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
September 30, 1998 File
No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer
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, 1998, there were 42,683,595 shares of the
Registrant's Common Stock outstanding.
Page 1 of 23
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
September 30,December31,
1998 1997
Assets
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,047.6 and $2,340.6) $1,942.9 $2,276.4
Available for sale - at market
(amortized cost - $3,802.2 and $3,922.0)
4,035.1 4,099.4
Equity securities - at market
(cost - $41.6 and $30.9) 81.2 83.0
Investment in affiliate 20.4 16.8
Mortgage loans on real estate 41.4 52.1
Real estate 49.9 42.0
Policy loans 221.2 241.0
Short-term investments 54.7 13.9
Total investments 6,446.8 6,824.6
Cash 139.1 36.8
Accrued investment income 96.7 101.6
Unamortized insurance acquisition costs, net 236.1 261.6
Other assets 153.6 185.2
Assets held in separate accounts 84.9 300.5
$7,157.2 $7,710.3
Liabilities and Capital
Annuity benefits accumulated $5,424.7 $5,528.1
Life, accident and health reserves 339.6 709.9
Notes payable 161.2 135.8
Payable to affiliates, net 53.4 35.8
Deferred taxes on unrealized gains 82.3 71.8
Accounts payable, accrued expenses and other
liabilities 103.1 119.5
Liabilities related to separate accounts 84.9 300.5
Total liabilities 6,249.2 6,901.4
Mandatorily redeemable preferred securities
of subsidiary trusts 225.0 225.0
Stockholders' Equity:
Common Stock, $1 par value
-100,000,000 shares authorized
- 42,839,057 and 43,199,147
shares outstanding 42.8 43.2
Capital surplus 359.8 368.0
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 336.0 252.1
Unrealized gains on
marketable securities, net 157.0 133.2
Total stockholders' equity 683.0 583.9
$7,157.2 $7,710.3
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,
1998 1997 1998 1997
Revenues:
Life, accident and
health premiums $ 50.4 $ 32.1 $145.7 $84.8
Net investment income 129.8 126.7 387.7 369.4
Realized gains on
sales of investments 4.0 1.5 15.7 1.7
Gain on sale of
subsidiaries 21.6 - 21.6 -
Equity in net earnings
(loss) of affiliate (0.6) (1.5) 4.0 1.8
Other income 4.4 2.9 11.4 8.2
209.6 161.7 586.1 465.9
Costs and Expenses:
Annuity benefits 64.5 72.9 204.7 212.3
Life, accident and
health benefits 40.5 28.2 115.2 78.2
Insurance acquisition
expenses 19.5 7.6 49.4 23.8
Trust preferred distribution
requirement 4.8 4.7 14.3 10.7
Interest and other
debt expenses 2.8 1.9 8.0 6.9
Provision for
relocation expenses - 4.0 - 4.0
Other expenses 22.5 18.7 69.1 54.2
154.6 138.0 460.7 390.1
Income before income taxes
and extraordinary item 55.0 23.7 125.4 75.8
Provision for income
taxes 17.7 7.3 40.7 23.7
Income before
extraordinary item 37.3 16.4 84.7 52.1
Extraordinary item -
loss on prepayment of debt - (1.5) (0.8) (1.5)
Net Income $ 37.3 $ 14.9 $ 83.9 $ 50.6
Preferred dividend requirement - - - 1.0
Net income applicable
to Common Stock $ 37.3 $ 14.9 $ 83.9 $49.6
Average number of common shares:
Basic 43.0 43.2 43.1 43.2
Diluted 43.7 43.8 43.8 43.6
Basic earnings (loss) per common share:
Before extraordinary item $0.87 $0.38 $1.97 $1.18
Loss on prepayment of debt - (0.03) (0.02) (0.03)
Net income $0.87 $0.35 $1.95 $1.15
Diluted earnings (loss) per common share:
Before extraordinary item $0.85 $0.37 $1.93 $1.17
Loss on prepayment
of debt - (0.03) (0.02) (0.03)
Net income $0.85 $0.34 $1.91 $1.14
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,
1998 1997
Preferred Stock:
Balance at beginning of period $ - $ 49.0
Preferred Stock retired - (49.0)
Balance at end of period $ - $ -
Common Stock:
Balance at beginning of period $ 43.2 $ 43.3
Common Stock retired (0.4) (0.1)
Balance at end of period $ 42.8 $ 43.2
Capital Surplus:
Balance at beginning of period $368.0 $358.5
Common Stock issued 0.4 0.2
Common Stock retired (8.6) (0.7)
Preferred Stock retired - 2.0
Preferred dividends declared - (1.0)
Balance at end of period $359.8 $359.0
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of period $ 252.1 $186.5
Net income 83.9 50.6
Balance at end of period $336.0 $237.1
Unrealized Gains, Net:
Balance at beginning of period $133.2 $ 61.8
Change during period 23.8 57.2
Balance at end of period $157.0 $119.0
Comprehensive Income:
Net income $ 83.9 $ 50.6
Other comprehensive income -
change in net unrealized
gains on marketable securities 23.8 57.2
Comprehensive income $107.7 $107.8
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,
1998 1997
Cash Flows from Operating Activities:
Net income $ 83.9 $ 50.6
Adjustments:
Extraordinary loss on prepayment of debt 0.8 1.5
Increase in life, accident
and health reserves 45.1 24.7
Benefits to annuity policyholders 204.7 212.3
Amortization of deferred
policy acquisition costs
and present value of future
profits acquired 39.5 21.2
Equity in net earnings of affiliate (4.0) (1.8)
Depreciation and amortization 7.1 3.8
Realized gains on sales of investments (15.7) (1.7)
Gain on sale of subsidiaries (21.6) -
Increase in insurance acquisition costs (87.4) (52.5)
Increase in accrued investment income (3.6) (4.5)
Increase in other assets (24.8) (20.2)
Increase in other liabilities 22.2 16.0
Other, net (21.1) (13.5)
225.1 235.9
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (838.8)(1,037.3)
Equity securities (17.0) (7.6)
Real estate, mortgage loans and
other assets (18.6) (8.6)
Affiliates - (4.9)
Purchase of subsidiaries, net
of cash acquired (9.5) -
Maturities and redemptions of
fixed maturity investments 546.2 290.1
Sales of:
Subsidiaries 164.6 -
Fixed maturity investments 268.3 480.7
Equity securities 5.1 5.3
Real estate, mortgage loans
and other assets 22.5 7.9
Cash and short-term investments
of subsidiaries sold (40.5) -
Decrease (increase) in policy loans 0.8 (2.9)
83.1 (277.3)
Cash Flows from Financing Activities:
Fixed annuity receipts 358.7 369.7
Annuity surrenders, benefits
and withdrawals (538.9) (439.8)
Additions to notes payable 150.0 63.0
Reductions of notes payable (125.9) (94.7)
Issuance of trust preferred securities - 149.3
Retirement of Common Stock (9.0) (0.8)
Retirement of Preferred Stock - (47.0)
Cash dividends paid - (1.0)
(165.1) (1.3)
Net increase (decrease) in cash
and short-term investments 143.1 (42.7)
Cash and short-term investments
at beginning of period 50.7 84.1
Cash and short-term investments
at end of period $193.8 $ 41.4
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
retirement products, primarily fixed and variable annuities,
and various forms of life and supplemental health insurance
on a nationwide basis through independent agents, payroll
deduction plans, financial institutions and in-home sales.
American Financial Group, Inc. ("AFG") and its subsidiaries
owned 82% of AAG's Common Stock at November 1, 1998.
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.
All acquisitions subsequent to the 1992 acquisition of Great
American Life Insurance Company ("GALIC") have been treated
as purchases. The results of operations of companies since
their acquisition have been included in AAG's Consolidated
Financial Statements.
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. 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
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.
Investment in Affiliate AAG's investments in equity securities
of companies that are 20% to 50% owned by AFG and its
subsidiaries are generally carried at cost, adjusted for a
proportionate share of their undistributed earnings or losses.
Changes in AAG's equity in its affiliate caused by issuances of
the affiliate's stock are recognized in earnings when such
issuances are not part of a broader reorganization.
Insurance Acquisition Expenses Insurance acquisition expenses
consist primarily of deferred policy acquisition costs and the
present value of future profits on business in force of acquired
insurance companies. In addition, certain marketing and
commission costs are expensed as paid and included in insurance
acquisition expenses.
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.
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.
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.
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.
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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.
Start-up Costs Certain costs associated with introducing new
products and distribution channels are deferred and amortized
on a straight-line basis over five years. See Management's
Discussion and Analysis - "New Accounting Standards to be
Implemented."
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 Reserves Liabilities for future
policy benefits under traditional 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
Separate account assets and related liabilities represent
variable annuity deposits and, in 1997, include deposits
maintained by several banks under a previously offered tax-
deferred annuity program, which was part of the Funeral
Services Division.
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 and its principal subsidiary, GALIC, have
separate tax allocation agreements with American Financial
Corporation ("AFC"), a subsidiary of AFG, 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. 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
basis 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."
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.
Earnings Per Share In 1997, AAG implemented SFAS No. 128,
"Earnings Per Share." This standard requires the
presentation of basic and diluted earnings per share for
entities with potentially dilutive securities. Basic
earnings per share are calculated using the weighted average
number of shares of common stock outstanding during the
period. Diluted earnings per share include the effect of the
assumed exercise of dilutive common stock options.
Comprehensive Income Effective January 1, 1998, AAG
implemented SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 uses the term "comprehensive income" to describe
the total of net earnings plus other comprehensive income.
For AAG, other comprehensive income represents the change in
net unrealized gains on marketable securities net of deferred
taxes and a reclassification adjustment for gains and losses
included in net earnings. Implementation of this statement
had no impact on net earnings or stockholders' equity. Prior
periods have been restated to conform to the current
presentation.
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. Acquisitions and Sales of Subsidiaries
In December 1997, AAG acquired Great American Life Assurance
Company of Puerto Rico, Inc. ("GA Life", formerly General
Accident Life Assurance Company of Puerto Rico, Inc.) for
approximately $50 million in cash.
On September 30, 1998, AAG sold its Funeral Services Division
("FSD") for approximately $165 million in cash realizing a
$14.8 million after tax gain. This division included American
Memorial Life Insurance Company and Arkansas National Life
Insurance Company and had assets of approximately $1 billion.
Proforma operations for AAG, assuming the sale had taken
place at the beginning of each period presented, were as
follows (in millions):
Proforma Adjustments
Nine months
ended
September Gain on Use of
30, 1998 Historical (FSD)1 Sale Proceeds Adjusted
Revenues:
Life, accident
and health
premiums $145.7 ($ 78.6) $ - $ - $ 67.1
Net investment
income 387.7 (30.7) - 8.0 365.0
Realized gains
on sales of
investments 15.7 (0.5) - - 15.2
Gain on sale of
subsidiaries 21.6 - (21.6) - -
Equity in net
earnings of
affiliate 4.0 - - - 4.0
Other income 11.4 (2.2) - - 9.2
586.1 (112.0) (21.6) 8.0 460.5
Costs and Expenses:
Annuity benefits 204.7 (4.3) - - 200.4
Life, accident
and health
benefits 115.2 (72.9) - - 42.3
Insurance
acquisition
expenses 49.4 (16.2) - - 33.2
Trust preferred
distribution
requirement 14.3 - - - 14.3
Interest and
other debt
expenses 8.0 - - - 8.0
Other expenses 69.1 (7.3) - - 61.8
460.7 (100.7) - - 360.0
Income before
income taxes 125.4 (11.3) (21.6) 8.0 100.5
Provision for
income taxes 40.7 (4.2) (6.8) 2.8 32.5
Income from
continuing
operations $ 84.7 ($ 7.1) ($14.8) $5.2 $ 68.0
Basic earnings per common share:
Operations $1.33 $1.29
Realized gains
(including
sale of FSD) 0.58 0.23
Equity in net
earnings of
affiliate 0.06 0.06
Income from
continuing
operations $1.97 $1.58
Diluted earnings per common share:
Operations $1.30 $1.26
Realized gains
(including sale
of FSD) 0.57 0.23
Equity in net
earnings of
affiliate 0.06 0.06
Income from
continuing
operations $1.93 $1.55
(1) Reflects results of operations of the Funeral Services
Division.
(2) Assumes the after tax proceeds (approximately $145 million)
from the sale were invested at the beginning of 1998 earning
7.4%.
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Proforma Adjustments
Year ended Use of
December 31, 1997 Historical FSD(1) Proceeds(2) Adjusted
Revenues:
Life, accident and
health premiums $121.5 ($ 77.7) $ - $ 43.8
Net investment
income 494.3 (36.0) 10.7 469.0
Realized gains on
sales of investments 5.2 0.1 - 5.3
Equity in net earnings
of affiliate 0.8 - - 0.8
Other income 12.4 (2.1) - 10.3
634.2 (115.7) 10.7 529.2
Costs and Expenses:
Annuity benefits 278.8 (4.4) - 274.4
Life, accident
and health
benefits 110.1 (76.4) - 33.7
Insurance acquisition
expenses 36.3 (13.8) - 22.5
Trust preferred
distribution
requirement 15.5 - - 15.5
Interest and other
debt expenses 8.9 - - 8.9
Provision for
relocation
expenses 4.0 - - 4.0
Other expenses 76.4 (7.5) - 68.9
530.0 (102.1) - 427.9
Income before
income taxes 104.2 (13.6) 10.7 101.3
Provision for
income taxes 32.8 (4.8) 3.7 31.7
Income from
continuing
operations $ 71.4 ($ 8.8) $ 7.0 $ 69.6
Preferred dividend
requirement 1.0 - - 1.0
Basic earnings per common share:
Operations $1.54 $1.50
Realized gains 0.08 0.08
Equity in net
earnings of
affiliate 0.01 0.01
Income from
continuing
operations $1.63 $1.59
Diluted earnings per common share:
Operations $1.52 $1.48
Realized gains 0.08 0.08
Equity in net
earnings of
affiliate 0.01 0.01
Income from
continuing
operations $1.61 $1.57
(1) Reflects results of operations of Funeral Services Division.
(2) Assumes the after tax proceeds (approximately $145 million)
from the sale were invested at the beginning of 1997 earning
7.4%.
11
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 September 30, 1998:
Held to Available
Maturity for Sale Total
U. S. Government and government
agencies and authorities -% 4% 4%
States, municipalities and political
subdivisions * 1 1
Public utilities 6 2 8
Mortgage-backed securities 9 21 30
All other corporate 18 39 57
33% 67% 100%
* less than 1%
"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
1998
Purchases $ - ($ 838.8) ($838.8)
Maturities and paydowns 233.7 312.5 546.2
Sales 32.3* 236.0 268.3
1997
Purchases $ - ($1,037.3) ($1,037.3)
Maturities and paydowns 140.0 150.1 290.1
Sales - 480.7 480.7
* Sold (at a gain of $0.6 million) due to significant deterioration of the
issuers' creditworthiness.
E. Investment in Affiliate
Investment in affiliate reflects AAG's 4% ownership (2.7
million shares; carrying value of $20.4 million at September
30, 1998) of the common stock of Chiquita Brands
International which is accounted for under the equity method.
AFG and its other subsidiaries own an additional 33% 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
approximately $28 million at September 30, 1998 and $44
million at December 31, 1997.
Included in equity in Chiquita's 1998 earnings is a $1.0
million gain attributable to Chiquita's issuance of common
stock. In November 1998, Chiquita reported that it had
incurred significant damage to its operations in Honduras as
a result of widespread flooding caused by Hurricane Mitch.
Chiquita estimated that its asset write-offs relating to
Honduras for its fourth quarter will be in the $50 million
range pretax. Accordingly, AAG would record its
proportionate share (4%) of any after tax write-off.
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the
following (in millions):
September 30, December 31,
1998 1997
Deferred policy acquisition costs $301.0 $300.6
Present value of future profits acquired 66.5 102.0
Unearned revenues (131.4) (141.0)
$236.1 $261.6
G. Notes Payable
Notes payable consisted of the following (in millions):
September 30, December 31,
1998 1997
Direct obligations of AAG $ 1.3 $ 1.3
Obligations of AAG Holding
(guaranteed by AAG):
6-7/8% Senior Notes due 2008 100.0 -
Unsecured Bank Credit Line due 2003 57.0 -
Secured Bank Credit Line due 1999 - 75.0
Unsecured Bank Credit Line due 1998 - 32.0
11-1/8% Senior Subordinated Notes due 2003 - 24.1
Other subsidiary debt 2.9 3.4
Total $161.2 $135.8
In June 1998, AAG Holding sold $100 million principal amount
of 6-7/8% Senior Notes due 2008 and used the net proceeds to
repay outstanding indebtedness under the unsecured bank
credit line.
In January 1998, AAG Holding replaced its existing bank lines
with a new $200 million unsecured credit agreement. Loans
under the credit agreement mature from 2000 to 2003 and bear
interest at floating rates based on prime or Eurodollar
rates. In February 1998, AAG Holding borrowed $50 million
under the new credit line and retired its 11-1/8% Notes
realizing a pretax extraordinary loss of $1.2 million;
included in the Notes retired by AAG Holding was
approximately $24.3 million principal amount of 11-1/8% Notes
previously acquired by AAG and GALIC.
In August 1997, AAG Holding retired its 9-1/2% Senior Notes
realizing a pretax extraordinary loss of $2.4 million.
At September 30, 1998, scheduled principal payments on debt
for the remainder of 1998 and the subsequent five years were
as follows (in millions):
1998 1999 2000 2001 2002 2003
$0.2 $0.8 $0.8 $0.6 $0.5 $57.5
At September 30, 1998 and December 31, 1997, the weighted
average interest rate on amounts borrowed under AAG
Holding's bank credit lines was 6.11% and 6.80%,
respectively.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
H. Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts
Wholly-owned subsidiary trusts of AAG Holding have issued
$225 million of preferred securities and, in turn,
purchased $225 million of newly-issued AAG Holding
subordinated debt which provide interest and principal
payments to fund the Trusts' obligations. The preferred
securities are mandatorily redeemable upon maturity or
redemption of the subordinated debt. The three preferred
securities issues are summarized as follows:
Date of Optional
Issuance Issue(Maturity Date) Amount Redemption Dates
November 1996 9-1/4% TOPrS* (2026) $75,000,000 On or after
11/7/2001
March 1997 8-7/8% Preferred
Securities (2027) 75,000,000 On or after
3/1/2007
May 1997 7-1/4% ROPES** (2041) 75,000,000 Prior to
9/28/2000 and
after 9/28/2001
* Trust Originated Preferred Securities
** Remarketed Par Securities
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.
In March 1997, AAG retired all of its outstanding Series B
Preferred Stock for approximately $47 million.
At September 30, 1998, there were 3.0 million shares of AAG
Common Stock reserved for issuance under AAG's Employee
Stock Option Plan. Under the Stock Option Plan, the
exercise price of each option equals the market price of AAG
Common Stock at the date of grant. Options become
exercisable at the rate of 20% per year commencing one year
after grant. All options expire ten years after the date of
grant.
"Retained earnings since January 1, 1993" reflects
accumulated changes in AAG's retained earnings since its
acquisition of GALIC.
The change in net unrealized gains on marketable securities for
the nine months ended September 30 included the following (in
millions):
1998 1997
Pretax Taxes Net Pretax Taxes Net
Unrealized
holding
gains on
securities
arising
during
the period $65.0 ($21.2) $43.8 $89.7 ($31.4) $58.3
Less reclassification
adjustment for
investment gains
realized in net
income and
unrealized
gains of
subsidiaries
sold (30.7) 10.7 (20.0) (1.7) 0.6 (1.1)
Change in net
unrealized
gains
on marketable
securities $34.3 ($10.5) $23.8 $88.0 ($30.8) $57.2
14
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.
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,
1998 1997
Capital and surplus $319.7 $317.0
Asset valuation reserve 60.1 64.7
Interest maintenance reserve 22.3 23.9
Nine months ended September 30,
1998 1997
Pretax income from operations $106.0 $67.7
Net income from operations 94.3 51.7
Net income 29.8 53.8
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,
1997, GALIC may pay $73.6 million in dividends in 1998 without
prior approval. In the first nine months of 1998, $27 million of
capital distributions were paid to AAG; an additional $45 million
was declared and accrued in September 1998.
15
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 and for the payment of interest and principal on
borrowings and stockholder dividends.
Year 2000 Status AAG's Year 2000 Project is a corporate-wide
program designed to ensure that its computer systems will
function properly in the year 2000. The Project also encompasses
communicating with agents, vendors, financial institutions and
others with which the companies conduct business to determine
their Year 2000 readiness and resulting effects on AAG. AAG's
Year 2000 Project is being coordinated by its Year 2000 Project
Office which monitors the work being performed by the various
business units and reports quarterly to the Audit Committee of
the Board of Directors and more frequently to senior management.
To address the Year 2000 problem, AAG's operations have been
divided into separate system groups. At September 30, 1998,
these groups were in the process of either (i) modifying their
software programs or (ii) replacing programs with new software
that is Year 2000 compliant. Nearly two-thirds of the groups are
"on target" to meet AAG's goal of having program modifications
and new software installations substantially completed by the end
of 1998, with testing continuing in 1999. About one-third of the
groups are being "closely watched" because there is some risk
that critical dates in the project schedule may be missed with a
potential for some disruption of normal business operations. One
group is considered "critical" since it has significantly missed
internal project deadlines. This project has recently been
reorganized and staffing levels have been increased. The project
is being closely monitored and will be reviewed to determine if
it can be upgraded to the "closely watched" category during the
fourth quarter of 1998.
As part of the Year 2000 Project, contingency plans will be
developed during the next six months in order to mitigate the
extent of any potential disruptions to business operations.
Many of the systems being replaced were planned replacements
which were merely accelerated due to the Year 2000 problem. In
addition, a significant portion of AAG's Year 2000 Project is
being completed using internal staff. Therefore, cost estimates
for the Year 2000 Project do not entirely represent incremental
costs.
Since the beginning of 1997, AAG has incurred $8 million in Year
2000 costs, including capitalized costs of $7 million for new
systems. During the first nine months of 1998, $1 million in
Year 2000 costs have been expensed. AAG estimates that it will
incur an additional $11 million of such costs in completing the
Project.
Projected Year 2000 costs and completion dates are based on
management's best estimates. However, there can be no assurance
that these estimates will be achieved. Should software
modifications and new software installations not be completed on
a timely basis, the resulting disruptions could have a material
adverse affect on operations.
AAG's operations could also be affected by the inability of third
parties such as agents, vendors and policyholders' employers to
become Year 2000 compliant.
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Forward-Looking Statements The Private Securities Litigation
Reform Act of 1995 encourages corporations to provide investors
with information about the Company's anticipated performance and
provides protection from liability if future results are not the
same as management's expectations. This document contains
certain forward-looking statements that are based on assumptions
which management believes are reasonable, but, by their nature,
inherently uncertain. Future results could differ materially
from those projected. Factors that could cause such differences
include, but are not limited to: changes in economic conditions,
regulatory actions, the Year 2000 issue and competitive
pressures. AAG undertakes no obligation to update any forward-
looking statements.
LIQUIDITY AND CAPITAL RESOURCES
Ratios AAG's ratio of earnings to fixed charges exceeds 6
times. Its proforma ratio of consolidated debt to capital at
September 30, 1998 was 16%. Proforma consolidated debt includes
the Company's notes payable and its Remarketed Par Securities
("ROPES"), net of unrestricted cash and marketable investments on
hand at AAG (parent). Capital represents the sum of proforma
consolidated debt, redeemable preferred securities of subsidiary
trusts and stockholders' equity (excluding unrealized gains).
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, 1998, the capital ratios of each of AAG's principal
insurance subsidiaries was at least 4.4 times its authorized
control level RBC.
Sources and Uses of Funds To pay interest and principal on
debt, dividends on preferred securities, obligations related to
discontinued manufacturing operations and other holding company
costs AAG and AAG Holding use cash and investments on hand as
well as payments from their principal subsidiary, Great American
Life Insurance Company ("GALIC"), in the form of capital
distributions. At September 30, 1998, AAG and AAG Holding had
approximately $100 million of cash and investments on hand. The
amount of capital distributions which can be paid by GALIC is
subject to restrictions relating to statutory surplus and
earnings. In the first nine months of 1998, GALIC made $27
million in such payments; the maximum amount of dividends payable
by GALIC during the remainder of 1998 without prior regulatory
approval is $47 million.
Since year-end 1996 (through September 1998), AAG has retired $65
million principal amount of its public debentures and $49 million
of preferred stock. In addition, AAG acquired Great American
Life Assurance Company of Puerto Rico, Inc. ("GA Life") for
approximately $50 million in December 1997. AAG funded these
outlays with issuances of trust preferred securities, bank
borrowings, dividends from GALIC and cash on hand. GALIC funded
its March 1998 acquisition of Arkansas National Life Insurance
Company using cash on hand.
In June 1998, AAG Holding retired $100 million of its bank line
using proceeds from a public debt offering.
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Including cash and investments on hand and the unused
availability under a bank line of credit, AAG and AAG Holding had
more than $240 million of liquidity at November 1, 1998. On
September 30, 1998, AAG sold its Funeral Services Division and
netted approximately $165 million in cash ($145 million after
tax). The majority of the proceeds were received by AAG's
insurance subsidiaries. The ultimate use of these proceeds has
not been determined. 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's operations.
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, 1998:
NAIC % of Total
Rating Comparable S&P Rating Market Value
1 AAA, AA, A 67%
2 BBB 25
Total investment grade 92
3 BB 4
4 B 3
5 CCC, CC, C 1
6 D -
Total non-investment grade 8
Total fixed maturities 100%
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, 1998. 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, 1998, AAG's mortgage-backed securities ("MBSs")
portfolio represented less than one-third of its fixed maturity
investments. AAG invests primarily in MBSs which have a lower
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 reduce the
effect of prepayments on earnings over the anticipated life of
the MBS portfolio.
Nearly 90% of AAG's MBSs are rated "AAA" with substantially all
being 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.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Contingencies A managing general agency which produced less
than 7% of GALIC's 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. This agent no longer
markets products for GALIC. The ultimate outcome is not expected
to have a material adverse impact on the financial condition of
the Company.
RESULTS OF OPERATIONS
General The operations of GA Life and Arkansas National are
included in AAG's consolidated financial statements from their
dates of acquisition in December 1997 and March 1998,
respectively. On September 30, 1998, the Company sold its
Funeral Services Division, which included American Memorial Life
Insurance Company and Arkansas National. The results contained
herein include the results of this division for all periods
presented.
The Company's principal products are its fixed annuities Single
Premium Deferred Annuities ("SPDAs") and Flexible Premium
Deferred Annuities ("FPDAs"). The following table summarizes
AAG's premiums for annuities and other forms of life and health
insurance (in millions):
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
Retirement Annuities:
SPDAs $ 70 $ 63 $190 $190
FPDAs - renewal 27 30 106 119
FPDAs - first year 8 6 25 24
Variable annuities
- flexible premium 6 - 14 1
Variable annuities
- single premium 21 12 50 27
Other life insurance 24 6 59 17
Accident and health insurance 5 5 15 16
Total premiums
(excluding Funeral
Services Division) 161 122 459 394
Funeral Services
Division premiums 36 28 102 79
Total premiums $197 $150 $561 $473
AAG's growth in total premiums (excluding the Funeral Services
Division) is primarily the result of increased sales of variable
annuities and the inclusion of premiums from GA Life.
Pretax Operating Earnings Pretax earnings from operations
(before realized gains, equity in results of affiliate and
provision for relocation expenses) for the third quarter and
first nine months of 1998 were $30.0 million and $84.1 million,
respectively, compared to $27.7 million and $76.3 million for the
same periods in 1997.
Life, Accident and Health Premiums and Benefits Increases in
life, accident and health premiums and benefits reflect primarily
the acquisition of GA Life and increased sales of pre-need life
insurance.
19
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Net Investment Income Net investment income increased 2% in the
third quarter and 5% in the first nine months of 1998 compared to
the same periods in 1997 due primarily to an increase in the
Company's average fixed maturity investment base.
This increase was partially offset by decreasing market interest
rates. Investment growth resulted from acquisitions, internal
cash flow generated by AAG's insurance operations and the
investment of a portion of the proceeds from the issuance of
trust preferred securities. Investment income is shown net of
investment expenses of $2.3 million in 1998 and $2.6 million in
1997. Lower investment expenses in 1998 reflect a decrease in
fees charged by an affiliate.
Equity in Net Earnings (Loss) of Affiliate Equity in net
earnings (loss) of affiliate represents AAG's proportionate share
of the results of Chiquita Brands International. Chiquita
reported net income (loss) for the third quarter and first nine
months of 1998 of ($11 million) and $83 million, respectively,
compared to ($28 million) and $56 million for the same
periods in 1997. Included in equity in Chiquita's 1998
earnings are gains attributable to Chiquita's issuance of
common stock.
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. While management
believes the recent interest rate environment has contributed to
an increase in annuitizations and surrenders, GALIC's persistency
rate remains over 87%. A continuation of the current interest
rate environment could adversely affect this rate.
Insurance Acquisition Expenses Insurance acquisition expenses
include amortization of deferred acquisition costs as well as
certain marketing expenses and commissions on sales of life
insurance products. The increase in 1998 reflects the
acquisition of GA Life as well as increased sales of pre-need
life insurance products. Expenses in the third quarter and the
first nine months of 1998 also include amortization of the
present value of future profits of businesses acquired amounting
to $2.9 million and $7.7 million, respectively, compared to $1.7
million and $5.4 million for the same periods in 1997.
Trust Preferred Distribution Requirement Trust preferred
distribution requirement represents amounts accrued on preferred
securities issued by subsidiaries of AAG Holding in 1997 and
1996. A portion of the proceeds from these issuances was used to
retire debt.
Interest and Other Debt Expenses AAG's interest expense
increased 16% in 1998. During 1997 and 1998 the Company replaced
higher coupon public debt with significantly lower interest rate
bank debt. This decrease in average rates was offset by higher
average debt, which resulted primarily from funds borrowed to
acquire GA Life.
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 to more closely coordinate its efforts with
those of other AAG operations. The estimated cost of the
relocation ($4.0 million) was expensed in the third quarter of
1997. The relocation was substantially completed in the first
quarter of 1998.
20
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Other Expenses Increases in other expenses reflect (i) the
acquisitions of GA Life and Arkansas National, (ii) higher
depreciation and amortization costs and (iii) increases in
personnel costs.
Extraordinary Item Extraordinary item reflects AAG's losses,
net of tax, on prepayment of its debt.
New Accounting Standards to be Implemented The Financial
Accounting Standards Board issued Statement of Financial
Accounting Standard ("SFAS") No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which is scheduled to
become effective during the fourth quarter of 1998. The
implementation of SFAS No. 131 will have no effect on AAG's
financial position or net income.
Statement of Position ("SOP") 98-5, "Reporting on the Costs of
Start-Up Activities," was issued during the second quarter of
1998. The SOP is effective for fiscal years beginning after
December 15, 1998, and requires that costs of start-up activities
be expensed as incurred. The SOP requires that unamortized
balances of previously deferred costs be expensed no later than
the first quarter of 1999 and reported as the cumulative effect
of a change in accounting principle. AAG had approximately
$8 million in capitalized start-up costs at September 30, 1998.
21
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 September 30,
1998. For submission in electronic filing only.
(b) Report on Form 8-K:
Date of Report Items Reported
October 15, 1998 Sale of Funeral Services
Division
22
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
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 16, 1998 BY:/s/William J. Maney
William J. Maney
Senior Vice President,
Treasurer and Chief Financial
Officer
23