SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
March 31, 1996 No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
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, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of May 1, 1996, there were 43,074,038 shares of the Registrant's Common
Stock outstanding.
Page 1 of 18
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
March 31, December 31,
1996 1995
ASSETS
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,558.5 and $2,600.0) $2,530.9 $2,497.2
Available for sale - at market
(amortized cost-$2,984.9 and $2,787.6) 3,030.1 2,926.6
Equity securities - at market (cost-$14.1
and $14.1) 34.4 32.6
Investment in affiliate 21.2 20.3
Mortgage loans on real estate 76.4 70.4
Real estate 39.9 39.9
Policy loans 243.4 241.4
Short-term investments 47.5 140.7
Total investments 6,023.8 5,969.1
Cash 20.6 28.7
Accrued investment income 95.3 87.4
Unamortized insurance acquisition costs, net 162.5 149.8
Other assets 169.1 137.5
Assets held in separate accounts 240.6 238.5
Total assets $6,711.9 $6,611.0
LIABILITIES AND STOCKHOLDERS' EQUITY
Annuity benefits accumulated $5,130.2 $5,052.0
Life, accident and health reserves 544.2 538.3
Notes payable 166.1 167.7
Payable for securities purchased 88.6 3.3
Payable to affiliates, net 22.3 29.1
Deferred taxes on unrealized gains 21.1 48.0
Accounts payable, accrued expenses and other
liabilities 108.0 104.8
Liabilities related to separate accounts 240.6 238.5
Total liabilities 6,321.1 6,181.7
Series B Preferred Stock (at redemption value) 17.0 17.0
Common Stock, $1 par value
-100,000,000 shares authorized
- 43,074,038 and 43,071,882 shares
outstanding 43.1 43.1
Capital surplus 361.1 361.1
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 144.5 131.4
Unrealized gain on marketable securities,
net of deferred income taxes and
insurance adjustments 37.7 89.3
Total stockholders' equity 390.8 429.3
Total liabilities and stockholders'
equity $6,711.9 $6,611.0
2
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Three months ended
March 31,
1996 1995
Revenues:
Net investment income $112.1 $95.9
Realized gains on sales of investments 0.3 0.1
Life, accident and health premiums 24.2 0.7
Equity in net earnings of affiliate 1.0 1.6
Other income 1.4 0.3
139.0 98.6
Costs and Expenses:
Annuity benefits 68.0 64.3
Life, accident and health benefits 21.6 0.4
Amortization of insurance acquisition costs 6.0 1.8
Interest and other debt expenses 4.1 4.6
Other expenses 16.6 10.0
116.3 81.1
Income from continuing operations before
income taxes 22.7 17.5
Provision for income taxes 8.0 6.1
Income from continuing operations 14.7 11.4
Extraordinary item-loss on prepayment of debt (1.6) -
Net Income $13.1 $11.4
Preferred dividend requirement 0.4 -
Net income applicable to Common Stock $12.7 $11.4
Average common shares outstanding 43.1 39.1
Earnings (loss) per common share:
Continuing operations $0.33 $0.29
Extraordinary item (0.04) -
Net income $0.29 $0.29
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Three months ended
March 31,
1996 1995
Preferred Stock:
Balance at beginning and end of period $ 17.0 $ -
Common Stock:
Balance at beginning and end of period $ 43.1 $ 39.1
Capital Surplus:
Balance at beginning and end of period $361.1 $330.8
Accumulated Deficit at December 31, 1992: ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Retained earnings from January 1, 1993 to
beginning of period $131.4 $ 76.1
Net income 13.1 11.4
Balance at end of period $144.5 $ 87.5
Unrealized Gains (Losses), Net:
Balance at beginning of period $ 89.3 ($ 29.0)
Change during period (51.6) 29.0
Balance at end of period $ 37.7 $ -
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Three months ended
March 31,
1996 1995
Cash Flows from Operating Activities:
Net income $ 13.1 $ 11.4
Adjustments:
Extraordinary losses on retirement of debt 1.6 -
Increase (decrease) in life, accident and
health reserves 5.9 (0.4)
Benefits to annuity policyholders 68.0 64.3
Amortization of insurance acquisition costs 6.0 1.8
Equity in net (earnings) losses of affiliate (1.0) (1.6)
Depreciation and amortization 2.8 0.6
Realized gains on investing activities (0.3) (0.1)
Increase in accrued investment income (7.9) (5.1)
Increase in insurance acquisition costs (15.0) (8.8)
Increase in accounts payable, accrued
expenses and other liabilities (3.9) 2.5
Other, net (3.6) 1.0
65.7 65.6
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (342.5) (181.6)
Equity securities (0.1) -
Real estate, mortgage loans and other assets (16.9) (1.7)
Maturities and redemptions of fixed maturity
investments 65.4 29.4
Sales of:
Fixed maturity investments 99.7 43.4
Equity securities 0.1 1.0
Real estate, mortgage loans and other assets 10.8 2.3
Increase in policy loans (2.0) (3.5)
(185.5) (110.7)
Cash Flows from Financing Activities:
Annuity receipts 137.2 119.4
Annuity surrenders, benefits and withdrawals (113.8) (99.4)
Additions to notes payable 31.2 2.5
Reductions of notes payable (36.1) (11.5)
18.5 11.0
Net decrease in cash and short-term investments (101.3) (34.1)
Cash and short-term investments at
beginning of period 169.4 62.7
Cash and short-term investments at
end of period $ 68.1 $ 28.6
5
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Description of the Company
American Annuity Group, Inc. ("AAG" or "the Company") markets (i)
individual and group annuities nationwide to the savings and retirement
markets, (ii) individual life insurance and annuity policies with the
sponsorship of state associations of funeral directors as well as
individual funeral directors across the country and (iii) various forms
of life, accident and health insurance and annuities through payroll
deduction plans and financial institutions.
AAG's parent, American Financial Corporation ("AFC"), was acquired by
American Financial Group, Inc. ("AFG") in April 1995. AFG and its
subsidiaries owned 35,059,995 shares (81%) of AAG's Common Stock at May
1, 1996.
B. Accounting Policies
Basis of Presentation The accompanying consolidated financial
statements for AAG and its subsidiaries are unaudited, but management
believes that all adjustments (consisting only of normal recurring
accruals unless otherwise disclosed herein) necessary for fair
presentation have been made. The results of operations for interim
periods are not necessarily indicative of results to be expected for the
year. The financial statements have been prepared in accordance with
the instructions to Form 10-Q and therefore do not include all
information and footnotes necessary to be in conformity with generally
accepted accounting principles. Certain reclassifications have been
made to prior periods to conform to the current year's presentation.
The preparation of the financial statements requires management to make
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Changes in circumstances
could cause actual results to differ materially from those estimates.
AAG's acquisition of Laurentian Capital Corporation ("LCC") in November
1995 was recorded as a purchase. The results of LCC's operations have
been included in AAG's consolidated financial statements since its
acquisition.
Investments Debt securities are classified as "held to maturity" and
reported at amortized cost if AAG has the positive intent and ability to
hold them to maturity. Debt and equity securities are classified as
"available for sale" and reported at fair value with unrealized gains
and losses reported as a separate component of stockholders' equity if
the securities are not classified as held to maturity or bought and held
principally for selling in the near term. Only in certain limited
circumstances, such as significant issuer credit deterioration or if
required by insurance or other regulators, may a company change its
intent to hold a certain security to maturity without calling into
question its intent to hold other debt securities to maturity in the
future.
Short-term investments are carried at cost; mortgage loans on real
estate are generally carried at amortized cost; policy loans are stated
at the aggregate unpaid balance.
Gains or losses on sales of securities are recognized at the time of
disposition with the amount of gain or loss determined on the specific
identification basis. When a decline in the value of a specific
investment is considered to be other than temporary, a provision for
impairment is charged to earnings and the
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
carrying value of that investment is reduced. Premiums and discounts on
mortgage-backed securities are amortized over their expected average
lives using the interest method.
Investment in Affiliate AAG's investments in equity securities of
companies that are 20% to 50% owned by AFG and its subsidiaries are
carried at cost, adjusted for a proportionate share of their
undistributed earnings or losses.
Insurance Acquisition Costs Unamortized insurance acquisition costs
consist primarily of deferred policy acquisition costs and the present
value of future profits of acquired companies. Amortization of life
insurance acquisition costs includes first year commissions to the
extent they exceed those on annual renewals.
Deferred Policy Acquisition Costs ("DPAC") DPAC (principally
commissions, advertising, underwriting, policy issuance and sales
expenses that vary with and are primarily related to the production of
new business) is deferred to the extent that such costs are deemed
recoverable.
Deferred costs related to annuities and universal life insurance
products are amortized, with interest, in relation to the present value
of expected gross profits on the policies. These expected gross profits
consist principally of estimated future net investment income and
surrender, mortality and other policy charges, less estimated future
interest on policyholders' funds, policy administration expenses and
death benefits in excess of account values. DPAC is reported net of
unearned revenue relating to certain policy charges that represent
compensation for future services. These unearned revenues are
recognized as income using the same assumptions and factors used to
amortize DPAC.
Deferred costs related to traditional life and health insurance are
amortized over the expected premium paying period of the related
policies, in proportion to the ratio of annual premium revenues to total
anticipated premium revenues. Such anticipated premium revenues were
estimated using the same assumptions used for computing liabilities for
future policy benefits.
To the extent that realized gains and losses result in adjustments to
the amortization of DPAC, such adjustments are reflected as components
of realized gains.
To the extent that unrealized gains (losses) from securities classified
as "available for sale" would result in adjustments to DPAC, unearned
revenues and policyholder liabilities had those gains (losses) actually
been realized, such balance sheet amounts are adjusted, net of deferred
taxes.
Present Value of Future Profits Included in Insurance Acquisition Costs
are amounts representing the present value of future profits on business
in force of the acquired insurance companies, which represent the
portion of the costs to acquire such companies that is allocated to the
value of the right to receive future cash flows from insurance contracts
existing at the date of acquisition. These amounts are amortized with
interest over the estimated remaining life of the acquired policies for
annuities and universal life products and over the expected premium
paying period for traditional life and health insurance products.
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Annuity Benefits Accumulated Annuity receipts and benefit payments are
generally recorded as increases or decreases in "annuity benefits
accumulated" rather than as revenue and expense. Increases in this
liability for interest credited are charged to expense and decreases for
surrender charges are credited to other income.
Life, Accident and Health Benefit Reserves Liabilities for future
policy benefits under traditional ordinary life, accident and health
policies are computed using the net level premium method. Computations
are based on anticipated investment yields, mortality, morbidity and
surrenders and include provisions for unfavorable deviations. Reserves
are modified as necessary to reflect actual experience and developing
trends.
The liability for future policy benefits for interest sensitive life
policies is equal to the sum of the accumulated fund balances under such
policies.
Assets Held In and Liabilities Related To Separate Accounts Investment
annuity deposits and related liabilities represent deposits maintained
by several banks under a previously offered tax-deferred annuity
program. The Company receives an annual fee from each bank for
sponsoring the program; if depositors elect to purchase an annuity from
the Company, funds are transferred to the Company.
Life, Accident and Health Premiums and Benefits For traditional life,
accident and health products, premiums are recognized as revenue when
legally collectible from policyholders. Policy reserves have been
established in a manner which allocates policy benefits and expenses on
a basis consistent with the recognition of related premiums and
generally results in the recognition of profits over the premium-paying
period of the policies.
For interest-sensitive life and universal life products, premiums are
recorded in a policyholder account which is reflected as a liability.
Revenue is recognized as amounts are assessed against the policyholder
account for mortality coverage and contract expenses. Surrender
benefits reduce the account value. Death benefits are expensed when
incurred, net of the account value.
Income Taxes AAG, Great American Life Insurance Company ("GALIC") and
all other 80%-owned U.S. non-life subsidiaries are consolidated with AFC
for federal income tax purposes. The life insurance subsidiaries of LCC
will file separate federal income tax returns through the year 2000.
AAG and GALIC have separate tax allocation agreements with AFC which
designate how tax payments are shared by members of the tax group. In
general, both companies compute taxes on a separate return basis. GALIC
is obligated to make payments to (or receive benefits from) AFC based on
taxable income without regard to temporary differences. In accordance
with terms of AAG's indentures, AAG receives GALIC's tax allocation
payments for the benefit of AAG's deductions arising from current
operations. If GALIC's taxable income (computed on a statutory
accounting basis) exceeds a current period net operating loss of AAG,
the taxes payable by GALIC associated with the excess are payable to
AFC. If the AFC tax group utilizes any of AAG's net operating losses or
deductions that originated prior to AAG's entering AFC's consolidated
tax group, AFC will pay to AAG an amount equal to the benefit received.
8
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax bases and are measured
using enacted tax rates. The Company recognizes deferred tax assets if
it is more likely than not that a benefit will be realized. Current and
deferred tax assets and liabilities of companies in AFC's consolidated
tax group are aggregated with other amounts receivable from or payable
to affiliates.
Benefit Plans AAG sponsors an Employee Stock Ownership Retirement Plan
("ESORP") covering all employees who are qualified as to age and length
of service. The ESORP, which invests primarily in securities of AAG, is
a trusteed, noncontributory plan for the benefit of the employees of AAG
and its subsidiaries. Contributions are discretionary by the directors
of AAG and are charged against earnings in the year for which they are
declared. Qualified employees having vested rights in the plan are
entitled to benefit payments at age 60.
AAG and certain of its subsidiaries provide certain benefits to eligible
retirees. The projected future cost of providing these benefits is
expensed over the period the employees earn such benefits.
Debt Issuance Costs Debt expenses are amortized over the terms of the
respective borrowings on the interest method.
Statement of Cash Flows For cash flow purposes, "investing activities"
are defined as making and collecting loans and acquiring and disposing
of debt or equity instruments and property and equipment. "Financing
activities" include annuity receipts, benefits and withdrawals and
obtaining resources from owners and providing them with a return on
their investments. All other activities are considered "operating".
Short-term investments having original maturities of three months or
less when purchased are considered to be cash equivalents for purposes
of financial statements.
C. 1995 Acquisition
In November 1995, AAG acquired all of the outstanding shares of LCC.
Its principal insurance subsidiaries were American Memorial Life
Insurance Company (formerly Prairie States Life Insurance Company) and
Loyal American Life Insurance Company.
AAG paid approximately $106 million for the outstanding common stock of
LCC and repaid $45 million of LCC indebtedness concurrently with the
acquisition. GALIC provided approximately $90 million of the purchase
price in exchange for American Memorial and Loyal. AAG funded the
balance of the cost of acquiring LCC with the proceeds from a Common
Stock rights offering completed in August 1995, borrowings under its
line of credit, and cash on hand.
9
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
D. Investments
The carrying value of AAG's fixed maturity portfolio was comprised of
the following at March 31, 1996:
Held to Available
Maturity for Sale Total
U. S. Government and government
agencies and authorities 0% 3% 3%
Public utilities 7 4 11
Mortgage-backed securities 13 20 33
All other corporate 26 27 53
46% 54% 100%
"Investing activities" related to fixed maturity investments in AAG's
Statement of Cash Flows consisted of the following (in millions):
Held to Available
Maturity for Sale Total
1996
Purchases ($22.2) ($320.3) ($342.5)
Maturities and paydowns 23.1 42.3 65.4
Sales - 99.7 99.7
1995
Purchases ($69.9) ($111.7) ($181.6)
Maturities and paydowns 12.7 16.7 29.4
Sales - 43.4 43.4
E. Investment in Affiliate
Investment in affiliate (carrying value of $21.2 million at March 31,
1996) reflects AAG's 5% ownership (2.7 million shares) of the common
stock of Chiquita Brands International which is accounted for under the
equity method. AFG and its other subsidiaries own an additional 38%
interest in the common stock of Chiquita. Chiquita is a leading
international marketer, processor and producer of quality food
products. The market value of AAG's investment in Chiquita was
approximately $41.4 million at March 31, 1996, and $36.7 million at
December 31, 1995.
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
March 31, December 31,
1996 1995
Deferred policy acquisition
costs $247.1 $228.2
Present value of future
profits acquired 71.7 73.4
Unearned revenues (156.3) (151.8)
$162.5 $149.8
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
G. Notes Payable
Notes payable consisted of the following (in millions):
March 31, December 31,
1996 1995
Direct obligations of AAG:
11-1/8% Senior Subordinated Notes due
February 2003 $ 79.3 $101.4
9-1/2% Senior Notes due August 2001 41.5 41.5
Bank Credit Line due September 1999 39.7 20.5
Other 1.4 -
Subsidiary debt 4.2 4.3
Total $166.1 $167.7
AAG has a $75 million revolving credit agreement with four banks.
Loans under the credit agreement bear interest at floating rates based
on prime or Eurodollar rates and are collateralized by 25% of the
Common Stock of GALIC. At March 31, 1996 and December 31, 1995, the
average rate on these borrowings was 6.60% and 6.83%, respectively.
In the first three months of 1996, the Company repurchased $22.1
million principal amount of its 11-1/8% Senior Subordinated Notes
(including $13.8 million purchased by GALIC) realizing a pretax
extraordinary loss of approximately $2.5 million.
At March 31, 1996, AAG's scheduled principal payments on debt for the
balance of 1996 and the subsequent five years were as follows (in
millions):
AAG
(Parent) Subsidiary Total
1996 $ - $0.2 $ 0.2
1997 0.1 0.6 0.7
1998 0.1 0.6 0.7
1999 39.8 0.7 40.5
2000 0.1 0.7 0.8
2001 41.6 0.5 42.1
The scheduled principal payments shown above assume that debentures
purchased are applied to the earliest scheduled retirements.
Subsequent to March 31, 1996, AAG borrowed substantially all of the
remaining amount available under its existing line of credit; proceeds
from these borrowings were used primarily to repurchase additional 11-
1/8% notes. On May 13, 1996, AAG obtained a $20 million unsecured bank
line of credit under terms similar to its existing credit line.
H. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred
Stock, par value $1.00 per share.
On December 28, 1995, AAG sold 170,000 shares of newly issued Series B
Preferred Stock to an affiliate for $17 million. The Series B
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Preferred Stock has a redemption value of $100 per share and is
redeemable at AAG's option. Dividends are cumulative and payable
quarterly (beginning April 1, 1996) at an annual rate of $8.50 per
share.
On December 31, 1992, AAG purchased GALIC for $468 million. "Retained
earnings since January 1, 1993" reflects AAG's results since the
acquisition of GALIC.
I. Contingencies
The Company is continuing its clean-up activities at certain of its
former manufacturing operations and third-party sites, in some cases in
accordance with consent agreements with federal and state environmental
agencies. Changes in regulatory standards and further investigations
could affect estimated costs in the future. Management believes that
reserves recorded are sufficient to satisfy the known liabilities and
that the ultimate cost will not, individually, or in the aggregate,
have a material adverse effect on the financial condition or results of
operations of AAG.
In 1991, the Company identified possible deficiencies in procedures for
reporting quality assurance information to the Defense Electronics
Supply Center with respect to the Company's former manufacturing
operations. Over the last several years, the Company has been engaged
in negotiations with the United States Government with respect to the
settlement of claims the Government might have arising out of the
reporting deficiencies. In March 1995, the Company received
notification of additional alleged reporting deficiencies and based on
management's evaluations additional reserves were established. The
Company believes it has sufficient reserves to cover the estimated
settlement amount.
J. Statutory Information
Insurance companies are required to file financial statements with
state insurance regulatory authorities prepared on an accounting basis
prescribed or permitted by such authorities (statutory basis). Certain
statutory amounts for GALIC were as follows (in millions):
March 31, December 31,
1996 1995
Policyholders' surplus $272.9 $272.8
Asset valuation reserve 91.2 90.2
Interest maintenance reserve 30.3 32.2
Three months ended March 31,
1996 1995
Net gain from operations $ 15.1 $ 12.4
Net income 14.9 12.9
The amount of dividends which can be paid by GALIC without prior
approval of regulatory authorities is subject to restrictions
relating to capital and surplus, statutory net gain from operations
and statutory net income. Based on net gain from operations at
December 31, 1995, GALIC may pay approximately $58.6 million in
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
dividends in 1996 without prior approval, according to the most
restrictive dividend requirements of GALIC's domiciliary states. In
the first three months of 1996, AAG received $19 million in capital
distributions from GALIC.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
American Annuity Group, Inc. ("AAG" or "the Company") is organized as a
holding company with nearly all of its operations being conducted by its
subsidiaries. The parent corporation, however, has continuing expenditures
for administrative expenses, corporate services, liabilities in connection
with discontinued operations and for the payment of interest and principal
on borrowings and shareholder dividends. Since its business is financial in
nature, AAG does not prepare its consolidated financial statements using a
current-noncurrent format. Consequently, certain traditional ratios and
financial analysis tests are not meaningful.
LIQUIDITY AND CAPITAL RESOURCES
Ratios AAG's ratio of earnings to fixed charges was 6.3 for the first
quarter of 1996 compared to 4.5 for the first quarter of 1995. The ratio of
AAG's consolidated debt to equity, excluding the effects of unrealized gains
and losses on stockholders' equity, was .47 at March 31, 1996, compared to
.49 at December 31, 1995 and .79 at December 31, 1994. These same ratios
including the effects of unrealized gains and losses were .43, .39, and .90,
respectively.
The National Association of Insurance Commissioners' ("NAIC") risk-based
capital ("RBC") formulas determine the amount of capital that an insurance
company needs to ensure that it has an acceptable expectation of not
becoming financially impaired. At March 31, 1996, the capital ratios of
each of AAG's principal insurance subsidiaries exceeded the RBC requirements
by substantial amounts.
Sources and Uses of Funds In 1994, management concluded that the Company's
operations would benefit from a reduction in total indebtedness and the
resulting reduction in debt service requirements. The perceived benefits
included (i) the ability to retain cash to be utilized to expand the
Company's operations, and (ii) the prospect for better ratings for the
Company's insurance subsidiaries. As a result, in March 1994, AAG began to
acquire its outstanding indebtedness, primarily through privately negotiated
transactions. In total (through May 13, 1996), the Company has repurchased
$132 million principal amount of outstanding indebtedness. The total
consideration paid in these transactions was 810,000 shares of the
Company's Common Stock and $128 million in cash.
As of May 13, 1996, AAG had $74.7 million borrowed under a $75 million
secured bank line of credit, most of which was utilized for the note
repurchases. The line of credit matures in 1999. During May 1996, AAG
arranged an additional $20 million unsecured line of credit with a bank
under terms similar to its existing line and expiring on November 30, 1996.
AAG is discussing with the banks a further expansion and extension of its
current lines of credit. These discussions should be completed prior to
November 30, 1996.
The November 1995 acquisition of Laurentian Capital Corporation ("LCC") was
funded primarily with internal funds supplemented by bank borrowings and the
proceeds of a common stock offering in August.
In December 1995, AAG sold $17 million of newly issued 8.5% Series B
Preferred Stock to a subsidiary of AFG. The proceeds from the sale were
contributed to GALIC.
14
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
AAG's ability to pay interest and principal on its debt, dividends on its
preferred stock, obligations related to the Company's discontinued
manufacturing operations and other holding company costs is dependent on
payments from GALIC in the form of capital distributions and income
tax payments. In the first quarter of 1996, AAG received $24.5 million
in such payments from GALIC. In the first quarter of 1996, AAG made
a capital contribution of $1 million to GALIC.
The amount of capital distributions which can be paid by GALIC is subject to
restrictions relating to statutory surplus and earnings. In addition, any
dividend or distribution paid from other than earned surplus is considered
an extraordinary dividend and may be paid only after regulatory approval.
The maximum amount of dividends payable by GALIC in 1996 without prior
regulatory approval is $58.6 million.
Based upon the current level of operations and anticipated growth, AAG
believes that it will have sufficient resources to meet its liquidity
requirements.
Investments Insurance laws restrict the types and amounts of investments
which are permissible for life insurers. These restrictions are designed to
ensure the safety and liquidity of insurers' investment portfolios. The
NAIC is still considering the formulation of a model investment law. The
formulation is in the preliminary stages and management believes its impact
on AAG's operations will not be material.
The NAIC assigns quality ratings to publicly traded as well as privately
placed securities. These ratings range from Class 1 (highest quality) to
Class 6 (lowest quality). The following table shows the Company's fixed
maturity portfolio by NAIC designation (and comparable Standard & Poor's
Corporation rating) as of March 31, 1996:
NAIC % of Total
Rating Comparable S&P Rating Market Value
1 AAA, AA, A 65%
2 BBB 29
Total investment grade 94
3 BB 3
4 B 3
5 CCC, CC, C *
6 D *
Total non-investment grade 6
Total fixed maturities 100%
* less than 1%
Management believes that AAG's high quality investment portfolio should
generate a stable and predictable overall investment return.
AAG invests primarily in fixed income investments which, including loans and
short-term investments, comprised over 98% of its investment portfolio at
March 31, 1996. AAG generally invests in securities with intermediate-term
maturities with an objective of optimizing interest yields while maintaining
an appropriate relationship of maturities between AAG's assets and expected
liabilities.
At March 31, 1996, AAG had approximately $72.7 million in net unrealized
gains on its fixed maturity portfolio compared to net unrealized gains of
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
$242 million at December 31, 1995. This decrease, representing
approximately 3% of the carrying value of AAG's bond portfolio, resulted
from an increase in the general level of interest rates.
At March 31, 1996, AAG had less than 2% of total assets invested in mortgage
loans and real estate. The majority of mortgage loans and real estate was
purchased within the last three years.
At March 31, 1996, AAG's mortgage-backed securities ("MBSs") portfolio
represented approximately 33% of fixed maturity investments compared to 28%
at March 31, 1995. This increase resulted from the acquisition of LCC,
which had a higher concentration of invested assets in MBSs. As of March
31, 1996, interest only (I/O), principal only (P/O) and other "high risk"
MBSs represented less than six-tenths of one percent of total assets. AAG
invests primarily in MBSs which have a reduced risk of prepayment. In
addition, the majority of MBSs held by AAG were purchased at a discount.
Management believes that the structure and discounted nature of the MBSs
will minimize the effect of prepayments on earnings over the anticipated
life of the MBS portfolio.
Approximately 90% of AAG's MBSs are rated "AAA" with substantially all being
of investment grade quality. The majority are collateralized by GNMA, FNMA
and FHLMC single-family residential pass-through certificates. The market
in which these securities trade is highly liquid. Aside from interest rate
risk, AAG does not believe a material risk (relative to earnings or
liquidity) is inherent in holding such investments.
RESULTS OF OPERATIONS
General The operations of American Memorial and Loyal are included in AAG's
financial statements from the date of their acquisition in November 1995.
Accordingly, first quarter 1996 and 1995 income statement components are not
comparable. Results of interim periods are not necessarily indicative of
future results of operations.
GALIC's principal products are Flexible Premium Deferred Annuities ("FPDAs")
and Single Premium Deferred Annuities ("SPDAs"). American Memorial offers a
variety of annuity products to finance pre-arranged funerals. The following
table summarizes AAG's annuity premiums (in millions):
Three months ended
March 31,
1996 1995
GALIC:
FPDAs - first year $ 10 $ 11
FPDAs - renewal 49 53
SPDAs 70 55
129 119
American Memorial 8 -
$137 $119
GALIC's increase is attributable to higher sales of single premium products.
American Memorial's annuity premiums increased 33% over the comparable
period in 1995.
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Pretax Operating Earnings Pretax earnings from operations (before realized
gains and non-recurring charges) for the first quarter of 1996 and 1995 were
$22.4 million and $17.4 million, respectively. The improvement in 1996 can
be attributed to the growth in invested assets, including the increase due
to the acquisition of American Memorial and Loyal.
Life, Accident and Health Premiums and Benefits Revenues and expenses
reflect the acquisition of American Memorial and Loyal and were at levels
comparable to those in the first quarter of 1995.
Net Investment Income Net investment income increased 17% over the
comparable three month period in 1995 due to an increase in the Company's
average fixed maturity investment base. Investment income is reflected net
of investment expenses of $1.6 million in 1996 and $1.2 million in 1995.
Realized Gains Individual securities are sold from time to time as market
opportunities appear to present optimal situations under AAG's investment
strategies.
Equity in Net Earnings of Affiliate Equity in net earnings of affiliate
represents AAG's proportionate share of Chiquita's earnings. Chiquita
reported net income for the first quarter of 1996 of $24.2 million compared
to $37.6 million for the first quarter of 1995.
Annuity Benefits Annuity benefits reflects primarily interest credited to
annuity policyholders' funds accumulated. GALIC's fixed rate annuity
products permit GALIC to change the crediting rate at any time (subject to
minimum interest rate guarantees of 3% or 4% per annum). As a result,
management has been able to react to changes in market interest rates and
maintain a desired interest rate spread without a substantial effect on
persistency. Annuity benefits increased 6% over the comparable three month
period in 1995 due primarily to an increase in average annuity benefits
accumulated.
Amortization of Insurance Acquisition Costs Amortization of insurance
acquisition costs increased to $6.0 million in the first quarter of 1996
from $1.8 million in the first quarter of 1995 due to the acquisition of
LCC.
Interest and Other Debt Expenses Interest on borrowings decreased 11% in
the first quarter of 1996 compared to the same period of 1995 due to
repurchases of debt during 1996 and 1995.
Other Expenses Other expenses increased in the first quarter of 1996
compared to the same period in 1995 reflecting the operating and general
expenses of American Memorial and Loyal as well as additional costs relating
to expanded distribution networks.
Extraordinary Item Extraordinary item reflects AAG's losses, net of tax, on
retirements of its debt during the first quarter of 1996. Subsequent to
March 31, 1996 (through May 13), AAG repurchased $28 million principal
amount of its indebtedness realizing a pretax extraordinary loss of
approximately $3 million.
17
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of March 31, 1996. For
submission in electronic filing only.
(b) Report on Form 8-K - None.
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 duly authorized.
American Annuity Group, Inc.
May 14, 1996 BY:William J. Maney
Senior Vice President, Treasurer
and Chief Financial Officer
18