SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
==============
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-8590
Equitable of Iowa Companies
(Exact name of registrant as specified in its charter)
Iowa 42-1083593
(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
909 Locust Street, Des Moines, Iowa 50309-2899
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (515) 698-7000
___________________________________________________________________________
Former name, former address and formal 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. Yes /X/ No / /
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. Yes / / No / /
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 0 shares of Common Stock
as of November 12, 1997.
FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
_____________________________
Person for whom the Financial Information is given: EQUITABLE OF IOWA
COMPANIES AND ITS
SUBSIDIARIES
Consolidated Statements of Income (Unaudited):
FOR THE THREE MONTHS ENDED
September 30, 1997 September 30, 1996
__________________ __________________
(Current Year) (Preceding Year)
(Dollars in thousands)
REVENUES:
Annuity and interest sensitive life
product charges $29,789 $19,006
Traditional life insurance premiums 9,642 9,814
Net investment income 202,892 180,346
Realized gains on investments 8,476 4,510
Other income 8,895 7,047
__________________ __________________
259,694 220,723
INSURANCE BENEFITS AND EXPENSES:
Annuity and interest sensitive life benefits:
Interest credited to account balances 126,612 111,156
Benefit claims incurred in excess of
account balances 5,070 1,993
Traditional life insurance benefits 10,817 9,831
Increase (decrease) in future policy
benefits (898) 733
Distributions to participating
policyholders 6,429 6,284
Underwriting, acquisition and insurance
expenses:
Commissions 50,887 35,409
General expenses 16,028 13,676
Insurance taxes 2,376 2,007
Policy acquisition costs deferred (60,707) (42,600)
Amortization:
Deferred policy acquisition costs 26,646 21,287
Present value of in force acquired 2,285 915
Goodwill 430 215
__________________ __________________
185,975 160,906
Interest expense 4,160 3,091
Other expenses 9,840 5,765
__________________ __________________
199,975 169,762
__________________ __________________
59,719 50,961
See accompanying notes.
Consolidated Statements of Income (Unaudited): (CONTINUATION)
FOR THE THREE MONTHS ENDED
September 30, 1997 September 30, 1996
__________________ __________________
(Current Year) (Preceding Year)
(Dollars in thousands,
except per share data)
Income taxes:
Current $16,606 $17,522
Deferred 2,742 (343)
__________________ __________________
19,348 17,179
__________________ __________________
40,371 33,782
Equity income, net of related tax expense
of $16 in 1996 -- 28
__________________ __________________
Net income before distributions on
company-obligated, mandatorily-
redeemable securities 40,371 33,810
Distributions on company-obligated,
mandatorily-redeemable securities,
of subsidiary trusts (3,772) (2,115)
__________________ __________________
NET INCOME $36,599 $31,695
================== ==================
NET INCOME PER COMMON SHARE (average
shares used: 1997 - 32,056,971;
1996 - 31,935,891): $1.14 $0.99
================== ==================
CASH DIVIDENDS PAID PER COMMON SHARE $0.165 $0.150
See accompanying notes.
Consolidated Statements of Income (Unaudited):
FOR THE NINE MONTHS ENDED
September 30, 1997 September 30, 1996
__________________ __________________
(Current Year) (Preceding Year)
(Dollars in thousands)
REVENUES:
Annuity and interest sensitive life
product charges $78,294 $48,953
Traditional life insurance premiums 28,740 29,712
Net investment income 593,001 528,612
Realized gains on investments 16,953 15,828
Other income 25,743 16,756
__________________ __________________
742,731 639,861
INSURANCE BENEFITS AND EXPENSES:
Annuity and interest sensitive life benefits:
Interest credited to account balances 366,563 328,380
Benefit claims incurred in excess of
account balances 9,882 6,367
Traditional life insurance benefits 34,373 34,761
Decrease in future policy benefits (4,210) (2,275)
Distributions to participating
policyholders 18,942 18,753
Underwriting, acquisition and insurance
expenses:
Commissions 128,020 97,402
General expenses 70,372 36,129
Insurance taxes 7,137 6,110
Policy acquisition costs deferred (155,848) (117,917)
Amortization:
Deferred policy acquisition costs 73,653 59,485
Present value of in force acquired 4,465 915
Goodwill 1,317 252
__________________ __________________
554,666 468,362
Interest expense 11,987 10,832
Other expenses 28,181 13,929
__________________ __________________
594,834 493,123
__________________ __________________
147,897 146,738
See accompanying notes.
Consolidated Statements of Income (Unaudited): (CONTINUATION)
FOR THE NINE MONTHS ENDED
September 30, 1997 September 30, 1996
__________________ __________________
(Current Year) (Preceding Year)
(Dollars in thousands,
except per share data)
Income taxes:
Current $45,742 $47,996
Deferred 2,204 2,869
__________________ __________________
47,946 50,865
__________________ __________________
99,951 95,873
Equity income (loss), net of related
tax (expense) benefit of $(191) in
1997 and $62 in 1996 355 (86)
__________________ __________________
Net income before distributions on
company-obligated, mandatorily-
redeemable securities 100,306 95,787
Distributions on company-obligated,
mandatorily-redeemable securities,
of subsidiary trusts (10,239) (2,115)
__________________ __________________
NET INCOME $90,067 $93,672
================== ==================
NET INCOME PER COMMON SHARE (average
shares used: 1997 - 32,040,666;
1996 - 31,880,469): $2.81 $2.94
================== ==================
CASH DIVIDENDS PAID PER COMMON SHARE $0.480 $0.435
See accompanying notes.
Consolidated Balance Sheets (Unaudited):
September 30, 1997 December 31, 1996
__________________ _________________
(Dollars in thousands,
except per share data)
ASSETS
Investments:
Fixed maturities, available for sale, at
fair value (cost: 1997 - $8,109,467;
1996 - $7,557,735) $8,426,489 $7,731,964
Equity securities, at fair value
(cost: 1997 - $43,004; 1996 - $48,857) 62,058 77,181
Mortgage loans on real estate 1,946,989 1,720,114
Real estate, less allowances for
depreciation of $747 in 1997
and $4,588 in 1996 12,929 8,613
Policy loans 198,575 190,487
Short-term investments 137,511 37,922
__________________ _________________
Total investments 10,784,551 9,766,281
Cash and cash equivalents 32,969 18,201
Securities and indebtedness of
related parties 12,357 8,305
Accrued investment income 146,314 135,291
Notes and other receivables 45,754 22,464
Deferred policy acquisition costs 762,544 733,158
Present value of in force acquired 78,156 83,051
Property and equipment, less
allowances for depreciation of
$17,523 in 1997 and $13,835 in 1996 14,063 10,465
Current income taxes recoverable 8,233 5,424
Intangible assets, less accumulated
amortization of $3,143 in 1997 and
$1,579 in 1996 50,330 46,726
Other assets 103,048 82,434
Separate account assets 2,533,253 1,657,879
__________________ _________________
TOTAL ASSETS $14,571,572 $12,569,679
================== =================
See accompanying notes.
Consolidated Balance Sheets (Unaudited): (CONTINUATION)
September 30, 1997 December 31, 1996
__________________ _________________
(Dollars in thousands,
except per share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy liabilities and accruals:
Future policy benefits:
Annuity and interest sensitive
life products $9,461,488 $8,675,175
Traditional life insurance products 708,751 712,296
Unearned revenue reserve 24,267 20,461
Other policy claims and benefits 10,657 7,481
__________________ _________________
10,205,163 9,415,413
Other policyholders' funds:
Advance premiums and other deposits 562 597
Accrued dividends 12,708 12,807
__________________ _________________
13,270 13,404
Deferred income taxes 84,281 45,681
Commercial paper notes 140,800 104,600
Long-term debt 100,000 100,000
Other liabilities 302,909 211,903
Separate account liabilities 2,533,253 1,657,879
__________________ _________________
TOTAL LIABILITIES 13,379,676 11,548,880
Commitments and contingencies
Company-obligated, mandatorily-redeemable
securities, of subsidiary trust 175,000 125,000
Stockholders' equity:
Serial preferred stock, without par
value, authorized 2,500,000 shares -- --
Common stock, without par value (stated
value $1.00 per share), authorized 70,000,000
shares, issued and outstanding 32,067,735
shares in 1997 and 31,988,410 in 1996 32,068 31,988
Additional paid-in capital 87,398 85,140
Unrealized appreciation of securities at
fair value 148,638 104,711
Retained earnings 752,870 678,219
Unearned compensation (deduction) (4,078) (4,259)
__________________ _________________
TOTAL STOCKHOLDERS' EQUITY 1,016,896 895,799
__________________ _________________
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $14,571,572 $12,569,679
================== =================
See accompanying notes.
Consolidated Statements of Cash Flows (Unaudited):
FOR THE NINE MONTHS ENDED
September 30, 1997 September 30, 1996
__________________ __________________
(Current Year) (Preceding Year)
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $90,067 $93,672
Adjustments to reconcile net income to
net cash provided by operations:
Adjustments related to annuity and
interest sensitive life products:
Interest credited to account balances 362,688 326,528
Charges for mortality and
administration (58,754) (49,811)
Change in unearned revenues 3,164 1,548
Increase (decrease) in traditional life
policy liabilities and accruals 601 (337)
Decrease in other policyholders' funds (134) (217)
Increase in accrued investment income (11,023) (4,096)
Policy acquisition costs deferred (155,848) (117,917)
Amortization of deferred policy
acquisition costs 73,653 59,485
Amortization of present value of in
force acquired 4,465 915
Change in other assets, other liabilities,
and accrued income taxes 36,411 (18,486)
Provision for depreciation and
amortization 8,035 69
Provision for deferred income taxes 2,243 2,908
Share of (income) losses of related
parties (546) 132
Realized gains on investments (16,953) (15,828)
__________________ __________________
NET CASH PROVIDED BY OPERATING
ACTIVITIES 338,069 278,565
INVESTING ACTIVITIES
Sale, maturity or repayment of investments:
Fixed maturities - available for sale 723,238 453,098
Equity securities 21,334 12,366
Mortgage loans on real estate 70,613 29,817
Real estate 2,648 7,213
Policy loans 24,282 25,745
__________________ __________________
842,115 528,239
Acquisition of investments:
Fixed maturities - available for sale (1,259,542) (614,575)
Equity securities (12,363) (13,287)
Mortgage loans on real estate (305,174) (512,943)
Real estate (100) (681)
Policy loans (32,369) (26,452)
Short-term investments - net (99,589) (1,826)
__________________ __________________
(1,709,137) (1,169,764)
See accompanying notes.
Consolidated Statements of Cash Flows (Unaudited): (CONTINUATION)
FOR THE NINE MONTHS ENDED
September 30, 1997 September 30, 1996
__________________ __________________
(Current Year) (Preceding Year)
(Dollars in thousands)
INVESTING ACTIVITIES - continued
Disposal of investments accounted for
by the equity method $3,785 $18
Additions to investments accounted
for by the equity method (5,669) --
Sales of property and equipment 112 86
Purchase of subsidiary, net of cash
acquired -- (136,172)
Purchases of property and equipment (7,795) (3,861)
__________________ __________________
NET CASH USED IN INVESTING ACTIVITIES (876,589) (781,454)
FINANCING ACTIVITIES
Issuance of commercial paper - net 36,200 17,300
Receipts from annuity and interest sensitive
life policies credited to policyholder
account balances 1,529,979 1,170,426
Return of policyholder account balances
on annuity contracts and interest
sensitive life policies (1,047,599) (778,154)
Issuance of company-obligated, mandatorily-
redeemable securities 50,000 125,000
Issuance of stock under stock plans 124 484
Cash dividends paid (15,416) (13,927)
__________________ __________________
NET CASH PROVIDED BY FINANCING
ACTIVITIES 553,288 521,129
__________________ __________________
INCREASE IN CASH AND CASH EQUIVALENTS 14,768 18,240
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR 18,201 10,730
__________________ __________________
CASH AND CASH EQUIVALENTS AT END OF
PERIOD $32,969 $28,970
================== ==================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid during the period for:
Interest $14,462 $12,889
Income taxes 47,611 52,506
Non-cash investing activities:
Foreclosure of mortgage loans 7,913 675
See accompanying notes.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for annual financial statements. In the opinion of management,
all adjustments considered necessary for a fair presentation have been
included. All adjustments were of a normal recurring nature, unless otherwise
noted in Management's Discussion and Analysis and the Notes to Financial
Statements. Operating results for the nine months ended September 30, 1997
are not necessarily indicative of the results that may be expected for the
year ending December 31, 1997. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
company's Annual Report on Form 10-K for the year ended December 31, 1996.
On August 13, 1996, Equitable of Iowa Companies ("Equitable") acquired all of
the outstanding capital stock of BT Variable, Inc. ("BT Variable") from
Whitewood Properties Corp. ("Whitewood") pursuant to the terms of a Stock
Purchase Agreement dated as of May 3, 1996 between Equitable and Whitewood
(the "Purchase Agreement"). Refer to Note 4 for additional information.
NOTE 2 -- INVESTMENT OPERATIONS
FIXED MATURITIES: All of the company's fixed maturity securities are
designated as available for sale although the company is not precluded from
designating fixed maturity securities as held for investment or trading at
some future date. Investments classified as available for sale securities
are reported at fair value and unrealized gains and losses on these securities
are included directly in stockholders' equity, after adjustment for related
changes in deferred policy acquisition costs, present value of in force
acquired, policy reserves and deferred income taxes. Securities the company
has the positive intent and ability to hold to maturity are designated as
"held for investment". Held for investment securities are reported at cost
adjusted for amortization of premiums and discounts. Changes in the fair
value of these securities, except for declines that are other than temporary,
are not reflected in the company's financial statements. Sales of securities
designated as held for investment are severely restricted by Statement of
Financial Accounting Standards ("SFAS") No. 115. Securities bought and held
principally for the purpose of selling them in the near term are designated as
trading securities. Unrealized gains and losses on trading securities are
included in current earnings. Transfers of securities between categories are
restricted and are recorded at fair value at the time of the transfer.
Securities determined to have a decline in value that is other than temporary
are written down to estimated fair value which becomes the security's new cost
basis by a charge to realized losses in the company's Statement of Income.
Premiums and discounts are amortized/accrued utilizing the scientific interest
method which results in a constant yield over the security's expected life.
Amortization/accrual of premiums and discounts on mortgage-backed securities
incorporates a prepayment assumption to estimate the securities' expected
lives.
EQUITY SECURITIES: Equity securities (common and nonredeemable preferred
stocks) are reported at estimated fair value if readily marketable or
conversion value, if applicable, or at cost if not readily marketable. The
change in unrealized appreciation and depreciation of marketable equity
securities (net of related deferred income taxes, if any) is included directly
in stockholders' equity. Equity securities determined to have a decline in
value that is other than temporary are written down to estimated fair value
which becomes the security's new cost basis, by a charge to realized losses in
the company's Statement of Income.
MORTGAGE LOANS: Mortgage loans on real estate are reported at cost adjusted
for amortization of premiums and accrual of discounts. If the value of any
mortgage loan is determined to be impaired (i.e. when it is probable that the
company will be unable to collect all amounts due according to the contractual
terms of the loan agreement), the carrying value of the mortgage loan is
reduced to the present value of expected future cash flows from the loan,
discounted at the loan's effective interest rate, or to the loan's observable
market price, or the fair value of the underlying collateral. The carrying
value of impaired loans is reduced by the establishment of a valuation
allowance which is adjusted at each reporting date for significant changes in
the calculated value of the loan. Changes in this valuation allowance are
charged or credited to income.
REAL ESTATE: Real estate, which includes real estate acquired through
foreclosure, is reported at cost less allowances for depreciation. Real
estate acquired through foreclosure, or in-substance foreclosure, is recorded
at the lower of cost (which includes the balance of the mortgage loan, any
accrued interest and any costs incurred to obtain title to the property) or
fair value at or before the foreclosure date. The carrying value of these
assets is subject to review when events or circumstances indicate an
impairment might exist. If the estimated undiscounted cash flows is less
than the carrying amount of the assets, an impairment in value is deemed to
exist and an impairment loss is recognized. The carrying value of the asset
is written down to an amount representing the sum of the estimated
undiscounted cash flows which becomes the asset's new cost basis.
OTHER INVESTMENTS: Policy loans are reported at unpaid principal. Short-
term investments are reported at cost adjusted for amortization of premiums
and accrual of discounts. Investments accounted for by the equity method
include investments in, and advances to, various joint ventures and
partnerships.
FAIR VALUES: Estimated fair values, as reported herein, of publicly traded
fixed maturity securities are as reported by an independent pricing service.
Fair values of conventional mortgage-backed securities not actively traded in
a liquid market are estimated using a third party pricing system. This
pricing system uses a matrix calculation assuming a spread over U.S. Treasury
bonds based upon the expected average lives of the securities. Fair values
of private placement bonds are estimated using a matrix that assumes a spread
(based on interest rates and a risk assessment of the bonds) over U.S.
Treasury bonds. Estimated fair values of redeemable preferred stocks are as
reported by the National Association of Insurance Commissioners ("NAIC").
Estimated fair values of equity securities are based on the latest quoted
market prices, or conversion value, if applicable. Estimated fair values of
the company's investment in its registered separate accounts are based upon
the quoted fair value of the securities comprising the individual portfolios
underlying the separate accounts. Fair values of equity securities which are
not readily marketable, are estimated based upon values which are
representative of the fair values of issues of comparable yield and quality.
Realized gains and losses are determined on the basis of specific
identification and average cost methods for manager initiated and issuer
initiated disposals, respectively.
FIXED MATURITY AND EQUITY SECURITIES
At September 30, 1997 and December 31, 1996, amortized cost, gross unrealized
gains and losses and estimated fair values of the company's fixed maturity
securities, all of which are designated as available for sale, are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
September 30, 1997 Cost Gains Losses Value
______________________________________________________________________________
(Dollars in thousands)
U.S. government and
governmental agencies
and authorities:
Mortgage-backed securities $277,852 $11,067 ($104) $288,815
Other 33,036 1,409 (10) 34,435
States, municipalities and
political subdivisions 14,842 1,309 -- 16,151
Foreign governments 12,621 3,084 -- 15,705
Public utilities 1,203,523 55,237 (5,099) 1,253,661
Investment grade corporate 3,230,670 201,182 (3,919) 3,427,933
Below investment grade
corporate 821,271 28,364 (5,510) 844,125
Mortgage-backed securities 2,515,045 52,087 (21,850) 2,545,282
Redeemable preferred stock 607 -- (225) 382
_______________________________________________
Total $8,109,467 $353,739 ($36,717) $8,426,489
===============================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1996 Cost Gains Losses Value
______________________________________________________________________________
(Dollars in thousands)
U.S. government and
governmental agencies
and authorities:
Mortgage-backed securities $322,244 $9,796 ($1,002) $331,038
Other 90,456 2,127 (1,424) 91,159
States, municipalities and
political subdivisions 15,131 1,134 -- 16,265
Foreign governments 10,572 2,706 -- 13,278
Public utilities 1,241,270 41,270 (15,796) 1,266,744
Investment grade corporate 2,789,228 157,554 (16,755) 2,930,027
Below investment grade
corporate 733,182 14,230 (16,049) 731,363
Mortgage-backed securities 2,355,036 41,925 (45,258) 2,351,703
Redeemable preferred stock 616 -- (229) 387
_______________________________________________
Total $7,557,735 $270,742 ($96,513) $7,731,964
===============================================
At September 30, 1997, net unrealized investment gains on fixed maturity
securities designated as available for sale totaled $317,022,000. This
appreciation caused an increase in stockholders' equity of $136,253,000 at
September 30, 1997 (net of deferred income taxes of $73,367,000, an adjustment
of $106,972,000 to deferred policy acquisition costs and present value of in
force acquired of $430,000). At December 31, 1996, net unrealized investment
gains on fixed maturity securities designated as available for sale totaled
$174,229,000. This appreciation caused an increase in stockholders' equity of
$76,387,000 at December 31, 1996 (net of deferred income taxes of $43,678,000
and an adjustment of $54,164,000 to deferred policy acquisition costs). No
fixed maturity securities were designated as held for investment or trading at
September 30, 1997 or December 31, 1996. Short-term investments, all with
maturities of 30 days or less, have been excluded from the above schedules.
Amortized cost approximates fair value for these securities.
At September 30, 1997, net unrealized appreciation of equity securities of
$19,054,000 was comprised of gross unrealized appreciation of $42,000 on the
company's investment in Equitable Life's registered separate account, gross
unrealized appreciation of $19,381,000 on an investment in a real estate
investment trust, and gross unrealized depreciation of $369,000 on other
equity securities. The company's investment in the real estate investment
trust had an estimated fair value of $56,527,000 and a cost basis of
$37,146,000 at September 30, 1997. The estimated fair value of the company's
investment is based upon conversion value. Conversion value is derived from
the quoted market value of the publicly traded security into which the
company's investment can be converted and the issuer's cash flow from
operations. As such, changes in operating cash flows or the quoted market
price of the issuer may result in significant volatility in the estimated
fair value of the company's investment.
The amortized cost and estimated fair value of fixed maturity securities,
designated as available for sale, by contractual maturity, at September 30,
1997, are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Estimated
Amortized Fair
September 30, 1997 Cost Value
____________________________________________________________________________
(Dollars in thousands)
Due within one year $10,941 $10,962
Due after one year through five years 371,802 384,466
Due after five years through ten years 2,273,211 2,371,306
Due after ten years 2,660,616 2,825,658
_____________________________
5,316,570 5,592,392
Mortgage-backed securities 2,792,897 2,834,097
_____________________________
Total $8,109,467 $8,426,489
=============================
An analysis of sales, maturities and principal repayments of the company's
fixed maturities portfolio, all of which were designated as available for
sale for the nine months ended September 30, 1997 and 1996 is as follows:
Gross Gross Proceeds
Nine months ended Amortized Realized Realized from
September 30, 1997 Cost Gains Losses Sale
______________________________________________________________________________
(Dollars in thousands)
Scheduled principal repayments,
calls and tenders $349,321 $9,115 ($310) $358,126
Sales 361,508 9,923 (6,319) 365,112
_____________________________________________
Total $710,829 $19,038 ($6,629) $723,238
=============================================
Gross Gross Proceeds
Nine months ended Amortized Realized Realized from
September 30, 1996 Cost Gains Losses Sale
______________________________________________________________________________
(Dollars in thousands)
Scheduled principal repayments,
calls and tenders $236,058 $10,581 ($286) $246,353
Sales 203,750 3,400 (405) 206,745
_____________________________________________
Total $439,808 $13,981 ($691) $453,098
=============================================
MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair value of mortgage-backed securities,
which comprise 34% of the company's investment in fixed maturity securities
at September 30, 1997, by type, are as follows:
Estimated
Amortized Fair
Cost Value
_____________________________
(Dollars in thousands)
Mortgage-backed securities:
Government and agency guaranteed pools:
Very accurately defined maturities $17,446 $18,290
Planned amortization class 70,429 74,890
Targeted amortization class 18,600 18,851
Sequential pay 87,190 88,543
Pass through 84,188 88,242
Private Label CMOs and REMICs:
Very accurately defined maturities 30,735 31,564
Planned amortization class 25,681 27,064
Targeted amortization class 410,284 408,439
Sequential pay 1,987,271 2,014,760
Mezzanines 37,426 38,184
Private placements and subordinate issues 23,647 25,270
_____________________________
Total mortgage-backed securities $2,792,897 $2,834,097
=============================
During periods of significant interest rate volatility, the mortgages
underlying mortgage-backed securities may prepay more quickly or more slowly
than anticipated. If the principal amount of such mortgages are prepaid
earlier than anticipated during periods of declining interest rates,
investment income may decline due to reinvestment of these funds at lower
current market rates. If principal repayments are slower than anticipated
during periods of rising interest rates, increases in investment yield may
lag behind increases in interest rates because funds will remain invested at
lower historical rates rather than reinvested at higher current rates. To
mitigate this prepayment volatility, the company invests primarily in
intermediate tranche collateralized mortgage obligations ("CMOs"). CMOs are
pools of mortgages segregated into sections, or tranches, which provide
sequential retirement of bonds rather than a pro-rata share of principal
return in the pass-through structure. The company owns no "interest only" or
"principal only" mortgage-backed securities. Further, the company has not
purchased obligations at significant premiums, thereby limiting exposure to
loss during periods of accelerated prepayments. At September 30, 1997,
unamortized premiums on mortgage-backed securities totaled $4,596,000 and
unaccrued discounts on mortgage-backed securities totaled $49,110,000.
OTHER INVESTMENT INFORMATION
INVESTMENT VALUATION ANALYSIS: The company analyzes its investment portfolio
at least quarterly in order to determine if the carrying value of any of its
investments has been impaired. The carrying value of debt and equity
securities is written down to fair value by a charge to realized losses when
an impairment in value appears to be other than temporary.
At September 30, 1997, one mortgage loan with a carrying value of $33,000 was
delinquent by 90 days or more. During the first quarter of 1997, the value
of a mortgage loan with a book value of $4,021,000 was determined to be
impaired other than temporary. At that time, a valuation allowance was
established to reduce the carrying value of this mortgage loan to its
estimated fair value, resulting in a charge to investment income of $245,000.
The company foreclosed on the property in June 1997, and based upon an
appraisal, recorded a permanent write-down on the real estate investment of
$430,000 resulting in a charge to realized losses. During the second quarter
of 1997, the company foreclosed on a mortgage loan with a book value of
$3,892,000. At this time the company does not believe any permanent
impairment exists on this property. At December 31, 1996, no investments
were identified as having an impairment other than temporary.
The carrying value of investments which have been non-income producing for
the nine months ended September 30, 1997 and the year ending December 31,
1996, totaled $239,000 related to a real estate property.
INVESTMENT DIVERSIFICATIONS: The company's investment policies related to
its investment portfolio require diversification by asset type, company and
industry and sets limits on the amount which can be invested in an individual
issuer. Such policies are at least as restrictive as those set forth by
regulatory authorities. The percentages quoted in the following sentences
relate to the holdings at September 30, 1997 and December 31, 1996,
respectively. Fixed maturity investments included investments in various non-
governmental mortgage-backed securities (30% in 1997 and 1996), public
utilities (16% in 1997 and 1996), basic industrials (24% in 1997, 23% in 1996)
and consumer products (11% in 1997, 12% in 1996). Mortgage loans on real
estate have been analyzed by geographical location and there are no
concentrations of mortgage loans in any state exceeding ten percent in 1997
and 1996. Mortgage loans on real estate have also been analyzed by collateral
type with significant concentrations identified in retail facilities (26% in
1997, 28% in 1996), industrial buildings (29% in 1997 and 1996), multi-family
residential buildings (18% in 1997, 20% in 1996) and office buildings (25% in
1997, 22% in 1996). Equity securities (which represent 0.4% of the company's
investments) consist primarily of investments in the company's registered
separate accounts and an investment of $56,527,000 in a real estate investment
trust. Real estate and investments accounted for by the equity method are not
significant to the company's overall investment portfolio.
No investment in any person or its affiliates (other than bonds issued by
agencies of the United States government) exceeded ten percent of
stockholders' equity at September 30, 1997.
NOTE 3 -- FINANCIAL INSTRUMENTS - RISK MANAGEMENT
HEDGING PROGRAM: During the second quarter of 1996, the company implemented
a hedging program under which certain derivative financial instruments,
interest rate caps ("caps") and cash settled put swaptions ("swaptions"), were
purchased to reduce the negative effects of potential increases in withdrawal
activity related to the company's annuity liabilities which may result from
extreme increases in interest rates. The company purchased caps and
swaptions, all during the second quarter of 1996, with notional amounts
totaling approximately $600,000,000 and $1,300,000,000, respectively, all of
which were outstanding at September 30, 1997. The company paid approximately
$21,100,000 in premiums for these caps and swaptions. The cost of this
program has been incorporated into the company's product pricing. The caps
and swaptions do not require any additional payments by the company.
In January 1997, the company introduced an equity-indexed annuity product
which provides a guaranteed base rate of return with a higher potential return
linked to the performance of a broad based equity index. Concurrently, the
company implemented a hedging program to purchase Standard & Poor's ("S&P")
500 (Reg.U.S.Pat.@Tm.Off.) Index Call Options ("call options", or collectively
with the interest rate caps and cash settled put swaptions, "instruments").
Call options are purchased to hedge potential increases in policyholder
account balances for equity-indexed annuity policies resulting from increases
in the index to which the product is linked. During the first nine months of
1997, the company paid approximately $12,364,000 in premiums for call options
which mature beginning in 2002 through 2004. The cost of this program has
been incorporated into the company's pricing of its equity-indexed annuity
product. The call options do not require any additional payments by the
company.
The agreements for the caps and swaptions entitle the company to receive
payments from the instruments' counterparties on future reset dates if
interest rates, as specified in the agreements, rise above a specified fixed
rate (9.0% and 9.5%). The amount of such payments to be received by the
company for the interest rate caps, if any, will be calculated by taking the
excess of the current applicable rate over the specified fixed rate, and
multiplying this excess by the notional amount of the caps. Payments on cash
settled put swaptions are also calculated based upon the excess of the current
applicable rate over the specified fixed rate multiplied by the notional
amount. The product of this rate differential times the notional amount is
assumed to continue for a series of defined future semi-annual payment dates
and the resulting hypothetical payments are discounted to the current payment
date using the discount rate defined in the agreement. The agreements for the
call options entitle the company to receive payments from the counterparty if
the S&P 500 index exceeds the specified strike price on the maturity date.
The amount of such payments to be received by the company for the call
options, if any, will be calculated by taking the excess of the average
closing price (as defined in the contract) at maturity over the specified
strike price, and multiplying this excess by the number of S&P 500 units
defined in the contract. Any payments received from the counterparties will
be recorded as an adjustment to interest credited.
The following table summarizes the contractual maturities of notional amounts
for the caps and swaptions at September 30, 1997:
1998 1999 2000 2001 2002 Total
________________________________________________________________________________
(Dollars in thousands)
Interest rate
caps $400,000 $200,000 $600,000
Cash settled
put swaptions $100,000 $400,000 $400,000 350,000 50,000 1,300,000
_________________________________________________________________
Total notional
amount $100,000 $400,000 $400,000 $750,000 $250,000 $1,900,000
=================================================================
ACCOUNTING TREATMENT: Premiums paid to purchase these instruments are
deferred and included in other assets. Premiums are amortized and included
in interest credited to account balances over the term of the instruments on
a straight-line basis. The company has recorded amortization of $4,034,000
and $1,851,000 in the first nine months of 1997, and 1996, respectively.
Unrealized gains and losses on caps and swaptions and related assets or
liabilities will not be recorded in income until realized. The call options
are carried at amortized cost plus the intrinsic value, if any, of the call
option as of the valuation date. The future policy benefit liability for the
equity-indexed annuity product is established as the full account value
without regard to the performance of the equity index, plus the intrinsic
value, if any, as of the valuation date. The Financial Accounting Standards
Board ("FASB") and the Securities and Exchange Commission ("SEC") are
evaluating the accounting and disclosure requirements for these instruments.
The SEC amended its derivative disclosure rules in January 1997 requiring
additional qualitative and quantitative disclosures by December 31, 1997.
FASB has issued an exposure draft titled "Accounting for Derivative and
Similar Financial Instruments and for Hedging Activities" which, if adopted
as a Statement of Financial Accounting Standards in its current form, would
require the company to change its accounting treatment for these instruments.
The requirements of any final standard which may result from this exposure
process are not known at this time and, therefore, the impact of such a
standard on the company's financial statements cannot be determined at this
time.
Any unrealized gain or loss on the caps and swaptions is off-balance sheet
and therefore, is not reflected in the financial statements. The effect of
changes in intrinsic value (which may vary from estimated market value) of
the call options and future policy benefits will be reflected in the financial
statements in the period of change. The following table summarizes the
amortized cost, gross unrealized gains and losses and estimated fair value on
these instruments as of September 30, 1997:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
September 30, 1997 Cost Gains Losses Value
______________________________________________________________________________
(Dollars in thousands)
Interest rate caps $4,346 $3,367 $979
Cash settled put swaptions 10,005 6,345 3,660
S&P 500 call options 10,583 $2,284 66 12,801
______________________________________________
Total $24,934 $2,284 $9,778 $17,440
==============================================
The decline in fair value from amortized cost reflects changes in interest
rates and market conditions since time of purchase.
EXPOSURE TO LOSS - COUNTERPARTY NONPERFORMANCE: The company is exposed to
the risk of losses in the event of non-performance by the counterparties of
these instruments. Losses recorded in the company's financial statements in
the event of non-performance will be limited to the unamortized premium
(remaining amortized cost) paid to purchase the instrument plus the recorded
intrinsic value, if any, for the call options because no additional payments
are required by the company on these instruments after the initial premium.
Counterparty non-performance would result in an economic loss if interest
rates exceeded the specified fixed rate or, for the S&P 500 index call
options, the average closing price at maturity exceeded the specified strike
price. Economic losses would be measured by the net replacement cost, or
estimated fair value, for such instruments. The estimated fair value is the
average of quotes, if more than one quote is available, obtained from related
and unrelated counterparties. The company limits its exposure to such losses
by: diversifying among counterparties, limiting exposure to any individual
counterparty based upon that counterparty's credit rating, and limiting its
exposure by instrument type to only those instruments that do not require
future payments. For purposes of determining risk exposure to any individual
counterparty, the company evaluates the combined exposure to that counterparty
on both a derivative financial instruments' level and on the total investment
portfolio credit risk and reports its exposure to senior management at least
monthly. The maximum potential economic loss (the cost of replacing an
instrument or the net replacement value) due to nonperformance of the
counterparties will increase or decrease during the life of the instruments as
a function of maturity and market conditions.
The company determines counterparty credit quality by reference to ratings
from independent rating agencies. As of September 30, 1997, the ratings
assigned by Standard & Poor's Corporation by instrument with respect to the
net replacement value (fair value) of the company's instruments was as
follows:
September 30, 1997 Net Replacement Value
______________________________________________________________________________
Interest Cash Settled
Rate Put S&P 500
Caps Swaptions Call Options Total
_________________________________________________
(Dollars in thousands)
Counterparties credit quality:
AAA $629 $1,844 $2,473
AA+ to AA- 350 1,114 $10,023 11,487
A+ to A- -- 702 2,778 3,480
_________________________________________________
Total $979 $3,660 $12,801 $17,440
=================================================
NOTE 4 -- ACQUISITION
TRANSACTION: On August 13, 1996, Equitable acquired all of the outstanding
capital stock of BT Variable Inc., ("BT Variable"), a New York corporation,
from Whitewood Properties Corp. ("Whitewood"), a New York corporation and
wholly-owned subsidiary of Bankers Trust Company ("Bankers Trust"), pursuant
to the terms of a Purchase Agreement dated as of May 3, 1996 between Equitable
and Whitewood. BT Variable, a New York corporation, in turn, owns all the
outstanding capital stock of Golden American Life Insurance Company ("Golden
American"), a Delaware stock life insurance company, and all of the
outstanding capital stock of Directed Services, Inc. ("DSI"), a New York
corporation and registered broker dealer and investment adviser. In exchange
for the outstanding capital stock of BT Variable, Equitable paid $93,000,000
in cash to Whitewood in accordance with the terms of the Purchase Agreement.
Equitable also paid $51,000,000 in cash to Bankers Trust to retire certain
debt owed by BT Variable to Bankers Trust pursuant to a revolving credit
arrangement. The funds used in completing the acquisition were obtained
primarily through a July 1996 offering of securities undertaken by Equitable
of Iowa Companies Capital Trust (the "Trust"), an affiliate of Equitable, the
proceeds of which were loaned to Equitable in exchange for subordinated
debentures issued by Equitable to the Trust. Additional funds were provided
by reducing short-term investments of Equitable and its insurance
subsidiaries. Funds provided by Equitable's insurance subsidiaries were
transferred to Equitable in the form of dividends paid. The acquisition was
accounted for using the purchase method, and the results of operations of BT
Variable are included in the consolidated statement of income from the date
of acquisition. Subsequent to the acquisition, the BT Variable, Inc. name
was changed to EIC Variable, Inc. On April 30, 1997, EIC Variable, Inc. was
liquidated and its investments in Golden American and DSI were transferred to
Equitable while the remainder of its net assets were contributed to Golden
American.
ACCOUNTING TREATMENT: The acquisition was accounted for as a purchase
resulting in a new basis of accounting, reflecting estimated fair values for
assets and liabilities at August 13, 1996. The purchase price was allocated
to the three companies purchased - BT Variable, DSI, and Golden American.
Goodwill relating to the acquisition was established for the excess of the
acquisition cost over the fair value of the net assets acquired and pushed
down to Golden American. The acquisition cost was preliminary with respect
to the final settlement of taxes with Bankers Trust and estimated expenses.
The total amount of goodwill and other intangibles deferred relating to the
acquisition was comprised of $41,113,000 of estimated goodwill and
approximately $4,695,000 of costs of issuance of the preferred securities
mentioned above. At June 30, 1997, goodwill was increased by $1,848,000 to
adjust the value of a receivable existing at the acquisition date. Goodwill
and preferred securities issuance costs will be amortized on a straight-line
basis over 25 years and 35 years, respectively, and the carrying value will
be reviewed periodically for any indication of impairment in value.
PRESENT VALUE OF IN FORCE ACQUIRED: As part of the acquisition, a portion of
the cost was allocated to the right to receive future cash flows from the
insurance contracts existing with Golden American at the date of acquisition.
This allocated cost represents the present value of in force acquired ("PVIF")
which reflects the value of those purchased policies calculated by discounting
the actuarially determined expected future cash flows at the discount rate
determined by the company.
An analysis of the PVIF asset for the nine months ended September 30, 1997 is
as follows:
(Dollars in thousands)
Beginning balance $83,051
Imputed interest 4,653
Amortization (9,118)
Adjustment for unrealized
gains on available for
sale securities (430)
_______________
Ending balance $78,156
===============
Interest is imputed on the unamortized balance of PVIF at rates of 7.70% to
7.80%. Amortization of PVIF is charged to expense and the asset is adjusted
for the change in unrealized gains (losses) on available for sale securities.
During the second quarter of 1997, PVIF was unlocked by $2,293,000 to reflect
narrower current spreads than the gross profit model assumed. Based on
current conditions and assumptions as to future events on acquired policies
in force, the expected approximate net amortization for the next five years,
relating to the balance of the PVIF as of September 30, 1997, is as follows:
Year Amount
_______________________________
(Dollars in thousands)
Remainder of 1997 $2,300
1998 10,100
1999 9,600
2000 8,300
2001 7,200
2002 6,100
Actual amortization may vary from the schedule above based upon changes in
assumptions and experience.
NOTE 5 -- MERGER
TRANSACTION: On October 23, 1997, Equitable of Iowa Companies ("Equitable")
shareholders approved the Agreement and Plan of Merger ("Merger Agreement")
dated as of July 7, 1997, between Equitable, PFHI Holdings, Inc. ("PFHI"),
and ING Groep N.V. ("ING"). On October 24, 1997, PFHI, a Delaware
corporation, acquired all of the outstanding capital stock of Equitable
pursuant to the Merger Agreement. PFHI is a wholly-owned subsidiary of ING,
a global financial services holding company based in The Netherlands.
Equitable, an Iowa corporation, in turn, owns all the outstanding capital
stock of Equitable Life Insurance Company of Iowa and Golden American Life
Insurance Company and their wholly-owned subsidiaries. Equitable also owns
all the outstanding capital stock of Locust Street Securities, Inc., Equitable
Investment Services, Inc., Directed Services, Inc., Equitable of Iowa
Companies Capital Trust, Equitable of Iowa Companies Capital Trust II and
Equitable of Iowa Securities Network, Inc. In exchange for the outstanding
capital stock of Equitable, ING will pay total consideration of approximately
$2,200,000,000 in cash and stock plus the assumption of approximately
$400,000,000 in debt according to the Merger Agreement. As a result of the
merger, Equitable of Iowa Companies was merged into PFHI which was
simultaneously renamed Equitable of Iowa Companies, Inc.
ACCOUNTING TREATMENT: The merger will be accounted for as a purchase
resulting in a new basis of accounting, reflecting estimated fair values for
assets and liabilities for Equitable and its subsidiaries as of the date of
the merger. The excess of the total acquisition cost over the fair value of
the net assets acquired will be recorded as goodwill.
NOTE 6 -- COMMITMENTS AND CONTINGENCIES
REINSURANCE: In the normal course of business, the company seeks to limit
its exposure to loss on any single insured and to recover a portion of
benefits paid by ceding reinsurance to other insurance enterprises or
reinsurers. Reinsurance coverages for life insurance vary according to the
age and risk classification of the insured with retention limits ranging up
to $500,000 of coverage per individual life. The company does not use
financial or surplus relief reinsurance.
Reinsurance contracts do not relieve the company from its obligations to its
policyholders. To the extent that reinsuring companies are later unable to
meet obligations under reinsurance agreements, the company's life insurance
subsidiaries would be liable for these obligations, and payment of these
obligations could result in losses to the company. To limit the possibility
of such losses the company evaluates the financial condition of its
reinsurers, monitors concentrations of credit risk arising from factors such
as similar geographic regions, and limits its exposure to any one reinsurer.
At September 30, 1997, the company had reinsurance treaties with 15
reinsurers, all of which are deemed to be long-duration, retroactive
contracts, and has established a receivable totaling $17,662,000 for reserve
credits, reinsurance claims and other receivables from these reinsurers. No
allowance for uncollectible amounts has been established since none of the
receivables are deemed to be uncollectible, and because such receivables,
either individually or in the aggregate, are not material to the company's
operations. The company's liability for future policy benefits and notes and
other receivables has been increased by $15,921,000 at September 30, 1997,
for reserve credits on reinsured policies. This "gross-up" of assets and
liabilities for reserve credits on reinsurance had no impact on the company's
net income. Insurance premiums and product charges have been reduced by
$2,417,000 in the third quarter and $6,818,000 in the first nine months of
1997 compared to $1,984,000 and $5,431,000 for the same periods of 1996.
Insurance benefits and expenses have been reduced by $1,718,000 for the third
quarter and $4,869,000 in the first nine months of 1997 compared to
$1,190,000, and $4,186,000 in the same periods of 1996. The amount of
reinsurance assumed is not significant.
INVESTMENT COMMITMENTS: At September 30, 1997, outstanding commitments to
fund mortgage loans on real estate, mortgage-backed securities and equity
investments totaled $116,695,000, $15,341,000 and $8,684,000, respectively.
GUARANTY FUND ASSESSMENTS: Assessments are levied on the company's life
insurance subsidiaries by life and health guaranty associations in most
states in which these subsidiaries are licensed to cover losses of
policyholders of insolvent or rehabilitated insurers. In some states, these
assessments can be partially recovered through a reduction in future premium
taxes. The company cannot predict whether and to what extent legislative
initiatives may affect the right to offset. The associated cost for a
particular insurance company can vary significantly based upon its premium
volume by line of business and state premiums levels as well as its potential
for premium tax offset. The company has established a reserve to cover such
assessments and regularly reviews information regarding known failures and
revises its estimates of future guaranty fund assessments. During the third
quarter and first nine months of 1997, the company accrued and charged to
expense $135,000 and $417,000, respectively. At September 30, 1997, the
company has an undiscounted reserve of $43,806,000 to cover estimated future
assessments (net of related anticipated premium tax credits) and has
established an asset totaling $14,482,000 for assessments paid which may be
recoverable through future premium tax offsets. The company believes this
reserve is sufficient to cover expected future insurance guaranty fund
assessments, based upon previous premium levels, and known insolvencies at
this time.
COMPANY-OBLIGATED, MANDATORILY-REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY
TRUST II: On April 3, 1997, Equitable of Iowa Companies Capital Trust II
(the "Trust II"), a consolidated, wholly-owned subsidiary of Equitable,
issued $50,000,000 of its 8.424% Capital Securities (the "Capital
Securities"). Concurrent with the issuance of the Trust II's Capital
Securities, Equitable issued to the Trust II $50,000,000 in principal amount,
of its 8.424% Subordinated Deferrable Interest Debentures (the "Debt
Securities") due April 1, 2027. The sole assets of the Trust II are and will
remain the Debt Securities and any accrued interest thereon. The interest
and other payment dates on the Debt Securities correspond to the distribution
and other payment dates on the Capital Securities. The Debt Securities
mature on April 1, 2027, and are redeemable by Equitable, in whole, at the
occurrence of a special event. The Capital Securities will mature or be
called simultaneously with the Debt Securities. The Capital Securities have
a liquidation value of $1,000 per capital security plus accrued and unpaid
distributions. As of September 30, 1997, 50,000 shares of Capital Securities
were outstanding.
Equitable has obligations under the Debt Securities, the Capital Securities
Agreement, the Declaration of Trust, as amended, and the Indenture, as amended
by the First Supplemental Indenture. These obligations, when considered
together, constitute a full and unconditional guarantee by Equitable of the
Trust II's obligations under the Capital Securities.
The company utilized the estimated net proceeds of approximately $49,237,000
from the issuance of Capital Securities, for general corporate purposes
including, but not limited to, investments in its subsidiaries.
EARNINGS PER SHARE: In February 1997, the Financial Accounting Standards
Board issued Statement No. 128, "Earnings per Share", which is required to be
adopted on December 31, 1997. At that time the company will be required to
disclose both basic earnings per share and fully diluted earnings per share
on the face of the income statement or in the notes to the financial
statements. The impact of the fully-diluted earnings per share would dilute
primary earnings per share by approximately $0.02 and $0.06 per share for the
third quarter and the first nine months of 1997, respectively, and $0.01 and
$0.05 for the same periods of 1996.
LITIGATION: USG is a defendant in a class action complaint filed in the
state circuit court of Kentucky in September 1997. The suit claims
unspecified damages and injunctive relief as a result of alleged improper
actions related to the interest rate adjustment provisions of USG's fixed
annuity contracts. The case has been removed to Federal Court in the
Northern District of Kentucky. The original plaintiff putative class
representative has been joined by an additional named plaintiff who claims
also to be a class representative. The company believes the allegations are
without merit. The suit is in the early procedural stage. The company
intends to defend the suit vigorously, including vigorously contesting its
class action status. ING advised the company this litigation would not
effect the terms or closing of the merger between Equitable and a subsidiary
of ING. The amount of any liability which may arise as a result of this
suit, if any, cannot be reasonably estimated and no provision for loss has
been made in the accompanying financial statements.
The company has entered into a proposed settlement of two related and
virtually identical class-action lawsuits regarding alleged improper life
insurance sales practices. The company denies the allegations in these class-
action lawsuits, but entered into this settlement to limit additional expense
and burden on the company's operations. The class-action lawsuits were filed
in the United States District Court for the Middle District of Florida (Tampa
Division) in February of 1996, and in the Superior Court of Arizona (Pima
County) in July of 1997. Subject to the approval of the federal court in the
Florida action and the Arizona court in the Arizona action, hearings
regarding final approval of the settlement are anticipated to be scheduled
during the fourth quarter of 1997 or the first quarter of 1998. Two
different but related class-action lawsuits are also pending against the
company in the Court of Common Pleas of Allegany County, Pennsylvania, and
the District Court for Bexar County Texas. These two class-action lawsuits,
filed in June of 1996 and April of 1996, respectively, are still pending, but
the company expects the claims asserted therein to be resolved as a part of
the proposed settlement in the Florida and Arizona actions.
During the second quarter of 1997, the company accrued a pre-tax expense of
approximately $20,495,000 for policy liabilities and administrative and other
costs anticipated with the proposed settlement. Owners of approximately
130,000 universal and whole life insurance policies issued by the company
from 1984 through 1996 may be eligible to receive the following benefits
provided by the proposed settlement: 1) one-time enhancement to the interest
component of the policy; 2) one-time enhancement to the dividend component of
the policy; 3) optional premium loans that would allow policyholders to
borrow at reduced rates; 4) enhanced value deferred annuities to holders of
affected policies; 5) enhanced value immediate annuities to affected
policyholders; and 6) enhanced value life policies to affected policyholders.
In addition, the proposed settlement provides Individual Claim-Review Relief
(an arbitration-type process) for policyholders who believe they may have
been misled or otherwise harmed in connection with their policies.
In the ordinary course of business, the company and its subsidiaries are also
engaged in certain other litigation, none of which management believes is
material.
Vulnerability from Concentrations: The company has various concentrations in
its investment portfolio (see Note 2 for further information). The company's
asset growth, net investment income and cash flow are primarily generated
from the sale of individual fixed annuity policies, variable products and
associated future policy benefits and separate account liabilities.
Substantial changes in tax laws that would make these products less
attractive to consumers, extreme fluctuations in interest rates or stock
market returns which may result in higher lapse experience than assumed,
could cause a severe impact to the company's financial condition. The
company has purchased interest rate caps and swaptions for its hedging
program (see Note 3) to mitigate the financial statement impact of
significant increases in interest rates.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The purpose of this section is to discuss and analyze the company's
consolidated results of operations, financial condition, and liquidity and
capital resources. This analysis should be read in conjunction with the
consolidated financial statements and related notes which appear elsewhere in
this report. The company reports financial results on a consolidated basis.
The consolidated financial statements include the accounts of the company and
its subsidiaries, all of which are wholly owned at September 30, 1997. The
company's primary subsidiaries are Equitable Life Insurance Company of Iowa
("Equitable Life"), Golden American Life Insurance Company ("Golden
American") and USG Annuity & Life Company ("USG").
RESULTS OF OPERATIONS
_____________________
ACQUISITION
On August 13, 1996, Equitable of Iowa Companies ("Equitable") acquired all of
the outstanding capital stock of BT Variable, Inc. ("BT Variable") and its
wholly-owned subsidiaries, Golden American and Directed Services, Inc.
("DSI") for $144,000,000. Golden American is a Delaware stock life insurance
company and DSI is a New York corporation and registered broker/dealer and
investment adviser. The purchase price consisted of $93,000,000 in cash paid
to Whitewood Properties Corporation (parent of BT Variable) and $51,000,000
in cash paid to Bankers Trust (parent of Whitewood) to retire certain debt
owed by BT Variable to Bankers Trust. The funds used in completing the
acquisition were obtained primarily through a July 1996 offering of
securities undertaken by Equitable of Iowa Companies Capital Trust (the
"Trust"), an affiliate of Equitable, the proceeds of which were loaned to
Equitable in exchange for subordinated debentures issued by Equitable to the
Trust. Additional funds were provided by reducing short-term investments of
Equitable and its insurance subsidiaries. Funds provided by Equitable's
insurance subsidiaries were transferred to Equitable in the form of dividends
paid. Subsequent to the acquisition, the BT Variable, Inc. name was changed
to EIC Variable, Inc. ("EIC Variable"). On April 30, 1997, EIC Variable,
Inc. was liquidated and its investments in Golden American and DSI were
transferred to Equitable while the remainder of its net assets were
contributed to Golden American.
The acquisition was accounted for as a purchase and, accordingly, the first
nine months of 1997 results of operations include the operations of EIC
Variable, Golden American and DSI. Information provided for the first nine
months of 1996 includes the operations of these companies for the period
August 14, 1996 through September 30, 1996. Certain additional information
has been provided in this discussion on a pro forma combined basis, as if the
operations of BT Variable had been included in the first nine months of 1996,
to assist the reader in assessing the operations and prospects of the company
as it is currently comprised. The following table reflects actual results
for the nine months ended September 30, 1997 and 1996.
PREMIUMS
Percentage Dollar
Quarter ended September 30 1997 Change Change 1996
________________________________________________________________________________
(Dollars in thousands)
Fixed annuity premiums $488,088 48.6% $159,624 $328,464
Variable annuity premiums:
Separate account 232,499 169.1 146,090 86,409
Fixed account 89,471 404.9 71,751 17,720
_______________________________________________
Total variable annuity premiums 321,970 209.2 217,841 104,129
_______________________________________________
Total annuity premiums 810,058 87.3 377,465 432,593
Life insurance premiums:
First year and single premiums 10,224 18.1 1,563 8,661
Renewal premiums 24,343 2.5 605 23,738
_______________________________________________
Total life insurance premiums 34,567 6.7 2,168 32,399
_______________________________________________
Total premiums $844,625 81.6% $379,633 $464,992
===============================================
Percentage Dollar
Nine months ended September 30 1997 Change Change 1996
________________________________________________________________________________
(Dollars in thousands)
Fixed annuity premiums $1,099,274 20.5% $187,098 $912,176
Variable annuity premiums:
Separate account 593,089 229.8 413,246 179,843
Fixed account 234,795 1,077.0 214,846 19,949
_______________________________________________
Total variable annuity premiums 827,884 314.4 628,092 199,792
_______________________________________________
Total annuity premiums 1,927,158 73.3 815,190 1,111,968
Life insurance premiums:
First year and single premiums 32,686 31.1 7,755 24,931
Renewal premiums 72,690 4.8 3,344 69,346
_______________________________________________
Total life insurance premiums 105,376 11.8 11,099 94,277
_______________________________________________
Total premiums $2,032,534 68.5% $826,289 $1,206,245
===============================================
Total annuity and life insurance premiums, increased 81.6%, to $844,625,000
in the third quarter and increased 68.5%, to $2,032,534,000, in the first
nine months of 1997. Fixed annuity premiums increased 48.6%, to $488,088,000
in the third quarter and increased 20.5%, to $1,099,274,000, in the first
nine months of 1997 as a result of increased sales through financial
institutions, agents and broker/dealer channels. In addition, the company's
equity-indexed annuity product, introduced in January 1997 resulted in
$60,047,000 of third quarter production. Variable annuity premiums continue
to reflect strong growth, with a 209.2% increase in the third quarter and a
314.4% increase in the first nine months of 1997. This increase is due, in
part, to the August 13, 1996 acquisition of Golden American, broadening
distribution channels, and sales of variable annuities in New York through
the company's recently formed subsidiary, First Golden.
Golden American reported variable annuity premiums of $146,119,000 and
$378,250,000, and variable life premiums of $3,261,000 and $13,639,000, in
the third quarter and first nine months of 1997, respectively. Equitable
Life introduced its variable annuity product in the fourth quarter of 1994.
Variable annuities have grown as a percentage of the company's total premiums
due to market conditions which have made products with variable returns
relatively more attractive than products with fixed returns, expansion of
variable product offerings and growth and diversification of distribution
channels. As a result, variable annuity premiums have grown to 40.8% of
total premiums in the first nine months of 1997, compared to 16.6% for the
first nine months of 1996. Fixed annuity premiums represent 54.1% of total
premiums in the first nine months of 1997, compared to 75.6% for the same
period of 1996, while life insurance premiums represent approximately 5.1% of
total premiums in the first nine months of 1997, compared to 7.8% for the
same period of 1996.
The acquisition of Golden American has complemented and significantly enhanced
the company's existing variable annuity business. As a result of the
acquisition, the company has expanded the distribution of its variable
products, and plans to continue this expansion as well as market fixed
products through Golden American's distribution system. The company believes
the product diversification achieved with the acquisition of Golden American,
expansion and diversification of distribution channels, its commitment to
customer service, the quality of its investment portfolio, competitive pricing
and its overall financial strength will continue to attract consumers to its
annuity products as consumers seek a secure return on their retirement savings.
The diversity of products and distribution channels the company now offers is
intended to improve the stability of sales under a variety of market
conditions. Insurance agents and broker/dealers are attracted to sell the
company's products by several factors, including the company's diversified
product portfolio, competitive commissions, rapid policy issuance and level of
agent support.
The tables above include premiums for Golden American for the third quarter
and first nine months of 1997 and for the period August 14, 1996 through
September 30, 1996. As a result, the premiums provide insight as to the
reported results of operations. However, the significant increase in variable
annuity premiums is primarily attributable to the acquisition of Golden
American and significant growth in sales of Equitable Life's variable annuity
products. The following tables are provided on a pro forma combined basis
including Golden American premiums for the third quarter and first nine months
of 1997 and 1996.
PRO FORMA PREMIUMS
Percentage Dollar
Quarter ended September 30 1997 Change Change 1996
________________________________________________________________________________
(Dollars in thousands)
Fixed annuity premiums $488,088 48.6% $159,625 $328,463
Variable annuity premiums:
Separate account:
Equitable Life 174,063 140.1 101,565 72,498
Golden American 58,436 45.2 18,205 40,231
Fixed account:
Equitable Life 1,788 8.7 143 1,645
Golden American 87,683 224.7 60,684 26,999
_______________________________________________
Total variable annuity premiums 321,970 127.8 180,597 141,373
_______________________________________________
Total annuity premiums 810,058 72.4 340,222 469,836
Life insurance premiums:
Equitable Life & USG 31,305 1.2 356 30,949
Golden American 3,262 (25.7) (1,128) 4,390
_______________________________________________
Life insurance premiums 34,567 (2.2) (772) 35,339
_______________________________________________
Total premiums $844,625 67.2% $339,450 $505,175
===============================================
Percentage Dollar
Nine months ended September 30 1997 Change Change 1996
________________________________________________________________________________
(Dollars in thousands)
Fixed annuity premiums $1,099,274 20.5% $187,098 $912,176
Variable annuity premiums:
Separate account:
Equitable Life 443,363 167.2 277,431 165,932
Golden American 149,726 6.2 8,796 140,930
Fixed account:
Equitable Life 6,271 61.9 2,397 3,874
Golden American 228,524 55.0 81,096 147,428
_______________________________________________
Total variable annuity premiums 827,884 80.7 369,720 458,164
_______________________________________________
Total annuity premiums 1,927,158 40.6 556,818 1,370,340
Life insurance premiums:
Equitable Life & USG 91,736 (1.2) (1,090) 92,826
Golden American 13,640 14.1 1,683 11,957
_______________________________________________
Life insurance premiums 105,376 0.6 593 104,783
_______________________________________________
Total premiums $2,032,534 37.8% $557,411 $1,475,123
===============================================
On a pro forma combined basis, total annuity and life insurance premiums
increased 67.2% in the third quarter to $844,625,000 and increased 37.8% in
the first nine months of 1997 to $2,032,534,000. On a pro forma combined
basis, variable annuity separate account premiums increased 106.2% in the
third quarter to $232,499,000 and increased 93.3% to $593,089,000 in the
first nine months of 1997. The variable annuity fixed account increased
212.4% in the third quarter to $89,471,000 and increased 55.2% to $234,795,000
during the first nine months of 1997 on a pro forma basis. This increase in
variable annuity premiums is the result of the company's broadening
distribution channels and the sale of variable annuities in New York through
its recently formed subsidiary, First Golden. Equitable Life introduced its
variable annuity product in the fourth quarter of 1994 and premiums from this
product have grown dramatically over the last two years although year over
year percentage increases have declined due to increases in the amount of in
force attributable to this product. The company expects variable annuity
premiums to continue to grow as it expands and diversifies its product
offerings and distribution channels, but year over year percentage increases
will decline as the amount of variable annuities in force increases.
Equitable Life and USG offer interest-sensitive and traditional life insurance
products Golden American offers only variable products, including variable
life insurance. Premiums, net of reinsurance, for variable annuity and
variable life products from significant sellers for the nine months ended
September 30, 1997 are as follows: Paine Webber, $110,000,000 or 13%; Smith
Barney, $143,000,000 or 17%; Locust Street Securities, Inc., an affiliate,
$124,000,000 or 15%; and Primerica Financial Services, $190,000,000 or 23%.
Primerica Financial Services has indicated that it may discontinue the sales
relationship in the second quarter of 1998. Discussion is currently ongoing
regarding this.
REVENUES
Percentage Dollar
Quarter ended September 30 1997 Change Change 1996
______________________________________________________________________________
(Dollars in thousands)
Annuity and interest
sensitive life
product charges $29,789 56.7% $10,783 $19,006
Traditional life insurance
premiums 9,642 (1.7) (172) 9,814
Net investment income 202,892 12.5 22,546 180,346
Realized gains on
investments 8,476 87.9 3,966 4,510
Other income 8,895 26.2 1,848 7,047
______________________________________________
$259,694 17.7% $38,971 $220,723
==============================================
Percentage Dollar
Nine months ended September 30 1997 Change Change 1996
______________________________________________________________________________
(Dollars in thousands)
Annuity and interest
sensitive life
product charges $78,294 59.9% $29,341 $48,953
Traditional life insurance
premiums 28,740 (3.3) (972) 29,712
Net investment income 593,001 12.2 64,389 528,612
Realized gains on
investments 16,953 7.1 1,125 15,828
Other income 25,743 53.6 8,987 16,756
______________________________________________
$742,731 16.1% $102,870 $639,861
==============================================
Total revenues increased 17.7% in the third quarter and 16.1% in the first
nine months of 1997. Annuity and interest sensitive life insurance product
charges increased 56.7% in the third quarter and 59.9% in the first nine
months of 1997. Excluding Golden American, annuity and interest sensitive
life product charges increased 42.3% in the third quarter and increased 33.9%
in the first nine months of 1997. These product charges consist primarily of
cost of insurance charges, policy administrative charges and surrender
charges that increase as the company's policyholder liabilities grow,
including variable separate account liabilities. In addition, withdrawals
and surrenders of the company's annuity products which contain a "market
value adjustment" feature generate greater surrender charge income as
interest rates increase and lower surrender charge income as interest rates
decrease. Surrender charge income allows the company to recover a portion of
the expenses incurred to generate policy sales and partially offsets the
amortization of deferred policy acquisition costs related to surrendered
policies. Premiums from traditional life insurance products, which are
included in revenue, decreased 1.7% in the third quarter and 3.3% in the
first nine months of 1997, as a result of the company's continued emphasis on
the more popular universal life and fixed premium, current interest life
insurance products (for which premiums are not included in revenues).
Net investment income increased 12.5% in the third quarter and 12.2% in the
first nine months of 1997 due to the increase in invested assets. During the
third quarter and first nine months of 1997, the company had realized gains
on the sale of investments of $8,476,000, and $16,953,000 compared to gains
of $4,510,000, and $15,828,000 in the same periods of 1996.
Other income increased 26.2% in the third quarter and 53.6% in the first nine
months of 1997 as a result of the acquisition of DSI and an increase in
commission income from an affiliated broker/dealer. The increase in
commission income from the broker/dealers is substantially offset by an
increase in other expense.
EXPENSES
Total insurance benefits and expenses increased $25,069,000, or 15.6%, to
$185,975,000 in the third quarter and $86,304,000, or 18.4% to $554,666,000
in the first nine months of 1997. Interest credited to annuity and interest
sensitive life account balances increased $15,456,000, or 13.9%, to
$126,612,000 in the third quarter and $38,183,000, or 11.6% to $366,563,000
in the first nine months of 1997 as a result of higher account balances
associated with those products. The amortization of financial instruments
purchased for the company's hedging programs during 1996 and 1997 increased
interest credited to account balances by $1,492,000 during the third quarter
and $4,034,000 during the first nine months of 1997. See further discussion
of the hedging programs in the Financial Instruments - Risk Management
section below.
The company's policy is to change rates credited to policy accounts as the
company's investment portfolio yield changes. Most of the company's interest
sensitive products, including fixed annuities, interest sensitive life
policies and participating policies, allow for interest rate adjustments at
least annually. The company also sells deferred annuities with multi-year
interest rate guarantees. The design of these products makes them competitive
with savings alternatives such as certificates of deposit. The following
table summarizes the effective annual yield on assets invested to support
policy accounts for interest-sensitive products, the average annual interest
rate credited to those products and the interest rate spread for the nine
months ended September 30, 1997 and 1996. Yield on assets and cost of funds
are estimated by calculating the weighted average of the nine month end values
for those items.
Golden American is included in the tables below for the first nine months of
1997 and for the period August 14, 1996 through September 30, 1996.
Yield on Credited Interest
Nine months ended September 30 Assets Rate Rate Spread
____________________________________________________________________________
Average base rate (excluding first
year bonus):
1997 8.34% 5.54% 2.80%
1996 8.44 5.58 2.86
Average total (including first
year bonus):
1997 8.34 5.72 2.62
1996 8.44 5.84 2.60
At September 30, 1997 and 1996, the effective annual yield on assets, credited
rate and interest rate spread were as follows:
Yield on Credited Interest
September 30, Assets Rate Rate Spread
____________________________________________________________________________
Base rate (excluding first
year bonus):
1997 8.29% 5.56% 2.73%
1996 8.45 5.50 2.95
Total (including first year bonus):
1997 8.29 5.73 2.56
1996 8.45 5.74 2.71
The base interest credited rate represents the average interest rate credited
to policy accounts for interest sensitive products, including annuities,
interest sensitive life policies and participating policies. The total
interest credited rate includes first year bonus interest credited to certain
policies.
Death benefits on traditional life products and benefit claims incurred in
excess of account balances increased $2,287,000, or 30.3%, to $9,840,000 in
the third quarter and $1,541,000, or 6.0%, to $27,085,000 in the first nine
months of 1997. After adjustment for charges for mortality risk, reserves
released on death claims and taxes, the overall impact of mortality on net
income was more favorable in 1997 by approximately $1,471,000 in the third
quarter and $652,000 on a year-to-date basis.
Commissions increased $15,478,000, or 43.7%, to $50,887,000 in the third
quarter and $30,618,000, or 31.4% to $128,020,000 in the first nine months of
1997. Excluding Golden American, commissions increased 28.0% in the third
quarter and 11.2% in the first nine months of 1997. Insurance taxes increased
$369,000, or 18.4%, to $2,376,000 in the third quarter and $1,027,000, or
16.8%, to $7,137,000 in the first nine months of 1997. Increases and
decreases in commissions and insurance taxes are generally related to changes
in the level of annuity sales. Commissions are also affected by the mix of
annuity sales. Most costs incurred as the result of new sales have been
deferred, and thus have very little impact on total insurance expenses.
General expenses increased $2,352,000, or 17.2%, to $16,028,000 in the third
quarter and $34,243,000, or 94.8% to $70,372,000 in the first nine months of
1997. The increase in 1997 is primarily attributable to an accrual of
$20,495,000 in the second quarter related to the litigation settlement accrual
(see further discussion in the Accounting and Legal Developments - Litigation
section below) and Golden American expenses. Golden American was acquired in
the third quarter of 1996, and therefore is included in 1996 expenses for the
period August 14, 1996 through September 30, 1996. In addition, Golden
American uses a network of wholesalers to distribute its products and the
salaries of these wholesalers are included in general expenses. The company
experienced growth in sales of fixed and variable annuities through these
wholesalers during 1997. The portion of these salaries and related expenses
which vary with sales production levels are deferred, thus having little
impact on current earnings. Management expects general expenses to continue
to increase substantially in 1997 as a result of the inclusion of Golden
American operations for the full year and the continued emphasis on expanding
the salaried wholesaler distribution network as well as certain expenses
associated with the ING merger.
Most of the company's annuity products have surrender charges which are
designed to discourage early withdrawals and to allow the company to recover
a portion of the expenses incurred to generate annuity sales in the event of
early withdrawal. Withdrawal rates have been impacted by certain factors.
(1) The company expected and has experienced an increase in withdrawals as
its annuity liabilities age. (2) Withdrawals tend to increase in periods of
rising interest rates as policyholders seek higher returns on their savings.
The company has implemented a hedging program which uses certain derivative
instruments (interest rate caps and swaptions) to reduce the negative effect
of increased withdrawal activity which may result from extreme increases in
interest rates (see further discussion of the hedging program in the
financial instruments section below).
The following table summarizes the annualized annuity withdrawal rates and
the life insurance lapse ratios for the three and nine months ended September
30, 1997 and 1996.
Three Months Ended Nine Months Ended
September 30 September 30
__________________ __________________
1997 1996 1997 1996
________ ________ ________ ________
Annuity withdrawals 11.4% 9.0% 10.2% 8.6%
Life insurance lapse ratio 8.9% 7.8% 8.1% 7.5%
The withdrawal ratio for the company's annuity products is calculated by
dividing aggregate surrenders and withdrawals by beginning of period account
balances. The company's annualized lapse ratio for life insurance is measured
in terms of face amount and uses A.M. Best's formula.
The amortization of deferred policy acquisition costs ("DPAC") increased by
$5,359,000, or 25.2%, in the third quarter and $14,168,000, or 23.8% in the
first nine months of 1997. Increases in amortization of deferred acquisition
costs related to operating earnings are the result of increases in the
deferred policy acquisition cost asset (before adjustment to reflect the
impact of SFAS No. 115) as costs of generating sales of the company's products
are deferred and amortized in later periods. Also, higher withdrawals and
surrenders of the company's products have accelerated the amortization of
deferred acquisition costs related to those products although surrender
charges assessed on certain withdrawals offset some of the earnings impact of
this accelerated amortization. Amortization related to realized gains
declined as a result of a decrease in realized and prepayment gains from
assets backing fixed annuity and interest sensitive life insurance
liabilities.
A breakdown of the amortization of deferred policy acquisition costs for the
three and nine months ended September 30, 1997 and 1996 is as follows:
Percentage Dollar
Quarter ended September 30 1997 Change Change 1996
________________________________________________________________________________
(Dollars in thousands)
Amortization related to:
Operating income $24,092 19.5% $3,928 $20,164
Realized gains 2,554 127.4 1,431 1,123
-------------------------------------------------
Total $26,646 25.2% $5,359 $21,287
=================================================
Percentage Dollar
Nine months ended September 30 1997 Change Change 1996
________________________________________________________________________________
(Dollars in thousands)
Amortization related to:
Operating income $69,404 27.1% $14,798 $54,606
Realized gains 4,249 (12.3) (630) 4,879
-------------------------------------------------
Total $73,653 23.8% $14,168 $59,485
=================================================
As a part of the acquisition of Golden American, $85,796,000 of the cost was
allocated to the right to receive future cash flows from the insurance
contracts existing with Golden American at the date of acquisition. This
allocated cost represents the present value of in force acquired ("PVIF")
which reflects the value of those purchased policies calculated by
discounting the actuarially determined expected future cash flows at the
discounted rate determined by the company. Amortization of PVIF totaled
$2,285,000 in the third quarter and $4,465,000 in the first nine months of
1997 ($915,000 from August 14, 1996 to September 30, 1996). During the
second quarter of 1997, PVIF was unlocked by $2,293,000 to reflect narrower
current spreads than the gross profit model assumed. Based on current
conditions and assumptions as to the impact of future events on acquired
policies in force, amortization of PVIF is expected to be approximately
$2,300,000 for the remainder of 1997, $10,100,000 in 1998, $9,600,000 in
1999, $8,300,000 in 2000, $7,200,000 in 2001 and $6,100,000 in 2002. Actual
amortization may vary based upon changes in assumptions and experience.
The acquisition of Golden American was accounted for as a purchase resulting
in a new basis of accounting, reflecting estimated fair values for assets and
liabilities at the acquisition date. Goodwill of $41,113,000 was established
for the excess of the acquisition cost over the fair value of net assets
acquired. The acquisition cost was preliminary with respect to the final
settlement of taxes with Bankers Trust and estimated expenses. At June 30,
1997, goodwill was increased by $1,848,000 to adjust the value of a receivable
existing at the acquisition date. Amortization of goodwill relating to Golden
American during the third quarter totaled $411,000 and $1,261,000 during the
first nine months of 1997 ($196,000 in the third quarter and first nine months
of 1996). Amortization of goodwill attributed to licenses acquired in
conjunction with the purchase of USG totaled $19,000 in the third quarter and
$56,000 in the first nine months of 1997 and 1996, respectively. Goodwill
resulting from the acquisition of Golden American is being amortized on a
straight-line basis over 25 years and is expected to total approximately
$1,644,000 annually.
Other expenses increased $4,075,000, or 70.7% to $9,840,000 in the third
quarter and $14,252,000, or 102.3% to $28,181,000 in the first nine months of
1997. The increase in other expenses resulted from increased commissions
paid to registered representatives selling investment products through the
company's broker/dealer operations and accounting, custodial and
administrative expenses of variable products operations.
On July 23, 1996, Equitable of Iowa Companies Capital Trust (the "Trust"), a
consolidated, wholly-owned subsidiary of the company issued $125,000,000 of
8.70% Trust Originated Preferred Securities. In addition, on April 3, 1997,
Equitable of Iowa Companies Capital Trust II (the "Trust II"), a consolidated,
wholly-owned subsidiary of the company issued $50,000,000 of 8.424% Capital
Securities. See Liquidity and Capital Resources section below for a
discussion of these transactions. Pre-tax distributions to the holders of
these company-obligated, mandatorily-redeemable securities totaled $3,772,000
in the third quarter and $10,239,000 in the first nine months of 1997
($2,115,000 in the third quarter and first nine months of 1996).
INCOME
Operating income (income excluding realized gains and losses, commercial
mortgage and mortgage-backed securities prepayment gains and related
amortization of deferred policy acquisition costs and the second quarter 1997
litigation settlement accrual), increased $3,781,000, or 13.0%, in the third
quarter and $8,538,000, or 10.0% in the first nine months of 1997. Net
income increased $4,904,000, or 15.5%, in the third quarter and decreased
$3,605,000, or 3.8%, in the first nine months of 1997. A breakdown of income
is as follows:
Quarter ended September 30 1997 1996
______________________________________________________________________________
$ Per Share $ Per Share
_____________________________________________
(Dollars in thousands, except per share data)
Operating income $32,884 $1.03 $29,103 $0.91
Realized gains (net of tax):
Gains realized on disposal
of investments 5,598 0.17 2,932 0.09
Commercial mortgage and
mortgage-backed securities
prepayment gains (losses) (222) (0.01) 390 0.02
Realized gains related
amortization of DPAC (1,661) (0.05) (730) (0.03)
_____________________________________________
3,715 0.11 2,592 0.08
_____________________________________________
Net income $36,599 $1.14 $31,695 $0.99
=============================================
Nine months ended September 30 1997 1996
______________________________________________________________________________
$ Per Share $ Per Share
_____________________________________________
(Dollars in thousands, except per share data)
Operating income $93,921 $2.93 $85,383 $2.68
Realized gains (net of tax):
Gains realized on disposal
of investments 11,108 0.35 10,288 0.32
Commercial mortgage and
mortgage-backed securities
prepayment gains 1,121 0.04 1,172 0.04
Realized gains related
amortization of DPAC (2,761) (0.09) (3,171) (0.10)
Litigation settlement accrual (13,322) (0.42) -- --
_____________________________________________
(3,854) (0.12) 8,289 0.26
_____________________________________________
Net income $90,067 $2.81 $93,672 $2.94
=============================================
Average shares outstanding totaled 32,056,971 in the third quarter and
32,040,666 in the first nine months of 1997 up from 31,935,891 and 31,880,469
in the same periods of 1996.
FINANCIAL CONDITION
___________________
INVESTMENTS
The financial statement carrying value of the company's total investment
portfolio increased 10.6% in the first nine months of 1997. The amortized
cost basis of the company's total investment portfolio grew 9.4% during the
same period. All of the company's investments, other than mortgage loans and
real estate, are carried at fair value in the company's financial statements.
As such, growth in the carrying value of the company's investment portfolio
included changes in unrealized appreciation and depreciation of fixed maturity
and equity securities as well as growth in the cost basis of these securities.
Growth in the cost basis of the company's investment portfolio resulted from
the investment of premiums from the sale of the company's fixed annuity and
insurance products. The company manages the growth of its insurance
operations in order to maintain adequate capital ratios.
INVESTMENT PORTFOLIO SUMMARY: To support the company's fixed annuities and
life insurance products, cash flow was invested primarily in fixed maturity
securities. At September 30, 1997, the company's investment portfolio was
comprised of the following:
Yield at
Estimated Amort-
Amortized % of Fair % of ized
Cost Total Value Total Cost
_______________________________________________
(Dollars in thousands)
Investment cash and short-term
investments $136,400 1.3% $136,400 1.3% 5.7%
Governments and agency mortgage-
backed securities 338,351 3.3 355,107 3.3 8.1
Conventional mortgage-backed
securities 2,515,045 24.6 2,545,282 23.8 7.8
Investment grade corporate
securities 4,434,800 43.3 4,681,975 43.9 8.0
Below-investment grade corporate
securities 821,271 8.0 844,125 7.9 9.1
Mortgage loans 1,946,989 19.0 2,038,127 19.1 8.2
_______________________________________________
Total cash and fixed income
investments 10,192,856 99.5 10,601,016 99.3 8.0
Equity securities 43,004 0.4 62,058 0.6 11.0
Real estate 12,929 0.1 12,929 0.1 2.3
_______________________________________________
Total investments $10,248,789 100.0% $10,676,003 100.0% 8.1%
===============================================
Estimated fair values of publicly traded securities are as reported
by an independent pricing service. Fair values of conventional
mortgage-backed securities not actively traded in a liquid market are
estimated using a third party pricing system. This pricing system
uses a matrix calculation assuming a spread over U.S. Treasury bonds
based upon the expected average lives of the securities. Fair values
of private placement bonds are estimated using a matrix that assumes
a spread (based on interest rates and a risk assessment of the bonds)
over U.S. Treasury bonds. Estimated fair values of redeemable
preferred stocks are as reported by the National Association of
Insurance Commissioners ("NAIC"). Fair values of mortgage loans on
real estate are estimated by discounting expected cash flows, using
interest rates currently being offered for similar loans. Estimated
fair values of equity securities are based on the latest quoted
market prices or conversion value, if applicable. Estimated fair
values of the company's investment in its registered separate
account, included in equity securities, are based upon the quoted
fair value of the securities comprising the individual portfolios
underlying the separate account. Fair value of owned real estate is
estimated to be equal to, or in excess of, carrying value based upon
appraised values.
FIXED MATURITY SECURITIES: At September 30, 1997, the ratings assigned by
Standard & Poor's Corporation to the individual securities in the company's
fixed maturities portfolio are summarized as follows:
Amortized % of Estimated % of
Cost Total Fair Value Total
____________________________________________
(Dollars in thousands)
U.S. governments, agencies
& AAA Corporates $2,775,881 34.2% $2,822,744 33.5%
AA+ to AA- 362,925 4.5 380,964 4.5
A+ to A- 2,324,984 28.7 2,456,792 29.2
BBB+ to BBB- 1,671,401 20.6 1,763,513 20.9
BB+ to BB- 650,160 8.0 671,426 8.0
B+ to B- 158,865 2.0 161,361 1.9
Issues not rated by S&P
(by NAIC rating):
Rated 1 (AAA to A-) 89,426 1.1 93,047 1.1
Rated 2 (BBB+ to BBB-) 26,355 0.3 27,825 0.3
Rated 3 (BB+ to BB-) 40,198 0.5 41,020 0.5
Rated 5 (CCC+ to C) 8,665 0.1 7,415 0.1
Redeemable preferred stock 607 -- 382 --
____________________________________________
Total fixed maturities $8,109,467 100.0% $8,426,489 100.0%
============================================
All of the company's fixed maturity securities are designated as available
for sale although the company is not precluded from designating fixed
maturity securities as held for investment or trading at some future date.
Investments classified as available for sale securities are reported at fair
value and unrealized gains and losses on these securities are included
directly in stockholders' equity, after adjustment for related changes in
deferred policy acquisition costs, present value of in force acquired, policy
reserves and deferred income taxes. Securities the company has the positive
intent and ability to hold to maturity are designated as "held for
investment". Held for investment securities are reported at cost adjusted for
amortization of premiums and discounts. Changes in the fair value of these
securities, except for declines that are other than temporary, are not
reflected in the company's financial statements. Sales of securities
designated as held for investment are severely restricted by Statement of
Financial Accounting Standards ("SFAS") No. 115. Securities bought and held
principally for the purpose of selling them in the near term are designated
as trading securities. Unrealized gains and losses on trading securities are
included in current earnings. Transfers of securities between categories are
restricted and are recorded at fair value at the time of the transfer.
Securities determined to have a decline in value that is other than temporary
are written down to estimated fair value which becomes the security's new
cost basis by a charge to realized losses in the company's Statement of
Income. Premiums and discounts are amortized/accrued utilizing the scientific
interest method which results in a constant yield over the security's
expected life. Amortization/accrual of premiums and discounts on mortgage-
backed securities incorporates a prepayment assumption to estimate the
securities' expected lives.
On September 30, 1997, fixed income securities with an amortized cost of
$8,109,467,000 and an estimated fair value of $8,426,489,000 were designated
as available for sale. Unrealized holding gains on these securities, net of
adjustments to deferred policy acquisition costs, present value of in force
acquired and deferred income taxes, increased stockholders' equity by
$136,253,000, or $4.25 per share at September 30, 1997, compared to an
increase of $76,387,000, or $2.38 per share at December 31, 1996.
Net unrealized appreciation of fixed maturity investments of $317,022,000 was
comprised of gross appreciation of $353,739,000 and gross depreciation of
$36,717,000.
The percentage of the company's portfolio invested in below investment grade
securities increased slightly during the first nine months of 1997. At
September 30, 1997, the amortized cost value of the company's total investment
in below investment grade securities consisted of investments in 100 issuers
totaling $821,271,000, or 8.0% of the company's investment portfolio compared
to 93 issuers totaling $733,182,000, or 7.8%, at December 31, 1996. The
company intends to purchase additional below investment grade securities but
it does not expect the percentage of its portfolio invested in below
investment grade securities to exceed 10% of the investment portfolio. At
September 30, 1997, the yield at amortized cost on the company's below
investment grade portfolio was 9.1% compared to 8.0% for the company's
investment grade corporate bond portfolio. The company estimates the fair
value of its below investment grade portfolio was $844,125,000, or 102.8% of
amortized cost value, at September 30, 1997.
Below investment grade securities have different characteristics than
investment grade corporate debt securities. Risk of loss upon default by the
borrower is significantly greater with respect to below investment grade
securities than with other corporate debt securities. Below investment grade
securities are generally unsecured and are often subordinated to other
creditors of the issuer. Also, issuers of below investment grade securities
usually have higher levels of debt and are more sensitive to adverse economic
conditions, such as recession or increasing interest rates, than are
investment grade issuers. The company attempts to reduce the overall risk in
its below investment grade portfolio, as in all of its investments, through
careful credit analysis, strict investment policy guidelines, and
diversification by company and by industry.
The company analyzes its investment portfolio, including below investment
grade securities, at least quarterly in order to determine if its ability to
realize its carrying value on any investment has been impaired. For debt and
equity securities, if impairment in value is determined to be other than
temporary (i.e. if it is probable that the company will be unable to collect
all amounts due according to the contractual terms of the security), the cost
basis of the impaired security is written down to fair value, which becomes
the security's new cost basis. The amount of the write-down is included in
earnings as a realized loss. Future events may occur, or additional or
updated information may be received, which may necessitate future write-downs
of securities in the company's portfolio. Significant write-downs in the
carrying value of investments could materially adversely affect the company's
net income in future periods.
During the first nine months of 1997, fixed maturity securities designated as
available for sale with a combined amortized cost value of $349,321,000 were
called or repaid by their issuers generating net realized gains totaling
$8,805,000. In total, net pre-tax gains from sales, calls, repayments,
tenders and writedowns of fixed maturity investments amounted to $12,409,000
in the first nine months of 1997.
The company's fixed maturity investment portfolio had a combined yield at
amortized cost of 8.0% at September 30, 1997 and 8.1% at December 31, 1996.
At September 30, 1997, no fixed maturity securities were deemed to have
impairments in value that are other than temporary.
EQUITY SECURITIES: At September 30, 1997, the company owned equity
securities with a combined cost of $43,004,000 and an estimated fair value of
$62,058,000. Gross appreciation of equity securities totaled $19,422,000 and
gross depreciation totaled $368,000. Equity securities are primarily
comprised of the company's investment in shares of the mutual funds underlying
the company's registered separate accounts and an investment in a real estate
investment trust. The company's investment in the real estate investment trust
had an estimated fair value of $56,527,000 and a cost basis of $37,146,000 at
September 30, 1997. The estimated fair value of the company's investment is
based upon conversion value. Conversion value is derived from the quoted
market value of the publicly traded security into which the company's
investment can be converted and the issuer's cash flow from operations. As
such, changes in operating cash flows or the quoted market price of the issuer
may result in significant volatility in the estimated fair value of the
company's investment.
MORTGAGE LOANS: Mortgage loans make up approximately 19.0% of the company's
investment portfolio. The company resumed active mortgage lending in 1994 to
broaden its investment alternatives and has continued to increase the lending
activity. Mortgages outstanding increased to $1,946,989,000 from
$1,720,114,000 at December 31, 1996. The company's mortgage loan portfolio,
excluding farm loans, includes 633 loans with an average size of $3,076,000,
and average seasoning of 3.5 years if weighted by the number of loans, and
1.5 years if weighted by mortgage loan carrying values. The company's
mortgage loans are typically secured by occupied buildings in major
metropolitan locations and not speculative developments, and are diversified
by type of property and geographic location. At September 30, 1997, the
yield on the company's mortgage loan portfolio was 8.2%.
Distribution of these loans by type of collateral is as follows:
% of
# of Carrying Mortgage
Loans Value Portfolio
_______________________________
Collateral Breakdown (Dollars in thousands)
______________________________
Multi-family residential 101 $349,249 17.9%
Industrial 229 561,046 28.8
Office buildings 146 493,796 25.4
Retail 148 509,175 26.2
Farm 3 65 0.0
Other 9 33,658 1.7
_______________________________
Total 636 $1,946,989 100.0%
===============================
Distribution of these loans by geographic location is as follows:
% of
# of Carrying Mortgage
Loans Value Portfolio
_______________________________
Geographic Breakdown (Dollars in thousands)
______________________________
New England 10 $40,273 2.1%
Middle Atlantic 87 308,524 15.9
South Atlantic 102 351,498 18.1
East North Central 123 407,704 20.9
West North Central 79 241,352 12.4
East South Central 22 78,643 4.0
West South Central 33 85,382 4.4
Mountain 44 125,740 6.4
Pacific 136 307,873 15.8
_______________________________
Total 636 $1,946,989 100.0%
===============================
At September 30, 1997, one mortgage loan with a carrying value of $33,000 was
delinquent by 90 days or more. During the first quarter of 1997, the value
of a mortgage loan with a book value of $4,021,000 was determined to be
impaired other than temporary. At that time, a valuation allowance was
established to reduce the carrying value of this mortgage loan to its
estimated fair value, resulting in a charge to investment income of $245,000.
The company foreclosed on the property in June, 1997 and based upon an
appraisal, recorded a permanent write-down on the real estate investment of
$430,000 resulting in a charge to realized losses. During the second quarter
of 1997, the company foreclosed on a mortgage loan with a book value of
$3,892,000. At this time the company does not believe any permanent
impairment exists on this property. The company does not expect to incur
material losses from its mortgage loan portfolio because of the historically
low default rate in the company's mortgage loan portfolio and because the
company has been able to recover 100.8% of the principal amount of problem
mortgages resolved in the last three years.
REAL ESTATE: At September 30, 1997, the company owned real estate totaling
$12,929,000, including properties acquired through foreclosure valued at
$9,679,000.
In total, the company has experienced a relatively small number of problems
with its total investment portfolio, with none of the company's investment in
default at September 30, 1997. The company estimates its total investment
portfolio, excluding policy loans, had a fair value equal to 104.2% of
amortized cost value for accounting purposes at September 30, 1997.
FINANCIAL INSTRUMENTS - RISK MANAGEMENT
HEDGING PROGRAM: During the second quarter of 1996, the company implemented
a hedging program under which certain derivative financial instruments,
interest rate caps ("caps") and cash settled put swaptions ("swaptions"),
were purchased to reduce the negative effects of potential increases in
withdrawal activity related to the company's annuity liabilities which may
result from extreme increases in interest rates. The company purchased caps
and swaptions, all during the second quarter of 1996, with notional amounts
totaling approximately $600,000,000 and $1,300,000,000, respectively, all of
which were outstanding at September 30, 1997. The company paid approximately
$21,100,000 in premiums for these caps and swaptions. The cost of this
program has been incorporated into the company's product pricing. The caps
and swaptions do not require any additional payments by the company.
In January 1997, the company introduced an equity-indexed annuity product
which provides a guaranteed base rate of return with a higher potential
return linked to the performance of a broad based equity index. At the same
time, the company implemented a hedging program to purchase Standard & Poor's
("S&P") 500 (Reg.U.S.Pat.@Tm.Off.) Index Call Options ("call options", or
collectively with the interest rate caps and cash settled put swaptions,
"instruments"). Call options are purchased to hedge potential increases in
policyholder account balances for equity-indexed annuity policies resulting
from increases in the index to which the product is linked. During the first
nine months of 1997, the company paid approximately $12,364,000 in premiums
for call options which mature beginning in 2002 through 2004. The cost of
this program has been incorporated into the company's pricing of its equity-
indexed annuity product. The call options do not require any additional
payments by the company.
The agreements for the caps and swaptions entitle the company to receive
payments from the instruments' counterparties on future reset dates if
interest rates, as specified in the agreements, rise above a specified fixed
rate (9.0% and 9.5%). The amount of such payments to be received by the
company for the interest rate caps, if any, will be calculated by taking the
excess of the current applicable rate over the specified fixed rate, and
multiplying this excess by the notional amount of the caps. Payments on cash
settled put swaptions are also calculated based upon the excess of the
current applicable rate over the specified fixed rate multiplied by the
notional amount. The product of this rate differential times the notional
amount is assumed to continue for a series of defined future semi-annual
payment dates and the resulting hypothetical payments are discounted to the
current payment date using the discount rate defined in the agreement. The
agreements for the call options entitle the company to receive payments from
the counterparty if the S&P 500 index exceeds the specified strike price on
the maturity date. The amount of such payments to be received by the company
for the call options, if any, will be calculated by taking the excess of the
average closing price (as defined in the contract) at maturity over the
specified strike price, and multiplying this excess by the number of S&P 500
units defined in the contract. Any payments received from the counterparties
will be recorded as an adjustment to interest credited.
The following table summarizes the contractual maturities of notional amounts
for the caps and swaptions at September 30, 1997:
1998 1999 2000 2001 2002 Total
________________________________________________________________________________
(Dollars in thousands)
Interest rate
caps $400,000 $200,000 $600,000
Cash settled
put swaptions $100,000 $400,000 $400,000 350,000 50,000 1,300,000
_________________________________________________________________
Total notional
amount $100,000 $400,000 $400,000 $750,000 $250,000 $1,900,000
=================================================================
Any unrealized gain or loss on the caps and swaptions is off-balance sheet
and therefore, is not reflected in the financial statements. The effect of
changes in intrinsic value (which may vary from estimated market value) of
the call options and future policy benefits will be reflected in the financial
statements in the period of change. The following table summarizes the
amortized cost, gross unrealized gains and losses and estimated fair value on
these instruments as of September 30, 1997:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
September 30, 1997 Cost Gains Losses Value
______________________________________________________________________________
(Dollars in thousands)
Interest rate caps $4,346 $3,367 $979
Cash settled put swaptions 10,005 6,345 3,660
S&P 500 call options 10,583 $2,284 66 12,801
______________________________________________
Total $24,934 $2,284 $9,778 $17,440
==============================================
The decline in fair value from amortized cost reflects changes in interest
rates and market conditions since time of purchase.
EXPOSURE TO LOSS - COUNTERPARTY NONPERFORMANCE: The company is exposed to
the risk of losses in the event of non-performance by the counterparties of
these instruments. Losses recorded in the company's financial statements in
the event of non-performance will be limited to the unamortized premium
(remaining amortized cost) paid to purchase the instrument plus the recorded
intrinsic value, if any, for the call options because no additional payments
are required by the company on these instruments after the initial premium.
Counterparty non-performance would result in an economic loss if interest
rates exceeded the specified fixed rate or, for the S&P 500 index call
options, the average closing price at maturity exceeded the specified strike
price. Economic losses would be measured by the net replacement cost, or
estimated fair value, for such instruments. The estimated fair value is the
average of quotes, if more than one quote is available, obtained from related
and unrelated counterparties. The company limits its exposure to such losses
by: diversifying among counterparties, limiting exposure to any individual
counterparty based upon that counterparty's credit rating, and limiting its
exposure by instrument type to only those instruments that do not require
future payments. For purposes of determining risk exposure to any individual
counterparty, the company evaluates the combined exposure to that counterparty
on both a derivative financial instruments' level and on the total investment
portfolio credit risk and reports its exposure to senior management at least
monthly. The maximum potential economic loss (the cost of replacing an
instrument or the net replacement value) due to nonperformance of the
counterparties will increase or decrease during the life of the instruments as
a function of maturity and market conditions.
The company determines counterparty credit quality by reference to ratings
from independent rating agencies. As of September 30, 1997, the ratings
assigned by Standard & Poor's Corporation by instrument with respect to the
net replacement value (market value) of the company's instruments was as
follows:
September 30, 1997 Net Replacement Value
______________________________________________________________________________
Interest Cash Settled
Rate Put S&P 500
Caps Swaptions Call Options Total
_________________________________________________
(Dollars in thousands)
Counterparties credit quality:
AAA $629 $1,844 $2,473
AA+ to AA- 350 1,114 $10,023 11,487
A+ to A- -- 702 2,778 3,480
_________________________________________________
Total $979 $3,660 $12,801 $17,440
=================================================
OTHER ASSETS
Accrued investment income increased $11,023,000 primarily due to an increase
in the amortized cost of new fixed income investments and in the overall size
of the portfolio. Deferred policy acquisition costs increased $29,386,000
over year-end 1996 levels. Excluding the adjustment to reflect the impact of
SFAS No. 115, deferred policy acquisition costs increased $82,195,000 as the
deferral of current period costs, primarily commissions incurred to generate
insurance and annuity sales, totaled $155,848,000. Amortization of costs
deferred totaled $73,653,000.
Present value of in force acquired (PVIF) was established as a result of the
recent acquisition of variable annuity and life insurance business in force
on Golden American. At September 30, 1997, PVIF was $78,156,000 and
amortization (excluding the impact of SFAS No. 115) totaled $4,465,000 for
the first nine months of 1997.
At September 30, 1997, the company had $2,533,253,000 of separate account
assets compared to $1,657,879,000 at December 31, 1996. The increase in
separate account assets is due to the growth in the company's variable
annuity products. At September 30, 1997, the company had total assets of
$14,571,572,000 an increase of 15.9% over total assets at December 31, 1996.
LIABILITIES
In conjunction with the volume of annuity and insurance sales, and the
resulting increase in business in force, the company's liability for policy
liabilities and accruals increased $789,750,000, or 8.4%, during the first
nine months of 1997.
Reserves for the company's annuity contracts, including separate account
reserves for variable contracts, increased $1,590,454,000, or 16.4%, to
$11,268,863,000 at September 30, 1997. Life insurance reserves, including
separate account reserves for variable life policies, increased $46,942,000,
or 3.7%, during the first nine months of 1997 to $1,306,614,000.
The company incorporates a number of features in its annuity products designed
to reduce early withdrawal or surrender of the policies and to partially
compensate the company for its costs if policies are withdrawn early. Current
surrender charge periods on fixed annuity policies typically range from five
years to the term of the policy. During the first nine months of 1997, 86% of
such policies issued by Equitable Life and USG had a surrender charge period
of seven years or more. The initial surrender charge on Equitable Life and
USG fixed annuity policies ranges from 5% to 20% of the premium and decreases
over the surrender charge period.
The following table summarizes the company's non-par deferred fixed annuity
liabilities and sales for the nine months ended September 30, 1997 by
surrender charge range category. Notwithstanding policy features, the
withdrawal rates of policyholder funds may be affected by changes in interest
rates.
Deferred Deferred
Fixed Fixed
Annuity % of Annuity % of
Surrender Charge % Sales Total Liabilities Total
___________________________________________________________________
(Dollars in thousands)
No surrender charge $749,219 9.7%
1 to 4 percent 965,510 12.5
5 to 6 percent $109,729 11.4% 1,635,294 21.3
7 to 9 percent 777,593 81.2 3,059,908 39.8
10 percent and greater 70,517 7.4 1,285,911 16.7
_________________________________________
$957,839 100.0% $7,695,842 100.0%
=========================================
Deferred income taxes increased $38,600,000 to $84,281,000 at September 30,
1997, from December 31, 1996 of which $29,689,000 of the increase relates to
the change in unrealized appreciation of fixed maturity securities designated
as available for sale. Total consolidated debt increased $36,200,000 during
the first nine months of 1997 as the company issued additional commercial
paper. Commercial paper, issued to offset short-term timing differences in
investment related cash receipts and disbursements (investment smoothing) and
to provide for short-term operating needs, amounted to $140,800,000 at
September 30, 1997. At September 30, 1997, $16,960,000 of the commercial
paper was issued for investment smoothing purposes. Other liabilities
increased $91,006,000 from year-end 1996 levels primarily due to the
establishment of the litigation settlement accrual (see further discussion in
the Accounting and Legal Developments - Litigation section below), increases
in draft accounts payable, securities payable, outstanding checks,
remittances unapplied and mortgage trust funds, partially offset by decreases
in transfer and suspense accounts, guaranty fund assessment reserve and other
payables.
Separate account liabilities increased $875,374,000 to $2,533,253,000 from
December 31, 1996, due to the growth in the company's variable annuity
products. At September 30, 1997, the company had total liabilities of
$13,379,676,000 compared to $11,548,880,000 at December 31, 1996, a 15.9%
increase.
TRUST SECURITIES
On July 23, 1996, Equitable of Iowa Companies Capital Trust, a consolidated,
wholly-owned subsidiary of the company, issued $125,000,000 of 8.70% Trust
Originated Preferred Securities (see Liquidity and Capital Resources section
below). The net proceeds of this offering were used to fund, in part, the
acquisition of BT Variable, Inc.
On April 3, 1997, Equitable of Iowa Companies Capital Trust II, a
consolidated, wholly-owned subsidiary of the company, issued $50,000,000 of
8.424% Capital Securities (see Liquidity and Capital Resources section below).
The company utilized the net proceeds of this offering for general corporate
purposes including, but not limited to, investments in its subsidiaries.
EQUITY
At September 30, 1997, stockholders' equity was $1,016,896,000, or $31.74 per
share, compared to $895,799,000 or $28.00 per common share at year end 1996.
Unrealized appreciation of available for sale fixed maturity securities
increased stockholders' equity by $136,253,000, or $4.25 per share, after
adjustments to deferred acquisition costs and deferred income taxes, at
September 30, 1997 compared to an increase of $76,387,000 or $2.38 per share
at December 31, 1996. The ratio of consolidated debt to total capital was
16.8% (15.4% excluding SFAS No. 115) at September 30, 1997, compared to 16.7%
(17.8% excluding SFAS No. 115) at year-end 1996. At September 30, 1997,
there were 32,067,735 common shares outstanding compared to 31,988,410 shares
at December 31, 1996.
The effects of inflation and changing prices on the company are not material
since insurance assets and liabilities are both primarily monetary and remain
in balance. An effect of inflation, which has been low in recent years, is a
decline in purchasing power when monetary assets exceed monetary liabilities.
LIQUIDITY AND CAPITAL RESOURCES
_______________________________
The liquidity requirements of the company's subsidiaries are met by cash flow
from annuity and insurance premiums, investment income, and maturities of
fixed maturity investments and mortgage loans. The company primarily uses
funds for the payment of annuity and insurance benefits, operating expenses
and commissions, and the purchase of new investments.
The company's home office operations are currently housed in a leased 200,000
square foot office building in downtown Des Moines, Iowa which houses all of
the company's Des Moines based home office operations, a leased location in
Wilmington, Delaware and a leased location in New York, New York. The company
began moving in July 1997 to the new Des Moines location and the majority of
Des Moines operations were moved during the third quarter. The company
anticipates an additional $3,000,000 to $4,000,000 for fixed assets will be
spent during 1997 for the new location. In addition, the company intends to
increase its commitment to improve product development, customer service and
operating efficiencies by spending approximately $9,000,000 to $11,000,000
over the next three years on capital needs, primarily for information
technology, as compared to the approximately $5,400,000 spent in 1996. No
other material capital expenditures are planned.
Equitable has studied its computer software and hardware to determine its
exposure to the change of the century date problem. The year 2000 date
problem consists of a date format shortcoming where the year is represented
by only two digits causing programs that perform arithmetic operations,
comparisons, or sorting of date fields to yield incorrect results. The
projected cost of the year 2000 project is approximately $5,000,000 to
$8,000,000. The work began in 1997 and is expected to be completed during
the second quarter of 1999. The cost will be directly reflected in the
Statement of Income as incurred.
The company issues short-term debt, including commercial paper notes, for
working capital needs, investment smoothing and to provide short-term
liquidity. At September 30, 1997, the company had $140,800,000 in commercial
paper notes outstanding, an increase of $36,200,000 from December 31, 1996.
The company's commercial paper is rated A1 by Standard and Poor's, D1 by Duff
& Phelps Credit Rating Co., and P2 by Moody's. As a result of the merger,
the company is retiring its outstanding commercial paper with funding from an
ING affiliate.
To enhance short term liquidity and back up its outstanding commercial paper
notes, the company maintains a line of credit agreement with several banks.
On May 10, 1996, the company amended its agreement to increase the line of
credit to $300,000,000. The line of credit was amended on October 22, 1997,
and will expire on December 1, 1997. The terms of the agreement require the
company to maintain certain adjusted consolidated tangible net worth levels.
"Adjusted consolidated tangible net worth" is defined as consolidated
stockholders' equity, adjusted to exclude the effects of SFAS No. 115, less
intangible assets. The most restrictive covenant requires the company
maintain adjusted consolidated tangible net worth equal to or in excess of
the sum of (1) $490,000,000, plus (2) 50% of consolidated net income from
January 1, 1995 to the end of the most recent quarter, plus (3) net proceeds
from the issuance of capital stock from January 1, 1995 to the end of the
most recent quarter. At September 30, 1997, $361,754,000 of retained earnings
were free of restrictions and could be distributed to the company's public
stockholders.
Since Equitable of Iowa Companies is a holding company, funds required to
meet its debt service requirements, dividend payments and other expenses are
primarily provided by its subsidiaries. On August 12, 1996, Equitable Life
paid a dividend of $24,000,000 to provide additional funding for the
acquisition of Golden American. The ability of Equitable Life and Golden
American to pay dividends to the parent company is restricted because prior
approval of insurance regulatory authorities is required for payment of
dividends to the stockholder which exceed an annual limitation. During the
remainder of 1997, Equitable Life and Golden American could pay dividends to
the parent company of approximately $95,363,000 and $2,186,000, respectively,
without prior approval of statutory authorities. The company's insurance
subsidiaries have maintained adequate statutory capital and surplus and have
not used surplus relief or financial reinsurance, which have come under
scrutiny by many state insurance departments.
The NAIC's risk-based capital requirements require insurance companies to
calculate and report information under a risk-based capital formula. These
requirements are intended to allow insurance regulators to identify
inadequately capitalized insurance companies based upon the type and mixture
of risks inherent in the company's operations. The formula includes
components for asset risk, liability risk, interest rate exposure and other
factors. The company's insurance subsidiaries have complied with the NAIC's
risk-based capital reporting requirements. Amounts reported indicate the
company's insurance subsidiaries have total adjusted capital (as defined in
the requirements) which is well above all required capital levels.
Writing and supporting increased volumes of annuity and insurance business
requires increased amounts of capital and surplus for the company's insurance
operations. Historically, the company has funded growth in its insurance
operations internally through the retention of earnings. Increased levels of
growth in recent years have required capital contributions in excess of
amounts generated by operating activities. In February 1995, the company
issued $100,000,000 of 8.5% notes, maturing on February 15, 2005, receiving
net proceeds of $98,812,000, after expenses. The company contributed
$50,000,000 of the proceeds to its insurance subsidiaries and applied the
remaining net proceeds to the repayment of outstanding commercial paper
notes.
In order to respond to capital needs, the company will utilize retained
earnings or receive financing from a subsidiary of ING.
On July 23, 1996, Equitable of Iowa Companies Capital Trust (the "Trust"), a
consolidated, wholly-owned subsidiary of Equitable, issued $125,000,000 of
its 8.70% Trust Originated Preferred Securities (the "Preferred Securities").
Concurrent with the issuance of the Trust's Preferred Securities, Equitable
issued to the Trust $128,866,000 in principal amount of its 8.70%
Subordinated Deferrable Interest Debentures (the "Debt Securities") due July
30, 2026. The sole assets of the Trust are and will remain the Debt
Securities and any accrued interest thereon. The interest and other payment
dates on the Debt Securities correspond to the distribution and other payment
dates on the Preferred Securities. The Debt Securities mature on July 30,
2026, with an option to extend the maturity an additional 19 years, and are
redeemable by Equitable, in whole or in part, beginning July 30, 2001. The
Preferred Securities will mature or be called simultaneously with the Debt
Securities. The Preferred Securities have a liquidation value of $25 per
Preferred Security plus accrued and unpaid distributions. As of September
30, 1997, 5,000,000 shares of Preferred Securities were outstanding.
Equitable has obligations under the Debt Securities, the Preferred Securities
Guarantee Agreement, the Declaration of Trust, as amended, and the Indenture,
as amended by the First Supplemental Indenture. These obligations, when
considered together, constitute a full and unconditional guarantee by
Equitable of the Trust's obligations under the Preferred Securities. Net
proceeds of approximately $120,305,000 from the issuance of $125,000,000 of
Preferred Securities were used to fund, in part, the acquisition of BT
Variable, a New York Corporation who owns all the outstanding capital stock
of Golden American Life Insurance Company and Directed Services, Inc.
As discussed above, on August 13, 1996, Equitable acquired all of the
outstanding capital stock of BT Variable from Whitewood, pursuant to the
terms of the Purchase Agreement dated as of May 3, 1996 between Equitable and
Whitewood. In exchange for the outstanding capital stock of BT Variable,
Equitable paid $93,000,000 in cash to Whitewood in accordance with the terms
of the Purchase Agreement. Equitable also paid $51,000,000 in cash to
Bankers Trust to retire certain debt owed by BT Variable to Bankers Trust
pursuant to a revolving credit arrangement. The funds used in completing the
acquisition were obtained primarily through the July 1996 offering of
securities undertaken by the Trust, the proceeds of which were loaned to
Equitable in exchange for subordinated debentures issued by Equitable to the
Trust. Additional funds were provided by reducing short-term investments of
Equitable and its insurance subsidiaries. Funds provided by Equitable's
insurance subsidiaries were transferred to Equitable in the form of dividends
paid. Subsequent to the acquisition, the name BT Variable, Inc. was changed
to EIC Variable, Inc. ("EIC Variable"). On April 30, 1997, EIC Variable, was
liquidated and its investment in Golden American and DSI were transferred to
Equitable while the remainder of its net assets were contributed to Golden
American.
On April 3, 1997, Equitable of Iowa Companies Capital Trust II (the "Trust
II"), a consolidated, wholly-owned subsidiary of Equitable, issued
$50,000,000 of its 8.424% Capital Securities (the "Capital Securities").
Concurrent with the issuance of the Trust II's Capital Securities, Equitable
issued to the Trust II $50,000,000 in principal amount, of its 8.424%
Subordinated Deferrable Interest Debentures (the "Debentures") due April 1,
2027. The sole assets of the Trust II are and will remain the Debentures and
any accrued interest theron. The interest and other payment dates on the
Debentures correspond to the distribution and other payment dates on the
Capital Securities. The Debentures mature on April 1, 2027, and are
redeemable by Equitable, in whole, at the occurrence of a special event. The
Capital Securities will mature or be called simultaneously with the
Debentures. The Capital Securities have a liquidation value of $1,000 per
security plus accrued and unpaid distributions. As of September 30, 1997,
50,000 shares of Capital Securities were outstanding.
Equitable has obligations under the Debentures, the Capital Securities
Agreement, the Declaration of Trust, as amended, and the Indenture, as
amended by the First Supplemental Indenture. These obligations, when
considered together, constitute a full and unconditional guarantee by
Equitable of the Trust II's obligations under the Capital Securities.
The company utilized the net proceeds of approximately $49,237,000 from the
issuance of Capital Securities for general corporate purposes including, but
not limited to, investments in its subsidiaries.
TRANSACTION: On October 23, 1997, Equitable of Iowa Companies ("Equitable")
shareholders approved the Agreement and Plan of Merger ("Merger Agreement")
dated as of July 7, 1997, between Equitable, PFHI Holdings, Inc. ("PFHI"),
and ING Groep N.V. ("ING"). On October 24, 1997, PFHI, a Delaware
corporation, acquired all of the outstanding capital stock of Equitable
pursuant to the Merger Agreement. PFHI is a wholly-owned subsidiary of ING,
a global financial services holding company based in The Netherlands.
Equitable, an Iowa corporation, in turn, owns all the outstanding capital
stock of Equitable Life Insurance Company of Iowa and Golden American Life
Insurance Company and their wholly-owned subsidiaries. Equitable also owns
all the outstanding capital stock of Locust Street Securities, Inc.,
Equitable Investment Services, Inc., Directed Services, Inc., Equitable of
Iowa Companies Capital Trust, Equitable of Iowa Companies Capital Trust II
and Equitable of Iowa Securities Network, Inc. In exchange for the
outstanding capital stock of Equitable, ING will pay total consideration of
approximately $2,200,000,000 in cash and stock plus the assumption of
approximately $400,000,000 in debt according to the Merger Agreement. As a
result of the merger, Equitable of Iowa Companies was merged into PFHI which
was simultaneously renamed Equitable of Iowa Companies, Inc.
ACCOUNTING TREATMENT: The merger will be accounted for as a purchase
resulting in a new basis of accounting, reflecting estimated fair values for
assets and liabilities for Equitable and its subsidiaries as of the date of
the merger. The excess of the total acquisition cost over the fair value of
the net assets acquired will be recorded as goodwill.
The company intends to continue growing its insurance operations. Future
growth in the company's insurance operations may require additional capital.
Sources of additional capital include the retention of earnings and as a
result of the recent merger, other capital resources from affiliates will be
available.
The company's insurance subsidiaries operate under the regulatory scrutiny of
each of the state insurance departments supervising business activities in
the states where each company is licensed. The company is not aware of any
current recommendations by these regulatory authorities which, if they were
to be implemented, would have a material effect on the company's liquidity,
capital resources or operations.
INSURANCE INDUSTRY ISSUES
_________________________
The company's insurance subsidiaries are assessed contributions by life and
health guaranty associations in almost all states to indemnify policyholders
of failed companies. In several states the company may reduce premium taxes
paid to recover a portion of assessments paid to the states' guaranty fund
association. This right of "offset" may come under review by the various
states, and the company cannot predict whether and to what extent legislative
initiatives may affect this right to offset. Also, some state guaranty
associations have adjusted the basis by which they assess the cost of
insolvencies to individual companies. The company believes its reserve for
future guaranty fund assessments is sufficient to provide for assessments
related to known insolvencies. This reserve is based upon management's
current expectation of the availability of this right of offset, known
insolvencies and state guaranty fund assessment bases. However, changes in
the basis whereby assessments are charged to individual companies and changes
in the availability of the right to offset assessments against premium tax
payments could materially affect the company's results.
Currently, the company's insurance subsidiaries are subject to regulation and
supervision by the states in which they are admitted to transact business.
State insurance laws generally establish supervisory agencies with broad
administrative and supervisory powers related to granting and revoking
licenses to transact business, establishing guaranty fund associations,
licensing agents, market conduct, approving policy forms, regulating premium
rates for some lines of business, establishing reserve requirements,
prescribing the form and content of required financial statements and
reports, determining the reasonableness and adequacy of statutory capital and
surplus and regulating the type and amount of investments permitted.
The insurance regulatory framework continues to be scrutinized by various
states, the federal government and the NAIC. The NAIC, in conjunction with
state regulators reviews existing insurance laws and regulations on a
continuing basis.
A task force of the NAIC is currently undertaking a project to codify a
comprehensive set of statutory insurance accounting rules and regulations.
This project is not expected to be completed earlier than 1999. Specific
recommendations have been set forth in papers issued by the NAIC for industry
review. The company is monitoring and, through an industry trade association,
actively participating in this process, but the potential impact of any
changes in insurance accounting standards is not yet known.
In 1995, the NAIC adopted Guideline XXXIII, which, based upon liabilities at
December 31, 1996, requires the company to increase annuity reserves in its
statutory financial statements by approximately $23,000,000. The company has
received approval from the Iowa and Oklahoma insurance departments for a
three year phase in. The 1996 statutory financial statements included an
increase in fixed annuity reserves of approximately $7,200,000 pursuant to
the requirements of the guideline. The quarterly statutory financial
statements include an increase in annuity reserves of approximately
$2,202,000 pursuant to the requirements of the guideline for the nine months
ended September 30, 1997. The guideline has no effect on financial statements
prepared in accordance with GAAP.
There has been increased scrutiny by insurance regulators and the insurance
industry itself of insurance sales and marketing activities. New rules for
life insurance illustrations have been adopted as a model regulation by the
NAIC. Many states have adopted the regulation effective January 1, 1997, and
an NAIC committee has begun to work on the issue of annuity marketing. The
company conducts an ongoing thorough review of its sales and marketing process
and continues to emphasize its compliance efforts.
Legislative and regulatory initiatives regarding changes in the regulation of
banks and other financial services businesses and restructuring of the federal
income tax system could, if adopted and depending on the form they take, have
an adverse impact on the company by altering the competitive environment for
its products. The outcome and timing of any such changes cannot be
anticipated at this time, but the company will continue to monitor
developments in order to respond to any opportunities or increased competition
that may occur.
ACCOUNTING AND LEGAL DEVELOPMENTS
_________________________________
EARNINGS PER SHARE: In February 1997, the Financial Accounting Standards
Board issued Statement No. 128, "Earnings per Share", which is required to be
adopted on December 31, 1997. At that time the company will be required to
disclose both basic earnings per share and fully diluted earnings per share
on the face of the income statement or in the notes to the financial
statements. The impact of the fully-diluted earnings per share would dilute
primary earnings per share by approximately $0.02 and $0.01 per share for the
third quarters of 1997 and 1996, respectively, and $0.06 and $0.05 per share
for the first nine months of 1997 and 1996, respectively.
DERIVATIVES: On June 20, 1996, the FASB issued an exposure draft of its
Proposed Statement of Financial Accounting Standards "Accounting for
Derivative and Similar Financial Instruments and Hedging Activities". This
proposed standard, if adopted in the form presented in the exposure draft,
would establish accounting and reporting standards for derivative and other
similar financial instruments and for hedging activities which are
significantly different than practices currently used by the company and
others. The proposed standard would require the recognition of all
derivatives in the statement of financial condition and would require that
these instruments be measured at fair value. Changes in the fair value of the
derivative would be recorded in the enterprise's Statement of Income in the
period of change. If certain conditions are met, a derivative may be
designated as (1) a fair value hedge, (2) a cash flow hedge, or (3) a foreign
currency hedge. Changes in fair value of derivatives designated as fair
value hedges would be recognized in earnings in the period of change along
with the offsetting gain or loss on the hedged item. For a derivative
designated as a cash flow hedge, the gain or loss from changes in fair value
would be reported as a component of other comprehensive income (see below)
outside of earnings in the period of change and recognized in earnings on the
projected date of the forecasted transaction. Changes in fair value of
foreign currency hedges would also be reported in other comprehensive income
to the extent they offset foreign currency transaction gain or loss. Any
excess gain or loss from changes in fair value of the foreign currency hedge
would be recognized in earnings. In most cases, the criteria which must be
met to qualify for "hedge" treatment are very restrictive and would preclude
many common hedging practices in use today. Because of this concern, and the
significant volatility in earnings and stockholders' equity which would
result from application of the accounting required by the proposed standard,
FASB received a large number of comment letters regarding this proposal, most
of which were critical of the approach proposed by FASB. As a result of this
and other aspects of FASB's procedural requirements for adoption of a new
SFAS, FASB has announced various modifications to the accounting and
reporting requirements proposed in the exposure draft. Many of these
modifications are directed at easing restrictions on hedge accounting and
correcting technical problems with the exposure draft. The impact on the
company's financial statements of any change in accounting for derivatives
cannot be estimated until the final form of such requirements is known.
On January 28, 1997, the Securities and Exchange Commission ("SEC") adopted
new disclosure rules for derivative financial instruments. The new rules
require expanded disclosure of accounting policies for derivatives in
footnotes to financial statements, as well as disclosure of quantitative and
qualitative information concerning market risk of derivatives and other
financial instruments to be presented outside the financial statements.
Quantitative disclosures regarding market risk sensitive instruments may be
presented as: 1) a tabular presentation of fair value information and
contract terms, 2) a sensitivity analysis presenting potential losses in
future earnings, fair values or cash flows from hypothetical changes in
market rates and prices, or 3) a value at risk presentation of the potential
loss in future earnings, fair values or cash flows from market movements over
a stated period of time and related probability of such loss. The company
will be required to provide the new disclosures for the first time in its
financial statements and Form 10K for the period ended December 31, 1998,
although the SEC has indicated it expects the expanded accounting policy
disclosures in current filings. The company has provided disclosures in its
footnotes and Management's Discussion and Analysis which comply with the
accounting policy disclosure requirements in addition to much of the required
quantitative disclosures. The company is analyzing the rules for additional
requirements and will provide required disclosures no later than in its
December 31, 1998 financial statements.
GUARANTY FUND ASSESSMENTS: On December 5, 1996, the American Institute of
CPAs ("AICPA") issued an exposure draft of its Proposed Statement of Position
on "Accounting for Guaranty-Fund Assessments". This proposed standard
provides: (1) guidance for determining when an insurance enterprise should
recognize a liability for guaranty fund and other assessments; (2) guidance
on how to measure the liability and allows discounting the liability, if the
amount and timing of the cash payments are fixed and reliably determinable;
(3) criteria for when an asset may be recognized for a portion or all of the
assessment liability or paid assessment that can be recovered through premium
tax offsets or policy surcharges; and (4) requirements for disclosure of
certain information. The company's liability established for guaranty fund
assessments and related premiums tax offset at September 30, 1997 is
undiscounted and adequately reserves for guaranty fund assessments based upon
the Proposal as currently written.
COMPREHENSIVE INCOME: In June 1997, FASB issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income".
Comprehensive income is defined as "the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. It includes all changes in equity
during a period except those resulting from investments by owners and
distributions to owners". Comprehensive income will be reported in either
one or two statements of financial performance and an enterprise will be
required to report an amount representing total comprehensive income. In
addition to items currently reported in net income, comprehensive income
would include in other comprehensive income such items as changes in fair
value of fixed maturity securities designated as available for sale, changes
in fair value of derivatives designated as cash flow or foreign currency
hedges and unrecognized assets or liabilities of pension plans pursuant to
SFAS No. 87. This new standard will not change the company's reported net
income but will increase the prominence of changes in the items listed above.
This proposal is expected to cause increased volatility in stockholders'
equity primarily due to fluctuations in the fair value of derivatives not
currently reflected in equity. The new standard is effective for fiscal
years beginning after December 15, 1997. Reclassification of financial
statements for prior periods provided for comparable purposes is required.
SEGMENT DISCLOSURES: In June 1997, FASB issued SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information". This statement
establishes standards for reporting about operating segments and products and
services, geographic areas and major customers in a company's public
financial statements. Segments are to be defined consistent with the basis
management uses internally to assess performance and allocate resources.
Segment disclosures include segment profit or loss, certain revenue and
expense items and segment assets. This statement will be effective for
periods beginning after December 15, 1997. In the initial year of
application, comparative information for earlier years is to be restated.
LITIGATION: USG is a defendant in a class action complaint filed in the
state circuit court of Kentucky in September 1997. The suit claims
unspecified damages and injunctive relief as a result of alleged improper
actions related to the interest rate adjustment provisions of USG's fixed
annuity contracts. The company believes the allegations are without merit.
The case has been removed to Federal Court in the Northern District of
Kentucky. The original plaintiff putative class representative has been
joined by an additional named plaintiff who claims also to be a class
representative. The suit is in the early procedural stage. The company
intends to defend the suit vigorously, including vigorously contesting its
class action status. ING advised the company this litigation would not
effect the terms or closing of the merger between Equitable and a subsidiary
of ING. The amount of any liability which may arise as a result of this
suit, if any, cannot be reasonably estimated and no provision for loss has
been made in the accompanying financial statements.
The company has entered into a proposed settlement of two related and
virtually identical class-action lawsuits regarding alleged improper life
insurance sales practices. The company denies the allegations in these class-
action lawsuits, but entered into this settlement to limit additional expense
and burden on the company's operations. The class-action lawsuits were filed
in the United States District Court for the Middle District of Florida (Tampa
Division) in February of 1996, and in the Superior Court of Arizona (Pima
County) in July of 1997. Subject to the approval of the federal court in the
Florida action and the Arizona court in the Arizona action, hearings
regarding final approval of the settlement are anticipated to be scheduled
during the fourth quarter of 1997 or the first quarter of 1998. Two
different but related class-action lawsuits are also pending against the
company in the Court of Common Pleas of Allegany County, Pennsylvania, and
the District Court for Bexar County Texas. These two class-action lawsuits,
filed in June of 1996 and April of 1996, respectively, are still pending, but
the company expects the claims asserted therein to be resolved as a part of
the proposed settlement in the Florida and Arizona actions.
During the second quarter of 1997, the company accrued a pre-tax expense of
approximately $20,495,000 for policy liabilities and administrative and other
costs anticipated with the proposed settlement. Owners of approximately
130,000 universal and whole life insurance policies issued by the company
from 1984 through 1996 may be eligible to receive the following benefits
provided by the proposed settlement: 1) one-time enhancement to the interest
component of the policy; 2) one-time enhancement to the dividend component of
the policy; 3) optional premium loans that would allow policyholders to
borrow at reduced rates; 4) enhanced value deferred annuities to holders of
affected policies; 5) enhanced value immediate annuities to affected
policyholders; and 6) enhanced value life policies to affected policyholders.
In addition, the proposed settlement provides Individual Claim-Review Relief
(an arbitration-type process) for policyholders who believe they may have
been misled or otherwise harmed in connection with their policies.
In the ordinary course of business, the company and its subsidiaries are also
engaged in certain other litigation, none of which management believes is
material.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
_________________________________________________________
Any forward-looking statement contained herein or in any other oral or
written statement by the company or any of its officers, directors or
employees is qualified by the fact that actual results of the company may
differ materially from such statement due to the following important factors,
among other risks and uncertainties inherent in the company's business:
1. Prevailing interest rate levels which may affect the ability of the
company to sell its products, the market value of the company's
investments and the lapse rate of the company's policies, notwithstanding
product design features intended to enhance persistency of the company's
products.
2. Changes in the federal income tax laws and regulations which may affect
the relative tax advantages of advantages of the company's products.
3. Changes in the regulation of financial services, including bank sales and
underwriting of insurance products, which may affect the competitive
environment for the company's products.
4. Increasing competition in the sale of the company's products.
5. Other factors affecting the performance of the company, including, but
not limited to, market conduct claims and other litigation (including the
matters described above in "Accounting and Legal Developments -
Litigation" section), insurance industry insolvencies, stock market
performance, investment performance of the underlying portfolios of the
variable products, variable product design and sales volume by
significant sellers of the company's variable products.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
USG is a defendant in a class action complaint filed in the state
circuit court of Kentucky in September 1997. The suit claims
unspecified damages and injunctive relief as a result of alleged
improper actions related to the interest rate adjustment provisions of
USG's fixed annuity contracts. The company believes the allegations
are without merit. The case has been removed to Federal Court in the
Northern District of Kentucky. The original plaintiff putative class
representative has been joined by an additional named plaintiff who
claims also to be a class representative. The suit is in the early
procedural stage. The company intends to defend the suit vigorously,
including vigorously contesting its class action status. ING advised
the company this litigation would not effect the terms or closing of
the merger between Equitable and a subsidiary of ING. The amount of
any liability which may arise as a result of this suit, if any, cannot
be reasonably estimated and no provision for loss has been made in the
accompanying financial statements.
The company has entered into a proposed settlement of two related and
virtually identical class-action lawsuits regarding alleged improper
life insurance sales practices. The company denies the allegations in
these class-action lawsuits, but entered into this settlement to limit
additional expense and burden on the company's operations. The class-
action lawsuits were filed in the United States District Court for the
Middle District of Florida (Tampa Division) in February of 1996, and
in the Superior Court of Arizona (Pima County) in July of 1997.
Subject to the approval of the federal court in the Florida action and
the Arizona court in the Arizona action, hearings regarding final
approval of the settlement are anticipated to be scheduled during the
fourth quarter of 1997 or the first quarter of 1998. Two different
but related class-action lawsuits are also pending against the company
in the Court of Common Pleas of Allegany County, Pennsylvania, and the
District Court for Bexar County Texas. These two class-action
lawsuits, filed in June of 1996 and April of 1996, respectively, are
still pending, but the company expects the claims asserted therein to
be resolved as a part of the proposed settlement in the Florida and
Arizona actions.
During the second quarter of 1997, the company accrued a pre-tax
expense of approximately $20,495,000 for policy liabilities and
administrative and other costs anticipated with the proposed
settlement. Owners of approximately 130,000 universal and whole life
insurance policies issued by the company from 1984 through 1996 may be
eligible to receive the following benefits provided by the proposed
settlement: 1) one-time enhancement to the interest component of the
policy; 2) one-time enhancement to the dividend component of the
policy; 3) optional premium loans that would allow policyholders to
borrow at reduced rates; 4) enhanced value deferred annuities to
holders of affected policies; 5) enhanced value immediate annuities to
affected policyholders; and 6) enhanced value life policies to
affected policyholders. In addition, the proposed settlement provides
Individual Claim-Review Relief (an arbitration-type process) for
policyholders who believe they may have been misled or otherwise
harmed in connection with their policies.
In the ordinary course of business, the company and its subsidiaries
are also engaged in certain other litigation, none of which management
believes is material.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
A list of exhibits included as part of this report is set forth
in the Exhibit Index which immediately precedes such exhibits
and is hereby incorporated by reference herein.
(b) The following reports on Form 8-K were filed during the quarter
ended September 30, 1997:
(i) The company's report on Form 8-K filed July 10, 1997,
containing the Press Release regarding the company's
agreement to merge with ING Groep N.V.
(ii) The company's report on Form 8-K filed July 11, 1997,
containing the company's Agreement and Plan of Merger with
ING Groep N.V.
(iii) The company's report on Form 8-K filed September 16, 1997,
containing the company's Press Release regarding the class
action complaint filed against USG, a subsidiary of
Equitable.
(iv) The company's report on Form 8-K filed September 25, 1997,
containing the company's Press Release regarding the
declaration by the company's board of directors of a regular
quarterly dividend.
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.
DATE: November 13, 1997 EQUITABLE OF IOWA COMPANIES, INC.
A Delaware corporation as successor to
Equitable of Iowa Companies, an Iowa
corporation.
By /s/ Paul E. Larson
_________________________________
Executive Vice President and CFO
(Principal Financial Officer)
By /s/ David A. Terwilliger
_________________________________
Vice President, Treasurer and
Controller
(Principal Accounting Officer)
INDEX
Exhibits to Form 10-Q
Nine Months ended September 30, 1997
EQUITABLE OF IOWA COMPANIES
2 PLAN OF ACQUISITION
(a) Stock Purchase Agreement dated as of May 3, 1996, between
Equitable and Whitewood Properties Corp. (incorporated by
reference from Exhibit 2 in Form 8-K filed August 28, 1996)
(b) Agreement and Plan of Merger dated as of July 7, 1997, among
ING Groep N.V., PFHI Holdings, Inc. and Equitable (incorporated
by reference from Exhibit 2 in Form 8-K filed July 11, 1997)
3 ARTICLES OF INCORPORATION AND BY-LAWS
(a) Restated Articles of Incorporation as amended through April 29,
1993, filed as Exhibit 3(a) to Form 10-Q for the period ended
June 30, 1993, is incorporated by reference
(b) Amended and restated By-Laws filed as Exhibit 2 to Form 8-K dated
November 11, 1991, is incorporated by reference
4 INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES
(a) Letter Agreement to furnish Commission upon request copies of
other long-term debt instruments
(b)(i) Rights Agreement filed as Exhibit 1 to Form 8-K dated April 30,
1992, is incorporated by reference
(ii) First amendment to Rights Agreement changing Rights Agent filed
as Exhibit 4(b)(ii) to Form 10-Q for the period ended September
30, 1992, is incorporated by reference
(iii) Second amendment to Rights Agreement dated April 29, 1993,
adjusting Purchase Price filed as Exhibit 2.2 to Form 8-A/A dated
May 13, 1993, is incorporated by reference
(iv) Third Amendment to Rights Agreement dated June 16, 1997, changing
Rights Agent filed as Exhibit 1 to Form 8-K dated June 16, 1997,
is incorporated by reference
(v) Fourth Amendment to Rights Agreement dated September 18, 1997,
amending rights agreement to restrict applicability to pending
merger transaction, filed as Exhibit 2(g)(v) to Form 8-A/A dated
September 19, 1997
(c)(i) Indenture dated as of January 17, 1995 by and between Equitable
of Iowa Companies and The First National Bank of Chicago, as
Trustee, relating to the company's $100,000,000 of 8.5% Notes
due 2005 (incorporated by reference from Exhibit 4.1 to the
company's Registration Statement on Form S-3 Registration No.
33-57343 filed January 18, 1995)
(ii) Form of Global 8.5% Note dated February 22, 1995 due February
15, 2005 in the principal amount of $100,000,000 (incorporated
by reference from Exhibit 4.3 to the company's Report on Form
8-K filed February 15, 1995)
INDEX
Exhibits to Form 10-Q
Nine Months ended September 30, 1997
EQUITABLE OF IOWA COMPANIES
(iii) Form of First Supplemental Indenture dated July 18, 1996,
including therein the Form of Subordinated Deferrable Interest
Debenture, relating to the company's $128,866,000 of 8.70%
Subordinated Deferrable Interest Debentures (incorporated by
reference from Exhibit 4.7.1 to the company's Report on Form
8-K filed July 3, 1996)
(iv) Form of Second Supplemental Indenture dated October 24, 1997,
relating to the assumption of the company's Indenture Securities
by PFHI Holdings, Inc.
(v) Form of Indenture dated March 31, 1997, including therein the
Form of Subordinated Deferrable Interest Debenture, relating to
the company's $51,550,000 of 8.424% Subordinated Deferrable
Interest Debentures (incorporated by reference from Exhibit 4.1
to the company's Report on Form 8-K filed April 4, 1997)
(vi) Form of First Supplemental Indenture dated October 24, 1997,
relating to the assumption of the company's Debentures by PFHI
Holdings, Inc.
(d)(i) Certificate of Trust of Equitable of Iowa Companies Capital Trust
(incorporated by reference from Exhibit 4.8 to the company's
Registration Statement on Form S-3 Registration No. 333-1909
filed March 22, 1996)
(ii) Certificate of Trust of Equitable of Iowa Companies Capital Trust
II (incorporated by reference from Exhibit 4.2 to the company's
Report on Form 8-K filed April 4, 1997)
(e)(i) Declaration of Trust of Equitable of Iowa Companies Capital Trust
(incorporated by reference from Exhibit 4.9 to the company's
Registration Statement on Form S-3 Registration No. 333-1909
filed March 22, 1996)
(ii) Form of First Amendment to Declaration of Trust of Equitable of
Iowa Companies Capital Trust dated July 18, 1996, including
therein the form of Preferred Securities, relating to
$125,000,000 of Trust Originated Preferred Securities issued by
Equitable of Iowa Companies Capital Trust (incorporated by
reference from Exhibit 4.9.1 to the company's Report on Form 8-K
filed July 3, 1996)
(iii) Amended and Restated Declaration of Trust of Equitable of Iowa
Companies Capital Trust II dated March 31, 1997, including therein
the form of Capital Securities, relating to $50,000,000 of Trust
Originated Capital Capital Securities issued by Equitable of Iowa
Companies Capital Trust II (incorporated by reference from Exhibit
4.3 to the company's Report on Form 8-K filed April 4, 1997)
INDEX
Exhibits to Form 10-Q
Nine Months ended September 30, 1997
EQUITABLE OF IOWA COMPANIES
(f)(i) Form of Preferred Securities Guarantee Agreement by Equitable of
Iowa Companies dated July 18, 1996 relating to $125,000,000 of
Trust Originated Preferred Securities issued by Equitable of Iowa
Companies Capital Trust (incorporated by reference from Exhibit
4.10 to the company's Report on Form 8-K filed July 3, 1996)
(ii) Series A Capital Securities Guarantee Agreement dated April 3,
1997 relating to $50,000,000 of Trust Originated Capital
Securities issued by Equitable of Iowa Companies Capital Trust II
(incorporated by reference from Exhibit 4.5 to the company's
Report on Form 8-K filed April 4, 1997)
10 MATERIAL CONTRACTS
(a) Executive compensation plans and arrangements *
(i) Restated Executive Severance Pay Plan filed as Exhibit 10(a)(i)
to Form 10-K for the year ended December 31, 1996, is
incorporated by reference
(ii) Directors' Deferred Compensation Plan filed as Exhibit 10(b) to
Form 10-K for the year ended December 31, 1989, is incorporated
by reference
(iii) 1982 Stock Incentive Plan filed as Exhibit 10(c) to Form 10-K for
the year ended December 31, 1989, is incorporated by reference
(iv) Excess Benefit Plan filed as Exhibit 10(d) to Form 10-K for the
year ended December 31, 1989, is incorporated by reference
(v) Supplemental Employee Retirement Plan filed as Exhibit 10(e) to
Form 10-K for the year ended December 31, 1989, is incorporated
by reference
(vi) Executive Flexible Perquisite Program filed as Exhibit 10(f) to
Form 10-K for the year ended December 31, 1992, is incorporated
by reference
(vii) Restated and Amended Key Employee Incentive Plan filed as Exhibit
A of Registrant's Proxy Statement dated March 14, 1995, is
incorporated by reference
(viii) Restated and Amended 1992 Stock Incentive Plan Registration
Statement No. 33-57492, filed as Exhibit B of Registrant's Proxy
Statement dated March 14, 1995, is incorporated by reference
(ix) 1996 Non-Employee Directors' Stock Option Plan filed as Exhibit A
of Registrant's Proxy Statement dated April 25, 1996, is
incorporated by reference
* Management contracts or compensation plans required to be filed
as an Exhibit pursuant to Item 14(c) of Form 10(K).
11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
INDEX
Exhibits to Form 10-Q
Nine Months ended September 30, 1997
EQUITABLE OF IOWA COMPANIES
21 SUBSIDIARIES LIST
23 CONSENT OF EXPERTS AND COUNSEL
(a) Consent of independent auditors (not required)
(b) Consent of counsel (not required)
27 FINANCIAL DATA SCHEDULE (ELECTRONIC FILING ONLY)
99 ADDITIONAL EXHIBITS
Independence Policy filed as an Exhibit to Form 8-K dated November 11,
1991, is incorporated by reference