SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended Commission File
December 31, 1998 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
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
American Annuity Group, Inc.:
Common Stock, Par Value $1.00 Per Share New York
American Annuity Group Capital Trust I (Guaranteed by Registrant):
9-1/4% Trust Originated Preferred Securities New York
Other Securities for which reports are submitted pursuant to Section 15(d)
of the Act:
American Annuity Group Capital Trust II (Guaranteed by Registrant):
8-7/8% Trust Preferred Securities
AAG Holding Company, Inc. (Guaranteed by Registrant):
6-7/8% Senior Notes due June 1, 2008
Securities Registered Pursuant to Section 12(g) of the Act: None
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
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and need not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this
Form 10-K. [X]
As of March 1, 1999, there were 42,484,366 shares of the Registrant's
Common Stock outstanding. The aggregate market value of Common Stock held
by non-affiliates at that date was approximately $161.5 million based upon
non-affiliate holdings of 7,424,371 shares and a market price of $21.75 per
share.
Documents Incorporated by Reference:
Proxy Statement for the 1999 Annual Meeting of Stockholders (portions of
which are incorporated by reference into Part III hereof).
AMERICAN ANNUITY GROUP, INC.
INDEX TO ANNUAL REPORT
ON FORM 10-K
Part I
Page
Item 1. Business
Introduction 1
Retirement Products 2
Life, Accident and Health Products 6
Sale of Funeral Services Division 6
Investments 6
Independent Ratings 8
Competition 9
Regulation 9
Employees 10
Foreign Operations 10
New Tax Legislation 11
Item 2. Properties 11
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders *
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations 15
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk **
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure *
Part III
Item 10. Directors and Executive Officers of the Registrant 23
Item 11. Executive Compensation 23
Item 12. Security Ownership of Certain Beneficial Owners
and Management 23
Item 13. Certain Relationships and Related Transactions 23
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K S-1
(*) The response to this item is "none".
(**) Included in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
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.
PART I
ITEM 1
Business
Introduction
American Annuity Group, Inc. ("AAG" or "the Company"), which was
incorporated as a Delaware corporation in 1987, is an 83%-owned subsidiary
of American Financial Group, Inc. ("AFG"). AAG is a holding company which
markets primarily retirement annuity products as well as life and
supplemental health insurance through the following subsidiaries (in
millions):
1998
Statutory
Subsidiary - year acquired Principal Products Premiums
Great American Life Insurance Traditional fixed annuities $301
Company ("GALIC") - 1992 Equity-indexed annuities 58
Annuity Investors Life Insurance Variable annuities 89
Company ("AILIC") - 1994 Traditional fixed annuities 73
Loyal American Life Insurance Supplemental health 20
Company ("Loyal") - 1995 Supplemental life 17
Great American Life Assurance Company
Life of Puerto Rico, Inc. ("GAPR")
- 1997 Life 37
Supplemental health 11
GALIC's Life Division (formed
in 1997) Term and universal life 19
GALIC and AILIC are rated A+ (Strong) by Standard & Poor's. All of the
above insurance companies are rated A (Excellent) by A.M. Best and, except
for GAPR, all are rated AA- (very high claims paying ability) by Duff &
Phelps. GAPR has not been rated by Duff & Phelps.
Acquisitions in recent years have supplemented AAG's internal growth as the
assets of the holding company and its operating subsidiaries have increased
from $4.5 billion at the end of 1992 to over $7.1 billion at the end of
1998. Premiums over the last five years were as follows (in millions):
Premiums*
Insurance Product 1998 1997 1996 1995 1994
Retirement annuities $521 $489 $540 $457 $443
Life and health 104 42 43 2 2
$625 $531 $583 $459 $445
* Table does not include premiums of subsidiaries or divisions until
their first full year following acquisition or formation. All periods
exclude premiums of subsidiaries sold.
In September 1998, AAG sold its Funeral Services Division. This division,
which included American Memorial Life Insurance Company and Arkansas
National Life Insurance Company, had assets of approximately $1 billion as
of September 30, 1998 and 1997 premiums of $111 million.
1
Retirement Products
AAG's principal retirement products are Flexible Premium Deferred Annuities
("FPDAs") and Single Premium Deferred Annuities ("SPDAs"). Annuities are
long-term retirement saving instruments that benefit from income accruing on
a tax-deferred basis. The issuer of the annuity collects premiums, credits
interest on the policy and pays out a benefit upon death, surrender or
annuitization. FPDAs are characterized by premium payments that are
flexible in both amount and timing as determined by the policyholder. SPDAs
are issued in exchange for a one-time lump-sum premium payment.
The following table (in millions) presents combined financial information
concerning AAG's principal retirement annuity subsidiaries, GALIC and AILIC.
Generally Accepted Accounting Principles ("GAAP") Basis
1998 1997 1996 1995 1994
Total assets $6,549 $6,289 $5,942 $5,611 $5,053
Fixed annuity reserves 5,396 5,355 5,211 4,920 4,598
Variable annuity reserves
(separate accounts) 120 37 3 - -
Stockholder's equity 862 770 658 623 455
Statutory Accounting Principles Basis
1998 1997 1996 1995 1994
Total assets $6,159 $5,977 $5,760 $5,417 $5,066
Fixed annuity reserves 5,538 5,469 5,302 4,977 4,658
Variable annuity reserves
(separate accounts) 120 37 3 - -
Capital and surplus 350 317 285 273 262
Asset valuation reserve(a) 63 65 91 90 80
Interest maintenance reserve(a) 21 24 25 32 28
Annuity receipts:
Flexible premium:
First year $ 45 $ 38 $ 36 $ 42 $ 39
Renewal 149 160 182 196 208
194 198 218 238 247
Single premium 327 291 322 219 196
Total annuity receipts $ 521 $ 489 $ 540 $ 457 $ 443
(a) Allocation of surplus.
Sales of annuities are affected by many factors, including: (i) competitive
annuity products and rates; (ii) the general level of interest rates; (iii)
the favorable tax treatment of annuities; (iv) commissions paid to agents;
(v) services offered; (vi) ratings from independent insurance rating
agencies; (vii) other alternative investments and (viii) general economic
conditions.
2
First year premiums increased in 1997 and 1998 due primarily to the
introduction of products linked to the performance of the stock market
(equity-indexed and variable annuities). Single premium annuity receipts
increased each year except 1997 due primarily to sales of newly introduced
products and the development of new distribution channels. This increase
more than offset the decline in renewal premiums during that period. Single
premium annuity receipts in 1997 reflect the decrease of business written by
a single agency from $99 million in 1996 to $23 million in 1997. AAG is no
longer writing business through this agency.
(See Item 3 - "Legal Proceedings".)
Annuity contracts are generally classified as either fixed rate (including
equity-indexed) or variable. With a fixed rate annuity, the interest
crediting rate is initially set by the issuer and thereafter may be changed
from time to time by the issuer subject to any guaranteed minimum interest
crediting rates in the policy. With a variable annuity, the value of the
policy is tied to an underlying securities portfolio or underlying mutual
funds. The following table presents premiums by classification:
Premiums 1998 1997 1996 1995 1994
Traditional fixed 72% 83% 98% 100% 100%
Equity-indexed 11 8 2 - -
Variable 17 9 * - -
100% 100% 100% 100% 100%
* less than 1%
The Company seeks to maintain a desired spread between the yield on its
investment portfolio and the rate it credits to its fixed rate annuities.
AAG accomplishes this by: (i) offering crediting rates which it has the
option to change; (ii) designing annuity products that encourage persistency
and (iii) maintaining an appropriate matching of assets and liabilities.
All of AAG's fixed rate annuities offer a minimum interest rate guarantee of
3% or 4%; the majority permit AAG to change the crediting rate at any time
(subject to the minimum guaranteed interest rates). In determining the
frequency and extent of changes in the crediting rate, AAG takes into
account the economic environment and the relative competitive position of
its products.
Over the last few years, traditional fixed rate annuities have met
substantial competition from mutual funds and other equity-based
investments. In response, AAG began offering equity-indexed annuities and
variable annuities. An equity-indexed fixed annuity provides policyholders
with a crediting rate tied, in part, to the performance of an existing stock
market index while protecting them against the related downside risk through
a guarantee of principal. AAG hedges the equity-based risk component of
this product through the purchase of call options on the appropriate index.
These options are designed to offset substantially all of the increases in
the liabilities associated with equity-indexed annuities. AAG has adopted
guidelines for approving counterparties (option issuers), counterparty
selection standards and counterparty credit exposure limits. At December
31, 1998, all counterparties to AAG's call options were rated Class 1 by the
National Association of Insurance Commissioners ("NAIC").
Industry sales of variable annuities have increased substantially over the
last ten years as investors have sought to obtain the returns available in
the equity markets while enjoying the tax-deferred status of annuities.
With a variable annuity, the earnings credited to the policy vary based on
the investment results of the underlying investment options chosen by the
policyholder. Premiums directed to the variable options in policies issued
by AAG are invested in funds managed by various independent investment
managers. AAG earns a fee on amounts deposited into variable accounts.
Policyholders may also choose to direct all or a portion of their premiums
to various fixed rate options, in which case AAG earns a spread on amounts
deposited.
3
The following tables present 1998 retirement annuity premium information
compared to 1994, and is more fully discussed below.
1998 1994 1998 1994
Type/Source By State
Qualified 67% 85% California 29% 21%
Non-qualified 33 15 Ohio 8 6
100% 100% Florida 5 9
Massachusetts 5 8
Washington 5 4
Texas 5 3
Minnesota 4 5
Channel
MGAs 80% 89% North Carolina 4 3
In-house agents 12 1 Michigan 3 9
PPGAs 6 9 New Jersey 3 5
Brokers/dealers All others 29 27
and other 2 1 100% 100%
100% 100%
AAG's FPDAs are sold primarily to employees of qualified not-for-profit
organizations under Section 403(b) of the Internal Revenue Code. Employees
of these organizations are eligible to save for retirement through
contributions made on a before-tax basis. Contributions are made at the
discretion of the participants through payroll deductions or through tax-
free "rollovers" of funds from other qualified investments. Federal income
taxes are not payable on contributions or earnings until amounts are
withdrawn.
Historically, the Company's principal marketing focus had been on sales to
employees of educational institutions in the kindergarten through high
school ("K-12") segment. However, sales of non-qualified annuities have
begun to represent an increasing percentage of premiums as AAG has developed
products and distribution channels targeted to the non-qualified markets.
AAG distributes its annuity products through approximately 90 managing
general agents ("MGAs") who, in turn, direct approximately 1,000 actively
producing independent agents. The Company has developed its business on the
basis of its relationships with MGAs and independent agents primarily
through a consistent marketing approach and responsive service. One
marketing organization wrote approximately one-seventh of AAG's retirement
annuity premiums in 1998. No other organization wrote more than 5% in 1998.
AAG seeks to attract and retain agents who are experienced, highly motivated
and who consistently sell a high volume of the types of annuities offered by
the Company. Toward this end, AAG maintains a "President's Advisory
Council" consisting of leading producers who market primarily AAG products.
The President's Advisory Council serves as a major influence on new product
design and marketing strategy.
To extend the distribution of its annuities to a broader customer base, AAG
developed a personal producing general agent ("PPGA") distribution system.
More than 100 PPGAs are contracted to sell annuities in those territories
not served by an MGA.
4
Under federal law and the laws of many states, variable annuities are
considered securities. As a result, variable annuities can be sold only by
agents who possess the requisite securities licenses and are affiliated with
a broker/dealer. Accordingly, not all agents who market fixed annuities
also market variable annuities.
In the last several years, AAG has developed several organizations to
distribute its financial services and products to markets not previously
serviced by AAG's distribution system. AAG Securities, Inc. is a
broker/dealer licensed in all 50 states to sell stocks, bonds, options,
mutual funds and variable insurance contracts through independent
representatives and financial institutions. AAG Securities also acts as the
principal underwriter and distributor for the Company's variable annuity
products. Retirement Resource Group, Inc. was formed in 1995 to market
annuities and investment products to employees of hospitals and not-for-
profit organizations.
AAG designs its products with certain surrender penalties to discourage
policyholders from surrendering or withdrawing funds during the first five
to ten years after issuance of a policy. Partly due to these features,
annuity surrenders have averaged less than 10% of statutory reserves over
the past five years.
Persistency rates reflect the proportion of reserves maintained by the
Company and not paid out in the form of surrenders, annuitizations or death
benefits. The following table illustrates GALIC's annual persistency rates
for its major product groups over the past five years.
Persistency Rates
Product Group 1998 1997 1996 1995 1994
Flexible premium 88% 89% 90% 91% 93%
Single premium 88 90 92 94 94
Persistency rates are affected by many of the same factors that affect
annuity sales (see "Marketing and Distribution"). Although the recent stock
market and interest rate environment have affected persistency in the
Company's fixed rate annuities, management believes that its persistency
rate has benefited from the two-tier design of certain of its products. Two
account values are maintained for two-tier annuities -- the annuitization
(or upper-tier) value and the surrender (or lower-tier) value. The
annuitization value is paid upon a policyholder's death or election to
annuitize (withdraw funds in a series of periodic payments for at least the
minimum number of years specified in the policy). If a lump-sum payment is
chosen by the policyholder, the surrender benefit is paid. GALIC's two-tier
annuities are particularly attractive to policyholders who intend to
accumulate funds to provide retirement income since the annuitization value
is accumulated at competitive long-term interest rates. At December 31,
1998, two-tier annuities accounted for about half of the Company's fixed
annuity reserves, compared to over 90% at the beginning of 1994.
In 1998, approximately 60% of fixed annuity premiums received were on
single-tier policies compared to less than 40% in 1994. After the initial
surrender charges have been reduced to zero, single-tier annuities carry one
value whether the policy is surrendered or annuitized.
AAG is licensed to sell its fixed annuity products in all 50 states; it is
licensed to sell its variable products in all states except Vermont and New
Hampshire. At December 31, 1998, AAG had approximately 265,000 annuity
policies in force. The retirement products group employs over 700 people in
the United States (primarily in Cincinnati) and over 100 programmers and
administrative people in India.
5
Life, Accident and Health Products
AAG offers a variety of life, accident and health products through Loyal,
GAPR and GALIC's Life Division. This group produced over $100 million of
premiums in 1998. At year end 1998 it had assets of over $550 million. It
also had more than 500,000 policies and $7.1 billion of life insurance in
force.
Loyal offers a variety of life and supplemental health insurance products
that are normally sold on the basis of a fixed dollar amount per pay period.
For products sold through payroll deduction plans, the premiums are deducted
from the individual's paycheck and remitted to Loyal on a periodic basis.
For products sold through credit unions, the premiums are paid on a periodic
basis through deductions from the member's credit union account. The
principal products sold by Loyal include cancer, universal life, traditional
whole life, hospital indemnity and short-term disability insurance. Loyal's
marketing strategy emphasizes third party sponsorship to assist in its
selling process. In the payroll deduction market, Loyal's products are
presented by marketing companies who provide job-site presentations to the
employees; premium billings are sent directly to the employer for processing
and remittance. With credit unions, the products are offered with the
endorsement of the credit union management. The products are presented to
the membership by independent agents and marketing companies through in-
home, job-site or lobby sales. Loyal employs approximately 130 people,
primarily in Cincinnati.
GAPR sells in-home service life and supplemental health products through a
network of company-employed agents. Ordinary life, cancer, credit and group
life products are sold through independent agents. GAPR employs 550 people
in Puerto Rico, including approximately 400 agents.
In December 1997, GALIC's Life Division began offering term, universal and
whole life insurance products through national marketing organizations. In
1998, the Life Division had over 3,700 agents write at least one policy. In
1999, this division expects to begin cross-marketing certain non-life
products through its distribution channels. The Life Division employs
approximately 130 people in Cincinnati.
Sale of Funeral Services Division
In September 1998, AAG sold its Funeral Services Division for approximately
$165 million in cash, realizing a $14.8 million after-tax gain. The Funeral
Services Division provided life insurance and annuities to fund pre-arranged
funerals, as well as administrative services for pre-arranged funeral
trusts. This division included American Memorial Life Insurance Company
(acquired in 1995) and Arkansas National Life Insurance Company (acquired in
1998).
Investments
Investments comprise over 90% of the Company's assets and are the principal
source of income. Fixed income investments (consisting of fixed maturity
investments, policy loans, mortgage loans and short-term investments)
comprise 98% of AAG's investment portfolio. Risks inherent in connection
with fixed income securities include market price volatility and loss
upon default. Factors which can affect the market price of these
securities include: (i) changes in market interest rates;
(ii) creditworthiness of issuers; (iii) the number of market
makers and investors and (iv) defaults by major issuers of securities.
The Company's investment strategy emphasizes high-quality fixed income
securities which management believes should produce a relatively consistent
and predictable level of investment income.
6
The insurance laws of the domiciliary jurisdiction of each of AAG's life
insurance subsidiaries govern the types and amounts of investments which are
permissible. These rules are designed to ensure the safety and liquidity of
the insurers' investment portfolios by placing restrictions on the quality,
quantity and diversification of permitted investments.
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 at market value by NAIC designation (and comparable
Standard & Poor's Corporation rating) at December 31.
NAIC
Rating Comparable S&P Rating 1998
1 AAA, AA, A 67%
2 BBB 26
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%
AAG's primary investment objective in selecting securities for its fixed
maturity portfolio is to optimize interest yields while maintaining an
appropriate relationship of maturities between assets and liabilities. The
Company invests in bonds that have primarily intermediate-term maturities.
This practice provides flexibility to respond to fluctuations in the
marketplace.
At December 31, 1998, the average maturity of AAG's fixed maturity
investments was approximately five and one-half years (including mortgage-
backed securities, which had an estimated average life of approximately four
and one-half years). The table below sets forth the maturities of the
Company's fixed maturity investments based on their market value.
Maturity
One year or less 5%
After one year through five years 25
After five years through ten years 25
After ten years 14
69
Mortgage-backed securities 31
100%
7
The following table shows the performance of AAG's investment portfolio,
excluding equity investments in an affiliate (dollars in millions).
1998 1997 1996
Average cash and investments at cost $6,535 $6,417 $6,014
Gross investment income 512 499 474
Realized gains 11 5 1
Percentage earned:
Excluding realized gains 7.8% 7.8% 7.9%
Including realized gains 8.0% 7.9% 7.9%
Independent Ratings
The Company's principal insurance subsidiaries ("Insurance Companies") are
rated by Standard & Poor's, A.M. Best and Duff & Phelps. Such ratings are
generally based on items of concern to policyholders and agents and are not
directed toward the protection of investors.
Standard
& Poor's A.M. Best Duff & Phelps
GALIC A+ (Strong) A (Excellent) AA- (Very high)
AILIC A+ (Strong) A (Excellent) AA- (Very high)
Loyal A (Strong) A (Excellent) AA- (Very high)
GAPR Not rated A (Excellent) Not rated
In evaluating a company, independent rating agencies review such factors as
the company's: (i) profitability; (ii) leverage and liquidity; (iii) book of
business; (iv) quality and estimated market value of assets; (v) adequacy of
policy reserves; (vi) experience and competency of management and (vii)
operating profile.
Management believes that the ratings assigned by independent insurance
rating agencies are important because potential policyholders often use a
company's rating as an initial screening device in considering annuity
products. Management believes that a rating in the "A" category by at least
one rating agency is necessary for GALIC to successfully market tax-deferred
annuities to public education employees and other not-for-profit groups.
Loyal, GAPR and GALIC's Life Division compete in markets other than the sale
of tax-deferred annuities. While ratings are an important competitive
factor in their markets, management believes that these companies can
successfully compete in these markets with their respective ratings.
Ratings are less of a competitive factor in the variable annuity market in
which AILIC competes, in part because a substantial portion of the insurers'
assets are invested in the mutual funds which underlie the variable
annuities rather than in the insurers' general accounts.
Although management of AAG believes that its Insurance Companies' ratings
are very stable, those companies' operations could be materially adversely
affected by a downgrade in ratings.
8
Competition
The Insurance Companies operate in highly competitive markets. They compete
with other insurers and financial institutions based on many factors,
including:
(i) ratings; (ii) financial strength; (iii) reputation; (iv) service to
policyholders and agents; (v) product design (including interest rates
credited and premium rates charged) and (vi) commissions. Since policies
are marketed and distributed primarily through independent agents (except at
GAPR), the Insurance Companies must also compete for agents. Management
believes that consistently targeting the same market and emphasizing service
to agents and policyholders provides a competitive advantage.
No single insurer dominates the annuity marketplace. Competitors include:
(i) individual insurers and insurance groups; (ii) mutual funds and (iii)
other financial institutions of varying sizes. In a broader sense, AAG's
Insurance Companies compete for retirement savings with a variety of
financial institutions offering a full range of financial services.
Financial institutions have demonstrated a growing interest in marketing
investment and savings products other than traditional deposit accounts. In
addition, recent judicial and regulatory decisions have expanded powers of
financial institutions in this regard. It is too early to predict what
impact, if any, these developments will have on the Insurance Companies.
Regulation
The Insurance Companies are subject to comprehensive regulation under the
insurance laws of their states of domicile and the other states in which
they operate. These laws, in general, require approval of the particular
insurance regulators prior to certain actions such as the payment of
dividends in excess of statutory limitations, continuing service
arrangements with affiliates and certain other transactions. Regulation and
supervision are administered by a state insurance commissioner who has broad
statutory powers with respect to granting and revoking licenses, approving
forms of insurance contracts and determining types and amounts of business
which may be conducted in light of the financial strength and size of the
particular company.
State insurance departments periodically examine the business and accounts
of the Insurance Companies and require such companies to submit detailed
annual financial statements prepared in accordance with statutory
requirements. State insurance laws also regulate the character of each
insurance company's investments, reinsurance and security deposits.
Proposed federal legislation is being discussed which would revise, and in
some cases eliminate, existing restrictions on affiliations among banks,
insurance companies and securities firms. The legislation would also impact
the way these entities are regulated. It is too early to predict whether
this legislation will be adopted and if so, its impact on the Company and
its operations.
The Insurance Companies may be required, under the solvency or guaranty laws
of most states in which they do business, to pay assessments (up to certain
prescribed limits) to fund policyholder losses or liabilities of insurance
companies that become insolvent. These assessments may be deferred or
forgiven under most guaranty laws if they would threaten an insurer's
financial strength and, in certain instances, may be offset against future
premium taxes. The Insurance Companies paid $400,000 and $2.5 million in
assessments in 1998 and 1997, respectively.
The NAIC is an organization comprised of the chief insurance regulators for
each of the 50 states, the District of Columbia and the four U.S.
territories. One of its major roles is to develop model laws and
regulations affecting insurance
9
company operations and encourage uniform regulation through the adoption of
such model laws in all states. As part of the overall insurance regulatory
process, the NAIC forms numerous task forces to review, analyze and
recommend changes to a variety of areas affecting both the operating and
financial aspects of insurance companies. Recently, increased scrutiny has
been placed upon the insurance regulatory framework, and a number of state
legislatures have considered or enacted legislative proposals that alter,
and in many cases, increase state authority to regulate insurance companies
and their holding company systems. In light of recent legislative
developments, the NAIC and state insurance regulators have also become
involved in a process of re-examining existing laws and regulations and
their application to insurance companies. Legislation has also been
introduced in Congress which could result in the federal government assuming
some role in the insurance industry, although none has been enacted to date.
The maximum amount of dividends which can be paid in any 12 month period to
stockholders by life insurance companies domiciled in the State of Ohio
(including GALIC, AILIC and Loyal) without prior approval of the Ohio
Insurance Commissioner is the greater of 10% of policyholder surplus or
prior year's net income, but only to the extent of earned surplus as of the
preceding December 31.
The NAIC has under consideration numerous proposals related to the marketing
and sale of annuity products. In 1996 the NAIC adopted a model investment
law. The law will not be a requirement of the NAIC accreditation standards.
However, each state may adopt all, any part, or none of the model investment
law to regulate the investment policies of their insurance companies.
Many of the Company's other subsidiaries are subject to regulation by
various state, federal and other regulatory authorities. Several
subsidiaries are insurance agencies and as such are regulated by state
insurance departments. AAG Securities is subject to the rules of the
National Association of Securities Dealers, Inc. and the securities laws of
the states in which it transacts business. AILIC's variable insurance
products are subject to the rules and regulations of the Securities and
Exchange Commission and "Blue Sky" laws of the states in which their
products are sold.
Employees
As of December 31, 1998, AAG and its subsidiaries employed about 1,700
persons, including approximately 400 company-employed agents in Puerto Rico.
None of the employees is represented by a labor union. AAG believes that
its employee relations are satisfactory.
Foreign Operations
In 1998, AAG opened an office in Bangalore, India. Employees located at
this office perform computer programming and certain back office functions
for the Company's insurance operations. Management believes there are
sufficient resources available at domestic locations should there be any
interruption in the operations at this office and as a result no materially
adverse impact would result from any such interruption.
10
New Tax Legislation
The federal administration's 2000 budget proposal contains provisions to
change the taxation of insurance companies by requiring the capitalization
of a higher percentage of premiums as acquisition costs. A substantial
number of legislators have expressed doubt that these provisions will
ultimately be adopted. In part because of this uncertainty, the Company has
made no determination of the impact of these provisions if ultimately
adopted.
ITEM 2
Properties
Location
AAG, GALIC and Loyal rent office space in Cincinnati, Ohio totaling
approximately 230,000 square feet under leases expiring primarily in 2006
through 2008. Several of the Company's non-insurance subsidiaries lease
marketing and administrative offices in locations throughout the United
States.
Loyal's former home office building in Mobile, Alabama, contains
approximately 82,000 square feet, of which approximately one-third is leased
to unaffiliated tenants and approximately one-fifth is utilized by Loyal for
certain administrative functions which remain in Mobile. The remainder of
the space is vacant and the building is being marketed for lease or sale.
GAPR rents office space in Puerto Rico totaling approximately 70,000 square
feet under leases expiring primarily in 2000 through 2002.
American Data Source India Private Limited, a software development and
administrative services subsidiary of AAG, rents space in Bangalore, India
totaling approximately 30,000 square feet under leases expiring primarily in
2001.
Management believes that its corporate offices are generally well maintained
and adequate for the Company's present needs.
AAG owns facilities related to its former manufacturing operations totaling
approximately 200,000 square feet in North Adams, Massachusetts and 60,000
square feet in Longwood, Florida. These facilities are currently being
leased to companies using them for manufacturing and other operations.
Environmental Matters
See Item 3 - "Legal Proceedings" for a discussion concerning certain
environmental claims and litigation against the Company.
11
ITEM 3
Legal Proceedings
Federal and state laws and regulations, including the Federal Comprehensive
Environmental Response, Compensation, and Liability Act and similar state
laws, impose liability on the Company (as the successor to Sprague
Technologies, Inc.) for the investigation and clean-up of hazardous
substances disposed of or spilled by its former manufacturing operations at
facilities still owned by the Company and facilities transferred in
connection with the sales of certain operations, as well as at disposal
sites operated by third parties. In addition, the Company has indemnified
the purchasers of its former operations for the cost of such activities. At
several sites, the Company is conducting clean-up activities of soil and
ground water contamination in accordance with consent agreements between the
Company and state environmental agencies. The Company has also conducted or
is aware of investigations at a number of other locations of its former
operations that have disclosed environmental contamination that could cause
the Company to incur additional investigative, remedial and legal costs.
The Company has also been identified by state and federal regulators as a
potentially responsible party at a number of other disposal sites.
Based on the costs incurred by the Company over the past several years and
discussions with its independent environmental consultants, management
believes that reserves recorded are sufficient in all material respects to
satisfy the estimated liabilities. However, the regulatory standards for
clean-up are continually evolving and may impose more stringent
requirements. In addition, many of the environmental investigations at the
Company's former operating locations and third-party sites are still
preliminary, and where clean-up plans have been proposed, they have not yet
received full approval from the relevant regulatory agencies. Further, the
presence of Company-generated wastes at third-party disposal sites exposes
the Company to joint and several liability for the potential additional
costs of cleaning up wastes generated by others. Accordingly, there can be
no assurance that the costs of environmental clean-up for the Company may
not be significantly higher in future years, possibly necessitating
additional charges.
There are certain other claims involving the Company, including claims
relating to the generation, disposal or release into the environment of
allegedly hazardous substances. In management's opinion, the outcome of
these claims will not, individually or in the aggregate, have a material
adverse effect on the Company's financial condition or results of
operations.
A managing general agency which produced approximately $125 million of
GALIC's premiums in 1995 through 1997 was named defendant in a lawsuit filed
in July 1996 by two regulatory agencies in California. The MGA settled the
allegations brought against it by agreeing, among other things, to modify
certain sales practices. The regulatory agencies took a position that GALIC
was responsible for certain acts of its insurance agents in connection with
the sale of GALIC annuities. GALIC resolved this matter in 1998 by making a
$685,000 payment to the State of California and by subsequently offering all
California customers of this MGA who purchased GALIC annuities
(approximately $75 million of annuities at December 31, 1998) a full refund
of their money for a limited period. This agent no longer markets products
for GALIC. The ultimate outcome of the refund offer is not expected to have
a material adverse impact on the financial condition of the Company.
12
In January 1999, GALIC was named a defendant in a purported class action
lawsuit. The complaint seeks unspecified damages based on (i) alleged
failure of GALIC to allow the tax-free transfer of the annuity value of
certain annuities to other product providers, and (ii) misleading
disclosures concerning GALIC's interest crediting practices. The Company
has not completed its review of the complaint but believes it has
meritorious defenses. However, it is too early to predict the ultimate
outcome of this action and its impact on the Company.
AAG is subject to other litigation and arbitration in the normal course of
business. AAG is not a party to any material pending litigation or
arbitration.
PART II
ITEM 5
Market for Registrant's Common Equity
and Related Stockholder Matters
AAG's Common Stock is listed and traded principally on the New York Stock
Exchange ("NYSE") under the symbol AAG. On March 1, 1999, there were
approximately 7,400 holders of record of Common Stock. The following table
sets forth the range of high and low sales prices for the Common Stock on
the NYSE Composite Tape.
1998 1997
High Low High Low
First quarter $23.44 $21.75 $16.63 $13.75
Second quarter 25.38 22.38 20.00 15.25
Third quarter 24.50 21.88 22.13 18.00
Fourth quarter 23.81 22.06 23.88 19.75
The Company paid annual common dividends of $.10 per share in 1998 and 1997.
Although no future dividend policy has been determined, management believes
the Company will continue to have the capability to pay similar dividend
amounts.
AFG beneficially owned approximately 83% of AAG's Common Stock at March 1,
1999.
13
ITEM 6
Selected Financial Data
The following financial data has been summarized from, and should be read in
conjunction with, the Company's Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". The data reflects the acquisitions of American Memorial and
Loyal in November 1995, GAPR in December 1997 and the sale of the Funeral
Services Division in September 1998 (in millions, except per share amounts).
Income Statement Data: 1998 1997 1996 1995 1994
Total revenues $724.5 $634.2 $577.3 $439.6 $372.7
Income from continuing operations $ 97.5 $ 71.4 $ 61.1 $ 58.7 $ 40.9
Loss from discontinued operations - - - (3.2) (2.6)
Extraordinary items (0.8) (1.5) (6.0) (0.2) (1.7)
Change in accounting principle - - - - (0.5)
Net income $ 96.7 $ 69.9 $ 55.1 $ 55.3 $ 36.1
Basic earnings per common share:
Continuing operations $2.27 $1.63 $1.39 $1.45 $1.05
Discontinued operations - - - (0.08) (0.07)
Extraordinary items (0.02) (0.03) (0.14) - (0.05)
Change in accounting principle - - - - (0.01)
Net income $2.25 $1.60 $1.25 $1.37 $0.92
Diluted earnings per common share:
Continuing operations $2.23 $1.61 $1.39 $1.45 $1.05
Discontinued operations - - - (0.08) (0.07)
Extraordinary items (0.02) (0.03) (0.14) - (0.05)
Change in accounting principle - - - - (0.01)
Net income $2.21 $1.58 $1.25 $1.37 $0.92
Cash dividends per common share $0.10 $0.10 $0.08 $0.07 $0.06
Balance Sheet Data at year end:
Total assets $7,190.4$7,710.3$7,024.1$6,611.0$5,089.9
Notes payable 131.0 135.8 114.9 167.7 183.3
Mandatorily redeemable preferred
securities of subsidiary trusts 225.0 225.0 75.0 - -
Net unrealized gains (losses)
included in stockholders' equity 160.1 133.2 61.8 89.3 (29.0)
Total stockholders' equity 688.7 583.9 486.5 429.3 204.4
14
ITEM 7
Management's Discussion and Analysis
of Financial Condition and Results of Operations
General
Following is a discussion and analysis of the financial statements and other
statistical data that management believes will enhance the understanding of
the financial condition and results of operations of American Annuity Group,
Inc. ("AAG" or "the Company"). This discussion should be read in
conjunction with the financial statements beginning on page F-1.
AAG 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 shareholder dividends.
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 The following ratios may be considered relevant indicators of AAG's
liquidity and are typically presented by AAG in its prospectuses and similar
documents.
1998 1997 1996
Earnings to fixed charges 5.6 5.1 6.0
Consolidated debt to capital 23% 25% 18%
Proforma consolidated debt to capital 13% 17% 17%
For purposes of the calculations of consolidated debt to capital,
consolidated debt includes the Company's notes payable and its Remarketed
Par Securities ("ROPES") which were issued in May 1997. Capital represents
the sum of consolidated debt, redeemable preferred securities of subsidiary
trusts and stockholders' equity (excluding unrealized gains on fixed
maturity investments). Proforma amounts assume unrestricted cash and
marketable investments on hand at AAG (parent) have been used to reduce
consolidated debt.
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 December 31, 1998, the capital ratio of
each of AAG's principal insurance subsidiaries was at least 4.8 times its
authorized control level RBC.
15
Sources and Uses of Funds To pay interest and principal on borrowings,
obligations related to discontinued manufacturing operations and other
holding company costs, AAG (parent) and AAG Holding use cash and investments
on hand as well as capital distributions from their principal subsidiary,
Great American Life Insurance Company ("GALIC"). At December 31, 1998, AAG
(parent) had nearly $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 1998, GALIC
made $72 million in such payments; the maximum amount of dividends payable
by GALIC in 1999 without prior regulatory approval is $35.6 million.
In 1998, AAG and AAG Holding retired $128 million of debt (including $24
million held by affiliates) and $15 million of Common Stock using proceeds
from a public debt offering and cash on hand.
Including cash and investments on hand and the unused availability under a
bank line of credit, AAG and AAG Holding had nearly $270 million of
liquidity at March 1, 1999. The September 1998 sale of its Funeral Services
Division netted approximately $165 million in cash ($145 million after-tax).
The majority of the proceeds were received by AAG's insurance subsidiaries.
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. At December 31, 1998, 93% of AAG's fixed maturity
portfolio was comprised of investment grade bonds (NAIC rating of "1" or
"2"). 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
December 31, 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 December 31, 1998 and 1997, respectively, AAG had approximately $240
million and $242 million in net unrealized gains on its fixed maturity
portfolio. At December 31, 1998, all of AAG's fixed maturity investments
were classified as "available for sale" (See Note B).
At December 31, 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.
16
Uncertainties
Year 2000 Status AAG's Year 2000 Project is a corporate-wide
program designed to ensure that its computer hardware and software systems,
telecommunications and other business activities function properly in the
Year 2000. The project also encompasses communicating with agents, vendors,
financial institutions and others with which the Company conducts business
to determine their Year 2000 readiness and resulting effects on AAG. As
part of the project, the Company is also developing contingency plans for
the systems and procedures deemed most critical to the Company. AAG's Year
2000 Project is being coordinated by a team of individuals from a variety of
disciplines in the organization which monitors the work being performed by
the various business units and reports frequently to senior management. The
Company's internal audit staff reports at least quarterly to the Audit
Committee of the Board of Directors on the Company's Year 2000 progress.
To address its Year 2000 issue, AAG's operations have been divided into
separate systems groups. At December 31, 1998, these groups were in the
process of either (i) testing internally developed and third party software
applications believed to be Year 2000 compliant without need for any
modifications; (ii) modifying and testing other software applications or
(iii) replacing software with new applications that are Year 2000 compliant,
and testing those replacements for operational acceptance and Year 2000
compliance.
Approximately 40% of the operating units are currently on target with their
internal plans to be completed in the second quarter of 1999. Approximately
50% of the operating units have experienced some delay and their overall
projects are running behind schedule on internally established timelines.
These groups are expected to be complete in the third quarter of 1999. One
important replacement application experienced a significant delay from its
original targeted completion date. This project was reorganized and
restaffed in the fourth quarter of 1998, and management believes the project
has made significant progress. This application is currently involved in
testing and is expected to be completed and in operation in the third
quarter of 1999.
Contingency plans provide a documented order of actions necessary to keep
the Company's business functions operating and mitigate the extent of any
potential disruptions. The Company expects to complete its contingency
planning process for all mission critical software applications and
operational processes in the second quarter of 1999, and for less
significant software applications and operational processes in the third
quarter of 1999. These plans will be tested through the balance of the
year.
Many of the systems being replaced were planned replacements, which were
accelerated due to Year 2000 considerations. 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 represent solely incremental
costs. Since the beginning of 1997, AAG has incurred an estimated $13
million in Year 2000 costs, including capitalized costs of $10 million for
new systems; the Company expensed $3.5 million in Year 2000 costs in 1998.
AAG estimates it will spend an additional $9 million in connection with the
Year 2000 Project in 1999, of which $5 million is expected to be expensed.
Projected Year 2000 costs and completion dates are based on management's
best estimates. There can be no assurance that these estimates will be
achieved.
17
AAG believes it has reasonable plans in place to ensure business activities
function properly in the Year 2000. However, should software modifications
and new software installations not be completed on a timely basis, the
resulting disruptions could have a material adverse impact on operations.
AAG's operations could also be materially adversely affected by the
inability of third parties such as agents, vendors and policyholders'
employers to also function properly in the Year 2000.
Exposure to Market Risk Market risk represents the potential
economic loss arising from adverse changes in the fair value of financial
instruments. AAG's exposures to market risk relate primarily to its fixed
maturity investment portfolio, annuity contracts and long-term debt which
are exposed to interest rate risk. AAG's investments in equity securities
and derivatives were not significant at December 31, 1998.
Fixed Maturity Portfolio The fair value of AAG's fixed maturity
portfolio ($6.02 billion at December 31, 1998) is directly impacted by
changes in market interest rates. AAG's fixed maturity portfolio is
comprised of substantially all fixed rate investments with primarily short-
term and intermediate-term maturities. This practice allows flexibility in
reacting to fluctuations of interest rates. AAG's portfolio is managed with
an attempt to achieve an adequate risk-adjusted return while maintaining
sufficient liquidity to meet policyholder obligations. AAG uses various
actuarial models in an attempt to align the duration of invested assets to
the projected cash flows of policyholder liabilities.
The following table provides information about AAG's fixed maturity
investments at December 31, 1998. The table shows (dollars in millions)
principal cash flows and related weighted-average interest rates by expected
maturity dates. Callable bonds and notes are included based on call date or
maturity date depending upon which date produces the most conservative
yield. Mortgage-backed securities and sinking fund issues are included
based on maturity year adjusted for expected payment patterns. Actual cash
flows may differ from those expected.
1999 2000 2001 2002 2003 Remain
Principal Cash Flows $480 $550 $660 $700 $780 $2,680
Wtd.-Avg. Interest Rate 8.2% 7.8% 8.3% 7.8% 7.5% 7.6%
Annuity Contracts Substantially all of AAG's fixed rate annuity
contracts permit AAG to change crediting rates (subject to minimum interest
rate guarantees of 3% to 4% per annum) enabling management to react to
changes in market interest rates and maintain an adequate spread. Sales of
variable rate annuities have not been significant. Projected payments of
AAG's fixed annuity liabilities at December 31, 1998, were as follows
(dollars in millions):
1999 2000 2001 2002 2003 Remain
Annuity Payments $660 $620 $560 $500 $450 $2,610
About half of AAG's fixed annuity liabilities at December 31, 1998, were
two-tier in nature in that policyholders can receive a higher amount if they
annuitize rather than surrender their policy, even if the surrender period
has expired. Current stated crediting rates on AAG's principal fixed
annuity products range from 3% on equity-indexed annuities (before any
equity participation) to over 7% on certain new policies (including first
year bonus amounts). AAG estimates that its effective weighted-average
crediting rate over the next five years will range from 5% to 5.2%. This
range reflects actuarial assumptions as to: (i) deaths; (ii) the number of
policyholders who annuitize and receive higher credited amounts and (iii)
the number of policyholders who surrender. Actual experience and changes in
actuarial assumptions may result in different effective crediting rates than
those above.
18
Debt and Preferred Securities At December 31, 1998, AAG's debt
securities had a weighted-average interest rate of 6.7% and a weighted-
average life of approximately eight years. Variable debt comprised less
than 10% of AAG's total debt and preferred securities.
At December 31, 1998, AAG's preferred securities of its subsidiary trusts
had a weighted-average dividend rate of 8.5% and a weighted-average life of
approximately 34 years, based on final maturity dates. Based on initial
optional redemption dates, the trust preferred securities had an average
life of approximately four years. (See Notes H and I.)
Results of Operations
General The operations of Great American Life Assurance Company of Puerto
Rico, Inc. ("GAPR") and Arkansas National Life Insurance Company 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 the first nine
months of 1998 and for 1997 and 1996. Accordingly, the 1998 income
statement components are not comparable to 1997 and 1996.
Management believes the concept of net operating earnings (or "core"
earnings) is helpful in comparing the operating performance of AAG with that
of similar companies. Diluted net operating earnings per share for 1998 and
1997 were up 10% and 13%, respectively, over the prior years. However, net
operating earnings should not be considered a substitute for net income as
an indication of AAG's overall performance. The following table (in
millions, except per share amounts) compares the Company's net operating
earnings over the past three years.
AAG (Consolidated): 1998 1997 1996
Revenues per income statement $724.5 $634.2 $577.3
Less realized gains on sales of investments (10.7) (5.2) (1.2)
Less gain on sale of subsidiaries (21.6) - -
Less equity in net loss (earnings)
of affiliate 0.4 (0.8) 2.2
Operating revenues 692.6 628.2 578.3
Expenses per income statement (581.0) (530.0) (498.8)
Less provision for relocation expenses - 4.0 -
Operating expenses (581.0) (526.0) (498.8)
Operating earnings before tax 111.6 102.2 79.5
Income tax expense 35.4 32.1 17.8
Net operating earnings $ 76.2 $ 70.1 $61.7
Net operating earnings per
common share (basic) $ 1.77 $ 1.60 $ 1.40
Net operating earnings per
common share (diluted) $ 1.74 $ 1.58 $ 1.40
19
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 its retirement
annuities (in millions).
1998 1997 1996
Retirement Annuity Premiums:
SPDAs $260 $254 $319
FPDAs 172 192 217
Variable annuities - flexible premium 22 6 1
Variable annuities - single premium 67 37 3
Total retirement annuity premiums $521 $489 $540
The decrease in SPDA sales in 1997 reflects primarily the decrease of
business written by GALIC's largest premium producing agency in 1996 (from
$99 million to $23 million). GALIC is no longer writing business through
this agency (see Item 3 - "Legal Proceedings"). Management believes that
the success of the stock market and the recent interest rate environment
have also resulted in decreased sales and persistency of traditional fixed
annuities. Sales of annuity products linked to the performance of the stock
market (equity-indexed and variable annuities) helped offset this decrease.
Life, Accident and Health Premiums and Benefits
The following table summarizes AAG's life, accident and health premiums as
shown in the Consolidated Income Statement (in millions).
Premiums 1998 1997 1996
Life insurance (excluding Funeral Services
Division) $ 62 $ 23 $ 20
Accident and health insurance 30 21 21
92 44 41
Funeral Services Division 78 78 63
$170 $122 $104
Increases in life, accident and health premiums and benefits in 1998 reflect
primarily the acquisition of GAPR. Life, accident and health premiums and
benefits increased in 1997 due primarily to an increase in pre-need life
insurance sales by AAG's Funeral Services Division which was sold in
September 1998.
Net Investment Income Net investment income increased 3% in 1998 and 6% in
1997, reflecting an increase in the Company's average fixed maturity
investment base. This increase was partially offset by decreasing market
interest rates and the sale of AAG's Funeral Services Division. Investment
income is shown net of investment expenses of $4.7 million in 1998 and 1997
and $6.5 million in 1996. Lower investment expenses in 1998 and 1997
reflect a decrease in fees charged by an affiliate. (See Notes E and P.)
Realized Gains In September 1998, AAG sold its Funeral Services Division to
that Division's biggest customer, Service Corporation International. This
customer accounted for approximately one-half of American Memorial's sales
in 1997.
Individual securities are sold from time to time as market opportunities
appear to present optimal situations under AAG's investment strategies.
20
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 from continuing
operations before unusual items of $55 million in 1998, $0.3 million in 1997
and $43 million in 1996. Chiquita reported net income (loss) before
extraordinary items of ($18 million) in 1998, $0.3 million in 1997 and ($28
million) in 1996. Included in AAG's equity in Chiquita's 1998 and 1997
earnings are gains attributable to Chiquita's issuance of common stock.
Other Income Other income increased in 1998 and 1997 due primarily to
increased revenues from certain non-insurance subsidiaries and additional
insurance fees.
Annuity Benefits Annuity benefits reflect amounts accrued on annuity
policyholders' funds accumulated. The majority of AAG's fixed rate annuity
products permit AAG to change the crediting rate at any time (subject to
minimum interest rate guarantees of 3% to 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
interest rate and stock market environment over the last several years has
contributed to an increase in annuitizations and surrenders, the Company's
persistency rate remains approximately 88%. However, a continuation of the
current interest rate environment could adversely affect this rate.
On its deferred annuities (annuities in the accumulation phase), AAG
generally credits interest to policyholders' accounts at their current
stated "surrender" interest rates. Furthermore, for "two-tier" deferred
annuities (annuities under which a higher interest amount can be earned if a
policy is annuitized rather than surrendered), AAG accrues an additional
liability to provide for expected deaths and annuitizations. Changes in
crediting rates, actual surrender and annuitization experience or
modifications in actuarial assumptions can affect this accrual.
On immediate annuities (annuities in the pay-out phase), interest is
credited based on discount rates used at the time the policies are
annuitized. Discount rates are generally based on interest rates in effect
at annuitization.
Annuity benefits decreased 6% in 1998 due primarily to decreases in
crediting rates and changes in actuarial assumptions. Annuity benefits
increased 3% in 1997 due primarily to an increase in average annuity
benefits accumulated, partially offset by decreases in crediting rates.
Insurance Acquisition Expenses Insurance acquisition expenses include
amortization of deferred acquisition costs ("DAC") as well as certain
marketing expenses and commissions on sales of life insurance products. The
increase in 1998 reflects the acquisition of GAPR, commissions and
amortization related to increased sales of pre-need life insurance products
and increased amortization of DAC on fixed annuities due to actual
experience and changes in actuarial assumptions. Insurance acquisition
expenses also include amortization of the present value of future profits of
businesses acquired amounting to $10.6 million in 1998, $8.1 million in 1997
and $8.7 million in 1996.
Preferred Distributions and Interest Expenses Trust preferred distribution
requirements and interest and other debt expenses increased 22% in 1998 and
59% in 1997 due to higher average amounts outstanding. Issuances of debt
and preferred securities have been used to fund acquisitions and to maintain
a portfolio of investments at AAG (parent) (See "Sources and Uses of
Funds").
21
Provision for Relocation Expenses In 1997, AAG began relocating most of the
operations of Loyal 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.
Other Expenses Other expenses increased 21% in 1998, reflecting primarily:
(i) operating expenses of GAPR, which was acquired in December 1997; (ii)
higher depreciation and amortization costs and (iii) increases in personnel
costs. In 1997, other expenses decreased 10%, reflecting primarily the
absence of a $15.7 million pretax charge in 1996 related to pension and
other liabilities of the Company's former manufacturing operations.
Income Taxes AAG's effective tax rate reflects reductions of the valuation
allowance associated with certain deferred tax assets (See Note K).
Extraordinary Items Extraordinary items reflect AAG's losses, net of tax,
on retirements of its debt and, in 1996, also includes AAG's proportionate
share of Chiquita's extraordinary loss on the retirement of certain of its
debt.
Recent Accounting Standards The following accounting standards have been
implemented by AAG in 1997 or 1998 or will be implemented in 1999 or 2000.
Accounting Subject of Standard -
Standard (Year Implemented) Reference (See Note B)
SFAS #128 Earnings Per Share (1997) "Earnings Per Share"
SFAS #130 Comprehensive Income (1998) "Comprehensive Income"
SFAS #131 Segment Information (1998) "Segment Information"
SFAS #133 Derivatives (2000) "Derivatives"
SOP 98-5 Start-Up Costs (1999) "Start-Up Costs"
Implementation of Statement of Position ("SOP") 98-5 in the first quarter of
1999 will result in a one-time after-tax charge of approximately $5 million
resulting from a change in accounting principle. Implementation of
Statement of Financial Accounting Standard ("SFAS") No. 133 in the first
quarter of 2000 is not expected to have a significant effect on AAG.
Other standards issued in recent years did not apply to AAG or had only
negligible effects on AAG.
ITEM 7A
Quantitative and Qualitative Disclosures About Market Risk
The information required by Item 7A is included in Management's Discussion
and Analysis of Financial Condition and Results of Operations.
22
ITEM 8
Financial Statements and Supplementary Data
PAGE
Report of Independent Auditors F-1
Consolidated Balance Sheet:
December 31, 1998 and 1997 F-2
Consolidated Income Statement:
Years Ended December 31, 1998, 1997 and 1996 F-3
Consolidated Statement of Changes in Stockholders' Equity:
Years Ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statement of Cash Flows:
Years Ended December 31, 1998, 1997 and 1996 F-5
Notes to Consolidated Financial Statements F-6
"Selected Quarterly Financial Data" has been included in Note Q to the
Consolidated Financial Statements.
PART III
The information required by the following Items will be included in AAG's
definitive Proxy Statement for the 1999 Annual Meeting of Stockholders which
will be filed with the Securities and Exchange Commission within 120 days of
the Company's fiscal year end and is herein incorporated by reference:
ITEM 10 Directors and Executive Officers of the Registrant
ITEM 11 Executive Compensation
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management
ITEM 13 Certain Relationships and Related Transactions
23
REPORT OF INDEPENDENT AUDITORS
Board of Directors
American Annuity Group, Inc.
We have audited the accompanying consolidated balance sheet of American
Annuity Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of income, changes in stockholders'
equity and cash flows for each of the three years in the period ended
December 31, 1998. Our audits also included the financial statement
schedules listed in the Index at Item 14(a). These financial statements and
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of American Annuity Group, Inc. and subsidiaries at December 31,
1998 and 1997, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. Also, in
our opinion, the related financial statement schedules, when considered in
relation to the basic financial statements taken as a whole, present fairly
in all material respects the information set forth therein.
Ernst & Young LLP
Cincinnati, Ohio
March 19, 1999
F-1
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
December 31,
1998 1997
Assets
Investments:
Fixed maturities:
Available for sale - at market
(amortized cost - $5,782.8 and $3,922.0) $6,023.1 $4,099.4
Held to maturity - at amortized cost
(market $0 and $2,340.6) - 2,276.4
Equity securities - at market (cost - $46.7
and $30.9) 85.2 83.0
Investment in affiliate 15.9 16.8
Mortgage loans on real estate 40.1 52.1
Real estate 55.1 42.0
Policy loans 220.5 241.0
Short-term investments 73.6 13.9
Total investments 6,513.5 6,824.6
Cash 59.4 36.8
Accrued investment income 97.6 101.6
Unamortized insurance acquisition costs, net 247.4 261.6
Other assets 152.5 185.2
Assets held in separate accounts 120.0 300.5
$7,190.4 $7,710.3
Liabilities and Capital
Annuity benefits accumulated $5,449.6 $5,528.1
Life, accident and health reserves 341.6 709.9
Notes payable 131.0 135.8
Payable to affiliates, net 54.1 35.8
Deferred taxes on unrealized gains 84.3 71.8
Accounts payable, accrued expenses and other
liabilities 96.1 119.5
Liabilities related to separate accounts 120.0 300.5
Total liabilities 6,276.7 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
- 42,576,933 and 43,199,147
shares outstanding 42.6 43.2
Capital surplus 354.1 368.0
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 344.5 252.1
Unrealized gains on marketable
securities, net 160.1 133.2
Total stockholders' equity 688.7 583.9
$7,190.4 $7,710.3
See Notes to Consolidated Financial Statements.
F-2
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Year ended December 31,
1998 1997 1996
Revenues:
Life, accident and health premiums $170.4 $121.5 $103.6
Net investment income 506.9 494.3 467.7
Realized gains on sales of investments 10.7 5.2 1.2
Gain on sale of subsidiaries 21.6 - -
Equity in net earnings (loss) of affiliate(0.4) 0.8 (2.2)
Other income 15.3 12.4 7.0
724.5 634.2 577.3
Costs and Expenses:
Annuity benefits 261.7 278.8 271.8
Life, accident and health benefits 131.7 110.1 92.3
Insurance acquisition expenses 65.0 36.3 34.1
Trust preferred distribution requirement 19.0 15.5 1.0
Interest and other debt expenses 10.8 8.9 14.3
Provision for relocation expenses - 4.0 -
Other expenses 92.8 76.4 85.3
581.0 530.0 498.8
Income from continuing operations before
income taxes 143.5 104.2 78.5
Provision for income taxes 46.0 32.8 17.4
Income from continuing operations 97.5 71.4 61.1
Extraordinary items, net of tax (0.8) (1.5) (6.0)
Net Income $ 96.7 $ 69.9 $ 55.1
Preferred dividend requirement - 1.0 1.4
Net income applicable to Common Stock $ 96.7 $ 68.9 $ 53.7
Average number of common shares:
Basic 43.0 43.2 43.1
Diluted 43.7 43.7 43.1
Basic earnings (loss) per common share:
Continuing operations $2.27 $1.63 $1.39
Extraordinary items (0.02) (0.03) (0.14)
Net income $2.25 $1.60 $1.25
Diluted earnings (loss) per common share:
Continuing operations $2.23 $1.61 $1.39
Extraordinary items (0.02) (0.03) (0.14)
Net income $2.21 $1.58 $1.25
Cash dividends per common share $0.10 $0.10 $0.08
See Notes to Consolidated Financial Statements.
F-3
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Year ended December 31,
1998 1997 1996
Preferred Stock:
Balance at beginning of year $ - $ 49.0 $ 17.0
Preferred Stock issued - - 32.0
Preferred Stock retired - (49.0) -
Balance at end of year $ - $ - $ 49.0
Common Stock:
Balance at beginning of year $ 43.2 $ 43.3 $ 43.1
Common Stock issued - - 0.2
Common Stock retired (0.6) (0.1) -
Balance at end of year $ 42.6 $ 43.2 $ 43.3
Capital Surplus:
Balance at beginning of year $368.0 $358.5 $361.1
Capital contribution - 9.3 -
Common Stock issued 0.4 0.2 2.2
Common Stock retired (14.3) (1.0) -
Common dividends declared - - (3.4)
Preferred Stock retired - 2.0 -
Preferred dividends declared - (1.0) (1.4)
Balance at end of year $354.1 $368.0 $358.5
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of year $252.1 $186.5 $131.4
Net income 96.7 69.9 55.1
Common dividends declared (4.3) (4.3) -
Balance at end of year $344.5 $252.1 $186.5
Unrealized Gains, Net:
Balance at beginning of year $133.2 $ 61.8 $ 89.3
Change during year 26.9 71.4 (27.5)
Balance at end of year $160.1 $133.2 $ 61.8
Comprehensive Income:
Net Income $ 96.7 $ 69.9 $ 55.1
Other comprehensive income - change in net
unrealized gains on marketable
securities 26.9 71.4 (27.5)
Comprehensive income $123.6 $141.3 $ 27.6
See Notes to Consolidated Financial Statements.
F-4
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Year ended December 31,
1998 1997 1996
Cash Flows from Operating Activities:
Net income $ 96.7 $ 69.9 $ 55.1
Adjustments:
Extraordinary loss on prepayment of debt 0.8 1.5 6.0
Increase in life, accident and
health reserves 47.1 36.3 28.4
Benefits to annuity policyholders 261.7 278.8 271.8
Amortization of insurance acquisition
costs 55.4 36.3 34.1
Depreciation and amortization 12.6 5.1 6.5
Realized gains on sales of investments (10.7) (5.2) (1.2)
Gain on sale of subsidiaries (21.6) - -
Increase in insurance acquisition costs (117.2) (72.6) (68.5)
Increase in accrued investment income (4.5) (4.8) (7.4)
Increase in other assets (27.1) (32.6) (10.4)
Increase (decrease) in other liabilities 27.9 19.8 (6.3)
Other, net (18.3) (21.4) (2.6)
302.8 311.1 305.5
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,121.9)(1,449.9)(1,010.1)
Equity securities (23.5) (12.5) -
Real estate, mortgage loans and
other assets (25.7) (16.1) (26.7)
Purchase of subsidiaries, net of
cash acquired (9.5) (48.7) -
Maturities and redemptions of
fixed maturity investments 673.0 408.2 255.2
Sales and decreases in:
Subsidiaries 164.6 - -
Fixed maturity investments 369.5 747.6 261.0
Equity securities 6.3 5.8 1.3
Real estate, mortgage loans and
other assets 20.4 20.9 27.8
Cash and short-term investments
of subsidiaries sold (40.5) - -
Decrease (increase) in policy loans 1.5 (1.3) 5.4
14.2 (346.0) (486.1)
Cash Flows from Financing Activities:
Fixed annuity receipts 480.6 493.7 573.8
Annuity surrenders, benefits and
withdrawals (690.4) (607.2) (517.9)
Additions to notes payable 150.0 114.0 92.7
Reductions of notes payable (156.1) (94.9) (153.2)
Issuance of trust preferred securities - 149.3 72.4
Issuance of Common Stock 0.4 - -
Retirement of Common Stock (14.9) (1.1) -
Issuance of Preferred Stock - - 32.0
Retirement of Preferred Stock - (47.0) -
Cash dividends paid (4.3) (5.3) (4.5)
(234.7) 1.5 95.3
Net increase (decrease) in cash
and short-term investments 82.3 (33.4) (85.3)
Cash and short-term investments
at beginning of year 50.7 84.1 169.4
Cash and short-term investments
at end of year $ 133.0 $ 50.7 $ 84.1
See Notes to Consolidated Financial Statements.
F-5
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO NOTES
A. Description of the Company J. Stockholders' Equity
B. Summary of Significant Accounting Policies K. Income Taxes
C. Acquisitions and Sale of Subsidiaries L. Leases
D. Segments of Operations M. Earnings Per Share
E. Investments N. Contingencies
F. Investment in Affiliate O. Statutory Information
G. Unamortized Insurance Acquisition Costs P. Additional Information
H. Notes Payable Q. Quarterly Financial
I. Mandatorily Redeemable Preferred Data (Unaudited)
Securities of Subsidiary Trusts
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 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 December 31, 1998.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The accompanying Consolidated Financial Statements
include the accounts of AAG and its subsidiaries. Certain reclassifications
have been made to prior years to conform to the current year's presentation.
Acquisitions and sales of subsidiaries have resulted in certain differences
in the financial statements and have affected comparability between years.
All significant intercompany balances and transactions have been eliminated.
All acquisitions have been treated as purchases. The results of operations
of companies since their formation or acquisition are included in the
Consolidated Financial Statements.
The preparation of the financial statements in conformity with generally
accepted accounting principles 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. At December 31, 1998, AAG
reclassified "held to maturity" securities with an amortized cost of $1.9
billion to "available for sale" to give management greater flexibility to
react to changing market conditions. This reclassification resulted in an
increase of $72.4 million in the carrying value of fixed maturity
investments and an increase of $39.4 million in stockholders' equity. The
transfer had no effect on net earnings.
F-6
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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.
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 Costs and Expenses Insurance acquisition costs and
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.
F-7
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Present Value of Future Profits Included in insurance acquisition costs
are amounts representing the present value of future profits on business in
force of the acquired insurance companies, which represent the portion of
the costs to acquire such companies that is allocated to the value of the
right to receive future cash flows from insurance contracts existing at the
date of acquisition.
These amounts are amortized with interest over the estimated remaining life
of the acquired policies for annuities and universal life products and over
the expected premium paying period for traditional life and health insurance
products.
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 tax-
deferred annuity program previously offered by the Funeral Services
Division, which was sold in 1998. (See Note C.)
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, Great American Life
Insurance Company ("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.
F-8
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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.
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.
Start-Up Costs Certain costs associated with introducing new products and
distribution channels are deferred by AAG and are amortized on a straight-
line basis over five years. Statement of Position ("SOP") 98-5, "Reporting
on the Costs of Start-Up Activities," was issued during the second quarter
of 1998 and is effective for fiscal years beginning after December 15, 1998.
The SOP requires that (i) costs of start-up activities be expensed as
incurred and (ii) 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 $7 million in capitalized start-up costs at December 31, 1998.
Derivatives The Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," during the
second quarter of 1998. SFAS No. 133 is effective for fiscal periods (both
years and quarters) beginning after June 15, 1999. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including
derivative instruments that are embedded in other contracts, and for hedging
activities. SFAS No. 133 requires the recognition of all derivatives (both
assets and liabilities) in the statement of financial position at fair
value. Changes in fair value of derivative instruments are included in
current income or as a component of comprehensive income (outside current
income) depending on the type of derivative. Implementation of SFAS No. 133
is not expected to have a material effect on AAG's financial position or
results of operations.
F-9
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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. Basic earnings per share is 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. Per share amounts for prior
periods were restated.
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 gain on marketable securities net of deferred
taxes. Implementation of this statement had no impact on net earnings or
stockholders' equity. Appropriate data for prior periods has been added 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.
Fair Value of Financial Instruments Methods and assumptions used in
estimating fair values are described in Note P to the financial statements.
These fair values represent point-in-time estimates of value that might not
be particularly relevant in predicting AAG's future earnings or cash flows.
C. ACQUISITIONS AND SALE OF SUBSIDIARIES
In February 1999, AAG acquired Old Republic Life Insurance Company of New
York for approximately $25 million in cash. This acquisition provides AAG
with the opportunity to offer its life and annuity products in all 50
states.
In December 1997, AAG acquired GAPR for approximately $50 million in cash.
On September 30, 1998, AAG sold its Funeral Services Division for
approximately $165 million in cash realizing a $14.8 million after-tax gain.
This division included American Memorial Life Insurance Company (acquired in
1995) and Arkansas National Life Insurance Company (acquired in 1998) and
had assets of approximately $1 billion as of the sale date.
F-10
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
D. SEGMENTS OF OPERATIONS
AAG operates in three major segments: (i) retirement products, (ii) life,
accident and health insurance and (iii) corporate and other. AAG's
retirement product companies sell tax-deferred annuities to employees of
primary and secondary educational institutions, hospitals and in the non-
qualified markets. More than one-fourth of AAG's retirement annuity
premiums came from California in 1996 to 1998. No other state accounted for
more than 10% of premiums. Sales from AAG's top two Managing General
Agencies accounted for 14% and 5% of retirement annuity premiums in 1998.
AAG's life, accident and health businesses sell various forms of life and
supplemental health products in the United States and Puerto Rico. Sales in
Puerto Rico accounted for nearly one-half of AAG's life, accident and health
premiums in 1998.
Corporate and other consists primarily of AAG (parent), AAG Holding and the
Funeral Services Division.
Effective January 1, 1998, AAG implemented SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 requires
segment information to be reported based on how management internally
evaluates the operating performance of its business units. Implementation
of this standard had no impact on AAG's financial position or results of
operations.
The following tables (in millions) show AAG's assets, revenues and operating
profit (loss) by significant business segment. Operating profit (loss)
represents total revenues (excluding realized gains) less interest and
operating expenses.
Assets 1998 1997 1996
Retirement annuities $6,419.3 $6,142.9 $5,830.2
Life, accident & health 557.4 511.7 332.6
Corporate and other (a) 197.8 1,038.9 844.8
Investment in affiliate 15.9 16.8 16.5
Total assets per
balance sheet $7,190.4 $7,710.3 $7,024.1
Revenues
Retirement annuities $442.9 $437.7 $419.2
Life, accident & health 119.6 63.6 60.9
Corporate and other 130.1 126.9 98.2
Total operating revenues 692.6 628.2 578.3
Realized gains (b) 32.3 5.2 1.2
Equity in net earnings
(loss) of affiliate (0.4) 0.8 (2.2)
Total revenues per
income statement $724.5 $634.2 $577.3
Operating profit (loss) - pretax
Retirement annuities $111.6 $101.5 $ 91.7
Life, accident & health 12.6 8.0 9.5
Corporate and other (12.6) (7.3) (21.7)
Total pretax operating
income 111.6 102.2 79.5
Realized gains (b) 32.3 5.2 1.2
Equity in net earnings
(loss) of affiliate (0.4) 0.8 (2.2)
Provision for relocation
expenses - (4.0) -
Total pretax income per
income statement $143.5 $104.2 $ 78.5
(a) Decrease in "Corporate and other" assets reflects sale of Funeral
Services Division in 1998.
(b) Includes gain on sale of subsidiaries in 1998.
F-11
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
E. INVESTMENTS
Fixed maturity investments at December 31, consisted of the following (in
millions):
1998
Available for Sale
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and government
agencies and authorities $ 218.0 $ 233.9 $ 15.9 $ -
States, municipalities and political
subdivisions 34.2 36.3 2.1 -
Foreign governments 25.8 28.0 2.2 -
Public utilities 433.1 449.3 16.2 -
Mortgage-backed securities 1,800.6 1,877.4 82.8 (6.0)
All other corporate 3,257.4 3,383.6 143.9 (17.7)
Redeemable preferred stocks 13.7 14.6 1.0 (0.1)
$5,782.8 $ 6,023.1 $264.1 ($23.8)
As of December 31, 1998, $1.90 billion of fixed maturities investments
formerly classified as held to maturity were reclassed to available for sale
at their market price of $1.97 billion.
1998
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and government
agencies and authorities $ - $ - $ - $ -
States, municipalities and political
subdivisions - - - -
Foreign governments - - - -
Public utilities - - - -
Mortgage-backed securities - - - -
All other corporate - - - -
Redeemable preferred stocks - - - -
$ - $ - $ - $ -
1997
Available for Sale
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and government
agencies and authorities $ 303.1 $ 312.8 $9.8 ($0.1)
States, municipalities and political
subdivisions 26.8 27.6 0.8 -
Foreign governments 20.1 21.0 0.9 -
Public utilities 135.6 141.7 6.1 -
Mortgage-backed securities 1,250.6 1,302.5 51.9 -
All other corporate 2,169.2 2,274.9 105.7 -
Redeemable preferred stocks 16.6 18.9 2.3 -
$3,922.0 $4,099.4 $177.5 ($0.1)
1997
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and government
agencies and authorities $ - $ - $ - $ -
States, municipalities and political
subdivisions 39.8 40.2 0.4 -
Foreign governments 8.3 8.9 0.6 -
Public utilities 360.8 366.2 6.7 (1.3)
Mortgage-backed securities 659.2 684.6 25.6 (0.2)
All other corporate 1,208.3 1,240.7 33.2 (0.8)
Redeemable preferred stocks - - - -
$2,276.4 $2,340.6 $66.5 ($2.3)
"Investing activities" related to fixed maturity investments included in
AAG's Consolidated Statement of Cash Flows consisted of the following (in
millions):
1998
Available Held to
for Sale Maturity Total
Purchases ($1,121.9) $ - ($1,121.9)
Maturities and paydowns 394.7 278.3 673.0
Sales 336.2 33.3 369.5
Gross gains 8.9 3.4 12.3
Gross losses (9.3) (0.4) (9.7)
1997
Available Held to
for Sale Maturity Total
Purchases ($1,448.5) ( $1.4) ($1,449.9)
Maturities and paydowns 195.5 212.7 408.2
Sales 742.4 5.2 747.6
Gross gains 19.8 0.2 20.0
Gross losses (13.9) - (13.9)
1996
Available Held to
for Sale Maturity Total
Purchases ($893.8) ($116.3) ($1,010.1)
Maturities and paydowns 148.6 106.6 255.2
Sales 251.7 9.3 261.0
Gross gains 8.3 1.1 9.4
Gross losses (8.3) (0.3) (8.6)
Securities classified as "held to maturity" were sold for gains of $0.5
million in 1998 due to significant deterioration in the issuers'
creditworthiness. In 1997 and 1996, gains (losses) on such sales were
insignificant.
F-12
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The table below sets forth the scheduled maturities of AAG's fixed maturity
investments based on market value as of December 31:
Maturity 1998
One year or less 5%
After one year through five years 25
After five years through ten years 25
After ten years 14
69
Mortgage-backed securities 31
100%
The distribution of maturities based on amortized cost is generally the
same. Mortgage-backed securities had an estimated average life of
approximately four and one-half years at December 31, 1998.
AAG had no investments in any issue in excess of 10% of stockholders' equity
at December 31, 1998, other than investments issued or guaranteed by the
U.S. Government or government agencies.
At December 31, 1998 and 1997, AAG had no unrealized losses on its
marketable equity securities. Realized gains and changes in unrealized
appreciation on fixed maturity and equity security investments are
summarized as follows (in millions):
Fixed Equity Tax
Maturities Securities Other Effects Total
1998
Realized $ 2.6 $ 1.8 $6.3 ($ 3.9) $ 6.8
Change in unrealized (1.3) (13.6) - 5.2 (9.7)
1997
Realized $ 6.1 $ 1.7 ($2.6) ($ 1.8) $ 3.4
Change in unrealized 142.0 17.2 - (55.7) 103.5
1996
Realized $ 0.8 $ - $0.4 ($ 0.4) $ 0.8
Change in unrealized (142.2) 16.4 - 44.0 (81.8)
F-13
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Major categories of net investment income were as follows (in millions):
1998 1997 1996
Fixed maturities* $502.1 $492.6 $463.4
Other 9.5 6.4 10.8
Total investment income 511.6 499.0 474.2
Investment expenses (4.7) (4.7) (6.5)
Net investment income $506.9 $494.3 $467.7
* Includes income on fixed maturities, mortgage loans, policy loans and
short-term investments.
AAG's investment portfolio is managed by a subsidiary of AFG. Investment
expenses included investment management charges from this subsidiary
amounting to $3.3 million in 1998, $2.9 million in 1997 and $4.7 million in
1996. (See Note P - "Related Party Transactions".)
F. INVESTMENT IN AFFILIATE
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares;
carrying value of $15.9 million at December 31, 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 $26
million and $44 million at December 31, 1998 and 1997, respectively.
In the fourth quarter of 1998, Chiquita recorded an after-tax charge of $74
million due to significant damage to its operations as a result of
widespread flooding caused by Hurricane Mitch. Accordingly, AAG recorded
its proportionate share (4%) of this after-tax write-off. Included in
equity in Chiquita's earnings are gains of $1.0 million in 1998 and $1.3
million in 1997 attributable to Chiquita's issuance of common stock.
In 1996 AAG recorded a pretax extraordinary charge of $1.1 million
representing its proportionate share of Chiquita's loss on the retirement of
debt.
Included in AAG's retained earnings at December 31, 1998, was $8.7 million
applicable to equity in undistributed net losses of Chiquita.
G. UNAMORTIZED INSURANCE ACQUISITION COSTS
Unamortized insurance acquisition costs consisted of the following at
December 31, (in millions):
1998 1997
Deferred policy acquisition costs $320.1 $300.6
Present value of future profits
acquired 59.9 102.0
Unearned revenues (132.6) (141.0)
$247.4 $261.6
F-14
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
A progression of AAG's present value of future profits acquired ("PVFP") is
as follows (in millions):
1998 1997 1996
Beginning balance $102.0 $ 72.5 $73.4
Addition due to acquisition 3.6 37.5 -
Reduction due to sale (32.0) - -
Interest accrued 6.4 5.3 5.4
Amortization (17.0) (13.3)(14.1)
Other (3.1) - 7.8
$ 59.9 $102.0 $72.5
The interest accrual rates used range primarily from 5% to 7%. During each
of the next five years, the PVFP is expected to decrease at a rate of
approximately 9% of the balance at the beginning of each respective year.
H. NOTES PAYABLE
Notes payable consisted of the following at December 31, (in millions):
1998 1997
Direct obligations of AAG $ 1.2 $ 1.3
Obligations of AAG Holding (guaranteed by AAG):
6-7/8% Senior Notes due 2008 100.0 -
Bank Credit Line 27.0 107.0
11-1/8% Senior Subordinated Notes due 2003 - 24.1
Other subsidiary debt 2.8 3.4
Total $131.0 $135.8
In January 1998, AAG Holding replaced its existing bank lines with a
$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. In February 1998, AAG Holding borrowed under the new credit
line and retired its 11-1/8% Notes realizing a pretax extraordinary loss of
$1.2 million. In June 1998, AAG Holding sold $100 million principal amount
of 6-7/8% Senior Notes and used the net proceeds to repay outstanding
indebtedness under the unsecured bank credit line.
In August 1997, AAG Holding retired its 9-1/2% Senior Notes, realizing a
pretax extraordinary loss of $2.4 million. During 1996, a pretax
extraordinary loss of $8.2 million was realized on the repurchase of $78.0
million principal amount of Notes.
At December 31, 1998, AAG and its subsidiaries had no material amounts of
scheduled principal payments due until final maturity of the bank credit
line in 2003.
F-15
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
At December 31, 1998 and 1997, the weighted-average interest rate on amounts
borrowed under AAG Holding's bank credit lines was 6.09% and 6.80%,
respectively. At March 1, 1999, the weighted-average interest rate on its
credit line was 5.44%.
Cash interest payments were $10.9 million in 1998, $9.4 million in 1997 and
$17.4 million in 1996.
I. 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 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:
Optional
Date of Redemption
Issuance Issue (Maturity Date) Amount 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.
J. STOCKHOLDERS' EQUITY
The Company is authorized to issue 25,000,000 shares of Preferred Stock, par
value $1.00 per share.
In December 1997, AAG merged its underfunded pension plan with two pension
plans of affiliates (see Note P - "Pension Plan"). The net overfunded
amount of the affiliates' plans was recorded as a capital contribution.
In December 1996, AAG sold 320,000 shares of newly issued Preferred Stock
for $32 million (see Note P - "Related Party Transactions"). In March 1997,
AAG repurchased all 490,000 shares of its Preferred Stock for approximately
$47 million.
AAG's dividend paying capability is limited by certain customary debt
covenants to amounts based on cumulative earnings and losses, debt ratios
and other items.
"Retained earnings since January 1, 1993," reflects accumulated changes in
AAG's retained earnings since its acquisition of GALIC.
F-16
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The change in net unrealized gains on marketable securities included the
following (in millions):
1998
Pretax Taxes Net
Unrealized holding gains on
securities arising during
the period $ 6.6 ($1.0) $ 5.6
Unrealized gain on securities
transferred from held to
maturity 60.6 (21.2) 39.4
Reclassification adjustment for
investment losses (gains)
realized in net income and
unrealized gains of subsidiaries sold (27.8) 9.7 (18.1)
Changes in net unrealized gains on
marketable securities $39.4 ($12.5) $26.9
1997
Pretax Taxes Net
Unrealized holding gains on
securities arising during
the period $ 117.6 ($41.2) $ 76.4
Unrealized gain on securities
transferred from held to
maturity - - -
Reclassification adjustment for
investment losses (gains)
realized in net income and
unrealized gains of subsidiaries sold (7.7) 2.7 (5.0)
Changes in net unrealized gains on
marketable securities $109.9 ($38.5) $71.4
1996
Pretax Taxes Net
Unrealized holding gains on
securities arising during
the period ($42.1) $14.6 ($27.5)
Unrealized gain on securities
transferred from held to
maturity - - -
Reclassification adjustment for
investment losses (gains)
realized in net income and
unrealized gains of subsidiaries sold - - -
Changes in net unrealized gains on
marketable securities ($42.1) $14.6 ($27.5)
At December 31, 1998, there were 3.0 million shares of AAG Common Stock
reserved for issuance under AAG's stock option plans. Under the plans, the
exercise price of each option equals the market price of AAG Common Stock at
the date of grant. Options generally become exercisable at the rate of 20%
per year commencing one year after grant. All options expire ten years
after the date of grant.
Data for AAG's Stock Option Plan is presented below:
1998 1997
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding at
beginning of year 2,178,190 $15.21 1,548,969 $13.38
Granted 417,000 $22.51 633,070 $19.70
Forfeited (90,332) $16.57 (3,849) $13.51
Exercised (40,778) $13.80 - -
Outstanding at
end of year 2,464,080 $16.42 2,178,190 $15.21
Options exercisable
at year-end 701,561 $14.43 309,024 $13.38
1996
Average
Exercise
Shares Price
Outstanding at
beginning of year - -
Granted 1,557,759 $13.38
Forfeited (8,790) $13.25
Exercised - -
Outstanding at
end of year 1,548,969 $13.38
Options exercisable
at year-end - n/a
The average remaining life of AAG's options was 8.5 years at December 31,
1998. The exercise prices of options issued during the year ranged from
$22.13 to $24.38 in 1998; $14.00 to $21.75 in 1997 and $13.25 to $13.75 in
1996.
No compensation cost has been recognized for stock option grants. Had
compensation cost been determined for stock option awards based on the fair
values at grant dates consistent with the method prescribed by SFAS No. 123,
AAG's net income and earnings per share would have been approximately $7.5
million ($0.18 per share) lower. For SFAS No. 123 purposes, calculations
were determined using the Black-Scholes option pricing model and the
following assumptions: dividend yield of less than 1%; expected volatility
of 20%; risk-free interest rates of 4.7% - 5.7% for 1998; 5.7% - 6.5% for
1997 and 6.0% for 1996 and expected life of 7.5 years.
F-17
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
K. INCOME TAXES
The following is a reconciliation of income taxes at the statutory rate of
35% and income taxes as shown in the Consolidated Income Statement (in
millions).
1998 1997 1996
Income before income taxes:
Continuing operations $143.5 $104.2 $78.5
Extraordinary items (1.2) (2.3) (9.2)
Income before income taxes $142.3 $101.9 $69.3
Tax computed at statutory rate $ 49.8 $ 35.7 $24.3
Effect of:
Reduction of valuation allowance (6.6) (3.5) (10.0)
Book basis over tax basis of
subsidiaries sold 2.3 - -
Other, net 0.1 (0.2) (0.1)
Total provision (all current) 45.6 32.0 14.2
Amounts applicable to
extraordinary items 0.4 0.8 3.2
Provision for income tax as shown on
the Consolidated Income
Statement $ 46.0 $ 32.8 $17.4
The significant components of deferred tax assets and liabilities, excluding
the effects of unrealized gains and losses on marketable securities,
included in the Consolidated Balance Sheet were as follows (in millions):
December 31,
1998 1997
Deferred tax assets:
Net operating loss carryforwards $29.4 $39.8
Accrued expenses 5.1 8.4
Investment securities, including
affiliate 36.3 34.7
Valuation allowance for deferred
tax assets (26.4) (33.0)
Deferred tax liabilities:
Unamortized insurance
acquisition costs (68.8) (70.6)
Policyholder liabilities (17.2) (8.8)
Capitalized assets (8.6) -
At December 31, 1998, AAG had net operating loss carryforwards for federal
income tax purposes of approximately $84 million which are scheduled to
expire from 2003 through 2005.
F-18
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
L. LEASES
Future minimum lease payments under operating leases having initial or
remaining non-cancelable lease terms in excess of one year at December 31,
1998 are payable as follows: 1999 - $5.3 million; 2000 - $5.0 million; 2001
- $4.9 million; 2002 - $4.1 million; 2003 - $4.0 million; 2004 and beyond -
$13.5 million.
Rental expense for operating leases was $4.9 million in 1998, $2.9 million
in 1997 and $2.6 million in 1996.
M. EARNINGS PER SHARE
The number of common shares outstanding used in calculating diluted earnings
per share in 1998 and 1997 include 0.7 million shares and 0.5 million
shares, respectively, for the effect of the assumed exercise of AAG's stock
options.
N. 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. Based on prior
costs and discussions with independent environmental consultants, the
Company believes the remaining aggregate cost of environmental work at all
sites for which it has responsibility will range from $6.5 million to $14.5
million. AAG is actively pursuing recovery of a portion of the costs from
the companies which provided insurance coverage for the former manufacturing
operations. At December 31, 1998, AAG had settlement offers from certain of
these insurance companies totaling more than $4 million. In addition, the
Company's reserve for environmental costs was $4.7 million at December 31,
1998.
O. STATUTORY INFORMATION; RESTRICTIONS ON TRANSFERS OF FUNDS AND ASSETS OF
SUBSIDIARIES
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):
1998 1997 1996
Capital and surplus $350.4 $317.0 $285.0
Asset valuation reserve 62.6 64.7 91.4
Interest maintenance reserve 20.6 23.9 24.7
Pretax income from operations $111.2 $ 91.7 $ 87.1
Net income from operations 99.9 72.7 68.1
Net income 35.6 73.6 66.2
F-19
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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 at December 31, 1998,
GALIC may pay $35.6 million in dividends in 1999 without prior approval.
P. ADDITIONAL INFORMATION
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):
December 31,
Income Statement 1998 1997 1996*
Revenues $ 665 $ 617 $91
Pretax income 130 92 8
Net income 84 60 5
* Since November 1, 1996
Balance Sheet 1998 1997
Investments $6,291 $6,634
Unamortized insurance
acquisition costs 208 225
Assets held in separate accounts 120 300
Other assets 281 284
Insurance reserves $5,692 $6,142
Notes payable:
Due parent 115 159
Due others 130 135
Liabilities related to
separate accounts 120 300
Other liabilities 167 165
Mandatorily redeemable preferred securities
of subsidiary trusts $ 225 $ 225
Stockholder's equity $ 451 $ 317
Related Party Transactions In connection with AAG's purchase of GALIC from
Great American Insurance Company ("GAI"), a subsidiary of AFG, in 1992, GAI
agreed to neutralize the financial effects on GALIC of the adoption of an
actuarial guideline with respect to non-traditional life insurance and
annuity products. In satisfaction of this obligation, (i) GAI had agreed to
purchase, at AAG's option, up to $57 million of AAG Preferred Stock and (ii)
terms of GALIC's investment management services contract with AFG were
modified to reduce the fees owed under certain circumstances. In December
1996 and 1995, AAG sold $21.7 million and $17.0 million, respectively, of
its Series B Preferred Stock to GAI; the proceeds were contributed to GALIC.
Also in December 1996, AAG sold $10.3 million of its Series B Preferred
Stock to AFC. In March 1997, AAG repurchased all the Series B Preferred
Stock for approximately $47 million. In 1997, AAG and GAI agreed that no
additional shares of AAG Preferred Stock would be issued pursuant to this
arrangement and that the financial impact of the actuarial guideline would
be offset solely by reduction of investment management fees.
F-20
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
In a 1997 transaction, AAG purchased a minority ownership position in a
company engaged in the production of ethanol. AAG's Chairman purchased the
remaining ownership. During 1998, this company borrowed $4.0 million from
AAG under a subordinated note bearing interest at 14% and used the proceeds
to pay a portion of a $6.3 million capital distribution, including $3.1
million to AAG. AAG's equity investment in this company at December 31,
1998 was $1.8 million. In addition, AAG has extended a $5 million line of
credit to this company; no amounts have been borrowed under the credit line.
GALIC has a line of credit with a company owned in part by AFG and a brother
of AAG's Chairman. Under the agreement, this company may borrow up to $8
million at 13% with interest deferred and added to principal. At December
31, 1998, $6.1 million was due GALIC under the line.
Net investment income includes approximately $900,000 in 1998 and 1997 and
$1 million in 1996 of payments from a subsidiary of AFG for the rental of an
office building owned by GALIC.
Fair Value of Financial Instruments The following table shows (in millions)
the carrying value and estimated fair value of AAG's financial instruments
at December 31:
1998 1997
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
Assets
Fixed maturity investments $6,023.1 $6,023.1 $6,375.8 $6,440.0
Equity securities 85.2 85.2 83.0 83.0
Investment in affiliate 15.9 25.6 16.8 43.6
Liabilities
Annuity benefits accumulated $5,449.6 $5,307.2 $5,528.1 $5,319.1
Notes payable 131.0 130.4 135.8 136.6
Trust preferred securities $ 225.0 $ 231.4 $ 225.0 $ 230.3
Stockholders' equity $ 688.7 $ 979.3 $ 583.9 $ 950.4
When available, fair values are based on prices quoted in the most active
market for each security, including AAG Common Stock. If quoted prices are
not available, fair value is estimated based on present values, discounted
cash flows, fair value of comparable securities or similar methods. The
fair value of short-term investments, mortgage loans on real estate and
policy loans approximate their carrying value. The fair value of the
liability for annuities in the payout phase is assumed to be the present
value of the anticipated cash flows, discounted at current interest rates.
Fair value of annuities in the accumulation phase is assumed to be the
policyholders' cash surrender amount.
F-21
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Unrealized Gains on Marketable Securities, Net The components of the
Consolidated Balance Sheet caption "Unrealized gains on marketable
securities, net" in stockholders' equity are summarized as follows (in
millions):
Unadjusted
Asset Effect of Reported
(Liability ) SFAS 115 Amount
1998
Fixed maturities - available for sale $5,782.8 $240.3 $6,023.1
Equity securities 46.7 38.5 85.2
Unamortized insurance acquisition
costs, net 256.3 (8.9) 247.4
Annuity benefits accumulated (5,424.1) (25.5) (5,449.6)
Deferred taxes on unrealized gains - (84.3) (84.3)
Unrealized gains on marketable
securities, net $160.1
1997
Fixed maturities - available for sale $3,922.0 $177.4 $4,099.4
Equity securities 30.9 52.1 83.0
Unamortized insurance acquisition
costs, net 268.0 (6.4) 261.6
Annuity benefits accumulated (5,510.0) (18.1) (5,528.1)
Deferred taxes on unrealized gains - (71.8) (71.8)
Unrealized gains on marketable
securities, net $133.2
Pension Plan The Company has a defined benefit pension plan (the "Plan")
covering former U.S. employees of its discontinued manufacturing operations.
Pension benefits are based upon past service with the Company and
compensation levels. Contributions are made by the Company in amounts
necessary to satisfy requirements of ERISA. Effective December 31, 1997,
the Plan was merged with two other defined benefit plans which had been
sponsored by affiliates of the Company.
F-22
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Q. QUARTERLY FINANCIAL DATA (Unaudited)
Quarterly results necessarily rely heavily on estimates. These estimates
and certain other factors, such as the seasonal nature of the Company's
affiliate and certain other operations and the discretionary sales of
assets, cause the quarterly results not to be necessarily indicative of
results for longer periods of time. The following table represents
quarterly results of operations for the years ended December 31, 1998 and
1997 (in millions, except per share data).
First Second Third Fourth Total
1998 Quarter Quarter Quarter Quarter Year
Realized gains (losses)
on sales of investments $ 10.2 $ 1.5 $ 4.0 ($ 5.0) $ 10.7
Gain on sale of subsidiaries - - 21.6 - 21.6
Total revenues 189.6 186.9 209.6 138.4 724.5
Income from continuing operations 25.7 21.7 37.3 12.8 97.5
Extraordinary items (0.8) - - - (0.8)
Net income 24.9 21.7 37.3 12.8 96.7
Earnings (loss) per common share:
Basic:
Continuing operations $0.60 $0.50 $0.87 $0.30 $2.27
Extraordinary items (0.02) - - - (0.02)
Net income $0.58 $0.50 $0.87 $0.30 $2.25
Diluted:
Continuing operations $0.59 $0.49 $0.85 $0.30 $2.23
Extraordinary items (0.02) - - - (0.02)
Net income $0.57 $0.49 $0.85 $0.30 $2.21
Average common shares outstanding
Basic 43.1 43.1 43.0 42.7 43.0
Diluted 43.8 43.9 43.7 43.4 43.7
1997
Realized gains (losses) on
sales of investments $ 0.3 ($ 0.1) $ 1.5 $ 3.5 $ 5.2
Total revenues 149.7 154.5 161.7 168.3 634.2
Income from continuing operations 18.0 17.7 16.4* 19.3 71.4
Extraordinary items - - (1.5) - (1.5)
Net income 18.0 17.7 14.9* 19.3 69.9
Earnings (loss) per common share:
Basic:
Continuing operations $0.39 $0.41 $0.38* $0.45 $1.63
Extraordinary items - - (0.03) - (0.03)
Net income $0.39 $0.41 $0.35* $0.45 $1.60
Diluted:
Continuing operations $0.39 $0.41 $0.37* $0.44 $1.61
Extraordinary items - - (0.03) - (0.03)
Net income $0.39 $0.41 $0.34* $0.44 $1.58
Average common shares outstanding
Basic 43.2 43.2 43.2 43.2 43.2
Diluted 43.4 43.6 43.8 43.8 43.7
* In the third quarter of 1997, AAG recorded a $4 million ($2.6
million after-tax) charge relating to the relocation of Loyal American Life
Insurance Company (a wholly-owned subsidiary of AAG) from Mobile, Alabama to
Cincinnati, Ohio. Excluding this charge, third quarter 1997 basic and
diluted earnings per share would have been $0.06 higher.
F-23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. Financial Statements are Included in Part II, Item 8.
2. Financial Statement Schedules:
Selected Quarterly Financial Data is included in Note Q to the
Consolidated Financial Statements.
Schedules filed herewith:
For 1998, 1997 and 1996 Page
II - Condensed Financial Information of Registrant S-2
All other schedules for which provisions are made in the
applicable regulation of the Securities and Exchange
Commission have been omitted as they are not applicable, not
required, or the information required thereby is set forth in
the Financial Statements or the notes thereto.
3. Exhibits - See Exhibit Index on Page E-1.
(b) Report on Form 8-K:
Date of Report Items Reported
October 15, 1998 Sale of Funeral Services Division
S-1
AMERICAN ANNUITY GROUP, INC. - PARENT ONLY
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In millions)
Condensed Balance Sheet
December 31,
Assets: 1998 1997
Investments:
Fixed maturities:
Available for sale - at market
(amortized cost - $68.7 and $61.3) $ 67.6 $ 62.5
Equity securities - at market
(cost - $1.9 and $11.5) 1.9 11.5
Investment in affiliate 24.8 -
Cash and short-term investments 3.6 3.6
Investment in subsidiaries (a) 512.0 396.0
Note receivable from AAG Holding 115.0 115.7
Other assets 16.5 53.9
$741.4 $643.2
Liabilities and Capital:
Accounts payable, accrued expenses and
other liabilities $ 22.3 $ 24.3
Payables to affiliates 29.2 33.7
Notes payable 1.2 1.3
Stockholders' equity (b) 688.7 583.9
$741.4 $643.2
Condensed Income Statement
Year ended December 31,
1998 1997 1996
Revenues:
Net investment income and other income $ 37.5 $ 34.1 $ 10.6
Realized gains (losses) on sales of
investments (1.5) 0.1 -
Gain on sale of subsidiaries 4.6 - -
Equity in net loss of affiliate (4.4) - -
Equity in undistributed earnings of
subsidiaries 72.7 (92.9) 47.6
Capital distributions from subsidiaries 50.6 181.1 61.2
159.5 122.4 119.4
Costs and Expenses:
Interest and other financing expenses 0.1 0.2 15.2
Provision for relocation expenses - 4.0 -
Other expenses 15.9 14.0 25.7
16.0 18.2 40.9
Income from continuing operations before
income taxes 143.5 104.2 78.5
Provision for income taxes 46.0 32.8 17.4
Income from continuing operations 97.5 71.4 61.1
Extraordinary items, net of tax (0.8) (1.5) (6.0)
Net Income $ 96.7 $ 69.9 $ 55.1
(a) Includes unrealized gains of $160.8 million and $132.4 million in
1998 and 1997, respectively.
(b) Includes unrealized gains of $160.1 million and $133.2 million in 1998
and 1997, respectively.
S-2
AMERICAN ANNUITY GROUP, INC. - PARENT ONLY
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In millions)
Condensed Statement of Cash Flows
Year Ended December 31,
1998 1997 1996
Operating Activities:
Net income $ 96.7 $ 69.9 $55.1
Adjustments:
Extraordinary items 0.8 1.5 6.0
Equity in net earnings of subsidiaries (76.6) (58.8) (70.8)
Realized gains on investing activities 1.5 (0.1) -
Gain on sale of subsidiaries (4.6) - -
Depreciation and amortization 1.4 2.2 1.6
Decrease (increase) in other assets 1.1 (1.9) (8.5)
Increase (decrease) in balances with
affiliates (5.1) 9.5 (26.5)
Increase (decrease) in other liabilities (3.4) (11.2) 0.1
Capital distributions from subsidiaries 8.9 181.2 61.2
Contributions to subsidiaries (61.6) (3.1) (12.7)
Other, net 6.2 (0.7) 1.3
(34.7) 188.5 6.8
Investing Activities:
Purchase of investments (59.9) (104.8) -
Decrease (increase) in intercompany notes 13.3 0.7 (46.9)
Purchase of subsidiaries - (51.7) -
Maturities and redemptions of fixed maturity
investments 51.4 0.5 -
Sales of investments 38.2 22.0 -
Sale of subsidiaries 10.6 - -
Sales of real estate and other assets - - 0.2
53.6 (133.3) (46.7)
Financing Activities:
Additions to notes payable - - 87.7
Reductions of notes payable (0.1) (0.1) (74.8)
Issuance of Common Stock 0.4 - -
Retirement of Common Stock (14.9) (1.1) -
Issuance of Preferred Stock - - 32.0
Retirement of Preferred Stock - (47.0) -
Cash dividends paid (4.3) (5.3) (4.5)
(18.9) (53.5) 40.4
Net Increase (Decrease) in Cash and
Short-term Investments - 1.7 0.5
Cash and short-term investments at beginning
of period 3.6 1.9 1.4
Cash and short-term investments
at end of period $ 3.6 $ 3.6 $ 1.9
S-3
AMERICAN ANNUITY GROUP, INC.
INDEX TO EXHIBITS
Number Exhibit Description
3.1 Certificate of Incorporation of Registrant
3.2 By-laws of Registrant
4 Registrant has no outstanding debt issues exceeding 10% of the
assets of Registrant and consolidated subsidiaries.
10.1 Agreement of Allocation of Payment of Federal Income Taxes
("American Annuity Tax Allocation Agreement"), dated December 31,
1992, between American Financial Corporation and the Registrant
incorporated herein by reference to Exhibit 10.12 to the
Registrant's Registration Statement on Form S-2 dated January 7,
1993.
10.2 Assignment of Tax Allocation Payments dated December 31, 1992,
between American Financial Corporation and the Registrant
incorporated herein by reference to Exhibit 10.15 to the
Registrant's Registration Statement on Form S-2 dated January 7,
1993.
10.3 Agreement for the Allocation of Federal Income Taxes dated May 13,
1974, between American Financial Corporation and Great American Life
Insurance Company, as supplemented on January 1, 1987 incorporated
herein by reference to Exhibit 10.16 to the Registrant's
Registration Statement on Form S-2 dated January 7, 1993.
10.4 Investment Services Agreement, dated December 31, 1992, between
Great American Life Insurance Company and American Money Management
Corporation incorporated herein by reference to Exhibit 10.17 to the
Registrant's Registration Statement on Form S-2 dated January 7,
1993.
10.5 Common Stock Registration Agreement, dated December 31, 1992,
between the Registrant and American Financial Corporation and its
wholly owned subsidiary Great American Insurance Company
incorporated herein by reference to Exhibit 10.22 to the
Registrant's Registration Statement on Form S-2 dated January 7,
1993.
10.6 Common Stock Registration Agreement, dated December 31, 1992 between
Chiquita Brands International, Inc. and Great American Life
Insurance Company incorporated herein by reference to Exhibit 10.24
to the Registrant's Registration Statement on Form S-2 dated January
7, 1993.
12 Earnings to fixed charges.
21 Subsidiaries of the Registrant.
23 Consent of Independent Auditors.
27.1 Financial Data Schedule for 1998 - included in Report filed
electronically with the Securities and Exchange Commission.
27.2 Restated Financial Data Schedule for nine months ended September 30,
1997 - included in Report filed electronically with the Securities
and Exchange Commission.
E-1
Signatures
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, American Annuity Group, Inc. has duly caused this
Report to be signed on its behalf by the undersigned, duly authorized.
American Annuity Group, Inc.
Signed: March 30, 1999 BY:s/CARL H. LINDNER
Carl H. Lindner
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated:
Signature Capacity Date
s/CARL H. LINDNER Chairman of the Board March 30, 1999
Carl H. Lindner of Directors
s/S. CRAIG LINDNER Director March 30, 1999
S. Craig Lindner
s/ROBERT A. ADAMS Director March 30, 1999
Robert A. Adams
s/WILLIAM R. MARTIN Director March 30, 1999
William R. Martin*
s/JOHN T. LAWRENCE, III Director March 30, 1999
John T. Lawrence, III
s/WILLIAM J. MANEY Senior Vice President, March 30, 1999
William J. Maney Treasurer and Chief
Financial Officer
(Principal Accounting Officer)
* Chairman of Audit Committee