UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
[ ] 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: 0-20174
American Life Holding Company
Delaware No. 42-1362294
---------------------- ------------------------------
State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
------------------------------ --------------
Address of principal executive offices Telephone
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 [ ]
Shares of common stock outstanding as of August 1, 1997: 1,500,100
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
June 30, December 31,
1997 1996
---- ----
(unaudited)
Investments:
Actively managed fixed maturity securities at fair value (amortized cost:
1997 - $4,919.7; 1996 - $5,099.6).................................................. $5,010.6 $5,215.5
Equity securities at fair value (cost: 1997 - $6.0; 1996 - $5.8)..................... 6.9 6.5
Mortgage loans....................................................................... 53.8 58.5
Credit-tenant loans.................................................................. 85.8 37.1
Policy loans......................................................................... 65.0 63.9
Short-term investments............................................................... 120.9 15.4
Other invested assets................................................................ 84.6 59.3
-------- --------
Total investments............................................................... 5,427.6 5,456.2
Accrued investment income............................................................... 83.0 87.1
Cost of policies purchased.............................................................. 306.5 331.9
Cost of policies produced............................................................... 107.9 68.9
Income tax assets....................................................................... - 2.2
Securities segregated for the future redemption of redeemable preferred stock........... 33.3 45.6
Goodwill (net of accumulated amortization: 1997 - $25.9; 1996 - $20.6).................. 408.3 409.7
Other assets............................................................................ 41.2 38.7
-------- --------
Total assets.................................................................... $6,407.8 $6,440.3
======== ========
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
2
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Continued)
(Dollars in millions, except per share amounts)
LIABILITIES AND SHAREHOLDER'S EQUITY
June 30, December 31,
1997 1996
---- ----
(unaudited)
Liabilities:
Insurance liabilities............................................................... $5,416.5 $5,342.3
Income tax liabilities.............................................................. 3.6 -
Investment borrowings............................................................... 88.1 186.5
Payable to ALH upon determination of the Savings Bank Litigation.................... 30.1 30.1
Other liabilities................................................................... 79.8 88.1
Accounts payable to affiliates...................................................... 10.3 9.9
Notes payable:
To affiliates..................................................................... 134.4 54.7
To non-affiliates................................................................. 23.2 103.4
-------- --------
Total liabilities.............................................................. 5,786.0 5,815.0
Minority interest...................................................................... .7 .7
Mandatorily redeemable preferred stock:
Held by non-affiliates.............................................................. 67.7 97.0
Held by affiliates.................................................................. 35.1 6.5
Shareholder's equity:
Common stock, $.01 par value, and additional paid-in capital; 1,600,000
shares authorized; 1,500,100 shares issued and outstanding........................ 428.3 429.0
Unrealized appreciation of securities:
Fixed maturity securities (net of applicable
deferred income taxes: 1997 - $13.6; 1996 - $21.6)............................. 25.3 40.1
Other investments (net of applicable deferred income taxes:
1997 - $.1; 1996 - ($.4))...................................................... .1 (.8)
Retained earnings................................................................... 64.6 52.8
-------- --------
Total shareholder's equity..................................................... 518.3 521.1
-------- --------
Total liabilities and shareholder's equity..................................... $6,407.8 $6,440.3
======== ========
The accompanying notes are an integral
part of the consolidated financial
statements.
3
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
(unaudited)
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
1997 1996 1997 1996
---- ---- ---- ----
(prior (prior
basis) basis)
Revenues:
Insurance policy income........................................... $ 13.3 $ 11.0 $ 25.1 $ 22.1
Net investment income............................................. 120.5 101.5 225.5 203.6
Net investment gains (losses) .................................... 10.2 (.4) 15.5 3.0
Other income...................................................... .8 1.2 1.6 2.2
------- ------- ------- -------
Total revenues............................................... 144.8 113.3 267.7 230.9
------- ------- ------- -------
Benefits and expenses:
Insurance policy benefits......................................... 7.6 5.2 15.9 12.0
Change in future policy benefits.................................. (.5) (.3) (1.9) (.8)
Amounts added to annuity and financial product policyholder
account balances................................................ 75.3 60.8 137.4 122.0
Interest expense on notes payable................................. 3.9 6.9 7.9 13.8
Interest expense on investment borrowings......................... 1.2 .8 2.9 1.8
Amortization related to operations................................ 11.0 11.7 22.0 22.7
Amortization related to investment gains.......................... 10.0 - 14.8 2.6
Other operating costs and expenses................................ 6.3 6.5 13.7 14.9
------- ------- ------- -------
Total benefits and expenses.................................. 114.8 91.6 212.7 189.0
------- ------- ------- -------
Income before income taxes................................... 30.0 21.7 55.0 41.9
Income tax expense................................................... 12.1 8.3 21.5 16.1
------- ------- ------- -------
Net income................................................... 17.9 13.4 33.5 25.8
Dividend requirements of Series Preferred Stock...................... 1.8 2.2 3.6 4.4
------- ------- ------- -------
Net income applicable to common stock........................ $ 16.1 $ 11.2 $ 29.9 $ 21.4
======= ======= ======= ======
The accompanying notes are an integral
part of the consolidated financial
statements.
4
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(Dollars in millions)
(unaudited)
Six months ended
June 30,
----------------------
1997 1996
---- ----
(prior
basis)
Common stock and additional paid-in capital:
Balance, beginning of period..................................................... $429.0 $ 143.0
Adjustment of balance due to adoption of new basis............................. (.7) -
------ -------
Balance, end of period........................................................... $428.3 $ 143.0
====== =======
Unrealized appreciation (depreciation) of securities:
Fixed maturity securities:
Balance, beginning of period................................................... $ 40.1 $ 194.9
Change in unrealized appreciation (depreciation)............................ (14.8) (157.3)
------ -------
Balance, end of period......................................................... $ 25.3 $ 37.6
====== =======
Other investments:
Balance, beginning of period................................................... $ (.8) $ 1.5
Change in unrealized appreciation (depreciation)............................ .9 .4
------ -------
Balance, end of period......................................................... $ .1 $ 1.9
====== =======
Retained earnings:
Balance, beginning of period..................................................... $ 52.8 $ 79.8
Net income..................................................................... 33.5 25.8
Common stock dividends......................................................... (18.1) -
Preferred stock dividends...................................................... (3.6) (4.4)
------ -------
Balance, end of period........................................................... $ 64.6 $ 101.2
====== =======
Total shareholder's equity..................................................... $518.3 $ 283.7
====== =======
The accompanying notes are an integral
part of the consolidated financial
statements.
5
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
Six months ended
June 30,
----------------------
1997 1996
---- ----
(prior
basis)
Cash flows from operating activities:
Net income................................................................... $ 33.5 $ 25.8
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization and depreciation........................................... 36.9 25.7
Income taxes............................................................ 13.3 11.6
Insurance liabilities................................................... (7.9) 17.3
Interest credited to insurance liabilities.............................. 137.4 122.0
Fees charged to insurance liabilities................................... (19.6) (16.4)
Accrual and amortization of investment income........................... 2.8 (20.0)
Deferral of cost of policies produced................................... (35.2) (40.8)
Net investment gains.................................................... (15.5) (3.0)
Other................................................................... (11.0) 9.7
--------- -------
Net cash provided by operating activities............................ 134.7 131.9
--------- -------
Cash flows from investing activities:
Purchases of investments..................................................... (1,813.8) (770.4)
Sales of investments......................................................... 1,887.1 599.7
Maturities and redemptions................................................... 80.2 65.4
--------- -------
Net cash provided (used) by investing activities..................... 153.5 (105.3)
--------- -------
Cash flows from financing activities:
Investment borrowings, net................................................... (98.4) (72.4)
Deposits to insurance liabilities............................................ 349.5 353.0
Withdrawals from insurance liabilities....................................... (411.3) (403.3)
Common stock dividends paid.................................................. (18.1) -
Preferred stock dividends paid............................................... (4.4) (4.4)
--------- -------
Net cash used by financing activities................................ (182.7) (127.1)
--------- -------
Net increase (decrease) in short-term investments.................... 105.5 (100.5)
Short-term investments, beginning of period..................................... 15.4 107.8
--------- -------
Short-term investments, end of period........................................... $ 120.9 $ 7.3
========= =======
The accompanying notes are an integral
part of the consolidated financial
statements.
6
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following notes should be read in conjunction with the notes to the
consolidated financial statements included in the 1996 Form 10-K of American
Life Holding Company (the "Company").
SIGNIFICANT ACCOUNTING POLICIES
The unaudited consolidated financial statements as of and for the periods
ended June 30, 1997 and 1996, reflect all adjustments, consisting only of normal
recurring items, which are necessary to present fairly the Company's financial
position and results of operations on a basis consistent with that of prior
audited consolidated financial statements. Certain amounts previously reported
in the Form 10-Q for the period ended June 30, 1996, have been reclassified to
conform with the current presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that significantly affect various reported amounts. Actual
results could differ from those estimates. Significant estimates and assumptions
are utilized in the calculation of cost of policies produced, cost of policies
purchased, goodwill, insurance liabilities, liabilities related to litigation,
guaranty fund assessment accruals and deferred income taxes. It is reasonably
possible that actual experience could differ from the estimates and assumptions
utilized which could have a material impact on the financial statements.
The consolidated financial statements include the accounts of American Life
and Casualty Insurance Company ("American Life and Casualty") and Vulcan Life
Insurance Company ("Vulcan Life"). The Company owns 100 percent of American Life
and Casualty, which owns 98 percent of Vulcan Life.
The Company is a wholly owned subsidiary of American Life Holdings, Inc.
("ALH"). Effective September 30, 1996, ALH became a wholly owned subsidiary of
Conseco, Inc. ("Conseco"). Conseco is a financial services holding company
engaged primarily in the development, marketing and administration of annuity,
supplemental health and individual life products.
On September 29, 1994, Conseco Capital Partners II, L.P. ("Partnership
II"), a Delaware limited partnership, completed the acquisition (the
"Acquisition") of ALH. ALH's former shareholders received $15.25 in cash per
common equivalent share plus a contingent payment right (the "Contingent Payment
Right") to receive up to another $2.00 in cash per common equivalent share (the
"Contingent Consideration"), based on the outcome of ALH's and American Life and
Casualty's pending litigation against the U.S. Government concerning their
former savings bank subsidiary (the "Savings Bank Litigation"). The sole general
partner of Partnership II was a wholly owned subsidiary of Conseco. As a result
of the Acquisition and related financing transactions, Partnership II owned 80
percent of ALH's outstanding common stock. Conseco, through its direct
investment and interests in certain of its subsidiaries, had a 38 percent
ownership interest in ALH and the Company prior to the transactions described in
the following paragraphs. The Acquisition was accounted for using the purchase
method of accounting effective September 29, 1994. Under this method, the total
cost to acquire the Company was allocated to the assets and liabilities acquired
based on their fair values, with the excess of the total purchase cost over the
fair value of the net assets acquired recorded as goodwill.
Effective September 30, 1996, Conseco: (i) purchased all of the outstanding
common stock of ALH not previously owned by Conseco for $165.0 million in cash
(the "ALH Stock Purchase"); (ii) purchased 5,434,783 newly issued shares of ALH
common stock for $125.0 million; and (iii) terminated Partnership II.
ALH contributed the proceeds from the issuance of the shares to the
Company. The Company used the proceeds from the capital contribution to repay
all amounts borrowed under its senior credit facility. As a result of the ALH
Stock Purchase, the Company is an indirect wholly owned subsidiary of Conseco.
Effective September 30, 1996, the Company adopted a new basis of accounting
under the "push down" method. Under this method, the assets and liabilities of
the Company were revalued to reflect Conseco's cost basis, which is based on the
fair values of such assets and liabilities on the dates Conseco's ownership
interests were acquired. As a result, the assets and liabilities included in the
June 30, 1997, consolidated balance sheet represent the following combination of
values: (i) the portion of the Company's net assets acquired by Partnership II
in the Acquisition is valued as of September 29, 1994; and (ii) the portion of
the Company's net assets acquired in the ALH Stock Purchase is valued as of
September 30, 1996.
7
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The consolidated balance sheet as of June 30, 1997, and December 31, 1996,
and the consolidated statement of operations, shareholder's equity and cash
flows for the six months ended June 30, 1997, are reported under the new basis
of accounting described in the previous paragraph. The consolidated statements
of operations, shareholder's equity and cash flows for the six months ended June
30, 1996, are reported based on the September 1994 purchase values ("prior
basis").
ADJUSTMENT TO ACTIVELY MANAGED FIXED MATURITY SECURITIES
The Company classifies fixed maturity securities into three categories:
"actively managed" (which are carried at estimated fair value), "trading
account" (which are carried at estimated fair value) and "held to maturity"
(which are carried at amortized cost). The Company did not classify any
securities in the held to maturity or trading categories during the periods
presented in the accompanying consolidated financial statements.
The adjustments to carry actively managed fixed maturity securities at fair
value have no effect on the Company's earnings. Such adjustments are recorded,
net of tax and other adjustments, as an adjustment to shareholder's equity. The
components of the balance sheet caption "unrealized appreciation (depreciation)
of fixed maturity securities, net" in shareholder's equity at June 30, 1997 and
December 31, 1996 are as follows:
June 30, 1997 December 31, 1996
------------------------------------ -----------------------------------
Effect of Effect of
fair value Carrying fair value Carrying
Cost basis adjustments value Cost basis adjustments value
---------- ----------- ----- ---------- ----------- -----
(Dollars in millions)
Actively managed fixed maturity
securities............................... $4,919.7 $ 90.9 $5,010.6 $5,099.6 $115.9 $5,215.5
Other balance sheet items:
Cost of policies purchased............... 353.8 (47.3) 306.5 378.7 (46.8) 331.9
Cost of policies produced................ 112.6 (4.7) 107.9 76.3 (7.4) 68.9
Income tax assets (liabilities).......... 9.4 (13.6) (4.2) 23.8 (21.6) 2.2
------ ------
Unrealized appreciation
of fixed maturity securities, net..... $ 25.3 $ 40.1
====== ======
DERIVATIVE FINANCIAL INSTRUMENTS
In 1996, the Company introduced equity-indexed annuity products, which
provide a guaranteed base rate of return with a higher potential return linked
to the performance of a broad-based equity index. The Company also implemented a
hedging program under which it purchases Standard & Poor's 500 Index Call
Options ("S&P Options"). The Company buys S&P Options to offset potential
increases in policyholder account balances for equity-indexed annuity policies
resulting from increases in the index to which the product is linked. The cost
of the S&P Options are included in the pricing of the equity-indexed annuity
products. Changes in the values of the S&P Options, which fluctuate in
relationship to changes in policyholder liabilities, are reflected in investment
income.
During the six months ended June 30, 1997, net investment income increased
by $16.9 million as a result of changes in the value of the S&P Options. Such
investment income was offset by increases to interest credited on annuities and
financial products. The value of the S&P Options was $29.2 million at June 30,
1997. Such instruments are classified as other invested assets.
The Company is exposed to the risk of loss in the event of non-performance
by the counterparties of the S&P Options. The Company limits its exposure to
such a loss by diversifying among counterparties and limiting its exposure to
strong creditworthy parties. At June 30, 1997, all of the counterparties were
rated A or higher by Standard & Poor's Corporation.
8
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTES PAYABLE
In the first six months of 1997, subsidiaries of Conseco purchased $76.1
million par value of the Company's senior subordinated notes for approximately
$87.7 million.
MANDATORILY REDEEMABLE PREFERRED STOCK
In March 1997, Conseco purchased all of the Company's $2.32 Redeemable
Cumulative Preferred Stock not previously owned for $25.9 million. In addition,
Conseco agreed to release the Company from its obligation to maintain securities
segregated for the future redemption of the $2.32 preferred shares in an escrow
account. In the second quarter, the Company sold such securities which had an
amortized cost of $13.8 million and recognized a gain on the sale of $.2
million.
In the second quarter of 1997, Conseco purchased $4.4 million par value of
the Company's $2.16 Redeemable Cumulative Preferred Stock for $4.6 million.
PAYABLE TO ALH UPON DETERMINATION OF SAVINGS BANK LITIGATION
In conjunction with the Acquisition, each common or equivalent share of ALH
outstanding immediately prior to the Acquisition received a contingent payment
right, designed to provide holders with certain financial benefits that ALH and
American Life and Casualty (the "plaintiffs") may receive from a favorable
determination of the litigation against the United States of America described
in the notes to the consolidated financial statements included in the 1996 Form
10-K (the "Savings Bank Litigation"). A liability of $30.1 million was
established at the Acquisition date representing the consideration that would be
payable either to the holder of ALH's 1988 Series I and Series II Preferred
Stock or to ALH's other former shareholders, depending upon the outcome of the
Savings Bank Litigation. Since the timing of a final determination of the
Savings Bank Litigation is uncertain, the plaintiffs are unable to predict when
such $30.1 million amount will become payable.
On August 30, 1995, the United States Court of Appeals for the Federal
Circuit, in banc, affirmed the summary judgment of the Court of Federal Claims
in the plaintiffs' favor by a decision of nine to two. On July 1, 1996, the
Supreme Court affirmed the summary judgment of the Court of Federal Claims in
the plaintiffs' favor by a decision of seven to two. A trial has been scheduled
for January 1998, in the Court of Federal Claims to determine damages related
to the breach of contract by the United States of America.
RELATED PARTY TRANSACTIONS
The Company received services from or shared expenses with Conseco under
agreements or based on cost allocation principles in accordance with GAAP. Fees
charged under all such agreements totaled $21.9 million (including substantially
all operating costs of the Company) and $7.4 million (including investment
management, accounting and certain management costs of the Company) for the six
months ended June 30, 1997 and 1996, respectively.
9
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion addresses the principal factors affecting earnings
and financial condition including liquidity and capital resources. This
discussion should be read in conjunction with the consolidated financial
statements and notes thereto included in the 1996 Form 10-K.
RESULTS OF OPERATIONS
As explained in the accompanying notes to the consolidated financial
statements, the purchase accounting adjustments resulting from the ALH Stock
Purchase affect the comparability of operating data for the periods before and
after the ALH Stock Purchase.
Six Months Ended June 30, 1997 Compared to Six Months Ended June 30, 1996
Insurance policy income, which consists of premiums received on traditional
life insurance products and policy fund and surrender charges assessed against
investment type products, increased 14 percent to $25.1 million in 1997.
Surrender charges assessed against universal life-type and investment-type
contracts were $13.1 million in 1997 compared to $9.7 million in 1996;
withdrawals from such contracts were $411.3 million and $403.3 million for the
respective periods.
Net investment income, excluding income related to the S&P Options backing
the Company's equity-linked annuity products, increased 2.5 percent to $208.6
million in 1997. The increase was primarily due to an 8 percent increase in
average invested assets (amortized cost basis) offset by a decrease in yield to
7.8 percent from 8.2 percent. The decrease in yield primarily reflects purchase
accounting adjustments resulting from the ALH Stock Purchase.
Net investment income of $16.9 million in 1997 related to the S&P Options
is offset by a corresponding charge to amounts added to annuity and financial
product policyholder account balances. Such income fluctuates in relation to the
fair value of such assets.
Net investment gains (losses) often fluctuate from period to period. The
Company sold approximately $1.9 billion of investments (principally fixed
maturity securities) in 1997 compared to $.6 billion in 1996, which sales
resulted in net investment gains of $15.5 million in 1997 compared to net
investment gains of $3.0 million in 1996.
Selling securities at a gain and reinvesting the proceeds at lower yields
may, absent other management action, tend to decrease future investment yields.
The Company believes, however, the following factors would mitigate the adverse
effect of such decreases: (i) additional amortization of the cost of policies
purchased and the cost of policies produced is recognized in the same period as
the gain in order to reflect reduced future yields thereby reducing such
amortization in future periods (see amortization related to investment gains
below); (ii) interest rates credited to some products can be reduced thereby
diminishing the effect of the yield decrease on the investment spread; and (iii)
the investment portfolio grows as a result of reinvesting the investment gains.
Amounts added to annuity and financial product policyholder account
balances, excluding amounts related to the Company's equity-linked policies,
decreased 1.2 percent to $120.5 million in 1997 due to lower crediting rates.
The weighted average crediting rate for the Company's annuity liabilities
excluding interest rate bonuses guaranteed for the first year of the annuity
contract were 4.7 percent in 1997 and 4.8 percent in 1996.
Interest expense on notes payable decreased 43 percent to $7.9 million in
1997. The decrease was due to the repayment of the Company's bank debt using the
proceeds of a capital contribution from Conseco at the time of the ALH Stock
Purchase.
Interest expense on investment borrowings is primarily affected by changes
in investment borrowing activities.
Amortization related to operations decreased 3.1 percent to $22.0 million.
Amortization related to operations in 1997 reflects the different amortization
assumptions and bases as a result of the adoption of the new basis of accounting
in periods subsequent to the ALH Stock Purchase.
10
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Cost of policies produced represents the cost of producing new business
(primarily commissions, bonus interest and certain costs of policy issuance and
underwriting) which varies with and is primarily related to the production of
new business. Costs deferred may represent amounts paid in the period the new
business is written (such as underwriting costs and first year commissions) or
in periods after the business is written (such as commissions paid in subsequent
years in excess of ultimate commissions paid and bonus interest credited through
the first policy anniversary date). Cost of policies purchased represents the
portion of the cost to acquire the Company that is attributable to the right to
receive cash flows from insurance contracts in force at the acquisition dates.
Amortization of goodwill increased to $5.3 million in 1997 from $4.5
million in 1996 due to the adoption of the new basis of accounting subsequent to
the ALH Stock Purchase.
Amortization related to investment gains increased to $14.8 million in 1997
from $2.6 million in 1996 primarily as a result of an increase in investment
gains in 1997.
Other operating costs and expenses decreased 8.1 percent to $13.7 million
in 1997. Such decrease reflects the consolidation in the fourth quarter of 1996
of the Company's operations in Des Moines, Iowa, with those of Conseco
subsidiaries in Carmel, Indiana.
Income tax expense increased 37 percent to $22.1 million in 1997. This
increase is primarily due to the increase in pretax income to $55.0 million in
1997 from $41.9 million in 1996. The effective tax rate of 39 percent in 1997
and 38 percent in 1996 exceeded the statutory corporate tax rate (35 percent)
primarily because goodwill amortization is not deductible for federal income tax
purposes.
Second Quarter of 1997 Compared to Second Quarter of 1996
Insurance policy income, which consists of premiums received on traditional
life insurance products and policy fund and surrender charges assessed against
investment type products, increased 21 percent to $13.3 million in 1997.
Surrender charges assessed against universal life-type and investment-type
contracts were $7.6 million in 1997, compared to $5.2 million in 1996;
withdrawals from such contracts were $226.6 million and $218.0 million for the
respective periods.
Net investment income, excluding income related to the S&P Options backing
the Company's equity-linked annuity products, increased 4.1 percent to $105.7
million in 1997. The increase was primarily due to a 6 percent increase in
average invested assets (amortized cost basis) offset by a decrease in yield to
8.0 percent from 8.2 percent. The decrease in yield is consistent with the
explanation above for the six month periods.
Net investment income of $14.8 million in 1997 related to the S&P Options
is offset by a corresponding charge to amounts added to annuity and financial
product policyholder account balances. Such income fluctuates in relation to the
fair value of such assets.
Net investment gains (losses) often fluctuate from period to period. The
Company sold approximately $1.1 billion of investments (principally fixed
maturity securities) in 1997 compared to $.3 billion in 1996, which sales
resulted in net investment gains of $10.2 million in 1997 compared to net
investment losses of $.4 million in 1996.
Amounts added to annuity and financial product policyholder account
balances, excluding amounts related to the Company's equity-linked policies,
decreased .5 percent to $60.5 million in 1997 due to the factors described above
for the six month periods.
Interest expense on notes payable decreased 43 percent to $3.9 million in
1997 as a result of the factors discussed above for the six month periods.
Interest expense on investment borrowings is primarily affected by changes
in investment borrowing activities.
Amortization related to operations decreased 6.0 percent to $11.0 million
in 1997 consistent with the explanation above for the six month periods.
Amortization related to investment gains was $10.0 million in the second
quarter of 1997. There was no amortization related to investment gains (losses)
in the second quarter of 1996 as a result of insignificant investment losses.
Other operating costs and expenses decreased 3.1 percent to $6.3 million in
1997 consistent with the explanation above for the six month periods.
Income tax expense increased 53 percent to $12.7 million in 1997. This
increase is primarily due to the increase in pretax income to $30.0 million in
1997 from $21.7 million in 1996. The effective tax rate of 40 percent in 1997
and 38 percent in 1996 exceeded the statutory corporate tax rate (35 percent)
primarily because goodwill amortization is not deductible for federal income tax
purposes.
11
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
SALES
In accordance with GAAP, insurance policy income shown on the Company's
consolidated statement of operations consists of premiums received for policies
which have life contingencies or morbidity features. For annuity and universal
life contracts without such features, premiums collected are not reported as
revenues, but rather are reported as deposits to insurance liabilities. Revenues
for these products are recognized in the form of investment income and surrender
or other charges.
Net premiums collected in the six months ended June 30, 1997, were $354.9
million, of which $349.5 million were recorded as deposits to policy liability
accounts. This compared to $358.7 million collected and $353.0 million recorded
as deposits to policy liability accounts in the six months ended June 30, 1996.
Net premiums collected declined in the first six months of 1997 compared to the
first six months of 1996 primarily due to a declining interest rate environment
which resulted in increased competition from alternative investments such as
certificates of deposit, mutual funds and variable annuity products.
LIQUIDITY AND CAPITAL RESOURCES
Insurance Operations
The Company's annuity and life insurance business generally provides the
insurance subsidiaries with positive cash flows from premium collections and
investment income. Cash flows from insurance subsidiary financing activities are
principally the result of premium collections from annuities and
interest-sensitive insurance contracts and the related benefit payments,
including withdrawal and surrender payments.
Annuity deposits have declined in 1996 and 1997. The demand for individual
fixed annuity products offered by all insurance companies has decreased. Such
decrease is believed to be attributable to increased competition from products
such as mutual funds, traditional bank investments, variable annuities and other
investment and retirement funding alternatives as a result of a flattened yield
curve and rising equity markets.
Withdrawals and surrender payments were $411.3 million in the first six
months of 1997 compared to $403.3 million in the first six months of 1996.
Withdrawals and surrenders have increased in recent years due to: (i) the aging
of the Company's annuity business in force resulting in an increased amount of
deferred annuity liabilities that could be surrendered without penalty or with a
nominal penalty; (ii) growth in the Company's annuity business resulting from
the substantial volume of premium collections in 1993 through 1995; (iii)
increased policyholder utilization of the systematic withdrawal features which
first became available on annuity policies in 1992; and (iv) increased
competition from alternative investments such as certificates of deposit, mutual
funds and variable annuity products as a result of a flattened yield curve and
declining interest rates.
The following table summarizes the Company's deferred annuity liabilities
at June 30, 1997 and December 31, 1996, and sales for the six months and year
then ended, respectively, by surrender charge category (dollars in millions):
June 30, 1997 December 31, 1996
----------------------------------------- -------------------------------------
Annuity Annuity
Surrender charge percent deposits Percent Liabilities Percent deposits Percent Liabilities Percent
- ------------------------ -------- ------- ----------- ------- -------- ------- ----------- -------
No surrender charge................... $ .2 *% $ 822.4 17% $ .6 *% $ 891.2 18%
1 to 3.9 percent...................... - - 493.1 10 - - 442.0 9
4 to 6.9 percent...................... .6 * 801.2 16 2.4 * 776.2 16
7 to 9.9 percent...................... 108.3 34 1,567.5 32 96.9 16 1,481.7 30
10 to 11.9 percent.................... 51.5 16 725.5 15 180.7 29 867.8 18
12 percent and greater................ 157.4 50 500.2 10 345.4 55 422.4 9
------ --- -------- --- ------ --- -------- ---
$318.0 100% $4,909.9 100% $626.0 100% $4,881.3 100%
====== === ======== === ====== === ======== ===
<FN>
* less than 1%
</FN>
12
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Deferred annuity liabilities that could be surrendered without penalty
increased from $508.8 million, or 14 percent of deferred annuity liabilities, at
December 31, 1993 to $822.4 million, or 17 percent of deferred annuity
liabilities, at June 30, 1997. The following table summarizes the Company's
deferred annuity liabilities in which the surrender charge expires within the
first subsequent year and the second subsequent year at December 31, 1994, 1995
and 1996, and June 30, 1997.
Within
--------------------
first second Total
subsequent subsequent within next
year year 2 years
---- ---- -------
(Dollars in millions)
December 31, 1994......................... $456.0 $168.1 $624.1
December 31, 1995......................... 158.9 71.3 230.2
December 31, 1996......................... 64.9 202.1 267.0
June 30, 1997............................. 90.3 240.1 330.4
Most of the Company's assets are invested in bonds and other securities,
substantially all of which are readily marketable. Although there is no present
need or intent to dispose of such investments, the Company could liquidate
portions of its investments or use them to facilitate borrowings under reverse
repurchase agreements if such a need arose.
Parent Holding Company
The comparison of June 30, 1997, balances to December 31, 1996, balances in
the consolidated balance sheet primarily reflects the following: (i) a decrease
in investment borrowings; (ii) a decrease in the fair value of actively managed
fixed maturity securities; (iii) changes in investments and insurance
liabilities as a result of the Company's insurance operations; (iv) a decrease
in retained earnings attributable to common stock dividends of $18.1 million and
preferred stock dividends of $3.6 million; and (v) an increase in retained
earnings attributable to the Company's operations.
The ratio of debt to total capital excluding the effect of reporting fixed
maturities at fair value was .21 to 1 at June 30, 1997, and at December 31,
1996. The ratio of debt to total capital including the effect of the change in
the fair value of actively managed fixed maturity investments was .20 to 1 at
June 30, 1997, and at December 31, 1996.
INVESTMENTS
The amortized cost and estimated fair value of fixed maturity securities
(all of which were actively managed) were as follows at June 30, 1997:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
United States Treasury securities...................................... $ 44.6 $ 1.3 $ - $ 45.9
Obligations of states and political subdivisions....................... 37.6 1.2 - 38.8
Foreign government obligations......................................... 14.7 - .8 13.9
Public utility securities.............................................. 606.4 19.0 1.2 624.2
Other corporate securities............................................. 2,745.0 51.7 14.1 2,782.6
Mortgage-backed securities............................................. 1,471.4 37.4 3.6 1,505.2
-------- ------ ----- --------
Total fixed maturity securities ................................... $4,919.7 $110.6 $19.7 $5,010.6
======== ====== ===== ========
13
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
The following table sets forth fixed maturity securities at June 30, 1997,
classified by rating categories (designated categories include securities with
"+" or "-" rating modifiers). The category assigned is the highest rating by a
nationally recognized statistical rating organization or, as to $49.1 million
fair value of fixed maturities not rated by such firms, the rating assigned by
the National Association of Insurance Commissioners ("NAIC"). For the purposes
of this table, NAIC Class 1 is included in the "A" rating; Class 2, "BBB"; Class
3, "BB" and Classes 4 to 6, "B and below."
Percent of
-------------------------------
Fixed maturity Total
Investment rating securities investments
----------------- ---------- -----------
AAA...................................... 32% 30%
AA....................................... 11 10
A........................................ 27 25
BBB...................................... 26 24
---- ---
Investment grade.................. 96 89
---- ---
BB....................................... 3 3
B and below.............................. 1 1
---- ---
Below investment grade............ 4 4
---- ---
Total fixed maturity securities... 100% 93%
=== ==
At June 30, 1997, the Company's below investment grade fixed maturity
securities had an amortized cost of $185.2 million and an estimated fair value
of $191.1 million.
The Company's investment portfolio is subject to the risk of declines in
realizable value; however, the Company attempts to mitigate this risk through
the diversification and active management of its portfolio. As of June 30, 1997,
there were no fixed maturity securities about which the Company has serious
doubts as to the ability of the issuer to comply with the contractual terms of
their obligations on a timely basis.
Sales of investments (principally fixed maturity securities) during the
first six months of 1997 generated proceeds of $1,887.1 million and net
investment gains of $15.5 million. Sales of investments during the first six
months of 1996 generated proceeds of $599.7 billion and net investment gains of
$3.0 million.
At June 30, 1997, fixed maturity securities included $1.5 billion (30
percent of the fixed maturity investment portfolio) of mortgage-backed
securities. The yield characteristics of mortgage-backed securities differ from
those of traditional fixed income securities. Interest and principal payments
occur more frequently, often monthly, and mortgage-backed securities are subject
to risks associated with variable prepayments. Prepayment rates are influenced
by a number of factors which cannot be predicted with certainty, including the
relative sensitivity of the underlying mortgages backing the assets to changes
in interest rates, a variety of economic, geographic and other factors and the
repayment priority of the securities in the overall securitization structures.
In general, prepayments on the underlying mortgage loans, and the
securities backed by these loans, increase when the level of prevailing interest
rates declines significantly relative to the interest rates on such loans.
Mortgage-backed securities purchased at a discount to par will experience an
increase in yield when the underlying mortgages prepay faster than expected.
These securities purchased at a premium that prepay faster than expected will
incur a reduction in yield. When interest rates decline, the proceeds from the
prepayment of mortgage-backed securities are likely to be reinvested at lower
rates than the Company was earning on the prepaid securities. When interest
rates increase, prepayments on mortgage-backed securities decrease as fewer
underlying mortgages are refinanced. When this occurs, the average maturity and
duration of the mortgage-backed securities increase, which decreases the yield
on mortgage-backed securities purchased at a discount because the discount is
realized as income at a slower rate and increases the yield on those purchased
at a premium as a result of a decrease in annual amortization of the premium.
The following table sets forth the par value, amortized cost and estimated
fair value of mortgage-backed securities summarized by interest rates on the
underlying collateral at June 30, 1997:
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
Below 7 percent .................................................................. $ 402.0 $ 378.0 $ 384.0
7 percent - 8 percent............................................................... 971.9 917.2 940.4
8 percent - 9 percent............................................................... 140.6 134.1 139.0
9 percent and above................................................................. 47.0 42.1 41.8
-------- -------- --------
Total mortgage-backed securities....................................... $1,561.5 $1,471.4 $1,505.2
======== ======== ========
14
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
The amortized cost and estimated fair value of mortgage-backed securities
at June 30, 1997, summarized by type of security were as follows:
Estimated fair value
------------------------
Percent of
Amortized fixed maturity
Type cost Amount securities
- --- ---- ------ ----------
(Dollars in millions)
Pass-throughs and sequential and targeted amortization classes............ $1,033.6 $1,054.4 21%
Planned amortization classes and accretion directed bonds................. 208.9 212.7 4
Support classes........................................................... 106.3 111.7 2
Accrual (Z tranche) bonds................................................. 18.9 20.4 1
Subordinated classes ..................................................... 103.7 106.0 2
-------- -------- --
$1,471.4 $1,505.2 30%
======== ======== ==
Pass-throughs and sequential and targeted amortization classes have similar
prepayment variability. Pass-throughs historically provide the best liquidity in
the mortgage-backed securities market and provide the best price/performance
ratio in a highly volatile interest rate environment. This type of security is
also frequently used as collateral in the dollar-roll market. Sequential classes
pay in a strict sequence; all principal payments received by the collateralized
mortgage obligations ("CMOs") are paid to the sequential tranches in order of
priority. Targeted amortization classes provide a modest amount of prepayment
protection when prepayments on the underlying collateral increase from those
assumed at pricing. Thus, they offer slightly better call protection than
sequential classes or pass-throughs.
Planned amortization classes and accretion directed bonds are some of the
most stable and liquid instruments in the mortgage-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments as long as the underlying mortgage collateral experiences prepayments
within an expected range. Changes in prepayment rates are first absorbed by
support classes. This insulates the planned amortization classes from the
consequences of faster prepayments (average life shortening) and slower
prepayments (average life extension).
Support classes absorb the prepayment risk from which planned amortization
and targeted amortization classes are protected. As such, they are usually
extremely sensitive to prepayments. Most of the Company's support classes are
higher average life instruments that generally will not lengthen if interest
rates rise further and will have a tendency to shorten if interest rates
decline. However, since these bonds have costs below their par values, higher
prepayments will have the effect of increasing yields.
Accrual bonds are CMOs structured such that the payment of coupon interest
is deferred until principal payments begin. On each accrual date, the principal
balance is increased by the amount of the interest (based upon the stated coupon
rate) that otherwise would have been payable. As such, these securities act like
zero coupon bonds until cash payments begin. Cash payments typically do not
commence until earlier classes in the CMO structure have been retired, which can
be significantly influenced by the prepayment experience of the underlying
mortgage loan collateral in the CMO structure. Because of the zero coupon
element of these securities and the potential uncertainty as to the timing of
cash payments, their market values and yields are more sensitive to changing
interest rates than other CMOs, pass-through securities and coupon bonds.
Subordinated CMO classes have both prepayment and credit risk. The
subordinated classes are used to enhance the credit quality of the senior
securities and as such, rating agencies require that this support not
deteriorate due to the prepayment of the subordinated securities. The credit
risk of subordinated classes is derived from the negative leverage of owning a
small percentage of the underlying mortgage loan collateral while bearing a
majority of the risk of loss due to homeowner defaults.
At June 30, 1997, the mortgage loan portfolio was diversified across 55
properties with an average loan size of approximately $1.0 million.
Approximately 99 percent of the mortgage loan balance relates to commercial
loans including retail, multifamily residential, office, industrial, nursing
home, restaurant and other properties. Less than 1 percent of the mortgage loan
balance was noncurrent at June 30, 1997. There were no realized losses on
mortgage loans during the six months ended June 30, 1997 and 1996. At June 30,
1997, the Company had a loan loss reserve of $.3 million.
Investment borrowings averaged approximately $120.2 million during the
first six months of 1997, compared to approximately $66.4 million during the
same period of 1996 and were collateralized by investment securities with fair
values approximately equal to the loan value. The weighted average interest rate
on such borrowings was 4.8 percent and 5.3 percent during the first six months
of 1997 and 1996, respectively.
15
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
STATUTORY INFORMATION
Statutory accounting practices prescribed or permitted for the Company's
insurance subsidiaries by regulatory authorities differ in many respects from
those governing the preparation of financial statements under GAAP. Accordingly,
statutory operating results and statutory capital and surplus may differ
substantially from those amounts reported in the GAAP basis financial statements
for comparable items. The Company's insurance subsidiaries follow certain
permitted accounting practices which are not specifically prescribed in state
laws, regulations, general administrative rules and various NAIC publications.
Such permitted accounting practices do not enhance statutory surplus. After
appropriate eliminations of intercompany accounts, the Company's life insurance
subsidiaries reported combined statutory net income of $18.4 million for the six
months ended June 30, 1997, and the following amounts on the combined statutory
balance sheet at June 30, 1997 (dollars in millions):
Statutory capital and surplus................................................... $228.2
Asset valuation reserve......................................................... 51.2
Interest maintenance reserve ................................................... 22.4
------
Total........................................................................ $301.8
======
American Life and Casualty's surplus includes a surplus note with a balance
of $50.0 million at June 30, 1997. The payment of dividends and other
distributions, including surplus note payments, by American Life and Casualty is
subject to regulation by the Iowa Insurance Division. Currently, American Life
and Casualty may pay dividends or make other distributions without the prior
approval of the Iowa Insurance Division, unless such payments, together with all
other such payments within the preceding 12 months, exceed the greater of: (i)
American Life and Casualty's net gain from operations (excluding net realized
capital gains or losses) for the preceding calendar year; or (ii) 10 percent of
its statutory surplus at the preceding December 31. For 1997, up to $28.3
million can be distributed as dividends and surplus note payments, by American
Life and Casualty ($1.3 million of which had been distributed through June 30,
1997). Dividends and surplus note payments may be made only out of earned
surplus, and all surplus note payments are subject to prior approval by the Iowa
Insurance Division. At June 30, 1997, American Life and Casualty had earned
surplus of $122.4 million.
16
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibit.
27.0 Financial Data Schedule.
b) No reports on Form 8-K were filed for the quarter ended June 30, 1997.
17
SIGNATURE
Pursuant to the requirements 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.
AMERICAN LIFE HOLDING COMPANY
Dated: August 13, 1997 By: /s/ ROLLIN M. DICK
------------------
Rollin M. Dick
Executive Vice President and
Chief Financial Officer
(authorized officer and principal
financial officer)
18