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
September 30, 1998 Commission file number 33-23376
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Aetna Life Insurance and Annuity Company
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(Exact name of registrant as specified in its charter)
Connecticut 71-0294708
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
151 Farmington Avenue, Hartford, Connecticut 06156
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(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code (860) 273-0123
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None
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Former name, former address and former fiscal year if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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
---------- ----------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Shares Outstanding
Title of Class at October 31, 1998
- -------------- ---------------------
Common Stock,
par value $50 55,000
The registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) of Form 10-Q and is therefore filing this Form with the reduced disclosure
format.
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
TABLE OF CONTENTS
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PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Income............................ 3
Consolidated Balance Sheets.................................. 4
Consolidated Statements of Changes in Shareholder's Equity... 5
Consolidated Statements of Cash Flows........................ 6
Condensed Notes to Consolidated Financial Statements......... 7
Independent Auditors' Review Report............................. 12
Item 2. Management's Analysis of the Results of Operations.............. 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 22
Item 5. Other Information............................................... 22
Item 6. Exhibits and Reports on Form 8-K................................ 22
Signatures ................................................................ 23
2
PART I. FINANCIAL INFORMATION
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Statements of Income
(millions)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
1998 1997 1998 1997
--------------- --------------- --------------- ---------------
Revenue:
Premiums $ 20.1 $ 19.2 $ 54.5 $ 53.4
Charges assessed against policyholders 81.3 70.6 243.3 188.5
Net investment income 217.2 218.7 645.4 654.3
Net realized capital gains 2.7 6.6 9.3 14.7
Other income 8.2 11.3 22.2 28.2
-------- -------- -------- --------
Total revenue 329.5 326.4 974.7 939.1
Benefits and expenses:
Current and future benefits 181.7 189.3 529.7 545.6
Operating expenses 76.5 69.8 227.0 204.3
Amortization of deferred policy acquisition costs 28.6 24.5 79.4 57.3
-------- -------- -------- --------
Total benefits and expenses 286.8 283.6 836.1 807.2
-------- -------- -------- --------
Income from continuing operations before income
taxes 42.7 42.8 138.6 131.9
Income taxes 9.5 10.6 37.7 36.0
-------- -------- -------- --------
Income from continuing operations 33.2 32.2 100.9 95.9
Income from discontinued operations, net of tax 24.5 19.2 61.8 49.0
-------- -------- -------- --------
Net income $ 57.7 $ 51.4 $ 162.7 $ 144.9
======== ======== ======== ========
See Condensed Notes to Consolidated Financial Statements.
3
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Balance Sheets
(millions, except share data)
September 30, 1998 December 31, 1997
------------------ -----------------
Assets
- ------
Investments:
Debt securities available for sale, at fair value
(amortized cost: $11,655.7 and $12,912.2) $ 12,207.9 $ 13,463.8
Equity securities, available for sale:
Nonredeemable preferred stock (cost: $71.4 and $131.7) 73.9 147.6
Investment in affiliated mutual funds (cost: $119.9 and $78.1) 116.3 83.0
Common stock (cost: $0.3 and $0.2) 1.4 0.6
Short-term investments 23.1 95.6
Mortgage loans 12.7 12.8
Policy loans 521.5 469.6
----------- -----------
Total investments 12,956.8 14,273.0
Cash and cash equivalents 2,212.3 565.4
Short-term investments under securities loan agreement 652.9 -
Accrued investment income 165.3 163.0
Income taxes receivable 10.0 -
Premiums due and other receivables 68.8 63.7
Deferred policy acquisition costs 1,734.3 1,654.6
Reinsurance loan to affiliate 261.5 397.2
Other assets 50.9 46.8
Separate Accounts assets 24,773.6 22,982.7
---------- -----------
Total assets $ 42,886.4 $ 40,146.4
========== ===========
Liabilities and Shareholder's Equity
- ------------------------------------
Liabilities:
Future policy benefits $ 3,767.6 $ 3,785.7
Unpaid claims and claim expenses 34.0 38.0
Policyholders' funds left with the Company 11,230.1 11,121.5
---------- -----------
Total insurance reserve liabilities 15,031.7 14,945.2
Payables under securities loan agreement 652.9 -
Other liabilities 352.4 312.8
Income taxes:
Current - 12.4
Deferred 100.9 72.0
Separate Accounts liabilities 24,760.8 22,970.0
---------- -----------
Total liabilities 40,898.7 38,312.4
---------- -----------
Shareholder's equity:
Common stock, par value $50 (100,000 shares
authorized; 55,000 shares issued and outstanding) 2.8 2.8
Paid-in capital 418.0 418.0
Accumulated other comprehensive income 86.1 92.9
Retained earnings 1,480.8 1,320.3
---------- -----------
Total shareholder's equity 1,987.7 1,834.0
---------- -----------
Total liabilities and shareholder's equity $ 42,886.4 $ 40,146.4
========== ===========
See Condensed Notes to Consolidated Financial Statements.
4
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Statements of Changes in Shareholder's Equity
(millions)
Nine Months Ended September 30,
--------------------------------------
1998 1997
----------------- -----------------
Shareholder's equity, beginning of period $1,834.0 $1,609.5
Comprehensive income
Net income 162.7 144.9
Other comprehensive income, net of tax
Unrealized (losses) gains on securities ($(10.5),
$55.7, pretax, respectively ) (6.8) 36.2
-------- --------
Total comprehensive income 155.9 181.1
-------- --------
Other changes 0.8 3.7
Common stock dividends (3.0) (8.3)
-------- --------
Shareholder's equity, end of period $1,987.7 $1,786.0
======== ========
See Condensed Notes to Consolidated Financial Statements.
5
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Statements of Cash Flows
(millions)
Nine Months Ended September 30,
--------------------------------------
1998 1997
----------------- -----------------
Cash Flows from Operating Activities:
Net income $ 162.7 $ 144.9
Adjustments to reconcile net income to net cash provided by
(used for) operating activities:
Increase in accrued investment income (2.3) (24.0)
Decrease (increase) in premiums due and other receivables 23.8 (8.8)
Increase in policy loans (51.9) (54.4)
Increase in deferred policy acquisition costs (79.7) (105.3)
Decrease in reinsurance loan to affiliate 135.7 153.9
Net increase in universal life account balances 176.9 224.1
Decrease in other insurance reserve liabilities (148.7) (165.5)
Net decrease in other liabilities and other assets (96.3) (122.4)
Increase (decrease) in income taxes 14.9 (3.9)
Net accretion of discount on investments (24.3) (51.9)
Net realized capital gains (10.0) (17.9)
--------- -----------
Net cash provided by (used for) operating activities 100.8 (31.2)
--------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of:
Debt securities available for sale 5,680.9 3,828.5
Equity securities 120.7 61.3
Mortgage loans 0.2 0.1
Investment maturities and repayments of:
Debt securities available for sale 1,100.3 966.8
Short-term investments 166.1 43.2
Cost of investment purchases in:
Debt securities available for sale (5,416.9) (4,811.0)
Equity securities (93.7) (53.6)
Short-term investments (93.4) (120.1)
--------- -----------
Net cash provided by (used for) investing activities 1,464.2 (84.8)
--------- -----------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 1,144.6 1,230.2
Withdrawals of investment contracts (1,061.0) (925.8)
Capital contribution to Separate Account - (25.0)
Return of capital from Separate Account 1.3 -
Dividends paid to shareholder (3.0) (8.3)
--------- -----------
Net cash provided by financing activities 81.9 271.1
--------- -----------
Net increase in cash and cash equivalents 1,646.9 155.1
Cash and cash equivalents, beginning of period 565.4 459.1
--------- -----------
Cash and cash equivalents, end of period $ 2,212.3 $ 614.2
========= ===========
Supplemental cash flow information:
Income taxes paid, net $ 59.2 $ 68.7
========= ==========
See Condensed Notes to Consolidated Financial Statements.
6
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Condensed Notes to Consolidated Financial Statements
1) Basis of Presentation
---------------------
The consolidated financial statements include Aetna Life Insurance and
Annuity Company and its wholly owned subsidiary, Aetna Insurance Company of
America (collectively, the "Company"). On October 1, 1998, the Company sold
its individual life insurance operations to Lincoln National Corporation
("Lincoln") and accordingly, they are classified as Discontinued
Operations. (Please refer to Note 2 below). Aetna Life Insurance and
Annuity Company is a wholly owned subsidiary of Aetna Retirement Holdings,
Inc. ("HOLDCO"). HOLDCO is a wholly owned subsidiary of Aetna Retirement
Services, Inc., whose ultimate parent is Aetna Inc. ("Aetna").
These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles and are unaudited. Certain
reclassifications have been made to 1997 financial information to conform
to the 1998 presentation. These interim statements necessarily rely heavily
on estimates, including assumptions as to annualized tax rates. In the
opinion of management, all adjustments necessary for a fair statement of
results for the interim periods have been made. All such adjustments are of
a normal, recurring nature. The accompanying condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and related notes as presented in the Company's 1997
Annual Report on Form 10-K. Certain financial information that is normally
included in annual financial statements prepared in accordance with
generally accepted accounting principles, but that is not required for
interim reporting purposes, has been condensed or omitted.
2) Discontinued Operations - Individual Life Insurance
---------------------------------------------------
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln for $1 billion in cash, subject to adjustment as
provided by the related agreements. The transaction is generally in the
form of an indemnity reinsurance arrangement, under which Lincoln
contractually assumed from the Company certain policyholder liabilities and
obligations, although the Company remains directly obligated to
policyholders. Future policy benefit insurance reserves were approximately
$3 billion. Deferred policy acquisition costs related to the life policies
of $893 million were written off against the gain on the sale. Certain
invested assets related to and supporting the life policies were sold to
consummate the life sale and the Company recorded a reinsurance receivable
from Lincoln. The transaction will result in an after-tax gain on the sale
of approximately $95 million, the majority of which will be deferred and
amortized over approximately 15 years.
7
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Condensed Notes to Consolidated Financial Statements (continued)
2) Discontinued Operations - Individual Life Insurance (continued)
---------------------------------------------------------------
The operating results of the individual life business are presented as
Discontinued Operations. All prior year income statement data has been
restated to reflect the presentation as Discontinued Operations. Revenues
for the individual life segment were $160.5 million and $159.2 million for
the third quarters of 1998 and 1997, respectively, and $441.2 million and
$462.8 million for the nine months ended September 30, 1998 and 1997,
respectively. Net income was $24.5 million and $19.2 million for the third
quarters of 1998 and 1997, respectively, and $61.8 million and $49.0
million for the nine months ended September 30, 1998 and 1997,
respectively.
3) New Accounting Standards
------------------------
On January 1, 1998, the Company adopted Statement of Position ("SOP") 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use, issued by the American Institute of Certified Public
Accountants ("AICPA"). This statement requires that certain costs incurred
in developing internal-use computer software be capitalized, and provides
guidance for determining whether computer software is considered to be for
internal use. The Company will amortize these costs over a period of 3 to 5
years. Previously, the Company expensed the cost of internal-use computer
software as incurred. The adoption of this statement resulted in an
increase to net income of $.7 million and $4.1 million for the three and
nine months ended September 30, 1998, respectively.
Financial Accounting Standard ("FAS") No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, was
issued in September 1996 and provides accounting and reporting standards
for transfers of financial assets and extinguishments of liabilities. FAS
No. 125 was effective for 1997 financial statements, however, certain
provisions relating to accounting for repurchase agreements and securities
lending were not effective until January 1, 1998. The adoption of those
provisions effective in 1998 did not have a material effect on the
Company's financial position or results of operations.
8
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Condensed Notes to Consolidated Financial Statements (continued)
4) Future Application of Accounting Standards
------------------------------------------
In October 1998, the AICPA issued SOP 98-7, Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance
Risk, which provides guidance on how to account for all insurance and
reinsurance contracts that do not transfer insurance risk, except for
long-duration life and health insurance contracts. This statement is
effective for the Company's financial statements beginning January 1, 2000,
with early adoption permitted. The Company is currently evaluating the
impact of the adoption of this statement and the potential effect on its
financial position and results of operations.
In June 1998, the Financial Accounting Standards Board issued FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This standard
requires companies to record all derivatives on the balance sheet as either
assets or liabilities and measure those instruments at fair value. The
manner in which companies are to record gains or losses resulting from
changes in the values of those derivatives depends on the use of the
derivative and whether it qualifies for hedge accounting. This standard is
effective for the Company's financial statements beginning January 1, 2000,
with early adoption permitted. The Company is currently evaluating the
impact of the adoption of this statement and the potential effect on its
financial position or results of operations.
In December 1997, the AICPA issued SOP 97-3, Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments, which provides
guidance for determining when an insurance or other enterprise should
recognize a liability for guaranty-fund and other insurance-related
assessments and guidance for measuring the liability. This statement is
effective for 1999 financial statements, with early adoption permitted. The
Company does not expect adoption of this statement to have a material
effect on its financial position or results of operations.
5) Financial Instruments
---------------------
The Company engages in hedging activities to manage interest rate risk.
Such hedging activities have principally consisted of using
off-balance-sheet instruments such as treasury futures. (See General
Account Investments of the Management's Analysis of the Results of
Operations and Note 3 of the Notes to the Financial Statements in the
Company's 1997 Annual Report on Form 10-K for a description of the
Company's hedging activities). The notional amounts, carrying values and
estimated fair values of the Company's open treasury futures as of
September 30, 1998 are $786.2 million, ($6.3) million, and ($6.3) million,
respectively. These open treasury futures were related to hedging the
interest rate risk on the assets supporting the individual life business
that was sold to Lincoln on October 1, 1998. (See Note 2 above for further
discussion on the sale of the individual life business).
9
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Condensed Notes to Consolidated Financial Statements (continued)
6) Additional Information - Accumulated Other Comprehensive Income
---------------------------------------------------------------
Changes in accumulated other comprehensive income related to changes in
unrealized gains on securities (excluding those related to experience rated
contractholders) were as follows:
Nine Months Ended September 30,
--------------------------------------------------------------------------------------------------------------
(Millions) 1998 1997
--------------------------------------------------------------------------------------------------------------
Unrealized holding gains arising during the period (1) $15.5 $81.6
Less: reclassification adjustments for amortization of net investment
discounts and gains included in net income (2) 22.3 45.4
-------------------------------------------------------------------------------------------------------------
Net unrealized (loss)/gain on securities $(6.8) $36.2
=============================================================================================================
(1) Pretax unrealized holding gains arising during the period were $23.8
million and $125.5 million for 1998 and 1997, respectively.
(2) Pretax reclassification adjustments for amortization of net investment
discounts and gains included in net income were $34.3 million and $69.8
million for 1998 and 1997, respectively.
7) Severance and Facilities Charges
--------------------------------
During 1996, the Company was allocated severance and facilities reserves
from Aetna to reflect actions taken or to be taken to reduce the level of
corporate expenses and other costs previously absorbed by Aetna's
property-casualty operations.
Also during 1996, the Company established severance and facilities reserves
in the Financial Services and Individual Life Insurance segments to reflect
actions taken or to be taken in order to make its businesses more
competitive.
Activity for the nine months ended September 30, 1998 within the severance
and facilities reserves (pretax, in millions) was as follows:
-----------------------------------------------------------------------------------
Reserve
-----------------------------------------------------------------------------------
Balance at December 31, 1997 $ 20.8
Actions taken (1) (11.8)
--------
Balance at September 30, 1998 $ 9.0
-----------------------------------------------------------------------------------
(1) Includes $7.4 million of severance-related actions and $1.6 million of
corporate allocation-related actions.
The Company's severance actions were substantially completed by September
30, 1998; and, an evaluation of any remaining reserves will take place in
the fourth quarter. The corporate allocation actions were substantially
completed in 1997.
10
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Condensed Notes to Consolidated Financial Statements (continued)
8) Litigation
----------
The Company is involved in numerous lawsuits arising, for the most part, in
the ordinary course of its business operations. While the ultimate outcome
of litigation against the Company cannot be determined at this time, after
consideration of the defenses available to the Company and any related
reserves established, it is not expected to result in liability for amounts
material to the financial condition of the Company, although it may
adversely affect results of operations in future periods.
9) Dividends
---------
On January 30, 1998, the Company paid a $3.0 million dividend to HOLDCO. On
October 5, 1998, with prior approval from the Insurance Commissioner of the
State of Connecticut, the Company paid a dividend of $200 million to
HOLDCO. Additional dividends by the Company through December 31, 1998 will
require the approval of the Insurance Commissioner of the State of
Connecticut.
11
Independent Auditors' Review Report
The Board of Directors
Aetna Life Insurance and Annuity Company:
We have reviewed the accompanying condensed consolidated balance sheet of Aetna
Life Insurance and Annuity Company and Subsidiary as of September 30, 1998, and
the related condensed consolidated statements of income for the three-month and
nine-month periods ended September 30, 1998 and 1997, and the related condensed
consolidated statements of changes in shareholder's equity and cash flows for
the nine-month periods ended September 30, 1998 and 1997. These condensed
consolidated financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements for them
to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Aetna Life Insurance and Annuity
Company and Subsidiary as of December 31, 1997, and the related consolidated
statements of income, changes in shareholder's equity, and cash flows for the
year then ended (not presented herein); and in our report dated February 3,
1998, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 1997, is fairly
presented, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ KPMG Peat Marwick LLP
Hartford, Connecticut
November 3, 1998
12
Item 2. Management's Analysis of the Results of Operations
The following discussion and analysis presents a review of Aetna Life Insurance
and Annuity Company and its wholly owned subsidiary, Aetna Insurance Company of
America (collectively, the "Company") for the three and nine months ended
September 30, 1998 and 1997. This review should be read in conjunction with the
consolidated financial statements and other data presented herein. Aetna Life
Insurance and Annuity Company is a wholly owned subsidiary of Aetna Retirement
Holdings, Inc. ("HOLDCO"). HOLDCO is a wholly owned subsidiary of Aetna
Retirement Services, Inc., whose ultimate parent is Aetna Inc. ("Aetna").
Consolidated Overview
Sale of Domestic Individual Life Insurance Business
- ----------------------------------------------------
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln National Corporation ("Lincoln") for $1 billion in cash,
subject to adjustment as provided by the related agreements. The transaction is
generally in the form of an indemnity reinsurance arrangement, under which
Lincoln contractually assumed from the Company certain policyholder liabilities
and obligations, although the Company remains directly obligated to
policyholders. Future policy benefit insurance reserves were approximately $3
billion as of September 30, 1998. Certain invested assets related to and
supporting the life policies were sold to consummate the life sale and the
Company recorded a reinsurance receivable from Lincoln. The transaction will
result in an after-tax gain on the sale of approximately $95 million, the
majority of which will be deferred and amortized over approximately 15 years,
with the remainder recognized in the fourth quarter of 1998. The amount of the
gain will depend on the actual amount of assets transferred and liabilities
contractually assumed from the Company and the remaining related deferred
acquisition costs at the closing date.
Aetna expects to use the proceeds from the sale for general corporate purposes,
including internal growth, acquisitions, debt repayment and share repurchases.
The operating results, deposits not included in premiums and assets under
management of the individual life business are presented as Discontinued
Operations on separate lines in the table below. All prior year income statement
data has been restated to reflect the presentation as Discontinued Operations.
Results reported in the Operating Summary section (including the table) as
continuing operations represents the Company's Financial Services business.
13
Item 2. Management's Analysis of the Results of Operations (continued)
Consolidated Overview (continued)
Operating Summary:
- ------------------
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
(Millions)
- --------------------------------------------------------------------------------------------------------------------------
Premiums (1) $ 20.1 $ 19.2 $ 54.5 $ 53.4
Charges assessed against policyholders 81.3 70.6 243.3 188.5
Net investment income 217.2 218.7 645.4 654.3
Net realized capital gains 2.7 6.6 9.3 14.7
Other income 8.2 11.3 22.2 28.2
- --------------------------------------------------------------------------------------------------------------------------
Total revenue 329.5 326.4 974.7 939.1
- --------------------------------------------------------------------------------------------------------------------------
Current and future benefits 181.7 189.3 529.7 545.6
Operating expenses 76.5 69.8 227.0 204.3
Amortization of deferred policy acquisition costs 28.6 24.5 79.4 57.3
- --------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 286.8 283.6 836.1 807.2
- --------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before
income taxes 42.7 42.8 138.6 131.9
Income taxes 9.5 10.6 37.7 36.0
- --------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 33.2 32.2 100.9 95.9
Income from discontinued operations, net of tax 24.5 19.2 61.8 49.0
- --------------------------------------------------------------------------------------------------------------------------
Net income (2) $ 57.7 $ 51.4 $ 162.7 $ 144.9
===========================================================================================================================
Net realized capital gains, net of tax (included above) $ 2.3 $ 4.2 $ 6.6 $ 9.5
===========================================================================================================================
Deposits not included in premiums above:
Annuities--fixed options $ 238.8 $ 322.7 $ 847.5 $ 901.8
Annuities--variable options 850.3 806.0 2,704.9 2,420.0
----------------------------------------------------------------------
Financial Services 1,089.1 1,128.7 3,552.4 3,321.8
Discontinued Operations 113.5 113.3 374.2 351.2
----------------------------------------------------------------------
Total $ 1,202.6 $ 1,242.0 $ 3,926.6 $ 3,673.0
===========================================================================================================================
Assets under management:
Annuities--fixed options $ 12,043.8 $ 11,997.4
Annuities--variable options (3) 21,367.0 19,895.5
-----------------------------------
Subtotal annuities 33,410.8 31,892.9
Other investment advisory (4) (5) 5,080.0 2,362.9
-----------------------------------
Financial Services (6) 38,490.8 34,255.8
Discontinued Operations (7) 3,263.6 3,050.3
-----------------------------------
Total $ 41,754.4 $ 37,306.1
===========================================================================================================================
Discontinued Operations - coverage issued $ 3,001.0 $ 3,788.6
===========================================================================================================================
Discontinued Operations - coverage in force $ 45,438.9 $ 43,627.2
===========================================================================================================================
(1) Includes $14.9 million and $42.9 million for the three and nine months
ended September 30, 1998, respectively, and $17.1 million and $47.2
million, respectively, for the same periods a year ago, for annuity
premiums on contracts converting from the accumulation phase to payout
options with life contingencies.
(2) Net income for the three and nine months ended September 30, 1998 includes
a net benefit from capitalizing internal-use software of $.7 million ($.2
million for "income from continuing operations") and $4.1 million ($2.9
million for "income from continuing operations"), respectively.
(3) Includes $6,099.4 million and $7,003.6 million at September 30, 1998 and
1997, respectively, of assets invested through the Company's products in
unaffiliated mutual funds.
(4) The September 30, 1998 balance includes the transfer of $3,163.5 million of
assets that were previously held by an affiliate, reflecting the
consolidation of certain products which complement the Company's business
strategy.
(5) The September 30, 1997 balance includes $1,309.1 million of mutual fund
assets for which the Company is no longer the investment advisor. The
advisory agreement was transferred to an affiliate effective February 2,
1998.
(6) Excludes net unrealized capital gains of $500.6 million and $452.6 million
at September 30, 1998 and 1997, respectively.
(7) Excludes net unrealized capital gains of $51.7 million and $68.1 million
at September 30, 1998 and 1997, respectively.
14
Item 2. Management's Analysis of the Results of Operations (continued)
Consolidated Overview (continued)
Operating Summary: (continued)
- -----------------
The Company's net income for the third quarter of 1998 increased $6 million
compared to the same period a year ago. Net income for the nine months ended
September 30, 1998 increased $18 million compared to the same period in 1997.
Net income includes income from individual life insurance operations
("Discontinued Operations") of $25 million and $19 million for the third
quarters of 1998 and 1997, respectively, and of $62 million and $49 million for
the nine months ended September 30, 1998 and 1997, respectively.
The Company reported income from continuing operations for the third quarters of
1998 and 1997 of $33 million and $32 million, respectively, and, for the nine
months ended September 30, 1998 and 1997, $101 million and $96 million,
respectively. Results include Year 2000 remediation costs of $5 million (after
tax) for the third quarter of 1998 and $14 million (after tax) for the nine
months ended September 30, 1998. Excluding Year 2000 costs and net realized
capital gains, results for the third quarter of 1998 increased $8 million, or
30%, compared to the third quarter of 1997. Excluding Year 2000 costs and net
realized capital gains, results for the nine months ended September 30, 1998
increased $22 million, or 26%, from the same period a year ago. The 1998 results
reflect increased fee income primarily from higher levels of assets under
management.
Assets under management from continuing operations increased by 7%, net of
transfers (see Notes 4 and 5 to the Consolidated Operating Summary table),
primarily due to additional net deposits (deposits less surrenders) and
appreciation in the stock markets. Due to a downturn in the stock markets which
occurred in the latter part of the third quarter, assets under management were
approximately $2 billion less at September 30, 1998 than at June 30, 1998.
Of the $12.0 billion of fixed annuity assets under management at September 30,
1998 and 1997, 75% were experience rated and 25% were fully guaranteed. The
average annualized earned rate on investments supporting fully guaranteed
contracts was 7.6% and 7.8% and the average annualized earned rate on
investments supporting experience rated contracts was 7.9% and 8.0% for the nine
months ended September 30, 1998 and 1997. The average annualized credited rate
on fully guaranteed contracts was 6.4% and 6.6% and the average annualized
credited rate on experience rated contracts was 5.8% and 5.9% for the nine
months ended September 30, 1998 and 1997. The resulting annualized interest
margins were 1.2% on fully guaranteed contracts and 2.1% on experienced rated
contracts for each of the nine month periods ended September 30, 1998 and 1997.
15
Item 2. Management's Analysis of the Results of Operations (continued)
Financial Services
Financial information and analysis reported in this section in prior period
reports is presented as continuing operations in the Consolidated Overview
section.
Discontinued Operations - Individual Life Insurance
Amounts reflected in the table below are summarized on the line, "Income from
discontinued operations, net of tax", in the Operating Summary table of the
Consolidated Overview section. Results in the Operating Summary section below
exclude Year 2000 costs.
Operating Summary:
- ------------------
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
(Millions) 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
Premiums $ 53.3 $ 49.0 $ 131.1 $ 146.7
Charges assessed against policyholders 58.1 57.1 161.5 161.7
Net investment income 48.7 50.8 146.2 150.6
Net realized capital (losses) gains (.8) 2.2 .6 3.2
Other income 1.2 .1 1.8 .6
- ---------------------------------------------------------------------------------------------------------------------------
Total revenue 160.5 159.2 441.2 462.8
- ---------------------------------------------------------------------------------------------------------------------------
Current and future benefits 100.9 99.0 271.4 307.8
Operating expenses 11.9 14.7 41.3 43.0
Amortization of deferred policy acquisition costs 13.6 15.6 34.7 35.1
- ---------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 126.4 129.3 347.4 385.9
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 34.1 29.9 93.8 76.9
Income taxes 9.6 10.7 32.0 27.9
- ---------------------------------------------------------------------------------------------------------------------------
Net income (1) $ 24.5 $ 19.2 $ 61.8 $ 49.0
===========================================================================================================================
Net realized capital gains net of tax (included above) $ 2.8 $ 1.4 $ 3.7 $ 2.0
===========================================================================================================================
Deposits not included in premiums above $ 113.5 $ 113.3 $ 374.2 $ 351.2
===========================================================================================================================
Assets under management (2) $ 3,263.6 $ 3,050.3
===========================================================================================================================
Individual life insurance coverage issued $ 3,001.0 $ 3,788.6
===========================================================================================================================
Individual life insurance coverage in force $ 45,438.9 $ 43,627.2
===========================================================================================================================
(1) Net income for the three and nine months ended September 30, 1998 includes
a net benefit from capitalizing internal-use software of $.5 million and
$1.2 million, respectively, and excludes any effect of Year 2000 costs
recorded in 1998.
(2) Excludes net unrealized capital gains of $51.7 million and $68.1 million
at September 30, 1998 and 1997, respectively.
Excluding realized capital gains and Year 2000 costs, Discontinued Operations'
net income increased $4 million, or 22%, for the third quarter of 1998 compared
to the third quarter a year ago; and, excluding realized capital gains and Year
2000 costs, net income for the nine months ended September 30, 1998 increased
$11 million, or 24%, compared to the same period a year ago. Earnings for the
third quarter of 1998 increased primarily due to favorable expense control.
Earnings for the nine months ended September 30, 1998 increased primarily due to
favorable mortality experience.
16
Item 2. Management's Analysis of the Results of Operations (continued)
Discontinued Operations - Individual Life Insurance (continued)
Premiums and current and future benefits reflect offsetting amounts of $100
million and $113 million for the nine months ended September 30, 1998 and 1997,
respectively, related to the transition of the reinsurance agreement with Aetna
Life Insurance Company from a modified coinsurance to a coinsurance arrangement.
The Company's sale of its domestic individual life insurance business to Lincoln
on October 1, 1998 included the individual life business in force as well as
access to a managing general agent and brokerage distribution channel. The
transaction is generally in the form of an indemnity reinsurance arrangement and
covers the following lines of insurance: traditional life, universal life,
sponsored life, corporate-owned life insurance and pension life. Pension life
results, which are reported in Financial Services, are not material to the
individual life insurance business and, therefore, are not included in the
results from Discontinued Operations reported below. Net income from
Discontinued Operations, excluding net realized capital gains and Year 2000
costs in all periods, was $22 million for the third quarter of 1998 compared to
$18 million for the third quarter of 1997 and $58 million for the first nine
months of 1998 compared to $47 million for the same period in 1997, as well as
$64 million for the year ended December 31, 1997.
General Account Investments
The Company's invested assets were comprised of the following:
September 30, December 31,
(Millions) 1998 1997
- -------------------------------------------------------------------------------------------------------------
Debt securities, available for sale, at fair value $12,207.9 $ 13,463.8
Equity securities, available for sale:
Nonredeemable preferred stock 73.9 147.6
Investment in affiliated mutual funds 116.3 83.0
Common stock 1.4 0.6
Short-term investments 23.1 95.6
Mortgage loans 12.7 12.8
Policy loans 521.5 469.6
------------------------------------------
Total Investments $12,956.8 $14,273.0
=============================================================================================================
Total investments decreased for the third quarter of 1998 primarily because
investments supporting the individual life business were sold in preparation for
the sale of the life business (see Consolidated Overview and Discontinued
Operations - Individual Life Insurance sections for further discussion on the
sale). At September 30, 1998 and December 31, 1997, the Company's carrying value
of investments in debt securities represented 94% of the total general account
invested assets. For the same periods, $9.3 billion, or 76% of total debt
securities, and $10.7 billion, or 79% of total debt securities, supported
experience rated products.
17
Item 2. Management's Analysis of the Results of Operations (continued)
General Account Investments (continued)
It is management's objective that the portfolio of debt securities be of high
quality and be well-diversified by market sector. The debt securities in the
Company's portfolio are generally rated by external rating agencies, and, if not
externally rated, are rated by the Company on a basis believed to be similar to
that used by the rating agencies. The average quality rating of the Company's
debt security portfolio at September 30, 1998 and December 31, 1997 was A+ and
AA-, respectively.
The percentage of total debt securities by quality rating category is as
follows:
September 30, 1998 December 31, 1997
- ------------------------------------------------------------------------------------------
AAA 40.9% 48.3%
AA 12.0 10.4
A 24.4 21.7
BBB 15.5 12.9
BB 3.8 3.8
B and Below 3.4 2.9
------------------------------------------------
100.0% 100.0%
================================================
The percentage of total debt securities investments by market sector is as
follows:
September 30, 1998 December 31, 1997
- --------------------------------------------------------------------------------------------
U.S. Corporate Securities 45.6% 37.4%
Residential Mortgage-Backed Securities 22.5 24.3
Foreign Securities - U.S. Dollar Denominated 11.6 12.4
Commercial/Multifamily Mortgage-Backed Securities 10.1 8.6
Asset-Backed Securities 6.0 7.7
U.S. Treasuries/Agencies 4.2 9.6
-------------------------------------------
100.0% 100.0%
===========================================
Year 2000
The Year 2000 problem is the inability of computers, software and microchips to
properly interpret dates past 1999.
The Company relies heavily on information technology ("IT") systems and other
systems and facilities such as telephones, building access control systems and
heating and ventilation equipment ("embedded systems") to conduct its business.
The Company also has business relationships with financial institutions,
financial intermediaries, public utilities and other critical vendors as well as
regulators and customers who are themselves reliant on IT and embedded systems
to conduct their businesses.
18
State of Readiness
In 1997, the Company's ultimate parent, Aetna, organized a multi-disciplinary
Year 2000 Project Team that includes outside consultants. The Year 2000 Project
Team and Aetna's businesses and subsidiaries, including the Company, have
developed and are currently executing a comprehensive plan designed to make
their mission critical IT systems and embedded systems Year 2000 ready. Outside
consultants have reviewed Aetna's overall process, plan and progress to date.
Aetna's plan for IT systems consists of four phases: (1) inventory - identifying
all IT systems and risk rating each according to its potential business impact;
(2) assessment - identifying IT systems that use date functions and assessing
them for Year 2000 functionality; (3) remediation - reprogramming, or replacing
where necessary, inventoried items to ensure they are Year 2000 ready; and (4)
testing and certification - testing the code modifications and new inventory
with other associated systems, including extensive date testing and performing
quality assurance testing to ensure successful operation in the post-1999
environment. The Company is addressing its IT systems in a manner consistent
with Aetna's plan.
Aetna has completed the inventory and assessment phases for substantially all of
its IT systems and those of its subsidiaries, including those of the Company.
The Company's IT systems are currently in the remediation and testing and
certification phases. Aetna plans to complete the remediation of substantially
all of its mission critical IT systems and those of its subsidiaries, including
those of the Company, by year-end 1998, the remediation of their other IT
systems by March 30, 1999, and the testing and certification of all of their IT
systems by mid-1999.
Aetna is responsible for substantially all aspects of the Year 2000 issue as it
relates to the Company's embedded systems. Aetna has inventoried and risk rated
substantially all of its embedded systems and those of its subsidiaries,
including those of the facilities the Company occupies. The results of these
processes indicate that embedded systems should not present a material Year 2000
risk to the Company. Aetna's remaining steps include testing selected embedded
systems and remediating and certifying systems that exhibit Year 2000 issues.
Aetna is focusing its testing and remediation efforts on select embedded systems
of its mission critical facilities such as data centers, service centers,
communications centers and select office locations. Aetna plans to complete
testing of these systems by mid-1999, and the remediation and certification of
these systems by year-end 1999.
The Company believes that its Year 2000 project generally is on schedule.
External Relationships
The Company also faces the risk that one or more of its critical suppliers or
customers ("external relationships") will not be able to interact with the
Company due to the third party's inability to resolve its own Year 2000 issues,
including those associated with its own external relationships. The Company has
completed its inventory of external relationships and risk rated each external
relationship based upon the potential business impact, available alternatives
and cost of substitution. The Company is attempting to determine the overall
Year 2000 readiness of its external relationships. In the case of mission
critical suppliers such as banks, financial intermediaries (such as stock
exchanges), telecommunications providers and other utilities, mutual fund
companies, IT vendors and financial market data providers, the Company is
engaged in discussions with the third parties and is attempting to obtain
detailed information as to those parties' Year 2000 plans and state of
readiness. The Company, however, does not have sufficient information at the
current time to predict whether its external relationships will be Year 2000
ready.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Year 2000 (Continued)
Year 2000 Costs
Total Year 2000 project costs for the Company are currently estimated to be $22
million (after tax) in 1998 and $16 million (after tax) in 1999. A majority of
these costs are expected to be incremental expenses that will not recur in the
Year 2000 or thereafter. Year 2000 costs incurred were $5 million (after tax)
for the third quarter of 1998 and $14 million (after tax) for the first nine
months of 1998. Year 2000 costs were not material in 1997. The Company expenses
these costs as incurred and funds these costs through operating cash flows.
Year 2000 compliance is critical to the Company. The Company has redeployed some
resources from non-critical system enhancements to address Year 2000 issues. Due
to the importance of IT systems to the Company's business, management has not
deferred mission critical systems enhancements to become Year 2000 ready. The
Company does not expect these redeployments and deferrals to have a material
impact on the Company's financial condition or results of operations.
Risks and Contingency/Recovery Planning
If the Company's Year 2000 issues were unresolved, potential consequences would
include, among other possibilities, the inability to accurately and timely
update customers' accounts, process financial transactions, price securities,
bill customers, assess exposure to investment risks, determine liquidity
requirements or report accurate data to management, shareholders, customers,
regulators and others as well as business interruptions or shutdowns, financial
losses, reputational harm, increased scrutiny by regulators and litigation
related to Year 2000 issues. The Company is attempting to limit the potential
impact of the Year 2000 by monitoring the progress of its own Year 2000 project
and those of its critical external relationships and by developing
contingency/recovery plans. The Company cannot guarantee that it will be able to
resolve all of its Year 2000 issues. Any critical unresolved Year 2000 issues at
the Company or its external relationships, however, could have a material
adverse effect on the Company's results of operations, liquidity or financial
condition.
The Company has begun to develop contingency/recovery plans aimed at ensuring
the continuity of critical business functions before and after December 31,
1999. As part of that process, the Company has begun to develop reasonably
likely failure scenarios for its critical IT systems and external relationships
and the embedded systems in its critical facilities. Once these scenarios are
identified, the Company will develop plans that are designed to reduce the
impact on the Company, and provide methods of returning to normal operations, if
one or more of those scenarios occur. The Company expects contingency/recovery
planning to be substantially complete by September 1999.
See "Forward-Looking Information/Risk Factors" for factors that could cause
actual Year 2000 results to differ from the Company's expectations.
20
Item 2. Management's Analysis of the Results of Operations (continued)
Forward-Looking Information/Risk Factors
The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides a
"safe harbor" for forward-looking statements, so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement. The Company desires to
take advantage of these safe harbor provisions.
Certain information contained in this management's analysis is forward-looking
within the meaning of the 1995 Act or Securities and Exchange Commission rules
including, but not limited to, the information that appears under the heading
"Year 2000". Words such as expects, projects, anticipates, intends, plans,
believes, seeks or estimates, or variations of such words and similar
expressions are also intended to identify forward-looking statements. These
forward-looking statements are subject to significant uncertainties and
contingencies, many of which are beyond the control of the Company.
Set forth below are certain important factors that, in addition to general
economic conditions and other factors, some of which are discussed under the
headings "Business-Other Matters/Regulation" and "Business-Other Matters/Forward
Looking" in the Company's 1997 Annual Report on Form 10-K may affect the
forward-looking statements and the Company's businesses generally.
Other Factors Affecting All of the Company's Businesses - Year 2000
Any critical unresolved Year 2000 issues at the Company or its external
relationships could have a material adverse effect on the Company's results of
operations, liquidity or financial condition. In addition, the Company's
expectations about the future costs and timely and successful completion of its
Year 2000 program are subject to uncertainties that could cause actual results
to differ materially from what has been discussed above under "Year 2000".
Factors that could influence the amount of future costs and the completion dates
and effectiveness of remediation, testing and certification and contingency
planning efforts include the Company's success in identifying IT systems, and
Aetna's success in identifying embedded systems, that contain two-digit year
codes, the nature and amount of required reprogramming, testing and
certification, the rate and magnitude of related labor and consulting costs, the
availability of qualified personnel and the success of the Company's external
relationships in addressing their own Year 2000 issues. See "Year 2000".
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is involved in numerous lawsuits arising, for the most part, in the
ordinary course of its business operations. While the ultimate outcome of
litigation against the Company cannot be determined at this time, after
consideration of the defenses available to the Company and any related reserves
established, it is not expected to result in liability for amounts material to
the financial condition of the Company, although it may adversely affect results
of operations in future periods.
Item 5. Other Information.
Ratings
The Company's claims paying ratings are as follows:
Rating Agencies
----------------------------------------------------------------------------
A.M. Best Duff & Phelps Moody's Investors Standard &
Service Poor's
----------------------------------------------------------------------------
August 4, 1998 (1) A+ AA+ Aa3 AA-
November 3, 1998 A AA Aa3 AA-
(1) As of August 4, 1998, A.M. Best ratings were on review and Duff & Phelps
ratings were on credit watch or review for possible downgrade.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
(27) Financial Data Schedule.
(b) Reports on Form 8-K.
None
22
SIGNATURES
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.
AETNA LIFE INSURANCE AND ANNUITY COMPANY
----------------------------------------
(Registrant)
November 13, 1998 By
- --------------------- ---------------------------------
(Date) Deborah Koltenuk
Vice President, Treasurer, and Corporate Controller
(Chief Accounting Officer)
23