SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
September 30, 1999 No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of November 1, 1999, there were 42,372,312 shares of the Registrant's
Common Stock outstanding.
Page 1 of 21
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
September 30, December 31,
1999 1998
Assets
Investments:
Fixed maturities - at market
(amortized cost - $5,936.6 and $5,782.8) $5,896.6 $6,023.1
Equity securities - at market
(cost - $42.8 and $46.7) 74.0 85.2
Investment in affiliate 15.7 15.9
Mortgage loans on real estate 17.9 40.1
Real estate 72.0 55.1
Policy loans 217.2 220.5
Short-term investments 79.3 73.6
Total investments 6,372.7 6,513.5
Cash 36.0 59.4
Accrued investment income 96.4 97.6
Unamortized insurance acquisition costs, net 317.4 247.4
Other assets 210.3 152.5
Assets held in separate accounts 243.4 120.0
$7,276.2 $7,190.4
Liabilities and Capital
Annuity benefits accumulated $5,473.6 $5,449.6
Life, accident and health reserves 369.4 341.6
Notes payable 199.5 131.0
Payable to affiliates, net 71.2 54.1
Deferred taxes on unrealized gains (losses) (0.9) 84.3
Accounts payable, accrued expenses and other
liabilities 127.3 96.1
Liabilities related to separate accounts 243.4 120.0
Total liabilities 6,483.5 6,276.7
Mandatorily redeemable preferred securities
of subsidiary trusts 219.6 225.0
Stockholders' Equity:
Common Stock, $1 par value
-100,000,000 shares authorized
- 42,392,953 and 42,576,933 shares
outstanding 42.4 42.6
Capital surplus 350.0 354.1
Retained earnings 183.4 131.9
Unrealized gains (losses) on marketable
securities, net (2.7) 160.1
Total stockholders' equity 573.1 688.7
$7,276.2 $7,190.4
2
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
Revenues:
Life, accident and health premiums $ 26.4 $ 50.4 $ 77.4 $145.7
Net investment income 128.7 129.8 371.5 387.7
Realized gains (losses) on sales of
investments (5.9) 4.0 (4.2) 15.7
Gain on sale of subsidiaries - 21.6 - 21.6
Equity in net earnings
(loss) of affiliate (1.6) (0.6) 0.3 4.0
Other income 6.7 5.2 14.4 14.0
154.3 210.4 459.4 588.7
Costs and Expenses:
Annuity benefits 66.4 64.5 195.0 204.7
Life, accident and health benefits 17.3 40.5 52.2 115.2
Insurance acquisition expenses 11.2 19.5 29.9 49.4
Trust preferred distribution requirement 4.7 4.8 13.9 14.3
Interest and other debt expenses 3.4 2.8 8.5 8.0
Other expenses 29.3 23.3 78.9 71.7
132.3 155.4 378.4 463.3
Income before income taxes, extraordinary
item and cumulative effect of
accounting change 22.0 55.0 81.0 125.4
Provision for income taxes 6.6 17.7 24.8 40.7
Income before extraordinary item and
cumulative effect of accounting change 15.4 37.3 56.2 84.7
Extraordinary item - loss on prepayment
of debt - - - (0.8)
Cumulative effect of accounting change - - (4.7) -
Net Income $ 15.4 $ 37.3 $ 51.5 $ 83.9
Average number of common shares:
Basic 42.4 43.0 42.4 43.1
Diluted 43.1 43.7 43.1 43.8
Basic earnings (loss) per common share:
Before extraordinary item and cumulative effect
of accounting change $0.36 $0.87 $1.32 $1.97
Loss on prepayment of debt - - - (0.02)
Cumulative effect of accounting change - - (0.11) -
Net income $0.36 $0.87 $1.21 $1.95
Diluted earnings (loss) per common share:
Before extraordinary item and cumulative effect
of accounting change $0.35 $0.85 $1.30 $1.93
Loss on prepayment of debt - - - (0.02)
Cumulative effect of accounting change - - (0.11) -
Net income $0.35 $0.85 $1.19 $1.91
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Nine months ended
September 30,
1999 1998
Common Stock:
Balance at beginning of period $ 42.6 $ 43.2
Common Stock retired (0.2) (0.4)
Balance at end of period $ 42.4 $ 42.8
Capital Surplus:
Balance at beginning of period $354.1 $368.0
Common Stock issued 0.5 0.4
Common Stock retired (4.6) (8.6)
Balance at end of period $350.0 $359.8
Retained Earnings:
Balance at beginning of period $131.9 $ 39.5
Net income 51.5 83.9
Balance at end of period $183.4 $123.4
Unrealized Gains (Losses), Net:
Balance at beginning of period $160.1 $133.2
Change during period (162.8) 23.8
Balance at end of period ($ 2.7) $157.0
Comprehensive Income (Loss):
Net income $ 51.5 $ 83.9
Other comprehensive income (loss) - change
in net unrealized gains (losses) on
marketable securities (162.8) 23.8
Comprehensive income (loss) ($111.3) $107.7
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Nine months ended
September 30,
1999 1998
Cash Flows from Operating Activities:
Net income $ 51.5 $ 83.9
Adjustments:
Extraordinary loss on prepayment of debt - 0.8
Cumulative effect of accounting change 4.7 -
Increase in life, accident and health
reserves 27.6 45.1
Benefits to annuity policyholders 195.0 204.7
Amortization of insurance acquisition costs 29.9 39.5
Equity in net earnings of affiliate (0.3) (4.0)
Depreciation and amortization 5.5 7.1
Gain on sale of subsidiaries - (21.6)
Realized (gains) losses on sales of
investments 4.2 (15.7)
Increase in insurance acquisition costs (87.0) (87.4)
Decrease (increase) in accrued investment
income 2.2 (3.6)
Increase in other assets (17.0) (24.8)
Increase in other liabilities 32.0 21.8
Other, net (11.6) (21.1)
236.7 224.7
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,081.4) (838.8)
Equity securities (6.3) (17.0)
Real estate, mortgage loans and other assets (38.8) (18.6)
Purchase of subsidiaries (47.7) (31.8)
Cash and short-term investments of acquired (sold)
subsidiaries 31.2 (18.2)
Maturities and redemptions of fixed maturity
investments 477.3 546.2
Sales of:
Subsidiaries - 164.6
Fixed maturity investments 492.9 268.3
Equity securities 10.5 5.1
Real estate, mortgage loans and other assets 39.3 22.5
Decrease in policy loans 3.3 0.8
(119.7) 83.1
Cash Flows from Financing Activities:
Fixed annuity receipts 330.7 358.7
Annuity surrenders, benefits and withdrawals (524.1) (538.9)
Additions to notes payable 69.1 150.0
Reductions of notes payable (0.6) (125.9)
Issuance of Common Stock 0.5 0.4
Retirement of Common Stock (4.8) (9.0)
Repurchase of trust preferred securities (5.5) -
(134.7) (164.7)
Net increase (decrease) in cash and short-term
investments (17.7) 143.1
Cash and short-term investments at
beginning of period 133.0 50.7
Cash and short-term investments at
end of period $115.3 $193.8
5
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Description of the Company
American Annuity Group, Inc. ("AAG" or "the Company") markets retirement
products, primarily fixed and variable annuities, and various forms of
life and supplemental health insurance through independent agents,
payroll deduction plans, financial institutions and in-home sales.
American Financial Group, Inc. ("AFG") and its subsidiaries owned 83% of
AAG's Common Stock at November 1, 1999.
B. Accounting Policies
Basis of Presentation The accompanying Consolidated Financial
Statements for AAG and its subsidiaries are unaudited, but management
believes that all adjustments (consisting only of normal recurring
accruals unless otherwise disclosed herein) necessary for fair
presentation have been made. The results of operations for interim
periods are not necessarily indicative of results to be expected for the
year. The financial statements have been prepared in accordance with
the instructions to Form 10-Q and therefore do not include all
information and footnotes necessary to be in conformity with generally
accepted accounting principles.
Certain reclassifications may have been made to prior periods to conform
to the current period's presentation. All acquisitions since the
acquisition of Great American Life Insurance Company ("GALIC"), AAG's
principal subsidiary, have been accounted for as purchases. All
significant intercompany balances and transactions have been eliminated.
The results of operations of companies since their formation or
acquisition are included in the consolidated financial statements.
The preparation of the financial statements requires management to make
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Changes in circumstances
could cause actual results to differ materially from those estimates.
Investments All fixed maturity securities are "available for sale" and
reported at fair value with unrealized gains and losses reported as a
separate component of stockholders' equity. 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.
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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.
Present Value of Future Profits Included in insurance acquisition costs
are amounts representing the present value of future profits on business
in force of acquired insurance companies, which represent the portion of
the costs to acquire such companies that is allocated to the value of
the right to receive future cash flows from insurance contracts existing
at the date of acquisition.
These amounts are amortized with interest over the estimated remaining
life of the acquired policies for annuities and universal life products
and over the expected premium paying period for traditional life and
health insurance products.
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,
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
mortality, morbidity and surrenders and include provisions for
unfavorable deviations. Reserves established for accident and health
claims are modified as necessary to reflect actual experience and
developing trends.
The liability for future policy benefits for interest sensitive life and
universal 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.
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 GALIC have separate tax allocation agreements with
American Financial Corporation ("AFC"), a subsidiary of AFG, which
designate how tax payments are shared by members of the tax group. In
general, both companies compute taxes on a separate return basis. GALIC
is obligated to make payments to (or receive benefits from) AFC based on
taxable income without regard to temporary differences. If GALIC's
taxable income (computed on a statutory accounting basis) exceeds a
current period net operating loss of AAG, the taxes payable by GALIC
associated with the excess are payable to AFC. If the AFC tax group
utilizes any of AAG's net operating losses or deductions that originated
prior to AAG's entering AFC's consolidated tax group, AFC will pay to
AAG an amount equal to the benefit received.
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.
8
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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 had been deferred by AAG and were being
amortized on a straight-line basis over five years. In 1999, AAG
implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs
of Start-Up Activities." The SOP requires that (i) costs of start-up
activities be expensed as incurred and(ii) unamortized balances of
previously deferred costs be expensed and reported as the cumulative
effect of a change in accounting principle. Accordingly, effective
January 1, 1999, AAG expensed previously capitalized start-up costs of
$4.7 million (net of tax) or $0.11 per diluted share.
Derivatives The Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities,"
during the second quarter of 1998. AAG must implement SFAS No. 133 by
no later than January 1, 2001. 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 in the balance sheet
of all derivatives (both assets and liabilities) 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.
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.
Comprehensive Income Comprehensive income represents 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.
Statement of Cash Flows For cash flow purposes, "investing activities"
are defined as making and collecting loans and acquiring and disposing
of debt or equity instruments and property and equipment. "Financing
activities" include annuity receipts, benefits and withdrawals and
obtaining resources from owners and providing them with a return on
their investments. All other activities are considered "operating."
Short-term investments having original maturities of three months or
less when purchased are considered to be cash equivalents for purposes
of the financial statements.
9
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
C. Acquisitions and Sale of Subsidiaries
In July 1999, AAG acquired Consolidated Financial Corp., an insurance
agency, for approximately $21 million in cash.
In February 1999, AAG acquired Old Republic Life Insurance Company of
New York for approximately $27 million in cash.
In September 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.
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 the first nine
months of 1999. No other state accounted for more than 10% of premiums.
Sales from AAG's top two Managing General Agencies accounted for 10% and
4% of retirement annuity premiums in the first nine months of 1999.
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 the first nine months of 1999.
Corporate and other consists primarily of AAG (parent), AAG Holding and,
in 1998, the Funeral Services Division.
In the first quarter of 1999, 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.
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The following tables (in millions) show AAG's revenues and operating
profit (loss) by significant business segment.
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
Revenues
Retirement annuities $123.4 $110.3 $349.5 $330.4
Life, accident & health 34.3 32.3 102.0 94.0
Corporate and other 4.1 42.8 11.8 123.0
Total operating revenues 161.8 185.4 463.3 547.4
Realized gains (losses) (5.9) 4.0 (4.2) 15.7
Gain on sale of subsidiaries - 21.6 - 21.6
Equity in results of affiliate (1.6) (0.6) 0.3 4.0
Total revenues per income
statement $154.3 $210.4 $459.4 $588.7
Operating profit (loss) - pretax
Retirement annuities $ 33.5 $ 29.7 $ 94.1 $ 85.0
Life, accident & health 2.6 4.1 12.0 12.8
Corporate and other (6.6) (3.8) (21.2) (13.7)
Pretax earnings from
operations 29.5 30.0 84.9 84.1
Realized gains (losses) (5.9) 4.0 (4.2) 15.7
Gain on sale of subsidiaries - 21.6 - 21.6
Equity in results of affiliate (1.6) (0.6) 0.3 4.0
Total pretax income per income
statement $ 22.0 $ 55.0 $ 81.0 $125.4
E. Investments
"Investing activities" related to fixed maturity investments in AAG's
Statement of Cash Flows for the nine months ending September 30,
consisted of the following (in millions):
Held to Available
Maturity for Sale Total
1999
Purchases $ - ($1,081.4)($1,081.4)
Maturities and paydowns - 477.3 477.3
Sales - 492.9 492.9
1998
Purchases $ - ($838.8) ($838.8)
Maturities and paydowns 233.7 312.5 546.2
Sales 32.3 236.0 268.3
At September 30, 1999, AAG's fixed maturity portfolio was comprised of
corporate bonds (57%), mortgage-backed securities (32%), public
utilities (6%) and government securities (5%).
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
F. Investment in Affiliate
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares;
carrying value of $15.7 million at September 30, 1999) of the common
stock of Chiquita Brands International which is accounted for under the
equity method. AFG and its other subsidiaries own an additional 32%
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 $16
million at September 30, 1999 and $26 million at December 31, 1998.
Included in equity in Chiquita's earnings for the first nine months of
1998 is a $1.0 million gain attributable to Chiquita's issuance of
common stock.
G. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
September 30, December 31,
1999 1998
Deferred policy acquisition costs $404.7 $320.1
Present value of future profits acquired 55.4 59.9
Unearned revenues (142.7) (132.6)
$317.4 $247.4
H. Notes Payable
Notes payable consisted of the following (in millions):
September 30, December 31,
1999 1998
Direct obligations of AAG $ 2.2 $ 1.2
Obligations of AAG Holding (guaranteed by AAG):
6-7/8% Senior Notes due 2008 100.0 100.0
Bank Credit Line 95.0 27.0
Other subsidiary debt 2.3 2.8
Total $199.5 $131.0
AAG Holding has a floating rate revolving credit agreement with several
banks under which it may borrow a maximum of $200 million through
September 29, 2000. The maximum amount available reduces quarterly
between September 30, 2000 and December 31, 2003. At September 30,
1999, and December 31, 1998, the weighted-average interest rate on
amounts borrowed under the bank credit line was 5.89% and 6.09%,
respectively.
In February 1998, AAG Holding borrowed $50 million under the 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 due 2008 and used the net proceeds to
repay outstanding indebtedness under the bank credit line.
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
At September 30, 1999, scheduled principal payments on debt for the
remainder of 1999 and the subsequent five years were as follows (in
millions):
1999 2000 2001 2002 2003 2004
$0.2 $0.9 $0.7 $35.7 $60.6 $0.2
I. Mandatorily Redeemable Preferred Securities of Subsidiary Trusts
Wholly owned subsidiary trusts of AAG Holding issued $225 million of
preferred securities and, in turn, purchased a like amount of AAG
Holding subordinated debt which provides 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 Issue Redemption
Issuance (Maturity Date) 9/30/99 12/31/98 Dates
November
1996 9-1/4% TOPrS* (2026) $74,600,000 $75,000,000 On or after
11/7/2001
March
1997 8-7/8% Preferred
Securities (2027) 70,000,000 75,000,000 On or after
3/1/2007
May
1997 7-1/4% ROPES** (2041) 75,000,000 75,000,000 Prior to
9/28/2000 and
after
9/28/2001
* Trust Originated Preferred Securities
** Remarketed Par Securities
In the first quarter of 1999, AAG repurchased $5.4 million of its preferred
securities for $5.5 million in cash.
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.
At September 30, 1999, 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.
The change in net unrealized gains on marketable securities for the
nine months ended September 30 included the following (in millions):
1999
Pretax Taxes Net
Unrealized holding gains
(losses) on securities
arising during the period ($253.4) $87.1 ($166.3)
Reclassification adjustment
for investment losses (gains)
realized in net income
and unrealized gains of
subsidiaries sold 5.4 (1.9) 3.5
Change in net unrealized gains
(losses) on marketable securities ($248.0) $85.2 ($162.8)
1998
Pretax Taxes Net
Unrealized holding gains
(losses) on securities
arising during the period $65.0 ($21.2) $43.8
Reclassification adjustment
for investment losses (gains)
realized in net income
and unrealized gains of
subsidiaries sold (30.7) 10.7 (20.0)
Change in net unrealized gains
(losses) on marketable securities $34.3 ($10.5) $23.8
13
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
K. Earnings Per Share
The number of common shares outstanding used in calculating diluted
earnings per share in both the third quarter and first nine months
of 1999 and 1998 includes 0.7 million shares respectively, for the
effect of the assumed exercise of AAG's outstanding stock options.
L. Contingencies
There have been no significant changes to the matters discussed and
referred to in "Legal Proceedings" in Part II of AAG's June 30,
1999, Form 10-Q and Note N "Contingencies" in AAG's Annual Report on
Form 10-K for 1998.
M. Additional Information
Statutory Information of Great American Life Insurance
Company Insurance companies are required to file financial
statements with state insurance regulatory authorities
prepared on an accounting basis prescribed or permitted by
such authorities (statutory basis). Certain statutory
amounts for GALIC, AAG's primary insurance subsidiary, were
as follows (in millions):
September 30, December 31,
1999 1998
Capital and surplus $363.0 $350.4
Asset valuation reserve 66.4 62.6
Interest maintenance reserve 12.2 20.6
Nine months ended September 30,
1999 1998
Pretax income from operations $38.3 $106.0
Net income from operations 29.5 94.3
Net income 29.7 29.8
The amount of dividends which can be paid by GALIC without prior
approval of regulatory authorities is subject to restrictions
relating to capital and surplus and statutory net income. Based
on net income for the year ended December 31, 1998, GALIC may pay
$35.6 million in dividends in 1999 without prior approval.
N. Subsequent Event
In October 1999, AAG acquired United Teacher Associates
Insurance Company ("UTA") for $81 million in cash, subject
to post-closing adjustments. UTA provides retired and
active teachers with supplemental health products and
retirement annuities, and purchases blocks of insurance
policies from other insurance companies. Premiums in 1998
were approximately $85 million and statutory assets were
approximately $210 million as of December 31, 1998.
14
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
American Annuity Group, Inc. ("AAG" or "the Company") and its subsidiary,
AAG Holding Company, Inc., are organized as holding companies with nearly
all of their operations being conducted by their subsidiaries. These
companies, however, have continuing expenditures for administrative
expenses, corporate services, satisfaction of liabilities in connection with
discontinued operations and for the payment of interest and principal on
borrowings and stockholder dividends.
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 monthly 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. These groups have completed virtually all of the
tests to be performed and are now engaged primarily in test documentation
activities.
Operating units have communicated with agents, vendors and financial
institutions and developed contingency plans based on information obtained.
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 has substantially completed its
contingency planning for all mission critical software applications and
operational processes. These plans will be tested through the balance of
the year.
Many of the systems which have been or are 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 $24 million in Year 2000 costs, including capitalized
costs of $14 million for new systems; the Company expensed $1.1 million in
Year 2000 costs in the first nine months of 1998 and $5.9 million in the
comparable 1999 period. AAG estimates it will spend an additional $2
million in connection with the Year 2000 Project during the remainder of
1999, of which $1 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.
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 fail to function as expected, the resulting
disruptions could have a material adverse impact on operations. AAG's
operations could be materially adversely affected by the inability of the
computer systems of third parties such as agents, vendors and policyholders'
employers to function properly in the Year 2000.
IT Initiative In the third quarter of 1999, AFG's newly hired Chief
Information Officer initiated an enterprise-wide study of its Information
Technology ("IT") resources, needs and opportunities (including those of
AAG). AAG expects that the initiative will entail extensive effort and
costs and may lead to substantial changes in the area, which should result
in significant cost savings, efficiencies and effectiveness in the future.
While the costs (most of which will be expensed) will precede any savings to
be realized, management expects benefits to greatly exceed the costs
incurred, all of which will be funded through available working capital.
Forward-Looking Statements The Private Securities Litigation Reform Act of
1995 encourages corporations to provide investors with information about the
Company's anticipated performance and provides protection from liability if
future results are not the same as management's expectations. This document
contains certain forward-looking statements that are based on assumptions
which management believes are reasonable, but, by their nature, inherently
uncertain. Future results could differ materially from those projected.
Factors that could cause such differences include, but are not limited to:
changes in economic conditions, regulatory actions, the Year 2000 issue and
competitive pressures. AAG undertakes no obligation to update any forward-
looking statements.
LIQUIDITY AND CAPITAL RESOURCES
Ratios AAG's ratio of earnings to fixed charges continues to exceed 4
times; its consolidated debt to capital ratio is 28%. Consolidated debt
includes the Company's notes payable and its Remarketed Par Securities
("ROPES"). Capital represents the sum of consolidated debt, redeemable
preferred securities of subsidiary trusts and stockholders' equity
(excluding unrealized gains (losses) on marketable securities).
The National Association of Insurance Commissioners' ("NAIC") risk-based
capital ("RBC") formulas determine the amount of capital that an insurance
company needs to ensure that it has an acceptable expectation of not
becoming financially impaired. At September 30, 1999, the capital ratio of
each of AAG's principal insurance subsidiaries was at least 3.8 times its
authorized control level RBC.
Sources and Uses of Funds During 1999, AAG and its subsidiaries used bank
borrowings and cash on hand to make acquisitions totalling approximately
$130 million (including the October 1999 acquisition of United Teacher
Associates Insurance Company) and to repurchase $5 million of its preferred
securities and $5 million of Common Stock.
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, capital
distributions from their principal subsidiary, Great American Life Insurance
Company ("GALIC") and bank borrowings. At October 31, 1999, AAG (parent)
had over $100 million available under its bank credit line. The amount of
capital distributions which can be paid by GALIC is subject to
restrictions relating to statutory surplus and earnings. The maximum amount
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
of dividends payable by GALIC during the remainder of 1999 without prior
regulatory approval is $35.6 million.
Based upon the current level of operations and anticipated growth, AAG
believes that it will have sufficient resources to meet its liquidity
requirements.
Investments AAG invests primarily in fixed income investments which,
including loans and short-term investments, comprised 98% of its investment
portfolio at September 30, 1999. 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.
The NAIC assigns quality ratings to publicly traded as well as privately
placed securities. At September 30, 1999, 91% 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.
At September 30, 1999, 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.
RESULTS OF OPERATIONS
General In September 1998, AAG sold its Funeral Services Division.
Accordingly, certain 1999 income statement components are not comparable to
1998.
Pretax earnings from operations (before realized gains (losses), equity in
results of affiliate, extraordinary item and accounting change) for the
third quarter and first nine months of 1999 were $29.5 million and $84.9
million, respectively, compared to $30.0 and $84.1 million for the same
periods in 1998. On a diluted basis, net earnings from operations (before
realized gains (losses), equity in results of affiliate, extraordinary item
and accounting change) for the same periods were $0.47 per share and $1.36
per share, respectively, compared to $0.47 per share and $1.30 per share.
Retirement Products The following table summarizes AAG's premiums for its
retirement annuities (in millions).
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
Retirement Annuity Premiums:
Single premium deferred annuities $ 61 $ 72 $172 $194
Flexible premium deferred annuities 28 33 110 127
Single premium variable annuities 42 21 115 50
Flexible premium variable annuities 11 6 35 14
Total $142 $132 $432 $385
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Sales of annuity products linked to the performance of the stock market
(equity-indexed and variable annuities) helped offset a decrease in sales of
traditional fixed annuities.
Life, Accident and Health Premiums The following table summarizes AAG's
life, accident and health premiums as shown in the Consolidated Income
Statement (in millions).
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
Life, Accident and Health Premiums:
Life insurance $18 $12 $53 $ 44
Accident and health insurance 8 11 24 23
26 23 77 67
Funeral Services Division - 28 - 79
$26 $51 $77 $146
Net Investment Income Net investment income decreased 1% in the third
quarter and 4% in the first nine months of 1999 compared to the same periods
in 1998 resulting primarily from less invested assets due to the sale of the
Funeral Services Division.
Realized Gains Individual securities are sold from time to time as market
opportunities appear to present optimal situations under AAG's investment
strategies.
Equity in Net Earnings of Affiliate Equity in net earnings of affiliate
represents AAG's proportionate share of the results of Chiquita Brands
International. Chiquita reported net income (loss) for the third quarter
and first nine months of 1999 of ($37 million) and $19 million,
respectively, compared to ($11 million) and $83 million for the same periods
in 1998. Included in equity in Chiquita's first nine months of 1998
earnings are gains attributable to Chiquita's issuance of common stock.
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% or 4% per annum). As a result,
management has been able to react to changes in market interest rates and
maintain a desired interest rate spread.
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.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Insurance Acquisition Expenses Insurance acquisition expenses include
amortization of deferred policy acquisition costs ("DPAC") as well as
certain marketing expenses and commissions on sales of life insurance
products. Insurance acquisition expenses also include amortization of the
present value of future profits of businesses acquired. The decrease in
both the third quarter and first nine months of 1999 compared to the same
periods in 1998 reflects primarily the sale of the Funeral Services
Division.
Interest and Other Debt Expenses Interest and other debt expenses
increased 21% in the third quarter and 6% in the first nine months of 1999
compared to the same periods in 1998 due primarily to higher average
borrowings outstanding.
Other Expenses Other expenses reflect (i) higher personnel costs and
consulting expenses (related primarily to expanded Year 2000 testing) and
(ii) increased costs associated with new business initiatives; these
increases in 1999 were offset by the absence of expenses resulting from the
sale of the Funeral Services Division.
Extraordinary Item Extraordinary item reflects AAG's losses, net of tax,
on retirements of its debt.
Accounting Change In the first quarter of 1999, AAG implemented Statement
of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities."
The SOP requires that costs of start-up activities be expensed as incurred
and that unamortized balances of previously deferred costs be expensed and
reported as the cumulative effect of a change in accounting principle.
Accordingly, AAG expensed previously capitalized start-up costs of $4.7
million (net of tax) in the first quarter of 1999.
19
AMERICAN ANNUITY GROUP, INC. 10-Q
ITEM 3
Qualitative and Quantitative Disclosure About Market Risk
The tables below show scheduled principal payments (in millions) on fixed-
rate and variable-rate long-term debt of AAG and its subsidiaries and
related average interest rates as of September 30, 1999 and December 31,
1998.
September 30, 1999
Fixed-Rate Debt Variable-Rate Debt
Weighted Weighted
Scheduled Average Scheduled Average
Principal Interest Principal Interest
Payments Rate Payments Rate
1999 (remainder) $ 0.2 4.43% $ - - %
2000 0.9 4.42 - -
2001 0.7 4.57 - -
2002 0.7 4.65 35.0 5.89
2003 0.6 4.36 60.0 5.89
2004 0.2 4.32 - -
Thereafter 101.2 6.86 - -
Total $104.5 6.78% $95.0 5.89%
Market Value $ 97.6 $95.0
December 31, 1998
Fixed-Rate Debt Variable-Rate Debt
Weighted Weighted
Scheduled Average Scheduled Average
Principal Interest Principal Interest
Payments Rate Payments Rate
1999 $ 0.8 4.48% $ - - %
2000 0.8 4.49 - -
2001 0.6 4.70 - -
2002 0.5 4.83 - -
2003 0.5 4.46 27.0 6.09
Thereafter 100.8 6.86 - -
Total $104.0 6.79% $27.0 6.09%
Market Value $103.4 $27.0
As of September 30, 1999, there were no material changes to the other
information provided in AAG's Form 10-K for 1998 under the caption "Exposure
to Market Risk" in Management's Discussion and Analysis of Financial
Condition and Results of Operations.
20
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of September 30, 1999. For
submission in electronic filing only.
(b) Report on Form 8-K - None
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned duly authorized.
American Annuity Group, Inc.
November 12, 1999 BY:/s/William J. Maney
William J. Maney
Executive Vice President, Treasurer
and Chief Financial Officer
21