1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-11733
AMERICAN STATES FINANCIAL CORPORATION
INDIANA NO. 35-1976549
State of Incorporation I.R.S. Employer Identification No.
500 NORTH MERIDIAN STREET
INDIANAPOLIS , INDIANA 46204 - 1275 (317) 262-6262
Address of principal executive offices Telephone Number
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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Shares of common stock outstanding as of November 8, 1996: 60,050,515
The exhibit index to this report is located on page 23.
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PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December, 31
1996 1995
------------- ------------
(Dollars in Thousands)
ASSETS
Investments:
Securities available-for-sale at fair value:
Fixed maturity (amortized cost: 1996 - $3,547,132; 1995 - $3,590,601) $3,688,524 $3,860,883
Equity (cost: 1996 - $351,405; $1995 - $374,232) 411,913 437,685
Mortgage loans 33,524 33,319
Short-term investments 109,752 63,170
Other invested assets 37,397 35,178
---------- ----------
Total investments 4,281,110 4,430,235
Cash 21,047 12,708
Premium receivable 417,566 377,802
Deferred policy acquisition costs 208,754 199,192
Properties to be sold 31,377 41,403
Property and equipment 31,168 29,823
Accrued investment income 57,205 66,173
Federal income taxes 149,004 93,552
Cost in excess of net assets of acquired subsidiaries 98,627 101,190
Ceded reinsurance on claims and claims expense reserves 172,002 136,939
Miscellaneous 56,635 43,073
---------- ----------
Total Assets $5,524,495 $5,532,090
========== ==========
(continued on next page)
See accompanying notes to consolidated financial statements.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
September 30, December, 31
1996 1995
------------ ------------
(Dollars in Thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Losses, loss adjustment expense and future policy benefits $2,897,081 $2,828,337
Unearned premiums 732,477 718,478
---------- ----------
Total policy liabilities and accruals 3,629,558 3,546,815
Commissions and other expenses 112,301 134,031
Outstanding checks 65,103 67,308
Other liabilities 155,946 115,229
Notes payable 99,462 -
Debt with affiliate 200,000 -
---------- ----------
Total liabilities 4,262,370 3,863,383
Shareholders' equity:
Common stock, no par value: 195,000,000 shares authorized, shares issued
and outstanding: 1996 - 60,050,515; 1995 - 50,000,000 304,792 387,547
Net unrealized gain on securities available-for-sale 129,439 211,767
Retained earnings 827,894 1,069,393
---------- ----------
Total shareholders' equity 1,262,125 1,668,707
---------- ----------
Total liabilities and shareholders' equity $5,524,495 $5,532,090
========== ==========
See accompanying notes to consolidated financial statements.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
--------- --------- ---------- ----------
(Dollars in Thousands,
Except Per Share Data)
Revenue:
Premiums and other revenue $407,067 $446,324 $1,255,544 $1,316,571
Net investment income 67,031 66,460 201,520 200,112
Realized gain on investments 2,531 7,742 31,001 41,213
---------- ---------- ---------- ----------
Total revenue 476,629 520,526 1,488,065 1,557,896
Benefits and expenses:
Benefits and settlement expenses 299,874 308,939 955,779 973,589
Commissions 67,491 74,444 211,873 218,868
Operating and administrative expenses 49,458 52,586 151,682 168,622
Taxes, licenses and fees 8,927 12,165 29,167 34,283
Interest on debt 5,283 - 7,118 -
---------- ---------- ---------- ----------
Total benefits and expenses 431,033 448,134 1,355,619 1,395,362
Income before federal income taxes 45,596 72,392 132,446 162,534
Federal income taxes 5,167 13,521 15,345 21,401
---------- ---------- ---------- ----------
Net income $ 40,429 $ 58,871 $ 117,101 $ 141,133
========== ========== ========== ==========
Net income per share $ .67 $ 1.18 $ 2.14 $ 2.82
========== ========== ========== ==========
Weighted average shares outstanding 60,050,515 50,000,000 54,601,884 50,000,000
========== ========== ========== ==========
Dividends per share of common stock:
Declared $ .21 $ - $ .21 $ -
Paid .21 - .21 -
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Nine Months Ended
September 30,
1996 1995
----------- -----------
(Dollars in Thousands)
Common stock:
Balance at beginning of period $ 387,547 $ 387,547
Issued in stock offering 215,482 -
Issued to employee benefit plans 1,161 -
Assumption and issuance of debt with affiliate (299,398) -
----------- -----------
Balance at end of period 304,792 387,547
Net unrealized gain (loss) on securities available-for-sale:
Balance at beginning of period 211,767 (9,110)
Change during the period (82,328) 190,809
----------- -----------
Balance at end of period 129,439 181,699
Retained earnings:
Balance at beginning of period 1,069,393 1,090,129
Dividend of assets to affiliate (299,866) -
Cash dividends declared (58,734) (138,000)
Net income 117,101 141,133
----------- -----------
Balance at end of period 827,894 1,093,262
----------- -----------
Total shareholders' equity $ 1,262,125 $ 1,662,508
=========== ===========
See accompanying notes to consolidated financial statements.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
1996 1995
----------- -----------
(Dollars in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 117,101 $ 141,133
Adjustments to reconcile net income to cash provided by
operating activities:
Deferred policy acquisition costs (4,385) (7,517)
Premiums and fees in course of collection (39,764) (12,037)
Accrual of discount on investments (13,995) (12,697)
Amortization of premium on investments 3,943 5,345
Accrued investment income 4,537 15,755
Policy liabilities and accruals 56,113 11,426
Federal income taxes (11,120) 10,802
Provisions for depreciation 5,710 7,869
Gain on sale of investments (31,001) (41,213)
Ceded reinsurance on claims and claims expense reserves (35,063) (1,539)
Other (14,140) (9,682)
----------- ----------
Net adjustments (79,165) (33,488)
----------- ----------
Net cash provided by operating activities 37,936 107,645
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available-for-sale: Purchase of investments (1,020,063) (790,263)
Sales of investments 779,727 746,213
Maturities and redemptions 52,271 55,893
Purchase of mortgage loans and other investments (8,377) (8,278)
Sale or maturity of mortgage loans and other investments 5,930 25,390
Net (increase) decrease in short-term investments (46,582) 19,860
Net purchase of property and equipment 2,970 (3,765)
Other 21,149 3,582
----------- ----------
Net cash provided by (used in) investing activities (212,975) 48,632
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 215,482 -
Universal life investment contract deposits 36,328 35,050
Universal life investment contract withdrawals (9,698) (6,464)
Dividends paid (58,734) (183,000)
----------- ----------
Net cash provided by (used in) financing activities 183,378 (154,414)
----------- ----------
Net increase in cash 8,339 1,863
Cash at beginning of period 12,708 11,134
----------- ----------
Cash at end of period $ 21,047 $ 12,997
=========== ==========
See accompanying notes to consolidated financial statements.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following notes should be read in conjunction with the notes to
consolidated financial statements included in the American States Financial
Corporation prospectus dated May 22, 1996. Unless the context otherwise
indicates; (i) the "Company" refers to American States Financial Corporation and
its wholly-owned, consolidated subsidiaries; (ii) "ASI" refers to American
States Insurance Company, the Company's sole direct wholly-owned subsidiary, and
its consolidated subsidiaries; and (iii) the "Subsidiaries" refer to the direct
and indirect subsidiaries of the Company, which include ASI and its
subsidiaries. Operating results for the nine months ended September 30, 1996
are not necessarily indicative of the results that may be expected for the full
year ending December 31, 1996.
1. ORGANIZATION AND BASIS OF PRESENTATION
On February 5, 1996, the Company was incorporated in the State of Indiana
to serve as the holding company for ASI. The formation of the Company was done
in contemplation of an initial public offering. On April 22, 1996, ASI
declared, and on May 15, 1996, it distributed to its parent, Lincoln National
Corporation ("LNC"), a dividend of $300 million, consisting primarily of
tax-exempt securities ("Dividended Assets"). On May 16, 1996, LNC transferred
all of the outstanding shares of ASI to the Company in exchange for 50,000,000
shares of the Company's common stock. Concurrently with the transfer of the ASI
stock, the Company assumed $100 million of LNC debt ("Assumed Debt") and issued
a $200 million note to LNC (the "Term Note").
On May 29, 1996, the Company issued 10,000,000 shares of common stock at
$23 per share to the public (the "Offering"). The net proceeds from the
Offering (after deduction of underwriting discounts and offering expenses) were
$215.5 million. The Company contributed $140.5 million of such net proceeds to
ASI to enable it to invest in taxable securities for its investment portfolio to
partially replace the Dividended Assets. The remainder of the net proceeds were
retained by the Company for general corporate purposes. As a result of the
Offering, LNC's ownership was reduced to approximately 83%.
The 50,000,000 shares held by LNC are "restricted shares" as defined by
Rule 144 of the Securities Act of 1993, as amended (the "Securities Act"). Such
shares may not be resold in the absence of registration under the Securities Act
or exemptions from such registration, including, among others, the exemption
provided by Rule 144 under the Securities Act. As an affiliate of the Company,
LNC is subject to certain volume restrictions on the sale of shares of the
Company's common stock.
The Company's common stock is publicly traded on the New York Stock
Exchange under the symbol "ASX".
The transfer of ASI stock to the Company by LNC in exchange for Company
common stock and the Assumed Debt and Term Note have been accounted for similar
to a pooling of interests in the consolidated financial statements of the
Company, in that the assets, liabilities, shareholders' equity and the results
of operation of the Company and its subsidiaries have been combined at
historical carrying values.
The consolidated financial statements as of and for the three and nine
months ended September 30, 1996 and 1995, are unaudited. In the opinion of
management, these financial statements include all adjustments, consisting only
of normal recurring items, which are necessary to present fairly the Company's
financial position and results of operations on a basis consistent with that of
prior audited consolidated financial statements. The balance sheet at December
31, 1995, has been derived from the audited financial statements at that date
but does not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. Significant
intercompany balances and transactions have been eliminated. Certain amounts
from prior periods were reclassified to conform to the 1996 presentation. Net
income and shareholders' equity have not been affected by these
reclassifications.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND BASIS OF PRESENTATION (Continued)
The Company underwrites property and casualty insurance, concentrating on
providing commercial insurance to small to medium-sized businesses and
preferred personal lines coverages to individuals. As a complement to its
property and casualty operations, the Company also markets life insurance. The
Company writes business throughout the United States with the greatest volume
in the Midwest and Pacific Northwest.
2. FEDERAL INCOME TAXES
Through December 31, 1995, a consolidated federal income tax return was
filed by LNC and included the Company. Pursuant to an agreement with LNC, the
Company provided for income taxes on the basis of a separate return
calculation; however, certain deductions, credits, losses, and other items that
may be limited or not allowed on a separate return basis are allowed. The
taxes computed were remitted to or collected from LNC.
Effective January 1, 1996, a new tax sharing agreement was executed which
resulted in the Company providing income taxes on a stand-alone basis. The new
agreement would have had no impact on the provision for federal income taxes
for 1995 had it been implemented January 1, 1995.
The effective tax rate on pre-tax income is lower than the prevailing
corporate federal income tax rate primarily due to tax-exempt interest on
municipal securities.
3. NOTES PAYABLE AND DEBT WITH AFFILIATE
The Assumed Debt is governed by an agreement between the Company and LNC
(the "Assumption Agreement") which provides for the payment by the Company of
the currently outstanding 7 1/8% notes due July 15, 1999, originally issued to
the public by LNC on July 15, 1992. LNC will continue to be the primary
obligor of this public debt; however, pursuant to the Assumption Agreement,
the Company will make a $100 million principal payment on July 15, 1999 to
repay the holders of the public debt. The Assumption Agreement also provides
that interest at 7 1/8% is payable semi-annually by the Company.
The Term Note will pay interest quarterly at a rate of 50 basis points
over the rate on three year Treasury Notes from the Effective Date through and
including November 14, 1997, 50 basis points over the rate on two year Treasury
Notes from November 15, 1997 through and including November 14, 1998 and 50
basis points over the rate on one-year Treasury Bills from November 15, 1998
through the maturity date. The Term Note will be payable in three equal
principal payments due on August 15, 1997, 1998 and 1999. Pursuant to the
provisions on the Term Note, the Company will have the right to prepay the Term
Note at any time. The Term Note also contains covenants that will, among other
things, (i) require the Company to maintain certain levels of adjusted
consolidated net worth (as defined in the Term Note), and (ii) restrict the
ability of the Company to incur indebtedness in excess of 50% of its adjusted
consolidated net worth and to enter into a major corporate transaction unless
the Company is the survivor and would not be in default.
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AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. NOTES PAYABLE AND DEBT WITH AFFILIATE (Continued)
On May 29, 1996, the Company entered into a revolving credit agreement in
which the Company may borrow and repay amounts up to a maximum of $200 million
(the "Line of Credit"). Borrowings using the Line of Credit will bear interest
generally at variable rates tied to LIBOR, an adjusted certificate of deposit
rate or other short-term indices. No debt was outstanding using the Line of
Credit at September 30, 1996.
4. CONTINGENCIES
On February 14, 1996, three of the Company's property and casualty
insurance subsidiaries were among 23 underwriters of real property insurance
named defendants in a case alleging that their underwriting, sales and
marketing practices violated a number of civil rights laws (including, without
limitation, the Fair Housing Act). It was also alleged that the defendants'
actions constituted a civil conspiracy. Brought in the United States District
Court for the Western District of Missouri, the plaintiffs seeks to represent
themselves and a putative class of similarly situated persons in the State of
Missouri. This action seeks injunction relief, unspecified compensatory
damages, punitive damages and attorneys' fees. In response to motions filed by
the defendants, the court dismissed the conspiracy count by Order dated October
2, 1996 but has required that the defendants answer the remaining counts.
Management believes, based upon current information, that the Company's
underwriting, sales and marketing practices have complied in all material
respects with the applicable requirements of both state and federal law. The
Company intends to vigorously defend this action.
On August 29, 1996, the first two actions were brought in Missouri state
courts alleging that underinsured motorist insurance coverage sold in that
state by three of the Company's property and casualty insurance subsidies
constitutes "phantom coverage" when sold at limits equal to the state's
financial responsibility requirements. In both actions, the plaintiffs seek to
represent themselves and a putative class of similarly situated persons in the
state of Missouri. The actions seek both compensatory and punitive damages
based upon a number of legal theories, including, without limitation, breach of
fiduciary duty, negligence, breach of contract, unjust enrichment and
misrepresentation. While it is too early to fully evaluate the plaintiffs'
allegations, the potential defenses available or the size of the putative class
of plaintiffs, management does not believe, based upon current information,
that the allegations have merit and it therefore intends to defend this action
vigorously.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
Except for historical information contained herein, the discussion in this
Quarterly Report on Form 10-Q includes certain forward-looking statements based
upon management expectations. Factors which could cause future results to
differ from these expectations include the following: financial markets (e.g.
interest rates and securities markets), state and federal legislative and
regulatory initiatives, acts of God (e.g. hurricanes, earthquakes and storms),
other insurance risks and competition.
RESULTS OF OPERATION
Three Months Ended September 30, 1996 and 1995
The discussion which follows compares the results of the third quarter
ended September 30, 1996 to the third quarter ended September 30, 1995:
CONSOLIDATED
The Company's revenues decreased 8.4% or $43.9 million to $476.6 million
in the third quarter of 1996 from $520.5 million in the third quarter of 1995.
Net premiums earned and other revenue decreased 8.8% or $39.2 million to $407.1
million in the third quarter of 1996 from $446.3 million in the third quarter
of 1995. Net investment income increased 0.9% or $0.5 million to $67.0 million
in the third quarter of 1996 from $66.5 million in the third quarter of 1995.
Realized gains on investments decreased 67.3% or $5.2 million to $2.5 million
in the third quarter of 1996 from $7.7 million in the third quarter of 1995.
Benefits and settlement expenses decreased 2.9% or $9.0 million to $299.9
million in the third quarter of 1996 from $308.9 million in the third quarter
of 1995. Commissions decreased 9.3% or $6.9 million to $67.5 million in the
third quarter of 1996 from $74.4 million in the third quarter of 1995.
Operating and administrative expenses decreased 5.9% or $3.1 million to $49.5
million in the third quarter of 1996 from $52.6 million in the third quarter of
1995. The company incurred interest on debt of $5.3 million in the third
quarter of 1996 from the Assumed Debt and Term Note.
Net income for the third quarter of 1996 was $40.4 million or 67 cents per
share compared to $58.9 million or $1.18 per share for the third quarter of
1995. Excluding realized gain on investments, the Company earned $38.4 million
or 64 cents per share for the third quarter of 1996 compared to $53.5 million
or $1.07 per share for the third quarter of 1995.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
RESULTS OF OPERATION (Continued)
PROPERTY AND CASUALTY
The following table sets forth certain summarized financial data and key
operating ratios for the Company's property and casualty operations for the
quarters ended September 30, 1996 and 1995. All ratios are computed using data
reported in accordance with statutory accounting principles ("SAP").
Three Months Ended
September 30,
1996 1995
----------- -----------
(Dollars in Millions)
Net premiums written $394.1 $430.7
Net premiums earned and other revenue $392.2 $432.4
Losses and loss adjustment expense 287.5 295.5
Other costs and expenses 120.2 133.8
------ ------
Underwriting income (loss) (15.5) 3.1
Net investment income 57.6 58.2
Realized gain on investments 2.5 6.4
Federal income tax expense 4.9 12.0
------ ------
Net income $ 39.7 $ 55.7
====== ======
Loss ratio 61.0% 56.9%
Loss adjustment expense ratio 12.6 11.8
Underwriting expense ratio 30.3 30.6
Policyholder dividend ratio .1 .2
Combined ratio 104.0% 99.6%
Net Premiums Written
Net premiums written decreased 8.5% or $36.6 million to $394.1 million in
the third quarter of 1996 from $430.7 million in the third quarter of 1995. The
decline in net premiums written is largely attributable to three factors.
First, the Company has experienced a decline in premium volume from
state-mandated workers' compensation pools. Second, return premiums from a
retrospective rated policy written for LNC also has had an adverse premium
impact. Finally, the Company continues its planned reduction of exposure in
California and Florida. For the states of California and Florida, net premiums
written decreased by 27.4% in the third quarter of 1996 compared to the third
quarter of 1995. For all other states, net premiums written decreased by 6.5%
in the third quarter of 1996 compared to the third quarter of 1995.
Net Premiums Earned and Other Revenue
Net premiums earned and other revenue (primarily finance and service fees)
decreased 9.3% or $40.2 million to $392.2 million in the third quarter of 1996
from $432.4 million in the third quarter of 1995.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
RESULTS OF OPERATION (Continued)
Losses and Loss Adjustment Expense ("LAE")
Losses and LAE decreased 2.7% or $8.0 million to $287.5 million in the
third quarter of 1996 from $295.5 million in the third quarter of 1995. The
SAP loss ratio for the third quarter of 1996 was 61.0% compared to 56.9% for
the third quarter of 1995. The 4.1 point increase in the quarter was primarily
due to an increase in natural peril losses and upward pressure on the
underlying loss ratio as a result of unabated price competition in the
industry. Loss comparisons are further complicated by a lower level of
favorable loss reserve development. Favorable loss reserve development in the
third quarter of 1996 was approximately $8 million less, after tax, than the
unusually robust development experienced in the third quarter of 1995.
The SAP LAE ratio was 12.6% and 11.8% for the third quarter of 1996 and
1995, respectively. The increase in the SAP LAE ratio is due to LAE not
declining in step with the decline in net premiums earned.
Other Costs and Expenses
Other costs and expenses decreased 10.2% or $13.7 million to $120.1
million in the third quarter of 1996 from $133.8 million in the third quarter
of 1995. The realignment of field offices and implementation of internal cost
controls, announced in the fourth quarter of 1995, continued to produce 1996
expense savings in line with expectations. In addition, variable underwriting
expenses decreased with the decline in net premiums written. The SAP
underwriting expense ratio decreased by .3 points to 30.3%.
Combined Ratio
The SAP combined ratio, after policyholder dividends, was 104.0% and 99.6%
for the third quarter of 1996 and 1995, respectively. The increase in the SAP
combined ratio is primarily due to (i) an increase in natural peril losses (ii)
upward pressure on the underlying loss ratio as a result of unabated price
competition in the industry and (iii) a lower level of favorable loss reserve
development.
Net Investment Income
Net investment income decreased .9% or $.6 million to $57.6 million in the
third quarter of 1996 from $58.2 million in the third quarter of 1995. This
decrease is due primarily to a decline in total average invested assets caused
by the distribution of the Dividended Assets. The pre-tax yield on invested
assets (excluding realized and unrealized gains) was 6.5% and 6.3% for the
third quarters of 1996 and 1995, respectively.
Federal Income Tax Expense
Federal income tax expense was $4.9 for the third quarter of 1996 compared
to $12.0 million for the third quarter of 1995. The decrease in expense is due
primarily to poorer underwriting results.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
RESULTS OF OPERATION (Continued)
LIFE
The following table sets forth certain summarized financial data for the
Company's life insurance operations for the quarters ended September 30, 1996
and 1995.
Three Months Ended
September 30,
1996 1995
----------- -----------
(Dollars in Millions)
Account values - Universal life and Annuities $ 336.3 $ 308.2
Life insurance in-force 15,424.2 15,214.0
Invested assets (at amortized cost) 456.5 435.2
Policy income $ 14.9 $ 13.9
Benefits and expenses 18.0 18.8
Net investment income 8.4 8.3
Realized gain on investments .1 1.4
Federal income tax expense 1.8 1.6
--------- ---------
Net income $ 3.6 $ 3.2
========= =========
Policy income increased 6.6% or $1.0 million to $14.9 million in the third
quarter of 1996 from $13.9 million in the third quarter of 1995. Account
values at September 30, 1996 increased by 9.1% from September 30, 1995. Net
investment income increased 1.8% in the third quarter of 1996 compared to the
third quarter of 1995. The pre-tax yield on invested assets (excluding realized
and unrealized gains) was 7.4% and 7.7% for the third quarters of 1996 and
1995, respectively. Net income for the third quarter of 1996 was higher than
the third quarter of 1995, a period of heavy mortality experience.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
RESULTS OF OPERATION (Continued)
Nine Months Ended September 30, 1996 and 1995
The discussion which follows compares the results of the nine months ended
September 30, 1996 to the nine months ended September 30, 1995:
CONSOLIDATED
The Company's revenues decreased 4.5% or $69.8 million to $1,488.1 million
in the first nine months of 1996 from $1,557.9 million in the first nine months
of 1995. Net premiums earned and other revenue decreased 4.6% or $61.1 million
to $1,255.5 million in the first nine months of 1996 from $1,316.6 million in
the first nine months of 1995. Net investment income increased .7% or $1.4
million to $201.5 million in the first nine months of 1996 from $200.1 million
in the first nine months of 1995. Realized gains on investments decreased
24.8% or $10.2 million to $31.0 million in the first nine months of 1996 from
$41.2 million in the first nine months of 1995.
Benefits and settlement expenses decreased 1.8% or $17.8 million to $955.8
million in the first nine months of 1996 from $973.6 million in the first nine
months of 1995. Commissions decreased 3.2% or $7.0 million to $211.9 million
in the first nine months of 1996 from $218.9 million in the first nine months
of 1995. Operating and administrative expenses decreased 10.0% or $16.9 million
to $151.7 million in the first nine months of 1996 from $168.6 million in the
first nine months of 1995. The company incurred interest on debt from the
Assumed Debt and Term Note of $7.1 million in the first nine months of 1996.
Net income for the first nine months of 1996 was $117.1 million or $2.14
per share compared to $141.1 million or $2.82 per share for the first nine
months of 1995. Excluding realized gain on investments, the Company earned
$98.2 million or $1.80 per share for the first nine months of 1996 compared to
$114.9 million or $2.30 per share for the first nine months of 1995.
PROPERTY AND CASUALTY
The following table sets forth certain summarized financial data and key
operating ratios for the Company's property and casualty operations for the
nine months ended September 30, 1996 and 1995. All ratios are computed using
data reported in accordance with SAP.
Nine Months Ended
September 30,
1996 1995
----------- -----------
(Dollars in Millions)
Net premiums written $1,219.0 $1,290.0
Net premiums earned and other revenue $1,211.8 $1,274.2
Losses and loss adjustment expense 918.3 937.0
Other costs and expenses 376.0 405.6
-------- --------
Underwriting loss (82.5) (68.4)
Net investment income 174.9 175.5
Realized gain on investments 30.5 40.0
Federal income tax expense 12.0 16.3
-------- --------
Net income $ 110.9 $ 130.8
======== ========
14
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
RESULTS OF OPERATION (Continued)
Loss ratio 64.3% 61.4%
Loss adjustment expense ratio 11.9 12.7
Underwriting expense ratio 30.9 31.2
Policyholder dividend ratio .1 .1
Combined ratio 107.2% 105.4%
Net Premiums Written
Net premiums written decreased 5.5% or $71.0 million to $1,219.0 million
in the first nine months of 1996 from $1,290.0 million in the first nine months
of 1995. The decline in net premiums written is largely attributable to three
factors. First and most pervasive is the intensifying commercial lines
competition with the impact most evident in workers' compensation and larger
accounts. In addition, premium volume from state-mandated workers'
compensation pools continues to decline. Finally, the Company continues its
planned reduction of exposure in California and Florida. For the states of
California and Florida, net premiums written decreased 16.0% in the first nine
months of 1996 compared to the first nine months of 1995. For all other
states, net premiums written decreased 4.3% in the first nine months of 1996
compared to the first nine months of 1995.
Net Premiums Earned and Other Revenue
Net premiums earned and other revenue (primarily finance and service fees)
decreased 4.9% or $62.4 million to $1,211.8 million in the first nine months
of 1996 from $1,274.2 million in the first nine months of 1995.
Losses and Loss Adjustment Expense
Losses and LAE decreased 2.0% or $18.7 million to $918.3 million in the
first nine months of 1996 from $937.0 million in the first nine months of 1995.
The SAP loss ratio for the first nine months of 1996 was 64.3% compared to
61.4% for the first nine months of 1995. The 2.9 point increase was due to an
increase of $30.8 million in natural peril losses resulting from widespread
severe winter storm activity and frequent wind and hail storms across the
Midwest. Natural peril losses were $126.5 million and $95.7 million for the
first nine months of 1996 and 1995, respectively.
The SAP LAE ratio was 11.9% and 12.7% for the first nine months of 1996
and 1995, respectively. The improvement in the LAE ratio in the first nine
months of 1996 compared to the first nine months of 1995 was due to (i) lower
LAE reserve levels in 1996 due to lower related loss reserves (ii) incurred
costs relating to division consolidation and an early retirement plan for
certain levels of management in 1995 and (iii) a reduction in errors and
omission insurance expense in 1996. The decrease in insurance expense in 1996
as compared to 1995 is due to the settlement of a lawsuit in 1995.
Other Costs and Expenses
Other costs and expenses decreased 7.3% or $29.6 million to $376.0 million
in the first nine months of 1996 from $405.6 million in the first nine months
of 1995. The Company has experienced a decrease in commission expense and
premium taxes due to a decline in net written premium. Costs incurred relating
to the division consolidation and early retirement added to expenses in the
first nine months of 1995. In addition, the realignment of field offices and
implementation of internal cost controls, which was announced in late 1995,
produced cost savings in 1996 payments. The SAP underwriting expense ratio
improved only .3 points to 30.9% due to a decline in net written premium.
15
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
RESULTS OF OPERATION (Continued)
Combined Ratio
The SAP combined ratio, after policyholder dividends, was 107.2% and
105.4% for the first nine months of 1996 and 1995, respectively. During the
first nine months of 1996, natural peril losses added 10.5 points to the SAP
loss ratio compared to 7.6 points for the first nine months of 1995.
Net Investment Income
Net investment income decreased $.6 million to $174.9 million in the first
nine months of 1996 from $175.5 million in the first nine months of 1995. The
pre-tax yield on invested assets (excluding realized and unrealized gains) was
6.5% and 6.3% for the first nine months of 1996 and 1995, respectively. The
increase in yield was offset by a decline in total average invested assets
caused by the distribution of Dividended Assets.
Federal Income Tax Expense
Income tax expense was $12.0 million for the first nine months of 1996
compared to $16.3 million for the first nine months of 1995. The decrease in
expense is due primarily to a decline in underwriting results.
LIFE
The following table sets forth certain summarized financial data for the
Company's life insurance operations for the nine months ended September 30,
1996 and 1995.
Nine Months Ended
September 30,
1996 1995
----------- -----------
(Dollars in Millions)
Account values - Universal life and Annuities $ 336.3 $ 308.2
Life insurance in-force 15,424.2 15,214.0
Invested assets (at amortized cost) 456.5 435.2
Policy income $ 43.7 $ 42.4
Benefits and expenses 53.8 52.8
Net investment income 25.3 24.6
Realized gain on investments .3 1.2
Federal income tax expense 5.4 5.1
--------- ---------
Net income $ 10.1 $ 10.3
========= =========
Policy income increased 3.3% in the first nine months of 1996 compared to
the first nine months of 1995. Account values at September 30, 1996, increased
by 9.1% from September 30, 1995. Net investment income increased 2.9% in the
first nine months of 1996 compared to the first nine months of 1995. The
overall increase in net investment income reflects the growth in account values
as well as the general growth in invested assets. This increase occurred
despite a drop in yield on average invested assets (excluding realized and
unrealized gains). The pre-tax yield was 7.5% and 7.7% for the first nine
months of 1996 and 1995, respectively. Net income for the first nine months of
1996 was lower compared to the first nine months of 1995 primarily due to
higher mortality.
16
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of funds available to the Company and its Subsidiaries
are premiums, investment income and proceeds from the sale or maturity of
invested assets. Such funds are used principally for the payment of claims,
operating expenses, commissions, dividends, debt service and the purchase of
investments. Cash outflows can be variable because of the potential for large
losses either individually or in the aggregate. Accordingly, the Company
maintains investment programs generally intended to provide adequate funds to
pay claims without the forced sale of investments. Finally, as noted below,
the Company has a $200 million Line of Credit, and intends to establish a
Medium Term Note Program, to augment its available liquidity.
Invested Assets
Since a substantial portion of the Company's revenues are generated from
its invested assets, the performance, quality and liquidity of its investment
portfolio materially effects the Company's financial condition and results of
operations. The Company pursues a total return investment strategy which seeks
an attractive level of current income combined with long-term capital
appreciation. The following table details, at carrying value, the distribution
of the Company's investment portfolio at September 30, 1996 (dollars in
millions):
Fixed maturity securities:
Tax-exempt municipal $2,034.2 47.5%
US government 205.9 4.8
Mortgage-backed and asset-backed 296.4 6.9
Corporate and other 1,072.4 25.0
Redeemable preferred stock 79.6 1.9
Equities:
Perpetual preferred stock 186.8 4.4
Common stock 225.1 5.2
Mortgage loans 33.5 .8
Short-term investments 109.8 2.6
Other 37.4 .9
-------- -----
Total $4,281.1 100.0%
======== =====
The total investment portfolio decreased $149.1 million in the first nine
months of 1996. This decrease is the net result of (i) the distribution of
Dividended Assets to LNC, (ii) a decrease in unrealized gains on securities
available-for-sale and (iii) an increase in invested assets from the proceeds
of the Offering.
The Company attempts to minimize the risk of loss due to default by the
borrower by maintaining a quality investment portfolio. As of September 30,
1996, approximately 88% of the Company's bond portfolio is rated "A" or
higher, or was a U.S. government obligation, and only $25.8 million, or .7% of
the carrying value of the bond portfolio, was rated below investment grade (Ba
and below). Ratings are based on the ratings, if any, assigned by Moody's
and/or Standard & Poors. If ratings were split, the rating used is generally
the higher of the two. Approximately $188.4 million of securities are private
placements for which ratings have been assigned by the Company based generally
on equivalent ratings supplied by the National Association of Insurance
Commissioners.
17
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
LIQUIDITY AND CAPITAL RESOURCES (Continued)
As of September 30, 1996, 47.5% of the Company's investment portfolio
consisted of tax-exempt municipal securities as compared to 53.6% as of
December 31, 1996. The Company has reduced its position in tax-exempt
municipal securities in order to provide for greater diversification of the
portfolio and to give the Company greater margin relative to the possibility of
being in a federal alternative minimum tax position.
The Company's fixed maturity securities are classified as
available-for-sale and accordingly, are carried at fair value. The difference
between amortized cost and fair value, less deferred income taxes, is reflected
as a component of shareholders' equity.
Cash Provided by Operations
Net cash provided by operating activities was $37.9 million for the first
nine months of 1996 compared to $107.6 million for the first nine months of
1995. The decrease in cash provided by operating activities is primarily due
to a decrease in premiums collected offset in part by a decrease in claims and
operating expenses paid.
Notes Payable and Debt with Affiliate
As disclosed in Note 3 to the Notes to Consolidated Financial Statements,
in the second quarter of 1996 the Company assumed $100 million of Assumed Debt
and issued a $200 million Term Note. The Company is obligated to make minimum
principal repayments totaling $66.7 million in 1997 and 1998, and $166.7
million in 1999. In addition, the Company is obligated to make interest
payments on this debt. Interest is payable on outstanding principle at a rate
of 7 1/8% per annum on the Assumed Debt, and at a variable rate (generally 50
basis points over three, two and one year U.S. Treasury obligations) on the
Term Note. The current rate on the Term Note is approximately 6.7%.
Line of Credit
On May 29, 1996, the Company entered the Line of Credit with third party
financial institutions under which the Company may borrow and repay amounts up
to a maximum of $200 million. Borrowings under the Line of Credit will bear
interest generally at variable rates tied to LIBOR, an adjusted certificate of
deposit rate or other short-term indices. The Company will use borrowings
under the Line of Credit to assist in funding short-term cash management
requirements. No debt was outstanding using this agreement at September 30,
1996.
Medium Term Note Program
For additional liquidity, the Company intends to establish a medium-term
note program (the "MTN Program") within the next year. The MTN Program, if
established, would enable the Company to issue debt from time to time for
general corporate purposes.
Subsidiary Dividend Restrictions
Historically, ASI has paid dividends to LNC, as its parent, based upon its
annual operating results and statutory surplus requirements. After taking into
account the one-time distribution of the Dividended Assets paid by ASI to LNC,
ASI will not be able to pay any additional dividends to the Company for the
twelve month period commencing on May 15, 1996 ("Twelve Month Period") without
notifying the Indiana Commissioner of Insurance and giving the Commissioner 30
days within to object. Regulatory restrictions on the ability of ASI to pay
dividends or make other payments to the Company could affect the Company's
ability to pay dividends and service its debt.
18
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION (Continued)
LIQUIDITY AND CAPITAL RESOURCES (Continued)
Offering Proceeds
On May 29, 1996, the company issued 10,000,000 shares of common stock to
the public at $23 per share. The net proceeds to the Company, after the
underwriting discount and other issue costs, was $215.5 million. The Company
contributed $140.5 million of the net proceeds to ASI to enable it to invest in
taxable securities for its investment portfolio to replace the Dividended
Assets. The Company retained $75.0 million of the net proceeds from the
Offering for general corporate purposes, including the funding of its regular
cash dividends, debt service obligations and other general corporate
obligations during the Twelve Month Period. Until utilized for such purposes,
the net proceeds from the Offering not contributed to ASI is invested and will
continue to be invested in short-term, interest bearing, investment-grade
securities. Based upon a quarterly dividend of $.21 per share and the terms of
the Assumed Debt, Term Note and Line of Credit, the Company expects that it
will need approximately $50 million to fund regular quarterly cash dividends
and approximately $20 million to fund debt service obligations and other
general corporate obligations during the Twelve Month Period.
19
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See the Notes to Consolidated Financial Statements - Contingencies regarding
pending and threatened litigation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits.
10.0 (6) Investment Management Agreement, dated October 21, 1996, between
Lincoln Investment Management, Inc. and Insurance Company of
Illinois
10.15 (1) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Insurance Company.
10.15 (2) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Economy Company.
10.15 (3) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Preferred Insurance Company.
10.15 (4) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States Life
Insurance Company.
10.15 (5) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Insurance Company of Texas.
10.15 (6) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and Insurance Company of
Illinois.
10.16 (1) Tax Sharing Agreement, dated August 22, 1996, between the
Registrant and Lincoln National Corporation.
10.16 (2) Tax Sharing Agreement, dated August 22, 1996, between the
Registrant, American States Insurance Company and Lincoln National
Corporation.
10.16 (3) Tax Sharing Agreement, dated August 22, 1996, between American
States Insurance Company, American Economy Insurance Company and
Lincoln National Corporation.
10.16 (4) Tax Sharing Agreement, dated August 22, 1996, between American
States Insurance Company, American States Preferred Insurance
Company and Lincoln National Corporation.
10.16 (5) Tax Sharing Agreement, dated August 22, 1996, between American
States Insurance Company, American States Life Insurance Company
and Lincoln National Corporation.
10.16 (6) Tax Sharing Agreement, dated October 9, 1996, between American
States Insurance Company, Insurance Company of Illinois and Lincoln
National Corporation.
10.16 (7) Tax Sharing Agreement, dated September 23, 1996, between Lincoln
National Corporation and Linsco Reinsurance Company.
20
21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (Continued)
a) Exhibits (Continued)
10.16 (8) Tax Sharing Agreement, dated August 22, 1996, between American
States Insurance Company, City Insurance Agency, Inc. and Lincoln
National Corporation.
10.18 (1) Services Agreement, dated September 26 1996, between the
Registrant and its subsidiaries and affiliates and Lincoln National
Corporation and its subsidiaries and affiliates.
10.18 (2) Services Agreement, dated October 10, 1996, between Insurance
Company of Illinois and Lincoln National Corporation and its
subsidiaries and affiliates.
11.0 Computations of Earnings Per Share
27.0 Financial Data Schedule
b) Reports on Form 8-K.
The Registrant filed a Form 8-K Current Report, dated September 16, 1996,
pertaining to the announced retirement of the Registrant's Chairman and Chief
Executive Officer.
21
22
SIGNATURE PAGE
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, thereunto duly authorized.
American States Financial Corporation
by: /s/ THOMAS M. OBER
-----------------------------
Thomas M. Ober
Vice President, Secretary and General Counsel
/s/ THOMAS R. KAEHR
------------------------------
Thomas R. Kaehr
Vice President and Chief Accounting Officer
Date: November 13, 1996
22
23
AMERICAN STATES FINANCIAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended September 30, 1996
Exhibit Page
Number Description Number
- - --------- ----------- ------
10.0 (6) Investment Management Agreement, dated October 21, 1996, between
Lincoln Investment Management, Inc. and Insurance Company of Illinois 25
10.15 (1) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Insurance Company. 40
10.15 (2) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American Economy
Insurance Company. 50
10.15 (3) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Preferred Insurance Company. 60
10.15 (4) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States Life
Insurance Company. 70
10.15 (5) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and American States
Insurance Company of Texas. 80
10.15 (6) ASFC Short-Term Investment Pool Participation Agreement, dated
September 16, 1996, between the Registrant and Insurance Company of
Illinois. 90
10.16 (1) Tax Sharing Agreement, dated August 22, 1996, between the Registrant
and Lincoln National Corporation. 100
10.16 (2) Tax Sharing Agreement, dated August 22, 1996, between the Registrant,
American States Insurance Company and Lincoln National Corporation. 110
10.16 (3) Tax Sharing Agreement, dated August 22, 1996, between American States
Insurance Company, American Economy Insurance Company and Lincoln
National Corporation. 119
10.16 (4) Tax Sharing Agreement, dated August 22, 1996, between American States
Insurance Company, American States Preferred Insurance Company and
Lincoln National Corporation. 128
10.16 (5) Tax Sharing Agreement, dated August 22, 1996, between American States
Insurance Company, American States Life Insurance Company and Lincoln
National Corporation. 137
10.16 (6) Tax Sharing Agreement, dated October 9, 1996, between American States
Insurance Company, Insurance Company of Illinois and Lincoln National
Corporation. 146
23
24
AMERICAN STATES FINANCIAL CORPORATION
Exhibit Index for the Report on Form 10-Q (Continued)
10.16 (7) Tax Sharing Agreement, dated September 23, 1996, between Lincoln
National Corporation and Linsco Reinsurance Company. 155
10.16 (8) Tax Sharing Agreement, dated August 22, 1996, between American States
Insurance Company, City Insurance Agency, Inc. and Lincoln National
Corporation. 164
10.18 (1) Services Agreement, dated October 10, 1996, between the Registrant and
its subsidiaries and affiliates and Lincoln National Corporation and
its subsidiaries and affiliates. 173
10.18 (2) Services Agreement, dated September 26 1996, between Insurance Company
of Illinois and Lincoln National Corporation and its subsidiaries and
affiliates. 183
11.0 Computations of Earnings Per Share 193
27.0 Financial Data Schedule 194
24