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
September 30, 1997 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 November 1, 1997, there were 43,214,083 shares of the Registrant's
Common Stock outstanding.
Page 1 of 20
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
September 30,December 31,
1997 1996
Assets
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,408.1 and $2,524.6) $2,354.7 $2,495.7
Available for sale - at market
(amortized cost - $3,708.4 and $3,254.9) 3,860.2 3,325.6
Equity securities - at market
(cost - $20.1 and $16.1) 73.0 51.0
Investment in affiliates 22.8 16.5
Mortgage loans on real estate 63.8 68.1
Real estate 40.3 37.6
Policy loans 238.9 236.0
Short-term investments 8.7 41.4
Total investments 6,662.4 6,271.9
Cash 32.7 42.7
Accrued investment income 99.3 94.8
Unamortized insurance acquisition costs, net 218.4 194.7
Other assets 168.4 172.4
Assets held in separate accounts 280.5 247.6
$7,461.7 $7,024.1
Liabilities and Capital
Annuity benefits accumulated $5,505.8 $5,365.6
Life, accident and health reserves 600.1 575.4
Notes payable 85.0 114.9
Payable to affiliates, net 26.1 14.5
Deferred taxes on unrealized gains 64.1 33.3
Accounts payable, accrued expenses and other
liabilities 129.4 111.3
Liabilities related to separate accounts 280.5 247.6
Total liabilities 6,691.0 6,462.6
Mandatorily redeemable preferred securities
of subsidiary trusts 225.0 75.0
Stockholders' Equity:
Series B Preferred Stock (at redemption value) - 49.0
Common Stock, $1 par value
-100,000,000 shares authorized
-43,213,201 and 43,255,705 shares
outstanding 43.2 43.3
Capital surplus 359.0 358.5
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 237.1 186.5
Unrealized gains on marketable securities,
net 119.0 61.8
Total stockholders' equity 545.7 486.5
$7,461.7 $7,024.1
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 Nine months ended
September 30, September 30,
1997 1996 1997 1996
Revenues:
Net investment income $126.7 $119.4 $369.4 $347.0
Realized gains on sales of investments 1.5 0.5 1.7 1.4
Life, accident and health premiums 32.1 24.8 84.8 80.3
Equity in net earnings (loss) of
affiliates (1.5) (0.6) 1.8 2.2
Other income 2.9 1.8 8.2 4.9
161.7 145.9 465.9 435.8
Costs and Expenses:
Annuity benefits 72.9 69.5 212.3 206.3
Life, accident and health benefits 28.2 21.7 78.2 70.2
Amortization of insurance acquisition
costs 7.6 6.9 23.8 21.1
Interest and other debt expenses 1.9 3.4 6.9 11.4
Trust preferred distribution requirement 4.7 - 10.7 -
Provision for relocation expenses 4.0 - 4.0 -
Other expenses 18.7 18.9 54.2 53.3
138.0 120.4 390.1 362.3
Income before income taxes
and extraordinary item 23.7 25.5 75.8 73.5
Provision for income taxes 7.3 8.4 23.7 25.4
Income before extraordinary item 16.4 17.1 52.1 48.1
Extraordinary item - loss on
prepayment of debt (1.5) (1.7) (1.5) (6.0)
Net Income $ 14.9 $ 15.4 $ 50.6 $ 42.1
Preferred dividend requirement - 0.4 1.0 1.1
Net income applicable to Common Stock $ 14.9 $ 15.0 $ 49.6 $ 41.0
Average common shares outstanding 43.2 43.1 43.2 43.1
Earnings per common share:
Income before extraordinary item $0.38 $0.39 $1.18 $1.09
Extraordinary item (0.03) (0.04) (0.03) (0.14)
Net income $0.35 $0.35 $1.15 $0.95
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Nine months ended
September 30,
1997 1996
Preferred Stock:
Balance at beginning of period $ 49.0 $ 17.0
Retired during the period (49.0) -
Balance at end of period $ - $ 17.0
Common Stock:
Balance at beginning of period $ 43.3 $ 43.1
Retired during the period (0.1) -
Balance at end of period $ 43.2 $ 43.1
Capital Surplus:
Balance at beginning of period $358.5 $361.1
Common Stock issuance 0.2 0.1
Common Stock retired (0.7) -
Preferred Stock retired 2.0 -
Preferred dividends declared (1.0) (0.7)
Balance at end of period $359.0 $360.5
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of period $186.5 $131.4
Net income 50.6 42.1
Balance at end of period $237.1 $173.5
Unrealized Gains, Net:
Balance at beginning of period $ 61.8 $ 89.3
Change during period 57.2 (57.8)
Balance at end of period $119.0 $ 31.5
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Nine months ended
September 30,
1997 1996
Cash Flows from Operating Activities:
Net income $ 50.6 $ 42.1
Adjustments:
Extraordinary losses on retirement of debt 1.5 6.0
Increase in life, accident and health reserves 24.7 22.8
Benefits to annuity policyholders 212.3 206.3
Amortization of insurance acquisition costs 23.8 21.1
Equity in net earnings of affiliates (1.8) (2.2)
Depreciation and amortization 3.8 3.9
Realized gains on investing activities (1.7) (1.4)
Increase in insurance acquisition costs (52.5) (46.9)
Increase in accrued investment income (4.5) (9.6)
Increase in other assets (20.2) (4.4)
Increase (decrease) in other liabilities 16.0 (4.8)
Other, net (16.1) (5.3)
235.9 227.6
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,037.3) (759.4)
Equity securities (7.6) -
Real estate, mortgage loans and other assets (8.6) (21.7)
Affiliates (4.9) -
Maturities and redemptions of fixed maturity
investments 290.1 195.1
Sales of:
Fixed maturity investments 480.7 207.9
Equity securities 5.3 1.2
Real estate, mortgage loans and other assets 7.9 21.1
Increase in policy loans (2.9) (5.8)
(277.3) (361.6)
Cash Flows from Financing Activities:
Fixed annuity receipts 369.7 410.2
Annuity surrenders, benefits and withdrawals (439.8) (372.0)
Additions to notes payable 63.0 82.2
Reductions of notes payable (94.7) (98.1)
Issuance of trust preferred securities 149.3 -
Issuance of Common Stock - 0.1
Retirement of Common Stock (0.8) -
Retirement of Preferred Stock (47.0) -
Cash dividends paid (1.0) (0.7)
(1.3) 21.7
Net decrease in cash and short-term investments (42.7) (112.3)
Cash and short-term investments at
beginning of period 84.1 169.4
Cash and short-term investments at
end of period $ 41.4 $ 57.1
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 in savings and retirement
markets, (ii) individual life insurance and annuity policies with the
sponsorship of state associations of funeral directors as well as
individual and large operators of funeral homes across the country and
(iii) various forms of supplemental life and health insurance through
payroll deduction plans and financial institutions.
American Financial Group, Inc. ("AFG") and its subsidiaries owned
35,059,995 shares (81%) of AAG's Common Stock at November 1, 1997.
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.
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.
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 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.
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Investment in Affiliates 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 on business in force of acquired insurance
companies. Certain commission costs are expensed as paid and are
included in amortization of life insurance acquisition costs.
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.
DPAC related to annuities and universal life insurance products is
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.
DPAC related to traditional life and health insurance is 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 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
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 primarily 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 material 80%-owned U.S. non-life subsidiaries are consolidated
for federal income tax purposes with American Financial Corporation
("AFC"), the common stock of which is owned by AFG. AAG's other life
insurance subsidiaries will likely be required to file separate federal
income tax returns through the sixth year from their acquisition or
formation.
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.
Stock-Based Compensation As permitted under Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation", AAG accounts for stock options and other stock-based
compensation plans using the intrinsic value based method prescribed
by Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees."
Earnings Per Share Earnings per share are calculated on the basis of
the weighted average number of shares of common stock outstanding
during the period. The effect of assumed exercise of common stock
options in 1997 was not deemed dilutive and is therefore not
reflected in the earnings per share presentation for that period.
AAG had no stock options outstanding prior to the fourth quarter of
1996.
New accounting standards issued in 1997 revise current rules for
computing and presenting earnings per share beginning with financial
statements issued for periods ending after December 15, 1997. The
new rules require the presentation of basic and diluted earnings per
share for entities with potentially dilutive securities.
Implementation of these new rules will not materially affect AAG's
reported earnings per share amounts.
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.
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 the financial statements.
9
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
C. 1997 Acquisition
In September 1997, AAG entered into an agreement to acquire General
Accident Life Assurance Company of Puerto Rico, Inc. which had total
assets of approximately $190 million at June 30, 1997. AAG will pay
approximately $50 million for General Accident and expects to fund the
acquisition with amounts borrowed under its bank lines of credit. The
acquisition is expected to be completed in the fourth quarter of 1997.
D. Investments
The carrying value of AAG's fixed maturity portfolio was comprised of
the following at September 30, 1997:
Held to Available
Maturity for Sale Total
U. S. Government and government
agencies and authorities 1% 3% 4%
Public utilities 6 3 9
Mortgage-backed securities 11 22 33
All other corporate 20 34 54
38% 62% 100%
"Investing activities" related to fixed maturity investments in AAG's
Statement of Cash Flows for the nine months ending September 30,
consisted of the following (in millions):
Held to Available
Maturity for Sale Total
1997
Purchases - ($1,037.3)($1,037.3)
Maturities and paydowns $140.0 150.1 290.1
Sales - 480.7 480.7
1996
Purchases ($103.9) ($655.5) ($759.4)
Maturities and paydowns 81.3 113.8 195.1
Sales 9.3 198.6 207.9
Securities classified as "held to maturity" having an amortized cost
of $9.5 million were sold in the first nine months of 1996 due to
significant deterioration of the issuers' creditworthiness.
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
E. Investment in Affiliates
Investment in affiliates reflects primarily AAG's 5% ownership (2.7
million shares; carrying value of $17.9 million at September 30, 1997)
of the common stock of Chiquita Brands International which is accounted
for under the equity method. AFG and its other subsidiaries own an
additional 35% interest in the common stock of Chiquita. Chiquita is a
leading international marketer, producer and distributor of bananas and
other quality fresh and processed food products. The market value of
AAG's investment in Chiquita was $43.1 million at September 30, 1997 and
$34.1 million at December 31, 1996.
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
September 30, December 31,
1997 1996
Deferred policy acquisition costs $296.4 $272.2
Present value of future profits acquired 67.1 72.5
Unearned revenues (145.1) (150.0)
$218.4 $194.7
G. Notes Payable
Notes payable consisted of the following (in millions):
September 30, December 31,
1997 1996
Direct obligations of AAG $ 1.3 $ 1.3
Obligations of AAG Holding:
Bank Credit Line due September 1999 40.0 44.7
Unsecured Bank Credit Line due
September 1998 16.0 -
9-1/2% Senior Notes due August 2001 - 40.8
11-1/8% Senior Subordinated Notes
due February 2003 24.1 24.1
Other subsidiary debt 3.6 4.0
Total $85.0 $114.9
In connection with the anticipated establishment of a new unsecured
line of credit, the Company transferred all the outstanding stock of
GALIC to AAG Holding Company, Inc., a wholly-owned subsidiary of the
Company, in November 1996. In connection with that transaction, AAG
Holding assumed all of the Company's obligations under the 9-1/2%
Senior Notes, 11-1/8% Senior Subordinated Notes and the bank lines of
credit. The Company has guaranteed the obligations of AAG Holding
under this indebtedness.
AAG Holding has a $75 million revolving credit agreement with four
banks. Loans under the credit agreement mature in 1999 and bear
interest at floating rates based on prime or Eurodollar rates and are
collateralized by 25% of the common stock of GALIC. At September 30,
1997 and December 31, 1996, the weighted average interest rate on
amounts borrowed under the bank credit line was 6.66% and 6.68%,
respectively. AAG Holding also has a $40 million unsecured bank line of
credit with terms similar to the $75 million credit agreement.
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
On August 15, 1997, AAG Holding retired its 9-1/2% Senior Notes
realizing a pretax extraordinary loss of $2.4 million.
In the first three quarters of 1996, the Company repurchased $77.9
million principal amount of its Notes (including $21.3 million purchased
by GALIC) realizing a pretax extraordinary loss of approximately $8.2
million.
At September 30, 1997, scheduled principal payments on debt for the last
three months of 1997 and the subsequent five years are shown below (in
millions). The scheduled principal payments assume that 11-1/8% Notes
previously purchased are applied to the earliest scheduled retirements.
1997 1998 1999 2000 2001 2002
$0.2 $16.7 $40.8 $0.8 $0.6 $0.5
H. Mandatorily Redeemable Preferred Securities of Subsidiary Trusts
In November 1996, a wholly-owned subsidiary trust of AAG Holding
issued three million units of 9-1/4% Trust Originated Preferred
Securities ("TOPrS") for $75 million in cash. The Trust then
purchased $75 million of newly issued AAG Holding 9-1/4% Subordinated
Debentures due 2026, which, along with related interest and principal
payments received, are the only assets of the Trust.
The TOPrS are mandatorily redeemable upon maturity or redemption of
the Subordinated Debentures. The Subordinated Debentures are
redeemable by AAG Holding on or after November 7, 2001.
In private offerings in March 1997 and May 1997, wholly-owned
subsidiary trusts of AAG Holding issued $75 million of 8-7/8% trust
preferred securities and $75 million of 7-1/4% Remarketed Par
Securities ("ROPES"), respectively, and used the proceeds to purchase
related debentures of AAG Holding which are scheduled to mature in
2027 and 2041, respectively. The 8-7/8% preferred securities and
related debentures are redeemable on or after March 1, 2007; the 7-
1/4% ROPES and related debentures are redeemable prior to September
28, 2000 and after September 28, 2001.
AAG and AAG Holding effectively provide an unconditional guarantee of
the trusts' obligations.
I. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred Stock,
par value $1.00 per share.
On March 27, 1997, AAG retired all of its outstanding Series B Preferred
Stock for approximately $47 million.
At September 30, 1997, there were 2.5 million shares of AAG Common Stock
reserved for issuance upon exercise of stock options. As of that date,
AAG had options for 1.7 million shares outstanding. The options vest at
a rate of 20% per year and expire ten years from the date of grant.
"Retained earnings since January 1, 1993" reflects AAG's results
since the acquisition of GALIC.
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. 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 September 1997, the
Government agreed to resolve these claims in exchange for a payment
of $3.5 million. The Company's previously established liability for
these claims was sufficient to cover this settlement.
K. Additional Information
Statutory Information of Great American Life Insurance Company
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, AAG's primary insurance
subsidiary, were as follows (in millions):
September 30,December 31,
1997 1996
Policyholders' surplus $329.6 $285.0
Asset valuation reserve 63.6 91.4
Interest maintenance reserve 20.4 24.7
Nine months ended September 30,
1997 1996
Net income from operations $ 51.7 $ 50.1
Net income 53.8 48.0
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 and statutory net income. Based on net income for the year ended
December 31, 1996, GALIC may pay $66.2 million in dividends in 1997 without
prior approval. In the first nine months of 1997, AAG received $45.0
million in capital distributions from GALIC.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Summary Financial Information of AAG Holding AAG has guaranteed all of the
outstanding debt of AAG Holding. Summarized consolidated financial
information for AAG Holding is as follows (in millions):
September 30, December 31,
1997 1996
Balance Sheet
Investments $6,576 $6,272
Unamortized insurance acquisition costs 218 195
Assets held in separate accounts 280 247
Other assets 269 278
Insurance reserves $6,108 $5,942
AAG Holding Company notes payable:
Due parent 165 166
Due others 80 110
Liabilities related to separate accounts 280 247
Other liabilities 159 96
Mandatorily redeemable preferred securities
of subsidiary trusts $ 225 $ 75
Stockholder's equity $ 326 $ 356
Nine months ended
September 30,
1997 1996
Income Statement
Revenues $ 456 *
Pretax income 68 *
Net income 43 *
* AAG Holding was formed on November 1, 1996.
14
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") and its subsidiary,
AAG Holding Company, Inc., are organized as holding companies with nearly
all of their operations being conducted by their subsidiaries. These
companies, however, have continuing expenditures for administrative
expenses, corporate services, satisfaction of liabilities in connection with
discontinued operations, the payment of interest and principal on borrowings
and shareholder dividends.
LIQUIDITY AND CAPITAL RESOURCES
Ratios The following ratios may be considered relevant indicators of AAG's
liquidity and are typically presented by AAG in its prospectuses and similar
documents.
Nine months ended
September 30,
1997 1996
Earnings to fixed charges 5.1 6.9
Earnings to fixed charges plus
preferred dividends 4.7 6.1
September 30, December 31,
1997 1996 1995
Consolidated debt to capital,
excluding unrealized gains 22% 19% 33%
Consolidated debt to capital,
including unrealized gains 19% 17% 28%
For purposes of the calculations of consolidated debt to capital,
consolidated debt includes the Company's notes payable and $75 million of
ROPES which were issued in May 1997. Capital represents the sum of notes
payable, redeemable preferred securities of subsidiary trusts, preferred
stock and common equity.
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 September 30, 1997, the capital ratios of
each of AAG's insurance subsidiaries exceeded the RBC requirements (the
lowest capital ratio of any AAG subsidiary was 4.4 times its authorized
control level RBC).
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Sources and Uses of Funds The ability to pay interest and principal on
debt, dividends on preferred securities, obligations related to discontinued
manufacturing operations and other holding company costs is largely
dependent upon payments from Great American Life Insurance Company ("GALIC")
in the form of capital distributions. The amount of capital distributions
which can be paid by GALIC is subject to restrictions relating to statutory
surplus and earnings. The maximum amount of dividends payable by GALIC in
1997 without prior regulatory approval is $66 million. In the first nine
months of 1997, GALIC made $45 million in such payments.
In 1995 and 1996, AAG issued shares of its Series B Preferred Stock to its
affiliates for $49 million in cash. In 1996 and 1997, subsidiary trusts
sold preferred securities for cash proceeds of $225 million. Approximately
half of the aggregate proceeds was used to retire debt and the Series B
preferred; another 14% was contributed to GALIC as capital; the remainder is
being used for general corporate purposes.
On August 15, 1997, AAG Holding redeemed all of its outstanding 9-1/2%
Senior Notes for approximately $42.5 million. AAG Holding financed the
redemption with funds borrowed under its bank credit lines.
At September 30, 1997, AAG Holding had $59 million available under its bank
lines of credit. AAG Holding expects to expand and extend its credit lines
in the near future.
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 has developed a model investment law which management believes will not
have a material impact on AAG.
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 September 30, 1997:
NAIC % of Total
Rating Comparable S&P Rating Market Value
1 AAA, AA, A 66%
2 BBB 27
Total investment grade 93
3 BB 4
4 B 3
5 CCC, CC, C *
6 D -
Total non-investment grade 7
Total fixed maturities 100%
* less than 1%
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Management believes that the high credit quality of AAG's investment
portfolio should generate a stable and predictable investment return.
AAG invests primarily in fixed income investments which, including loans and
short-term investments, comprised 98% of its investment portfolio at
September 30, 1997. 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 September 30, 1997, less than 2% of AAG's total assets were invested in
mortgage loans and real estate, the majority of which had been purchased
within the last four years.
At September 30, 1997, AAG's mortgage-backed securities ("MBSs") portfolio
represented approximately one-third of its fixed maturity investments.
Interest only (I/O), principal only (P/O) and other "high risk" MBSs
represented less than 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 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.
Contingencies A managing general agency which produced approximately one-
fifth of GALIC's premiums in 1996 and less than one-seventh of its premiums
in the first nine months of 1997 was named a defendant in a lawsuit filed in
July 1996 by two regulatory agencies in California. The managing general
agency has settled the allegations brought against it by agreeing, among
other things, to modify certain sales practices. The regulatory agencies
have taken a position that GALIC may be responsible for certain acts of its
insurance agents in connection with the sale of GALIC's annuities. GALIC is
engaged in discussions with the regulatory agencies to resolve this matter.
The ultimate outcome is not expected to have a material adverse impact on
the financial condition of the Company.
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
RESULTS OF OPERATIONS
General GALIC's principal products are Flexible Premium Deferred Annuities
("FPDAs") and Single Premium Deferred Annuities ("SPDAs"). The following
table summarizes AAG's premiums (in millions):
Three months ended Nine months ended
September 30, September 30,
1997 1996 1997 1996
Annuities:
FPDAs - first year $ 6 $ 7 $ 24 $ 26
FPDAs - renewal 30 33 119 134
SPDAs 63 81 190 223
Pre-need annuities 8 10 30 29
Variable annuities 12 - 28 -
119 131 391 412
Life, Accident and Health:
Life insurance 6 6 17 17
Pre-need life insurance 20 13 49 45
Accident and health
insurance 5 5 16 16
31 24 82 78
$150 $155 $473 $490
SPDA sales in 1997 reflect the decrease of business written by GALIC's
largest premium producing agency in 1996. GALIC is no longer writing
business with this agency (see "Management's Discussion and Analysis -
Contingencies").
Pretax Operating Earnings Pretax earnings from operations (before realized
gains, equity in net earnings (loss) of affiliates and provision for
relocation expenses) for the third quarter and first nine months of 1997
were $27.7 million and $76.3 million, respectively, compared to $25.6
million and $69.9 million for the same periods in 1996. The improvement in
1997 reflects the growth in invested assets as well as a decrease in the
effective average crediting rate on annuity policies.
Net Investment Income Net investment income increased 6% in both the third
quarter and first nine months of 1997 compared to the same periods in 1996
due to an increase in the Company's average fixed maturity investment base.
Investment income is reflected net of investment expenses of $2.6 million in
1997 and $4.9 million in 1996.
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 (Loss) of Affiliates Equity in net earnings (loss)
of affiliates represents primarily AAG's proportionate share of the results
of Chiquita Brands International. Chiquita reported a net loss before
extraordinary item for the third quarter of 1997 and 1996 of $28.0 million
and $7.6 million respectively. Net income before extraordinary item for the
first nine months of 1997 and 1996 was $56.4 million and $59.7 million,
respectively.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Other Income Other income increased $1.1 million and $3.3 million in the
third quarter and first nine months of 1997 compared to the same periods in
1996 due primarily to increased revenues from certain non-insurance
subsidiaries and additional annuity fees.
Annuity Benefits Annuity benefits reflect interest credited to annuity
policyholders' funds accumulated. The majority of 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 5% in the third quarter
and 3% in the first nine months of 1997 compared to the same periods in 1996
due primarily to an increase in average annuity benefits accumulated.
Amortization of Insurance Acquisition Costs Amortization of insurance
acquisition costs increased 10% in the third quarter and 13% in the first
nine months of 1997 compared to the same periods in 1996 due primarily to
higher average DPAC balances.
Interest and Other Debt Expenses Interest expense on borrowings decreased
44% in the third quarter and 39% in the first nine months of 1997 compared
to the same periods in 1996 due primarily to the retirement of debt during
1996 and 1997.
Trust Preferred Distribution Requirement Trust preferred distribution
requirement represents amounts accrued on $225 million of preferred
securities issued by subsidiaries of AAG in 1996 and 1997.
Provision for Relocation Expenses In the third quarter of 1997, AAG began
relocating most of the operations of Loyal American Life Insurance Company
from Mobile, Alabama to Cincinnati, Ohio. The estimated cost of the
relocation ($4.0 million) was expensed in the third quarter of 1997. The
relocation should be substantially completed during 1997.
Income Taxes AAG's effective tax rate decreased in 1997 due to a reduction
of the valuation allowance associated with certain deferred tax assets.
NEW TAX LEGISLATION
New federal tax legislation was signed into law in August 1997. Management
believes the legislation will not have a material affect on AAG's financial
condition or results of operations.
19
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 1
Legal Proceedings
In September 1997, the Company paid $3.5 million to settle claims with
respect to the Company's former manufacturing operations. (See Note J to
consolidated financial statements).
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of September 30, 1997. 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.
November 13, 1997 BY:/s/William J. Maney
William J. Maney
Senior Vice President, Treasurer
and Chief Financial Officer
20