate reserves are a discounted cash flow analysis using interest rates currently offered for certificates with similar remaining terms, less any applicable surrender charges.
5. Dividend restriction
Certain series of installment certificates outstanding provide that cash dividends may be paid by IDSC only in calendar years for which additional credits of at least one-half of 1% on such series of certificates have been authorized by IDSC. This restriction has been removed for 1995 and 1996 by action of IDSC on additional credits in excess of this requirement.
6. Fees paid to Parent and affiliated companies ($ not in thousands)
A) The basis of computing fees paid or payable to Parent for investment advisory and services is:
The investment advisory and services agreement with Parent provides for a graduated scale of fees equal on an annual basis to 0.75% on the first $250 million of total book value of assets of IDSC, 0.65% on the next $250 million, 0.55% on the next $250 million, 0.50% on the next $250 million and 0.45% on the amount in excess of $1 billion. The fee is payable monthly in an amount equal to one-twelfth of each of the percentages set forth above. Excluded from assets for purposes of this computation are first-mortgage loans, real estate and any other asset on which IDSC pays a service fee.
B) The basis of computing fees paid or payable to American Express Financial Advisors Inc. (formerly IDS Financial Services Inc.) (an affiliate) for distribution services is:
Fees payable to American Express Financial Advisors Inc. on sales of IDSC's certificates are based upon terms of agreements giving American Express Financial Advisors Inc. the exclusive right to distribute the certificates covered under the agreements. The agreements provide for payment of fees over a period of time. The aggregate fees payable under the agreements per $1,000 face amount of installment certificates and $1,000 purchase price of single payments, and a summary of the periods over which the fees are payable, shown by series are:
Fees on Cash Reserve and Flexible Savings (formerly Variable Term) certificates are paid at a rate of 0.25% of the purchase price at time of issuance and 0.25% of the reserves maintained for these certificates at the beginning of the second and subsequent quarters from issue date.
Fees on the Investors Certificate are paid at an annualized rate of 1% of the reserves maintained for the certificates. Fees are paid at the end of each term on certificates with a one, two or three-month term. Fees are paid each quarter from date of issuance on certificates with a six, 12, 24 or 36-month term.
Fees on the Stock Market Certificate are paid at a rate of 1.25% of the purchase price on the first day of the certificate's term and 1.25% of the reserves maintained for these certificates at the beginning of each subsequent term.
(a) At the end of the sixth through the 10th year, an additional fee is payable of 0.5% of the daily average balance of the certificate reserve maintained during the sixth through the 10th year, respectively.C) The basis of computing depositary fees paid or payable to American Express Trust Company (formerly IDS Trust Company) (an affiliate) is:
A transaction consists of the receipt or withdrawal of securities and commercial paper and/or a change in the security position. The charges are payable quarterly except for maintenance, which is an annual fee.
D) The basis for computing fees paid or payable to American Express Service Corporation (an affiliate) in connection with the American Express Savings Certificate was:
Distribution Fees - Fees were paid at a rate of 0.25% of the reserves maintained at the end of the first and subsequent calendar quarters.
Transfer Agent Fees - Fees of $3.50 per certificate account were paid each month.
E) The basis for computing fees paid or payable to American Express Bank Ltd. (an affiliate) for the distribution of the IDS Special Deposits certificate on an annualized basis is:
0.80% of the reserves maintained for the certificates on an amount from $250,000 to $499,000, 0.65% on an amount from $500,000 to $999,000 and 0.50% on an amount $1,000,000 or more. Fees are paid at the end of each term on certificates with a one, two or three-month term. Fees are paid at the end of each quarter from date of issuance on certificates with a six, 12, 24 or 36-month term.
7. Income taxes
Income tax expense (benefit) as shown in the statement of operations for the three years ended Dec. 31, consists of: 1994 1993 1992 Federal: Current ($8,743) ($19,777) ($1,571) Deferred 3,933 11,446 (13,501) (4,810) (8,331) (15,072) State 100 349 7 ($4,710) ($7,982) ($15,065)
Income tax expense (benefit) differs from that computed by using the U.S. Statutory rate of 35% for 1994 and 1993 and 34% for 1992. The principal causes of the difference in each year are shown below:
Deferred income taxes result from the net tax effects of temporary differences. Temporary differences are differences between the tax bases of assets and liabilities and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years. Principal components of IDSC's deferred tax assets and liabilities as of Dec. 31, are as follows.
1994 1993 Deferred tax assets:
Investment unrealized losses $12,470 $- Certificate reserves 4,315 6,127 Investments 1,390 1,225 Investment reserves 1,120 1,487 Purchased/written call options 283 -
Total deferred tax assets 19,578 8,839
Deferred tax liabilities:
Deferred distribution fees 9,500 6,865 Dividends receivable 1,000 1,255 Return of capital dividends 508 463 Purchased/written call options - 254 Other, net 198 167
Total deferred tax liabilities 11,206 9,004
Net deferred tax assets (liabilities) $8,372 ($165)
8. Derivative financial instruments
IDSC enters into transactions involving derivative financial instruments as an end user (nontrading). IDSC uses these instruments to manage its exposure to interest rate risk, including hedging specific transactions. IDSC manages risks associated with these instruments as described below.
Market risk is the possibility that the value of the derivative financial instrument will change due to fluctuations in a factor from which the instrument derives its value, primarily an interest rate or a major market index. IDSC is not impacted by market risk related to derivatives held because derivatives are largely used to manage risk and, therefore, the cash flows and income effects of the derivatives are inverse to the effects of the underlying hedged transactions.
Credit exposure is the possibility that the counterparty will not fulfill the terms of the contract. IDSC monitors credit exposure related to derivative financial instruments through established approval procedures, including setting concentration limits by counterparty, reviewing credit ratings and requiring collateral where appropriate. The majority of IDSC's counterparties to the interest rate caps are rated A or better by nationally recognized rating agencies. The counterparties to the call options are five major broker/dealers.
The notional or contract amount of a derivative financial instrument is generally used to calculate the cash flows that are received or paid over the life of the agreement. Notional amounts do not represent market risk or credit exposure.
Credit exposure related to derivative financial instruments is measured by the carrying amount, if higher, or the replacement cost of those contracts in a gain position at the balance sheet date. The replacement cost represents the fair value of the instrument, and is determined by market values, dealer quotes or pricing models.
IDSC's holdings of derivative financial instruments were as follows at Dec. 31, 1994.
The fair values of derivative financial instruments are based on market values, dealer quotes or pricing models. The interest rate caps expire on various dates from 1995 to 1997. The options expire in 1995.
Interest rate caps and options are used to manage IDSC's exposure to rising interest rates. These instruments are used primarily to protect the margin between the interest rate earned on investments and the interest rate accrued to related investment certificate holders. The interest rate caps are quarterly reset caps and IDSC earns interest on the notional amount to the extent the London Interbank Offering Rate exceeds the reference rates specified in the cap agreements. These reference rates range from 4% to 13%. The cost of these caps of $14,946 at Dec. 31, 1994, is being amortized over the terms of the agreements (three to seven years) on a straight line basis and is included in other qualified assets. The amortization, net of any interest earned, is included in investment expenses.
IDSC offers a series of certificates which pay interest based upon the relative change in a major stock market index between the beginning and end of the certificates' term. The certificate holders have the option of participating in the full amount of increase in the index during the term (subject to a specified maximum) or a lesser percentage of the increase plus a guaranteed minimum rate of interest. As a means of hedging its obligations under the provisions of these certificates, IDSC purchases and writes call options on the major market index. The options are cash settlement options, that is, there is no underlying security to deliver at the time the contract is closed out.
The option contracts are less than one year in term. The premiums paid or received on these index options are reported in other qualified assets or other liabilities, as appropriate, and are amortized into investment expenses over the life of the option. The intrinsic value of these index options is also reported in other qualified assets or other liabilities, as appropriate. The unrealized gains and losses related to the changes in the intrinsic value of these options are recognized currently in provision for certificate reserves.
Following is a summary of open option contracts at Dec. 31, 1994 and 1993.
9. Fair values of financial instruments
IDSC is required to disclose fair value information for most on- and off-balance sheet financial instruments for which it is practical to estimate that value. Certain financial instruments such as trade receivables and payables (when the carrying value approximates the fair value), and all non-financial instruments, such as deferred distribution fees, are excluded from required disclosure. IDSC's off-balance sheet intangible assets, such as IDSC's name and future earnings of the core business are also excluded. IDSC's management believes the value of these excluded assets is significant. The fair value of IDSC, therefore, cannot be estimated by aggregating the amounts presented.
A summary of fair values of financial instruments as of Dec. 31, is as follows: