THE AFADVANTAGE VARIABLE ANNUITY
issued by
AMERICAN FIDELITY SEPARATE ACCOUNT B
and
AMERICAN FIDELITY ASSURANCE COMPANY
May 1, 1998
This prospectus describes the AFAdvantage Variable Annuity offered by American
Fidelity Assurance Company (American Fidelity, our, us or we). Our home office
is 2000 N. Classen Boulevard, Oklahoma City, Oklahoma 73106.
The annuity is a fixed and variable deferred annuity policy which has 10
Investment Options - the Guaranteed Interest Account Option and the following
Portfolios:
THE DREYFUS SOCIALLY RESPONSIBLE GROWTH FUND, INC.
DREYFUS STOCK INDEX FUND
DREYFUS VARIABLE INVESTMENT FUND
Growth and Income Portfolio
Small Company Stock Portfolio
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
Merrill Lynch Prime Bond Fund
Merrill Lynch American Balanced Fund
Merrill Lynch High Current Income Fund
Merrill Lynch Special Value Focus Fund
Merrill Lynch International Equity Focus Fund
Please read this prospectus carefully before investing and keep it for future
reference. It contains important information about the AFAdvantage Variable
Annuity.
To learn more about the annuity offered by this prospectus, you can obtain a
copy of the Statement of Additional Information (SAI) dated May 1, 1998.
The SAI has been filed with the Securities and Exchange Commission (SEC) and is
incorporated by reference into this prospectus. The SEC maintains a Web site
(http://www.sec.gov) that contains the SAI, material incorporated by reference,
and other material regarding companies that file electronically with the SEC.
The Table of Contents of the SAI is found on the last page of this prospectus.
For a free copy of the SAI, call us at (800) 662-1106 or write us at: P.O. Box
25523, Oklahoma City, Oklahoma 73125-0523.
INVESTMENT IN A VARIABLE ANNUITY IS SUBJECT TO RISKS, INCLUDING THE POSSIBLE
LOSS OF PRINCIPAL. THE POLICIES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, ANY FINANCIAL INSTITUTION AND ARE NOT FEDERALLY
INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD,
OR ANY OTHER AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
TABLE OF CONTENTS
PAGE
GLOSSARY OF TERMS 1
SUMMARY 2
FEE TABLE 5
THE AFADVANTAGE VARIABLE ANNUITY 7
Policy Owner 7
Joint Owner 7
Beneficiary 7
Assignment of the Policy 7
ANNUITY PROVISIONS 8
Annuity Date 8
Selection of an Annuity Option 8
Annuity Payments 8
Annuity Options 8
HOW TO PURCHASE THE AFADVANTAGE VARIABLE ANNUITY 9
Purchase Payments 9
Allocation of Purchase Payments 9
Right to Examine Policy 9
Accumulation Units 9
INVESTMENT OPTIONS 10
Portfolios 10
Guaranteed Interest Account Option 11
Voting Rights 11
Substitution 11
Transfers 12
Transfers during the Accumulation Phase 12
Transfers during the Annuity Phase 12
Automatic Dollar Cost Averaging 12
Asset Rebalancing 12
PERFORMANCE 12
EXPENSES 13
Insurance Charges 13
Mortality and Expense Risk Charge 13
Administrative Charge 13
Distribution Expense Charge 13
Policy Maintenance Charge 13
Withdrawal Charge 13
Reduction or Elimination of the Withdrawal Charge 14
Transfer Fee 14
Premium Taxes 14
Income Taxes 14
Fund Expenses 15
TAXES 15
Annuities in General 15
Qualified and Non-Qualified Policies 15
Tax Treatment of Withdrawals - Non-Qualified Policies 16
Tax Treatment of Withdrawals - Qualified Policies 16
Tax Treatment of Withdrawals - Tax-Sheltered Annuities 17
Diversification 17
WITHDRAWALS 17
Systematic Withdrawal Program 17
Suspension of Payments or Transfers 18
LOANS 18
DEATH BENEFIT 18
Death Benefit Amount 18
Death of Owner Before Annuity Date 18
Death of Annuitant Before the Annuity Date 19
Death of Owner After the Annuity Date 19
Death of Annuitant After the Annuity Date 19
OTHER INFORMATION 20
American Fidelity 20
The Separate Account 20
Legal Proceedings 20
Distribution 20
Administration 20
Financial Statements 20
TABLE OF CONTENTS OF THE STATEMENT OF ADDITIONAL INFORMATION 21
GLOSSARY OF TERMS
Some of the terms used in this prospectus are technical. To help you understand
these terms, we have defined them below and have capitalized them throughout the
prospectus.
ACCOUNTS: The Guaranteed Interest Account and the Portfolios.
ACCOUNT VALUE: The value of your Policy in the Investment Options during the
Accumulation Phase.
ACCUMULATION PHASE: Until you decide to begin receiving Annuity Payments, your
annuity is in the Accumulation Phase.
ACCUMULATION UNIT: The unit of measurement we use to keep track of the value of
your Policy invested in the Portfolios during the Accumulation Phase.
ANNUITANT: The natural person on whose life Annuity Payments are based.
ANNUITY DATE: The date Annuity Payments begin. You can choose the month and year
in which Annuity Payments will begin.
ANNUITY OPTIONS: You can choose among available pay-out plans for your Annuity
Payments. These are referred to as Annuity Options.
ANNUITY PAYMENTS: You can receive regular income payments from your Policy.
These are referred to as Annuity Payments.
ANNUITY PHASE: The period during which we make Annuity Payments.
ANNUITY UNIT: The unit of measurement we use to calculate your Annuity Payments
during the Annuity Phase.
BENEFICIARY: The person or entity you name to receive any death benefits.
FUNDS: The Dreyfus Socially Responsible Growth Fund, Inc., Dreyfus Stock Index
Fund, Dreyfus Variable Investment Fund and Merrill Lynch Variable Series Funds,
Inc.
GUARANTEED INTEREST ACCOUNT OPTION: An investment option within our general
account which earns interest credited by us.
INVESTMENT OPTIONS: The Portfolios and the Guaranteed Interest Account Option.
JOINT OWNER: The Policy can be owned by you and your spouse (the Joint Owner).
NON-QUALIFIED: If you do not purchase the Policy under a Qualified plan, your
Policy is referred to as a Non-Qualified Policy.
POLICY: The AFAdvantage Variable Annuity.
POLICY ANNIVERSARY: The anniversary of the date your Policy was issued.
POLICY OWNER: The person or entity entitled to ownership rights under a Policy.
POLICY YEAR: The annual period which begins on the date your Policy was issued
and each anniversary of that date.
PORTFOLIOS: The variable Investment Options available under the Policy. Each
Portfolio has its own investment objective and is invested in a Fund or a
corresponding portfolio of a Fund.
PURCHASE PAYMENT: The money you invest to buy the Policy.
QUALIFIED: Policies purchased under special tax qualification rules (examples:
Individual Retirement Annuities, 403(b) Tax-Sheltered Annuities, H.R. 10 and
Corporate Pension and other qualified retirement plans).
TAX DEFERRAL: Tax deferral means that you are not taxed on earnings or
appreciation on the assets in your Policy until you take money out of your
Policy.
SUMMARY
The following information is a summary of some of the more important features of
your annuity Policy. More detailed information is contained in the corresponding
sections of this prospectus.
THE AFADVANTAGE VARIABLE ANNUITY. This prospectus describes the flexible premium
variable and fixed deferred annuity policy offered by American Fidelity
Assurance Company (American Fidelity). It is a contract between you, the Policy
Owner, and American Fidelity, an insurance company. The Policy provides a means
for investing on a Tax Deferred basis in the Portfolios and the Guaranteed
Interest Account Option. The AFAdvantage Variable Annuity is designed for people
seeking long-term Tax Deferred accumulation of assets, generally for retirement
or other long-term purposes. The Tax Deferred feature is most attractive to
people in high federal and state tax brackets. You should not buy the Policy if
you are looking for a short-term investment or if you cannot accept the risk of
getting back less money than you put in.
Like all deferred annuities, your Policy has two phases: the Accumulation Phase
and the Annuity Phase. During the Accumulation Phase, you invest money in your
annuity and your earnings accumulate on a Tax Deferred basis. Your earnings are
based on the investment performance of the Portfolios you selected and/or the
interest rate earned on the money you have in the Guaranteed Interest Account.
You can withdraw money from your Policy during the Accumulation Phase. During
the Accumulation Phase, the earnings are taxed as income only when you make a
withdrawal. A federal tax penalty may apply if you make withdrawals before age
59 1/2. The Annuity Phase occurs when you begin receiving regular payments from
your Policy. Among other factors, the amount of the payments you may receive
during the Annuity Phase will depend upon the amount of money you are able to
accumulate in your Policy during the Accumulation Phase.
ANNUITY PROVISIONS. You can receive monthly Annuity Payments from your Policy
under an Annuity Option. During the Annuity Phase, payments can come from the
Portfolios and/or the Guaranteed Interest Account.
HOW TO PURCHASE THE AFADVANTAGE VARIABLE ANNUITY. You may make Purchase Payments
at any time during the Accumulation Phase. Each payment must be at least $25.
You must complete an application and make your first Purchase Payment to
purchase the Policy.
INVESTMENT OPTIONS. You may allocate your money to the Guaranteed Interest
Account Option of American Fidelity or the following Portfolios:
THE DREYFUS SOCIALLY RESPONSIBLE GROWTH FUND, INC.
DREYFUS STOCK INDEX FUND
DREYFUS VARIABLE INVESTMENT FUND
Growth and Income Portfolio
Small Company Stock Portfolio
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
Merrill Lynch Prime Bond Fund
Merrill Lynch American Balanced Fund
Merrill Lynch High Current Income Fund
Merrill Lynch Special Value Focus Fund
Merrill Lynch International Equity Focus Fund
The Portfolios offer professionally managed investment choices and are fully
described in the attached prospectuses for the Funds. You can make or lose money
in the Portfolios, depending upon market conditions.
The Guaranteed Interest Account Option offers an interest rate that is
guaranteed by us. While your money is in the Guaranteed Interest Account Option,
the interest your money will earn (subject to a withdrawal charge on any
withdrawals from the Guaranteed Interest Account) is guaranteed by American
Fidelity.
EXPENSES. The following are the annual insurance charges which are deducted from
the average daily value of your Policy allocated to the Portfolios every year:
Mortality and Expense Risk Charge - 1.25%; Administrative Charge - .15%; and
Distribution Expense Charge - .10%. Each year we also deduct a $30 policy
maintenance charge from your Policy. There are also annual expenses of the
Portfolios which range from .28% to 1.12% of the average daily value of the
Portfolios, depending upon the Portfolio(s) you invest in.
You can transfer between accounts up to 12 times a Policy Year during the
Accumulation Phase. After that, the charge is the lesser of $25 or 2% of the
amount transferred. You may make one transfer a Policy Year during the Annuity
Phase. The one transfer is free.
During the first Policy Year, any withdrawals you make will have a withdrawal
charge. After the first Policy Year, you may make a withdrawal of up to 10% of
the value of your Policy once each Policy Year without incurring a withdrawal
charge (referred to as the "free withdrawal amount"). If you do not use the free
withdrawal amount in any year, it may not be carried forward and used the next
Policy Year.
The withdrawal charge is a percentage of the amount withdrawn in excess of the
free withdrawal amount as shown below:
<TABLE>
<CAPTION>
<S> <C>
Policy Year Withdrawal Charge %
- -------------------- -------------------
1 8%
2 7%
3 6%
4 5%
5 4%
6 3%
7 2%
8 1%
9 + 0%
</TABLE>
American Fidelity may assess a state premium tax charge which ranges from 0 -
4.0% (depending upon the state).
TAXES. Your earnings are not taxed until you take them out. In most cases, if
you take money out, earnings come out first and are taxed as income. If you are
younger than 59 1/2 when you take money out, you may be charged a federal tax
penalty on the taxable amounts withdrawn, which in most cases is 10% on the
taxable amounts. Payments during the Annuity Phase are considered partly a
return of your original investment. That part of each payment is not taxable as
income. If the Policy is tax-qualified, the entire payment may be taxable.
WITHDRAWALS. You may make a withdrawal at any time during the Accumulation
Phase. There may be limits to the amount you can withdraw from a Qualified Plan.
Any partial withdrawal must be for at least $250 (there are exceptions for
withdrawals allowed under 403(b) and 401 hardship provisions), but a withdrawal
must not reduce the value of your Policy below $100. This requirement is waived
if the partial withdrawal is pursuant to the Systematic Withdrawal Program. You
may request a withdrawal or elect the Systematic Withdrawal Program. Of course,
you may also have to pay income tax and a tax penalty on any money you take out.
DEATH BENEFIT. If you or the Annuitant die during the Accumulation Phase, the
person you have selected as your Beneficiary will receive a death benefit.
OTHER INFORMATION.
Free Look. If you cancel the Policy within 20 days after receiving it, we
will refund you the greater of the Purchase Payment paid or the value of your
Policy as of the earlier of the date we receive the Policy at our home office or
the date our agent receives the Policy.
No Probate. In most cases, when you die, your Beneficiary will receive the
death benefit without going through probate.
INQUIRIES. If you have any questions about your AFAdvantage Variable Annuity or
need more information, please contact us at:
American Fidelity Assurance Company
Annuity Services Department
P.O. Box 25523
Oklahoma City, OK 73125-0523
(800) 662-1106
FEE TABLE
OWNER TRANSACTION EXPENSES
<TABLE>
<CAPTION>
<S> <C> <C>
Withdrawal Charge
(as a percentage of
the amount withdrawn)
(see Note 2 below) Policy Year Withdrawal Charge
----------- ------------------
1 8%
2 7%
3 6%
4 5%
5 4%
6 3%
7 2%
8 1%
9+ 0%
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Transfer Fee No charge for first 12 transfers in a Policy
Year during the Accumulation Phase and no
charge for one transfer allowed each Policy
Year during the Annuity Phase; thereafter the
fee is the lesser of $25 or 2% of the amount
transferred.
Policy Maintenance Charge $30 per Policy per Policy Year.
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
SEPARATE ACCOUNT ANNUAL EXPENSES
(as a percentage of average account value)
Mortality and Expense Risk Charge 1.25%
Administrative Charge .15%
Distribution Expense Charge .10%
-----
Total Separate Account Annual Expenses 1.50%
</TABLE>
FUND ANNUAL EXPENSES
(as a percentage of the average daily net assets of a Portfolio)
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Other
Expenses
Management (after expense Total Annual
Fees reimbursement) Expenses
----------- ---------------------------- -------------------------
THE DREYFUS SOCIALLY RESPONSIBLE GROWTH FUND, INC. .75% .07% .82%
DREYFUS STOCK INDEX FUND .25% .03% .28%
DREYFUS VARIABLE INVESTMENT FUND
Growth and Income Portfolio .75% .05% .80%
Small Company Stock Portfolio .75% .37% 1.12%
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
(Class A Shares)
Merrill Lynch Prime Bond Fund .42% .05% .47%
Merrill Lynch American Balanced Fund .55% .05% .60%
Merrill Lynch High Current Income Fund .47% .07% .54%
Merrill Lynch Special Value Focus Fund .75% .05% .80%
Merrill Lynch International Equity Focus Fund .75% .15% .90%
</TABLE>
EXAMPLES
You would pay the following expenses on a $1,000 investment, assuming a 5%
annual return on your money if: (a) you surrender your Policy at the end of each
time period; or (b) if your Policy is not surrendered or is annuitized:
<TABLE>
<CAPTION>
<S> <C> <C>
Time Periods
1 Year 3 Years
THE DREYFUS SOCIALLY RESPONSIBLE GROWTH FUND, INC. a) $125.56 a) $191.59
b) $ 45.56 b) $136.95
DREYFUS STOCK INDEX FUND a) $120.14 a) $176.50
b) $ 40.14 b) $120.93
DREYFUS VARIABLE INVESTMENT FUND
Growth and Income Portfolio a) $125.36 a) $191.04
b) $ 45.36 b) $136.36
Small Company Stock Portfolio a) $128.56 a) $199.87
b) $ 48.56 b) $145.74
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
Merrill Lynch Prime Bond Fund a) $122.05 a) $181.84
b) $ 42.05 b) $126.60
Merrill Lynch American Balanced Fund a) $123.35 a) $185.48
b) $ 43.35 b) $130.46
Merrill Lynch High Current Income Fund a) $122.75 a) $183.80
b) $ 42.75 b) $128.68
Merrill Lynch Special Value Focus Fund a) $125.36 a) $191.04
b) $ 45.36 b) $136.36
Merrill Lynch International Equity Focus Fund a) $126.36 a) $193.81
b) $ 46.36 b) $139.30
</TABLE>
THE ANNUAL EXPENSES OF THE PORTFOLIOS ARE BASED ON DATA PROVIDED BY THE FUNDS
FOR THE YEAR ENDED DECEMBER 31,1997. AMERICAN FIDELITY DID NOT INDEPENDENTLY
VERIFY SUCH DATA. HOWEVER, WE DID PREPARE THE EXAMPLES.
1. The purpose of the Fee Table is to show you the various expenses you can
expect to incur directly or indirectly with the Policy. The Fee Table reflects
expenses of the Separate Account as well as the Funds.
2. Under certain circumstances, you can make a withdrawal without incurring
the withdrawal charge. (See Expenses - Withdrawal Charge.)
3. Premium taxes are not reflected. They may apply.
4. The assumed average Policy size is $1,360. The $30 policy maintenance
charge is reflected in the examples as $22.06.
5. THE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
As of December 31, 1997, the Separate Account had no assets. Therefore,
no condensed financial information is presented.
THE AFADVANTAGE VARIABLE ANNUITY
An annuity is a contract between you, the Policy Owner, and an insurance company
(in this case American Fidelity), where the insurance company promises to pay
you (or someone else you choose) an income in the form of Annuity Payments
beginning on a date chosen by you. Until you decide to begin receiving Annuity
Payments, your annuity is in the Accumulation Phase. Once you begin receiving
Annuity Payments, your Policy is in the Annuity Phase. If you or the Annuitant
die during the Accumulation Phase, American Fidelity will pay a death benefit to
your Beneficiary.
The Policy benefits from Tax Deferral. Tax Deferral means that you are not taxed
on earnings or appreciation on the assets in your Policy until you take money
out of your Policy.
The Policy is called a variable annuity because you can choose among the
available Portfolios and, depending upon market conditions, you can make or lose
money in any of these Portfolios. If you select the variable annuity portion of
the Policy, the amount of money you are able to accumulate in your Policy during
the Accumulation Phase depends in part upon the investment performance of the
Portfolio(s) you select. The Annuity Payments you will receive during the
Annuity Phase can come from the Portfolios and/or the Guaranteed Interest
Account.
The Guaranteed Interest Account Option offers an interest rate that is
guaranteed by American Fidelity. If you select the Guaranteed Interest Account
Option, your money will be placed with our other general assets. If you select
the Guaranteed Interest Account Option, the amount of money you are able to
accumulate in your Policy during the Accumulation Phase depends upon the total
interest credited to your Policy.
POLICY OWNER . You, as the Policy Owner, have all the rights under the Policy.
You can name a new Policy Owner. A change of Owner will revoke any prior
designation of Owner. Any ownership changes must be sent to our home office on a
form we accept. The change will go into effect when it is signed, subject to any
payments we make or other actions we take before we record it. American Fidelity
will not be liable for any payment made or action taken before it records the
change. The Policy Owner is as designated at the time the Policy is issued,
unless changed. A CHANGE OF OWNERSHIP MAY BE A TAXABLE EVENT.
JOINT OWNER . The Policy can be owned by Joint Owners. If Joint Owners are
named, any Joint Owner must be the spouse of the other Owner. Upon the death of
either Owner, the surviving spouse will be the primary Beneficiary. Any other
Beneficiary designation will be treated as a contingent Beneficiary unless
otherwise indicated in a form we accept.
BENEFICIARY . The Beneficiary is the person(s) or entity you name to receive any
death benefit. The Beneficiary is named at the time the Policy is issued unless
changed at a later date. If the Beneficiary and the Policy Owner or Annuitant,
as applicable, die at the same time, we will assume that the Beneficiary died
first for purposes of payment of the death benefit. You can name any Beneficiary
to be an irrevocable Beneficiary. The interest of an irrevocable Beneficiary
cannot be changed without his or her consent.
You can change the Beneficiary at any time during the Annuitant's life. To do
so, you need to send a request to our home office. The request must be on a form
we accept. The change will go into effect when signed, subject to any payments
we make or actions we take before we record the change. A change cancels all
prior Beneficiaries, except a change will not cancel any irrevocable Beneficiary
without his or her consent. The interest of the Beneficiary will be subject to:
any assignment of the Policy which is binding on us, and any Annuity Option in
effect at the Annuitant's death.
ASSIGNMENT OF THE POLICY
During the Annuitant's life, you can assign some or all of your rights under the
Policy to someone else. A signed copy of the assignment must be sent to our home
office on a form we accept. The assignment will go into effect when it is
signed, subject to any payments we make or other actions we take before we
record it. We are not responsible for the validity or effect of any assignment.
If there are irrevocable Beneficiaries, you need their consent before assigning
your ownership rights in the Policy. Any assignment made after the death benefit
has become payable will be valid only with our consent. If the Policy is
assigned, your rights may only be exercised with the consent of the assignee of
record. AN ASSIGNMENT MAY BE A TAXABLE EVENT.
If the Policy is issued pursuant to a Qualified plan, there may be limitations
on your ability to assign it.
ANNUITY PROVISIONS
ANNUITY DATE
You can receive regular monthly income payments (Annuity Payments) under your
Policy. You can choose the month and year in which those payments begin. We call
that date the Annuity Date. You can select an Annuity Date at any time during
the Accumulation Phase. You must notify us of this date at least 30 days prior
to the date you want your Annuity Payments to begin. Prior to the Annuity Date,
you may change the Annuity Date by written request. Any change must be requested
at least 30 days prior to the new Annuity Date. Your Annuity Date must be the
first day of a calendar month. The Annuity Date may not be later than the
earlier of when the Annuitant reaches attained age 85 or the maximum date
permitted under state law. Your Annuity Date cannot be any earlier than 30 days
after you buy the Contract.
SELECTION OF AN ANNUITY OPTION
You can choose among income plans. We call those Annuity Options. A selection to
receive Annuity Payments under an Annuity Option must be made at least 30 days
prior to the Annuity Date. If no option is selected, Option 2 with 120 monthly
payments guaranteed will automatically be applied. Prior to the Annuity Date,
you may change the Annuity Option selected by written request. Any change must
be requested at least 30 days prior to the Annuity Date. If an option is based
on life expectancy, we will require proof of the payee's date of birth.
ANNUITY PAYMENTS
Annuity Payments are paid in monthly installments. Annuity Payments can be made
on a variable basis (which means they will be based on the investment
performance of the Portfolios) and/or on a fixed basis (which means they will
come from the Guaranteed Interest Account). However, payments under Option 4 can
only come from the Guaranteed Interest Account (fixed annuity). Depending on
your election, the value of your Policy (adjusted for the policy maintenance
charge and any taxes) will be applied to provide the Annuity Payment. If no
election has been made 30 days prior to the Annuity Date, amounts in the
Guaranteed Interest Account will be used to provide a fixed annuity and amounts
in the Portfolios will be used to provide a variable annuity. If you choose to
have any portion of your Annuity Payments come from the Portfolio(s), the dollar
amount of your payment will depend upon 3 things: 1) the value of your Policy in
the Portfolio(s) on the Annuity Date, 2) the assumed investment rate used in the
annuity table for the Policy, and 3) the performance of the Portfolios you
selected. You can choose either a 3%, 4% or 5% assumed investment rate. If you
do not choose an assumed investment rate, the assumed investment rate will be
3%. If the actual performance exceeds the 3% assumed rate (or whichever rate you
choose), your Annuity Payments will increase. Similarly, if the actual rate is
less than 3% (or whichever rate you choose), your Annuity Payments will
decrease. If you choose a higher assumed investment rate, your initial Annuity
Payment will be higher. Subsequent payments will be only slightly higher when
actual performance (less any deductions and expenses) is more than the assumed
rate and will decrease more rapidly when actual performance (less any deductions
and expenses) is less than the assumed rate. The amount of the first Annuity
Payment will depend on the Annuity Option elected and the age of the Annuitant
at the time the first payment is due.
ANNUITY OPTIONS
You can choose one of the following Annuity Options or any other Annuity Option
acceptable to us. After Annuity Payments begin, you cannot change the Annuity
Option.
OPTION 1. LIFETIME ONLY ANNUITY: We will make monthly payments during the life
of the Annuitant. If this option is elected, payments will stop when the
Annuitant dies.
OPTION 2. LIFETIME ANNUITY WITH GUARANTEED PERIODS: We will make monthly
payments for the guaranteed period selected during the life of the Annuitant.
When the Annuitant dies, any amounts remaining under the guaranteed period
selected will be distributed to the Beneficiary at least as rapidly as they were
being paid as of the date of the Annuitant's death. The guaranteed period may be
10 years or 20 years.
OPTION 3. JOINT AND SURVIVOR ANNUITY: We will make monthly payments during the
joint lifetime of the Annuitant and a joint Annuitant. Payments will continue
during the lifetime of the surviving Annuitant and will be computed on the basis
of 100%, 66 2/3% or 50% of the Annuity Payment in effect during the joint
lifetime.
OPTION 4. PERIOD CERTAIN: We will make monthly payments for a specified period.
The specified period must be at least five years and cannot be more than 30
years. This option is available as a fixed annuity only.
HOW TO PURCHASE THE AFADVANTAGE VARIABLE ANNUITY
PURCHASE PAYMENTS
A Purchase Payment is the money you give us to buy the Policy. You may make
Purchase Payments at any time during the Accumulation Phase. You may increase,
decrease, or change the frequency of such payments. However, each Purchase
Payment must be for at least $25. If in any year no Purchase Payments are made,
the Policy will not lapse. We reserve the right to reject any application or
Purchase Payment. We may deduct amounts from Purchase Payments for premium
taxes, if any. At the time you buy the Policy, you and the Annuitant cannot be
older than 85 years old, or the maximum age permitted under state law.
ALLOCATION OF PURCHASE PAYMENTS
We will allocate the first net Purchase Payment to one or more Investment
Options according to your instructions. We will allocate subsequent Purchase
Payments in the same manner as the first unless you change your instructions.
You may change the allocations of Investment Options by using a form we accept.
We reserve the right to limit the available Investment Options from which you
may choose. All allocations must be in whole percentages, and must not be less
than $25.
Once we receive your Purchase Payment and application, we will issue your Policy
and allocate your first Purchase Payment within 2 business days. If you do not
give us all of the information we need, we will contact you to get it. If for
some reason we are unable to complete this process within 5 business days, we
will either send back your money or get your permission to keep it until we get
all of the necessary information. We will credit your subsequent Purchase
Payments to your Policy within one business day. Our business day closes when
the New York Stock Exchange closes, which is usually at 4:00 p.m. Eastern time.
RIGHT TO EXAMINE POLICY
If you change your mind about owning the Policy, you can cancel it within 20
days after receiving it. When you cancel the Policy within this time period, we
will not assess a withdrawal charge. If you return the Policy, it will be void
from the beginning and we will refund to you the greater of: the Purchase
Payments paid, or the value of your Policy as of the earlier of the date we
receive the Policy at our home office, or the date our agent receives the
Policy.
ACCUMULATION UNITS
The value of the portion of your Policy allocated to the Portfolios will go up
or down depending upon the investment performance of the Portfolio(s) you
choose. The value of your Policy will also depend on the expenses of the Policy.
In order to keep track of the value of your Policy, we use a measurement called
an Accumulation Unit. During the Annuity Phase, we call the unit an Annuity
Unit.
Every business day we determine the value of an Accumulation Unit for a share of
a Portfolio by multiplying the Accumulation Unit value for the previous period
by a factor for each Portfolio for the current period. The factor for each
Portfolio is determined by:
1. dividing the value of the underlying Fund share at the end of the
current period by the value of an underlying Fund share for the previous
period; and
2. subtracting from that amount any mortality and expense risk,
administrative and distribution expense charges.
The value of an Accumulation Unit may go up or down from day to day.
When you make a Purchase Payment, we credit your Policy with Accumulation Units.
The number of Accumulation Units credited is determined by dividing the amount
of the Purchase Payment allocated to a Portfolio by the value of the
Accumulation Unit for that Portfolio.
We calculate the value of an Accumulation Unit for each Portfolio after the New
York Stock Exchange closes each day and then credit your Policy accordingly.
EXAMPLE:
On Thursday we receive an additional Purchase Payment of $100 from you. You
direct this to go to the Merrill Lynch Special Value Focus Portfolio
Investment Option. When the New York Stock Exchange closes on that Thursday, we
determine that the value of an Accumulation Unit for the Merrill Lynch Special
Value Focus Portfolio is $10.75. We then divide $100 by $10.75 and credit your
Policy on Thursday night with 9.30 Accumulation Units for the Merrill Lynch
Special Value Focus Portfolio.
INVESTMENT OPTIONS
When you buy the Policy you can allocate your money to the Portfolios listed
below and/or the Guaranteed Interest Account.
PORTFOLIOS
THE DREYFUS SOCIALLY RESPONSIBLE GROWTH FUND, INC.
The Dreyfus Socially Responsible Growth Fund, Inc. is an open-end, diversified
management investment company. The Dreyfus Corporation serves as the Fund's
investment adviser. NCM Capital Management Group, Inc. serves as the Fund's
sub-investment adviser and provides day-to-day management of the Fund's
portfolio.
DREYFUS STOCK INDEX FUND
Dreyfus Stock Index Fund is an open-end, non-diversified, management investment
company. The Dreyfus Corporation serves as the Fund's manager. Dreyfus has hired
its affiliate, Mellon Equity Associates, to serve as the Fund's index fund
manager and provide day-to-day management of the Fund's investments.
THE DREYFUS VARIABLE INVESTMENT FUND
Dreyfus Variable Investment Fund is an open-end management investment company
with thirteen portfolios. The Dreyfus Corporation serves as the investment
adviser. The following are available under the Policy:
Growth and Income Portfolio
Small Company Stock Portfolio
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
Merrill Lynch Variable Series Funds, Inc. is an open-end management investment
company with eighteen separate funds. Merrill Lynch Asset Management, L.P. is
the investment adviser to the funds. The following funds are available under the
Policy:
Merrill Lynch Prime Bond Fund
Merrill Lynch American Balanced Fund
Merrill Lynch High Current Income Fund
Merrill Lynch Special Value Focus Fund
Merrill Lynch International Equity Focus Fund
Additional Portfolios and/or Funds may be available in the future.
Shares of the Funds are issued and redeemed in connection with investments in
and payments under certain variable annuity contracts and variable life
insurance policies of various life insurance companies which may or may not be
affiliated. The Funds do not believe that offering their shares in this manner
will be disadvantageous to you. Nevertheless, the Board of Trustees or the Board
of Directors, as applicable, intend to monitor events in order to identify any
material irreconcilable conflicts which may possibly arise and to determine what
action, if any, should be taken. If such a conflict were to occur, one or more
insurance company separate accounts might withdraw its investments in a Fund. An
irreconcilable conflict might result in the withdrawal of a substantial amount
of a Fund's assets which could adversely affect such Fund's net asset value per
share.
YOU SHOULD READ THE PROSPECTUSES FOR THE FUNDS CAREFULLY BEFORE INVESTING. THEY
CONTAIN DETAILED INFORMATION ABOUT THE FUNDS AND ARE ATTACHED TO THIS
PROSPECTUS. You can obtain a copy of the Statement of Additional Information for
the Funds by contacting American Fidelity's Annuity Service Office at: (800)
662-1106, P.O. Box 25523, Oklahoma City, Oklahoma 73125-0523.
GUARANTEED INTEREST ACCOUNT OPTION
The Guaranteed Interest Account Option is an Investment Option within our
general account which earns interest credited by us.
Because of certain exemptive and exclusionary provisions, interests in the
Guaranteed Interest Account are not registered under the Securities Act of 1933
and the Guaranteed Interest Account is not registered as an investment company
under the Investment Company Act of 1940. Therefore, neither the Guaranteed
Interest Account nor any interests in it are subject to the provisions of these
Acts. American Fidelity has been advised that the staff of the Securities and
Exchange Commission has not reviewed the disclosure in this prospectus relating
to the Guaranteed Interest Account Option. Disclosures regarding the Guaranteed
Interest Account Option may, however, be subject to certain generally applicable
provisions of the federal securities laws relating to the accuracy and
completeness of statements made in prospectuses.
VOTING RIGHTS
American Fidelity is the legal owner of the Fund shares. However, American
Fidelity believes that when a Fund solicits proxies in conjunction with a
shareholder vote, it is required to obtain from you and other Policy Owners
instructions as to how to vote those shares. When we receive those instructions,
we will vote all of the shares we own in proportion to those instructions.
Should we determine that we are no longer required to comply with the above, we
will vote the shares in our own right.
SUBSTITUTION
American Fidelity may substitute one of the Portfolios you have selected with
another Portfolio. We would not do this without the prior approval of the
Securities and Exchange Commission. We will give you notice of our intention to
do this.
TRANSFERS
You may direct us to make transfers between all Investment Options. A transfer
request must be in a form we accept. We reserve the right to limit the number of
transfers that may be made. If you elect to use this transfer privilege, we will
not be liable for transfers made as instructed by you. All transfers must be in
whole percentages. All transfers made on a given date count as one transfer.
We reserve the right, at any time and without prior notice, to end, suspend or
change the transfer privilege.
TRANSFERS DURING THE ACCUMULATION PHASE. If you make more than 12 transfers in a
Policy Year, there is a transfer fee deducted. The fee is the lesser of $25 per
transfer or 2% of the amount transferred. The minimum amount which you can
transfer is $500 from an Account or your entire value in the Account. All
transfers must be in whole percentages.
TRANSFERS DURING THE ANNUITY PHASE. You may make transfers among the Portfolios.
You may also make transfers from the Portfolios to the Guaranteed Interest
Account Option to provide for a fixed annuity. You may only make one transfer
each Policy Year during the Annuity Phase. There is no transfer fee charged for
the one transfer. You cannot make a transfer from your fixed annuity to a
Portfolio.
AUTOMATIC DOLLAR COST AVERAGING
Automatic Dollar Cost Averaging allows you to systematically transfer a set
amount each quarter from any Investment Option (source account) to any of the
other Investment Option(s). By allocating amounts on a regular schedule as
opposed to allocating the total amount at one particular time, you may be less
susceptible to the impact of market fluctuations. Automatic Dollar Cost
Averaging is only available during the Accumulation Phase. The minimum amount
which can be transferred each quarter is $500 from each source account.
If you participate in Automatic Dollar Cost Averaging, the transfers made under
the program are taken into account in determining any transfer fee.
ASSET REBALANCING
Once your money has been allocated among the Investment Options, the performance
of the Investment Options may cause your allocation to shift. You can direct us
to automatically rebalance your Policy to return to your original percentage
allocations by selecting our Asset Rebalancing service. The transfer date will
be the 1st day after the end of the Policy Year. Asset Rebalancing is only
available during the Accumulation Phase. If you participate in Asset
Rebalancing, the transfers made under the program are taken into account in
determining any transfer fee.
PERFORMANCE
American Fidelity may periodically advertise performance based on the historical
performance of the various Portfolios. American Fidelity will calculate
cumulative total return performance by determining the percentage change in the
value of an Accumulation Unit for various time periods. This performance number
reflects the deduction of the insurance charges, policy maintenance charge and
expenses of the Portfolios. It will be presented with and without the withdrawal
charge. Results calculated without the withdrawal charge will be higher.
American Fidelity may also advertise compound average annual total return
information. Compound average annual total return is determined the same way
except that the results are annualized and the withdrawal charge will not be
included. Any advertisement will also include average annual total return
figures which reflect the deduction of the insurance charges, policy maintenance
charge, withdrawal charges and the expenses of the Fund.
For periods starting prior to the date the Policies were first offered, the
performance will be based on the historical performance of the corresponding
Portfolios, modified to reflect the charges and expenses of the AFAdvantage
Variable Annuity as if the Policies had been in existence during the period
stated in the advertisement. These figures should not be interpreted to reflect
actual historic performance.
More detailed information regarding how performance is calculated is found in
the SAI.
Any past performance does not guarantee future results of the Portfolios.
EXPENSES
There are charges and other expenses associated with the Contract that will
reduce your investment return. These charges and expenses are:
INSURANCE CHARGES
We deduct insurance charges each day. We do this as part of the calculation of
the value of the Accumulation Units during the Accumulation Phase and the
Annuity Units during the Annuity Phase. The insurance charges are: 1) the
mortality and expense risk charge; 2) the administrative charge; and 3) the
distribution expense charge.
MORTALITY AND EXPENSE RISK CHARGE . This charge is equal, on an annual
basis, to 1.25% of the average daily value of the Policy invested in a
Portfolio, after the deduction of expenses. This charge compensates us for all
the insurance benefits provided by your Policy (for example, the guarantee of
annuity rates, the death benefits, certain expenses related to the Policy), and
for assuming the risk (expense risk) that the current charges will be
insufficient in the future to cover the cost of administering the Policy.
ADMINISTRATIVE CHARGE . This charge is equal, on an annual basis, to .15%
of the average daily value of the Policy invested in a Portfolio, after the
deduction of expenses. This charge may be increased but will never be more than
.25% of the average daily value of the Policy invested in a Portfolio. This
charge, together with the policy maintenance charge (which is explained below),
is for all the expenses associated with the administration of the Policy. Some
of these expenses include: preparation of the Policy, confirmations, annual
reports and statements, maintenance of Policy records, personnel costs, legal
and accounting fees, filing fees, and computer and systems costs.
DISTRIBUTION EXPENSE CHARGE . This charge is equal, on an annual basis, to
.10% of the average daily value of the Policy invested in a Portfolio, after the
deduction of expenses. This charge may be increased but will never be more than
.25% of the average daily value of the Policy invested in a Portfolio. This
charge compensates American Fidelity for the costs associated with the
distribution of the Policies.
POLICY MAINTENANCE CHARGE
Every Policy Year American Fidelity deducts $30 from your Policy as a policy
maintenance charge. American Fidelity reserves the right to change the policy
maintenance charge, however, it will never be more than $36 per year. The charge
will be deducted pro-rata from the Accounts. During the Accumulation Phase, the
policy maintenance charge will be deducted on each Policy Anniversary. If you
make a total withdrawal on other than a Policy Anniversary, the full policy
maintenance charge will be deducted at the time of the withdrawal. During the
Annuity Phase, the charge will be deducted pro-rata from Annuity Payments.
WITHDRAWAL CHARGE
Withdrawals may be subject to a withdrawal charge. During the Accumulation
Phase, you can make withdrawals from your Policy (see the "Withdrawals"
section). During the first Policy Year, all withdrawals will have a withdrawal
charge. After the first Policy Year, you can make a withdrawal of up to 10% of
the value of your Policy (at the time you request the withdrawal) once each
Policy Year without incurring a withdrawal charge (free withdrawal amount). If
you do not use the free withdrawal amount in any year, it cannot be carried
forward to the next Policy Year.
The withdrawal charge is a percentage of the amount withdrawn in excess of the
free withdrawal amount as shown below:
<TABLE>
<CAPTION>
<S> <C>
Policy Year Withdrawal Charge %
- -------------------- -------------------
1 8%
2 7%
3 6%
4 5%
5 4%
6 3%
7 2%
8 1%
9+ 0%
</TABLE>
The withdrawal charge is calculated at the time of each withdrawal and will
never exceed 8% of the total Purchase Payments. For partial withdrawals, the
charge will be deducted from the value of your Policy remaining. No withdrawal
charge will be applied when a death benefit is paid or payment under any Annuity
Option providing at least seven annual or 72 monthly payments.
The withdrawal charge compensates us for expenses associated with selling the
Policy.
NOTE: For tax purposes, withdrawals are considered to have come from the last
money you put into the Policy. Thus, for tax purposes, earnings are considered
to come out first. THERE ARE LIMITS TO THE AMOUNT YOU CAN WITHDRAW FROM A
QUALIFIED PLAN KNOWN AS SECTION 403(b) PLAN. See Taxes and the discussion in the
SAI.
REDUCTION OR ELIMINATION OF THE WITHDRAWAL CHARGE
American Fidelity may reduce or eliminate the amount of the withdrawal charge
when the Policy is sold under circumstances which reduce its sales expenses.
Some examples are: if there is a large group of individuals that will be
purchasing the Policy or a prospective purchaser already had a relationship with
American Fidelity. American Fidelity will not deduct a withdrawal charge under a
Policy issued to an officer, director or employee of American Fidelity or any of
its affiliates. Any circumstances resulting in the reduction or elimination of
the withdrawal charge requires our prior approval.
TRANSFER FEE
There is no charge for the first 12 transfers in a Policy Year during the
Accumulation Phase. Thereafter, the fee is the lesser of $25 or 2% of the amount
transferred. During the Annuity Phase, there is no charge for the one transfer
allowed during each Policy Year.
The transfer fee is deducted from the Investment Option which is the source of
the transfer. If your entire interest in an Investment Option is being
transferred, the transfer fee will be deducted from the amount being
transferred. If you make transfers from multiple Investment Options, the
transfer fee will be deducted pro-rata from each source Investment Option.
PREMIUM TAXES
Some states and other governmental entities (e.g., municipalities) charge
premium taxes or similar taxes. American Fidelity is responsible for the payment
of these taxes and will make a deduction from the value of your Policy for them.
Some of these taxes are due when the Policy is issued, others are due when
Annuity Payments begin. It is our current practice to pay any premium taxes when
they become payable to the states. Premium taxes generally range from 0% to
4.0%, depending on the state.
INCOME TAXES
American Fidelity will deduct from the Policy any income taxes which it may
incur because of the Policy. Currently, American Fidelity is not making any such
deductions.
FUND EXPENSES
There are deductions from and expenses paid out of the assets of the various
Funds which are described in the attached prospectuses for the Funds.
TAXES
NOTE: AMERICAN FIDELITY HAS PREPARED THE FOLLOWING INFORMATION ON TAXES AS A
GENERAL DISCUSSION OF THE SUBJECT. IT IS NOT INTENDED AS TAX ADVICE. YOU SHOULD
CONSULT YOUR OWN TAX ADVISER ABOUT YOUR OWN CIRCUMSTANCES. WE HAVE INCLUDED
ADDITIONAL INFORMATION REGARDING TAXES IN THE STATEMENT OF ADDITIONAL
INFORMATION.
ANNUITIES IN GENERAL
Annuity contracts are a means of setting aside money for future needs - usually
retirement. Congress recognized how important saving for retirement was and
provided special rules in the Internal Revenue Code (Code) for annuities.
Basically, these rules provide that you will not be taxed on the earnings on the
money held in your annuity until you take the money out. This is referred to as
Tax Deferral. There are different rules regarding how you will be taxed
depending upon how you take the money out and the type of Policy - Qualified or
Non-Qualified (see following sections).
You, as the Owner, will not be taxed on increases in the value of your Policy
until a distribution occurs - either as a withdrawal or as Annuity Payments.
When you make a withdrawal you are taxed on the amount of the withdrawal that is
earnings. For Annuity Payments, different rules apply. A portion of each Annuity
Payment you receive will be treated as a partial return of your Purchase
Payments and will not be taxed. The remaining portion of the Annuity Payment
will be treated as ordinary income. How the Annuity Payment is divided between
taxable and non-taxable portions depends upon the period over which the Annuity
Payments are expected to be made. Annuity Payments received after you have
received all of your Purchase Payments are fully includible in income.
When a Non-Qualified Policy is owned by a non-natural person (e.g., a
corporation or certain other entities other than tax-qualified trusts), the
Policy will generally not be treated as an annuity for tax purposes. This means
that the Policy may not receive the benefits of Tax Deferral. Income may be
taxed as ordinary income every year.
QUALIFIED AND NON-QUALIFIED POLICIES
If you purchase the Policy under a Qualified plan, your Policy is referred
to as a Qualified Policy. Examples of Qualified plans are: Individual Retirement
Annuities (IRAs), including Roth IRAs, Tax-Sheltered Annuities (sometimes
referred to as 403(b) Policies), H.R. 10 Plans (sometimes referred to as Keogh
plans) and Corporate Pension and Profit-Sharing Plans.
If you do not purchase the Policy under a Qualified plan, your Policy is
referred to as a Non-Qualified Policy.
TAX TREATMENT OF WITHDRAWALS - NON-QUALIFIED POLICIES
If you make a withdrawal from your Policy, the Code treats such a withdrawal as
first coming from earnings and then from your Purchase Payments. In most cases,
such withdrawn earnings are includible in income.
The Code also provides that any amount received under an annuity contract which
is included in income may be subject to a tax penalty. The amount of the penalty
is equal to 10% of the amount that is includible in income. Some withdrawals
will be exempt from the penalty. They include any amounts: (1) paid on or after
the taxpayer reaches age 59 1/2; (2) paid after the Owner dies; (3) paid if the
taxpayer becomes totally disabled (as that term is defined in the Code); (4)
paid in a series of substantially equal payments made annually (or more
frequently) for the life or life expectancy of the taxpayer; (5) paid under an
immediate annuity; or (6) which come from purchase payments made prior to August
14, 1982.
The Policy provides that when the Annuitant dies prior to the Annuity Date, a
death benefit will be paid to the Beneficiary. If the Owner is not the
Annuitant, such payments made when the Annuitant dies do not qualify for the
death of Owner exception described above, and will be subject to the 10% tax
penalty unless the Beneficiary is 59 1/2 years old or one of the other
exceptions to the penalty applies.
TAX TREATMENT OF WITHDRAWALS - QUALIFIED POLICIES
The above information describing the taxation of Non-Qualified Policies does not
apply to Qualified Policies. In the case of a withdrawal under a Qualified
Policy, a ratable portion of the amount received is taxable, generally based on
the ratio of your cost basis to your total accrued benefit under the retirement
plan. The Code imposes a 10% penalty tax on the taxable portion of any
distribution from qualified retirement plans, including Policies issued and
qualified under Code Sections 403(b) (Tax-Sheltered Annuities), 408 and 408A
(Individual Retirement Annuities) and 401 (H.R. 10 and Corporate Pension and
Profit-Sharing Plans). To the extent amounts are not includible in gross income
because they have been properly rolled over to an IRA or to another eligible
Qualified Plan, no tax penalty will be imposed. The tax penalty will not apply
to the following distributions: (a) if distribution is made on or after the date
on which the Owner or Annuitant (as applicable) reaches age 59 1/2; (b)
distributions following the death or disability of the Owner or Annuitant (as
applicable) (for this purpose disability is as defined in Section 72(m)(7) of
the Code); (c) after separation from service, distributions that are part of
substantially equal periodic payments made not less frequently than annually for
the life (or life expectancy) of the Owner or Annuitant (as applicable) or the
joint lives (or joint life expectancies) of such Owner or Annuitant (as
applicable) and his designated beneficiary; (d) distributions to an Owner or
Annuitant (as applicable) who has separated from service after he has attained
age 55; (e) distributions made to the Owner or Annuitant (as applicable) to the
extent such distributions do not exceed the amount allowable as a deduction
under Code Section 213 to the Owner or Annuitant (as applicable) for amounts
paid during the taxable year for medical care; (f) distributions made to an
alternate payee pursuant to a qualified domestic relations order; (g)
distributions from an Individual Retirement Annuity for the purchase of medical
insurance (as described in Section 213(d)(1)(D) of the Code) for the Owner or
Annuitant (as applicable) and his or her spouse and dependents if the Owner or
Annuitant (as applicable) has received unemployment compensation for at least 12
weeks (this exception will no longer apply after the Owner or Annuitant (as
applicable) has been re-employed for at least 60 days); (h) distributions from
an Individual Retirement Annuity made to the Owner or Annuitant (as applicable)
to the extent such distributions do not exceed the qualified higher education
expenses (as defined in Section 72(t)(7) of the Code) of the Owner or Annuitant
(as applicable) for the taxable year; and (i) distributions from an Individual
Retirement Annuity made to the Owner or Annuitant (as applicable) which are
qualified first-time home buyer distributions (as defined in Section 72(t)(8) of
the Code). The exceptions stated in items (d) and (f) above do not apply in the
case of an Individual Retirement Annuity. The exception stated in item (c)
applies to an Individual Retirement Annuity without the requirement that there
be a separation from service.
A more complete discussion of withdrawals from Qualified Policies is contained
in the SAI.
TAX TREATMENT OF WITHDRAWALS - TAX-SHELTERED ANNUITIES
The Code limits the withdrawal of purchase payments made by owners from certain
Tax-Sheltered Annuities. Withdrawals can only be made when an owner: (1) reaches
age 59 1/2; (2) leaves his/her job; (3) dies; (4) becomes disabled (as that term
is defined in the Code); or (5) in the case of hardship. However, in the case of
hardship, the owner can only withdraw the purchase payments and not any
earnings.
DIVERSIFICATION
The Code provides that the underlying investments for a variable annuity must
satisfy certain diversification requirements in order to be treated as an
annuity contract. American Fidelity believes that the Portfolios are being
managed so as to comply with the requirements.
Neither the Code nor the Internal Revenue Service Regulations issued to date
provide guidance as to the circumstances under which you, because of the degree
of control you exercise over the underlying investments, and not American
Fidelity would be considered the owner of the shares of the Portfolios. If this
occurs, it will result in the loss of the favorable tax treatment for the
Policy. It is unknown to what extent under federal tax law Owners are permitted
to select Portfolios, to make transfers among the Portfolios or the number and
type of Portfolios Owners may select from. If any guidance is provided which is
considered a new position, then the guidance would generally be applied
prospectively. However, if such guidance is considered not to be a new position,
it may be applied retroactively. This would mean that you, as the Owner of the
Policy, could be treated as the owner of the Portfolios.
Due to the uncertainty in this area, American Fidelity reserves the right to
modify the Policy in an attempt to maintain favorable tax treatment.
WITHDRAWALS
You can have access to the money in your Policy: (1) by making a withdrawal
(either a partial or a total withdrawal); (2) by receiving Annuity Payments; or
(3) when a death benefit is paid to your Beneficiary. Withdrawals can only be
made during the Accumulation Phase.
You may withdraw all or some of the value of your Policy, minus taxes due, if
any, minus the withdrawal charge and policy maintenance charge. You must apply
for a withdrawal using a form we accept. Any partial withdrawal amount must be
at least $250, with exceptions for hardship. This requirement is waived if the
partial withdrawal is pursuant to the Systematic Withdrawal Program (see below).
After a withdrawal, the value of your Policy cannot be less than $100. Any
amount withdrawn will be deducted pro-rata from the Investment Options. If you
want to withdraw amounts in any other proportion, you must tell us using a form
we accept.
INCOME TAXES, TAX PENALTIES AND CERTAIN RESTRICTIONS MAY APPLY TO ANY WITHDRAWAL
YOU MAKE.
There are limits to the amount you can withdraw from a Qualified plan referred
to as a 403(b) plan. For a more complete explanation see - Taxes and the
discussion in the SAI.
SYSTEMATIC WITHDRAWAL PROGRAM
After the first Policy Year, you can participate in a Systematic Withdrawal
Program in lieu of the 10% free withdrawal option. If the total amount of
systematic withdrawals during a Policy Year exceeds the 10% free withdrawal
amount, a withdrawal charge will be incurred. During the Policy Year that
systematic withdrawals begin, the 10% free withdrawal amount will be based on
the value of your Policy on the business day before you request systematic
withdrawals. The request must be made on a form we accept. During subsequent
years, the free withdrawal amount will be based on the value of your Policy on
the last Policy Anniversary. Systematic withdrawals can be made monthly,
quarterly or semi-annually. We reserve the right to limit the terms and
conditions under which systematic withdrawals can be elected and to stop
offering any or all systematic withdrawals at any time.
INCOME TAXES AND TAX PENALTIES MAY APPLY TO SYSTEMATIC WITHDRAWALS.
SUSPENSION OF PAYMENTS OR TRANSFERS
American Fidelity may be required to suspend or postpone payments for
withdrawals or transfers for any period when:
1. the New York Stock Exchange is closed (other than customary weekend and
holiday closings);
2. trading on the New York Stock Exchange is restricted;
3. an emergency exists as a result of which disposal of the Fund shares is
not reasonably practicable or American Fidelity cannot reasonably value the Fund
shares;
4. during any other period when the Securities and Exchange Commission, by
order, so permits for the protection of owners.
American Fidelity has reserved the right to defer payment for a withdrawal or
transfer from the Guaranteed Interest Account for the period permitted by law
but not for more than six months.
LOANS
If you purchased your Policy under a 403(b) Qualified plan, we may make a loan
to you at any time before Annuity Payments begin. However, no loans will be made
during the first Policy Year. The security for the loan will be the value of
your Policy in the Guaranteed Interest Account. The loan cannot be more than the
lesser of $50,000 or one-half of the value of your Policy in the Guaranteed
Interest Account. Under certain circumstances, the $50,000 limit may be reduced.
The minimum loan we will make is $2,500 (which can be changed by us at our
discretion).
If a loan payment is not made within 60 days of the date a payment is due, the
outstanding loan balance (principal plus interest) will become due and payable.
If not repaid, the loan balance plus interest will be considered in default and
will be treated as taxable income for the tax year of the default. Satisfaction
of any unpaid loan balance plus interest from the Guaranteed Interest Account
will only occur when you qualify for a plan distribution under the federal tax
guidelines. If the loan is in default and you do not yet qualify for a
distribution to satisfy the outstanding loan balance, the loan will continue to
accrue interest which, if not paid by you, will be taxable income in the tax
year accrued. Any amounts which may become taxable will be reported as plan
distributions and will be subject to income tax and tax penalties, if
applicable.
Upon your death, the Beneficiary will receive the death benefit reduced by the
loan balance. If Annuity Payments begin while there is an outstanding loan, the
value of the Guaranteed Interest Account will be reduced by the loan balance.
DEATH BENEFIT
DEATH BENEFIT AMOUNT
The death benefit will be the greater of: (1) the Purchase Payments you have
made, less any money you have taken out and any applicable withdrawal charges;
or (2) the value of your Policy minus the policy maintenance charge and taxes,
if any, determined on the business day we receive proof of death and an election
for the payment period.
DEATH OF OWNER BEFORE ANNUITY DATE
If you or any Joint Owner dies before the Annuity Date, the death benefit will
be paid to your Beneficiary. When any Joint Owner dies, the surviving Joint
Owner, if any, will be treated as the primary Beneficiary. Any other person
chosen as a Beneficiary at the time of death will be treated as a contingent
Beneficiary. The death benefit will be paid under one of the following death
benefit options.
Death Benefit Options:
If you or any Joint Owner dies before the Annuity Date, a Beneficiary who is not
your spouse must elect the death benefit to be paid under one of the following
options:
1. lump sum payment;
2. payment of the entire death benefit within five years of the date of
your death or the death of any Joint Owner; or
3. payment of the death benefit under any Annuity Option. If this option is
chosen, the annuity must be distributed over the lifetime of the Beneficiary or
over a period not extending beyond the life expectancy of the Beneficiary; and
the distribution must begin within one year of the date of your death or any
Joint Owner's death.
Any portion of the death benefit not applied under an Annuity Option within one
year of the date of death must be distributed within five years of the date of
death.
If the Beneficiary is your spouse (spousal Beneficiary), he or she may:
1. choose to continue the Policy in his or her own name at the current
value of the Policy;
2. choose a lump sum payment of the death benefit; or
3. apply the death benefit to an Annuity Option.
If the deceased Owner was also the Annuitant and the spousal Beneficiary
continues the Policy or applies the death benefit to an Annuity Option, the
spousal Beneficiary will become the new Annuitant.
If a lump sum payment is requested, we will pay the amount within seven days of
receipt of proof of death and the election, unless the Suspension or Deferral
Payments Provision is in effect. Payment to the Beneficiary (other than a lump
sum payment) may only be elected during the 60 day period beginning with the
date we receive proof of death. If the Beneficiary does not select a payment
method during the 60 day period after we receive proof of death, the death
benefit will be paid in a lump sum.
DEATH OF ANNUITANT BEFORE THE ANNUITY DATE
If you are not the Annuitant and the Annuitant dies before the Annuity Date, the
death benefit will be paid to the Beneficiary. The death benefit will be paid in
a lump sum and must be paid in full within five years of the date of death. If
the Owner is a non-individual (e.g., a corporation), the death of the Annuitant
will be treated as the death of the Owner.
DEATH OF OWNER AFTER THE ANNUITY DATE
If you, or any Joint Owner who is not the Annuitant, die during the Annuity
Period, any remaining payments under the Annuity Option elected will continue at
least as rapidly as they were being paid at your death or such Joint Owner's
death. When any Owner dies during the Annuity Period, the Beneficiary becomes
the Owner. Upon the death of any Joint Owner during the Annuity Period, the
surviving Joint Owner, if any, will be treated as the primary Beneficiary. Any
other Beneficiary designation on record at the time of death will be treated as
a contingent Beneficiary.
DEATH OF ANNUITANT AFTER THE ANNUITY DATE
If the Annuitant dies on or after the Annuity Date, the death benefit, if any,
will be as set forth in the Annuity Option elected. Death benefits will be paid
at least as rapidly as they were being paid at the Annuitant's death.
OTHER INFORMATION
AMERICAN FIDELITY
American Fidelity Assurance Company (American Fidelity), 2000 N. Classen
Boulevard, Oklahoma City, Oklahoma 73106 is an Oklahoma stock life insurance
company organized in 1960. American Fidelity is licensed to conduct life,
annuity and accident and health insurance business in forty-nine states and the
District of Columbia. American Fidelity is a wholly-owned subsidiary of American
Fidelity Corporation since 1974.
THE SEPARATE ACCOUNT
American Fidelity established a separate account, American Fidelity Separate
Account B (Separate Account), to hold the assets that underlie the Policies. Our
Board of Directors adopted a resolution to establish the Separate Account under
Oklahoma insurance law on September 20, 1996. American Fidelity has registered
the Separate Account with the Securities and Exchange Commission as a unit
investment trust under the Investment Company Act of 1940. The Separate Account
is divided into sub-accounts.
The assets of the Separate Account are held in American Fidelity 's name on
behalf of the Separate Account and legally belong to American Fidelity. However,
those assets that underlie the Policies, are not chargeable with liabilities
arising out of any other business we may conduct. All the income, gains and
losses (realized or unrealized) resulting from these assets are credited to or
charged against the Policies and not against any other Policies we may issue.
LEGAL PROCEEDINGS
There are no pending material legal proceedings affecting the Separate Account,
American Fidelity or American Fidelity Securities, Inc.
DISTRIBUTION
American Fidelity Securities, Inc. (AFS, Inc.) acts as the distributor of the
Policies. AFS, Inc. is a wholly-owned subsidiary of American Fidelity.
ADMINISTRATION
American Fidelity performs certain administrative services regarding the
Policies. The administrative services include issuance of the Policies and
maintenance of Policy Owner's records.
FINANCIAL STATEMENTS
The financial statements of American Fidelity have been included in the
Statement of Additional Information. No financial statements of the Separate
Account have been included because, as of December 31, 1997, the Separate
Account had no assets.
TABLE OF CONTENTS OF THE STATEMENT OF ADDITIONAL INFORMATION
Page
----
General Information and History of the Company 3
Experts 3
Legal Opinions 3
Distributor 3
Reduction or Elimination of the Withdrawal Charge 3
Calculation of Performance Information 4
Federal Tax Status 9
Annuity Provisions 18
Financial Statements 19
________________________________________________________________________
__________________
__________________
__________________
FRONT
- -----
American Fidelity Assurance Company
P.O. Box 25523
Oklahoma City, OK 73125
Attention: Pension and Annuity Department
<TABLE>
<CAPTION>
Please send me, the Statement of Additional Information for the following:
<S> <C>
[ ] AFAdvantage Variable Annuity [ ] Merrill Lynch Variable Series Fund, Inc.
[ ] The Dreyfus Socially Responsible Growth
Fund, Inc.
[ ] Dreyfus Stock Index Fund
[ ] Dreyfus Variable Investment Fund
</TABLE>
Name _______________________________________________________________________
(please print)
Address _______________________________________________________________________
(please print)
_______________________________________________________________________
(please print)
_______________________________________________________________________
(please print)
PART B
STATEMENT OF ADDITIONAL INFORMATION
INDIVIDUAL FLEXIBLE PREMIUM VARIABLE AND FIXED DEFERRED
ANNUITY POLICIES
ISSUED BY
AMERICAN FIDELITY SEPARATE ACCOUNT B
AND
AMERICAN FIDELITY ASSURANCE COMPANY
THIS IS NOT A PROSPECTUS. THIS STATEMENT OF ADDITIONAL INFORMATION SHOULD BE
READ IN CONJUNCTION WITH THE PROSPECTUS DATED MAY 1, 1998, FOR THE INDIVIDUAL
FLEXIBLE PREMIUM VARIABLE AND FIXED DEFERRED ANNUITY POLICIES WHICH ARE REFERRED
TO HEREIN.
THE PROSPECTUS CONCISELY SETS FORTH INFORMATION THAT A PROSPECTIVE INVESTOR
SHOULD KNOW BEFORE INVESTING. FOR A COPY OF THE PROSPECTUS CALL OR WRITE US AT:
AMERICAN FIDELITY ASSURANCE COMPANY, ANNUITY SERVICES DEPARTMENT, P.O. BOX
25523, OKLAHOMA CITY, OK 73125-0523, (800) 662-1106.
THIS STATEMENT OF ADDITIONAL INFORMATION IS DATED MAY 1, 1998.
TABLE OF CONTENTS
PAGE
GENERAL INFORMATION AND HISTORY OF THE COMPANY 3
EXPERTS 3
LEGAL OPINIONS 3
DISTRIBUTOR 3
REDUCTION OR ELIMINATION OF THE WITHDRAWAL CHARGE 3
CALCULATION OF PERFORMANCE INFORMATION 4
FEDERAL TAX STATUS 9
ANNUITY PROVISIONS 18
FINANCIAL STATEMENTS 19
GENERAL INFORMATION AND HISTORY OF THE COMPANY
American Fidelity Assurance Company ("Company") was organized in the State of
Oklahoma in 1960 and during its existence has never changed its name. Neither
the sales of variable annuity contracts nor the sales of any other insurance
product by the Company have ever been suspended by any state where the Company
has done or is presently doing business.
The Company is a wholly-owned subsidiary of American Fidelity Corporation, an
insurance holding company. The stock of American Fidelity Corporation is
controlled by a family investment partnership, Cameron Enterprises, A Limited
Partnership, an Oklahoma limited partnership ("CELP"). In accordance with the
partnership agreement, management of the affairs of CELP is vested in five
managing general partners: William M. Cameron, William E. Durrett, Edward C.
Joullian, III, John W. Rex and Theodore M. Elam.
EXPERTS
The financial statements of the Company as of and for the year ended December
31, 1997 and 1996 and for each of the years in the three year period ended
December 31, 1997, included in this Statement of Additional Information have
been audited by KPMG Peat Marwick LLP.
LEGAL OPINIONS
Blazzard, Grodd & Hasenauer, P.C., Westport, Connecticut, has provided advice on
certain matters relating to the federal securities and income tax laws in
connection with the Policies.
DISTRIBUTOR
American Fidelity Securities, Inc., a wholly-owned subsidiary of the Company,
acts as the distributor. The offering is on a continuous basis.
REDUCTION OR ELIMINATION OF THE WITHDRAWAL CHARGE
The amount of the withdrawal charge on the Policies may be reduced or eliminated
when sales of the Policies are made to individuals or to a group of individuals
in a manner that results in savings of sales expenses. The entitlement to a
reduction of the withdrawal charge will be determined by the Company after
examination of the following factors: 1) the size of the group; 2) the total
amount of purchase payments expected to be received from the group; 3) the
nature of the group for which the Policies are purchased, and the persistency
expected in that group; 4) the purpose for which the Policies are purchased and
whether that purpose makes it likely that expenses will be reduced; and 5) any
other circumstances which the Company believes to be relevant to determining
whether reduced sales or administrative expenses may be expected. None of the
reductions in charges for sales is contractually guaranteed.
The withdrawal charge will be eliminated when the Policies are issued to an
officer, director or employee of the Company or any of its affiliates. In no
event will any reduction or elimination of the withdrawal charge be permitted
where the reduction or elimination will be unfairly discriminatory to any
person.
CALCULATION OF PERFORMANCE INFORMATION
From time to time, the Company may advertise performance data as described in
the Prospectus. All performance advertising will include quotations of
standardized average annual total return, calculated in accordance with standard
methods prescribed by the rules of the Securities and Exchange Commission, to
facilitate comparison with standardized average annual total return advertised
by other variable annuity separate accounts. Standardized average annual total
return advertised for a specific period is found by first taking a hypothetical
$1,000 investment in a Portfolio on the first day of the period at the offering
price, which is the Accumulation Unit value per unit (initial investment) and
computing the ending redeemable value (redeemable value) of that investment at
the end of the period. The average annual total return (T) is computed by
equating the redeemable value (ERV) with the initial hypothetical $1,000
investment (P) over a period of years (n) according to the following formula:
ERV = P (1+T)**n (where "**n" means to the nth power). Standardized average
annual total return reflects the expenses of the Portfolio, the deduction of a
policy maintenance charge, mortality and expense risk, distribution expense and
administrative charges. The redeemable value also reflects the effect of any
applicable withdrawal charge that may be imposed at the end of the period. No
deduction is made for premium taxes which may be assessed by certain states.
Cumulative total return may also be provided. Cumulative total return is
calculated the same way as average annual total return except the results are
not annualized.
Nonstandardized compound average annual return and nonstandardized cumulative
total return may also be advertised. Nonstandardized compound average annual
return and nonstandardized cumulative total return will not include the
withdrawal charge and may be for periods other than those required to be
presented or may otherwise differ from standardized average annual total return
and cumulative total return.
The standardized average annual total return quotations will be current to the
last day of the calendar quarter preceding the date on which an advertisement is
submitted for publication. The standardized average annual total return will be
based on calendar quarters and will cover at least periods of one, five, and ten
years, or a period covering the time the Portfolio has been in existence if it
has not been in existence for one of the prescribed periods. If Accumulation
Units for the Policies have not been in existence for as long as the
corresponding Portfolio, the standardized average annual total return and
nonstandardized total return quotations will show what the investment
performance of Accumulation Units would have been (reduced by the applicable
charges) had they been held in a Portfolio for the period quoted (see below).
Quotations of standardized average annual total return and nonstandardized total
returns are based upon historical earnings and will fluctuate. Past performance
does not guarantee future results. Factors affecting the performance of a
Portfolio include general market conditions, operating expenses and investment
management. An Owner's value upon a withdrawal of a Policy may be more or less
than the original Purchase Payment.
PERFORMANCE INFORMATION
The Accumulation Units of the Separate Account are new and therefore have no
performance history. However, the corresponding Funds have been in existence for
some time and consequently have investment performance history. In order to
demonstrate how the historical investment experience of the Funds affects
Accumulation Unit values, the following performance information was developed.
The information is based upon the historical experience of the Funds and is for
the periods shown.
ACTUAL PERFORMANCE WILL VARY AND THE HYPOTHETICAL RESULTS SHOWN ARE NOT
NECESSARILY REPRESENTATIVE OF FUTURE RESULTS. Performance for periods ending
after those shown may vary substantially from the examples shown below. Chart 1
shows the performance of the Accumulation Units calculated for a specified
period of time assuming an initial Purchase Payment of $1,000 allocated to each
Portfolio and a deduction of all charges and deductions (see "Expenses" in the
prospectus). Chart 2 is identical to Chart 1 except that it does not reflect the
deduction of the withdrawal charge. Chart 3 shows cumulative total return with
the deduction of all charges. Chart 4 shows cumulative total return without the
deduction of the withdrawal charge. The performance figures in all 4 charts also
reflect the actual fees and expenses paid by each Portfolio. The percentage
increases are determined by subtracting the initial Purchase Payment from the
ending value and dividing the remainder by the beginning value. All calculations
do not reflect the deduction of any premium taxes.
HISTORICAL PERFORMANCE FOR PERIODS ENDING 12/31/97:
<TABLE>
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<S> <C> <C> <C> <C>
CHART 1 - AVERAGE ANNUAL TOTAL RETURN
10 YEARS
or Since INCEPTION
1 YEAR 5 YEARS Inception DATE
------ ------- --------- ----
The Dreyfus Socially
Responsible Growth Fund, Inc. 15.52% N/A 15.49% 10/07/93
Dreyfus Stock Index Fund 19.98% 14.44% 11.25% 9/29/89
Dreyfus Variable Investment Fund
Growth and Income Portfolio 3.48% N/A 18.67% 5/02/94
Small Company Stock Portfolio 8.96% N/A 8.62% 5/01/96
Merrill Lynch Variable Series
Funds, Inc.
Prime Bond Portfolio -3.98% 2.11% 4.65% 4/20/82
American Balanced Portfolio 7.49% 5.84% 6.64% 6/01/88
High Current Income Portfolio -1.65% 5.37% 8.28% 4/20/82
Special Value Focus Portfolio 1.14% 8.93% 7.74% 4/20/82
International Equity Focus
Portfolio -16.26% N/A -1.63% 7/01/93
</TABLE>
<TABLE>
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<S> <C> <C> <C> <C>
CHART 2 - COMPOUND AVERAGE ANNUAL RETURN (WITHOUT WITHDRAWAL CHARGES)
10 YEARS
or Since INCEPTION
1 YEAR 5 YEARS Inception DATE
------ ------- --------- ----
The Dreyfus Socially
Responsible Growth Fund, Inc. 23.52% N/A 16.49% 10/07/93
Dreyfus Stock Index Fund 27.98% 15.28% 11.25% 9/29/89
Dreyfus Variable Investment Fund
Growth and Income Portfolio 11.48% N/A 20.03% 5/02/94
Small Company Stock Portfolio 16.96% N/A 12.94% 5/01/96
Merrill Lynch Variable Series
Funds, Inc.
Prime Bond Portfolio 4.02% 2.86% 4.65% 4/20/82
American Balanced Portfolio 12.36% 6.62% 6.64% 6/01/88
High Current Income Portfolio 6.35% 6.14% 8.28% 4/20/82
Special Value Focus Portfolio 7.06% 9.73% 7.74% 4/20/82
International Equity Focus
Portfolio -8.98% N/A -0.82% 7/01/93
</TABLE>
<TABLE>
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<S> <C> <C> <C> <C>
CHART 3- CUMULATIVE TOTAL RETURN
10 YEARS
or Since INCEPTION
1 YEAR 5 YEARS Inception DATE
------ ------- --------- ----
The Dreyfus Socially
Responsible Growth Fund, Inc. 15.52% N/A 84.01% 10/07/93
Dreyfus Stock Index Fund 19.98% 96.27% 141.28% 9/29/89
Dreyfus Variable Investment Fund
Growth and Income Portfolio 3.48% N/A 87.37% 5/02/94
Small Company Stock Portfolio 8.96% N/A 14.81% 5/01/96
Merrill Lynch Variable Series
Funds, Inc.
Prime Bond Portfolio -3.98% 10.98% 57.57% 4/20/82
American Balanced Portfolio 7.49% 32.79% 85.26% 6/01/88
High Current Income Portfolio -1.65% 29.88% 121.56% 4/20/82
Special Value Focus Portfolio 1.14% 53.36% 110.68% 4/20/82
International Equity Focus
Portfolio -16.26% N/A -7.12% 7/01/93
</TABLE>
<TABLE>
<CAPTION>
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CHART 4- CUMULATIVE TOTAL RETURN WITHOUT WITHDRAWAL CHARGES
10 YEARS
or Since INCEPTION
1 YEAR 5 YEARS Inception DATE
------ ------- --------- ----
The Dreyfus Socially
Responsible Growth Fund, Inc. 23.52% N/A 90.88% 10/07/93
Dreyfus Stock Index Fund 27.98% 103.60% 141.28% 9/29/89
Dreyfus Variable Investment Fund
Growth and Income Portfolio 11.48% N/A 95.37% 5/02/94
Small Company Stock Portfolio 16.96% N/A 22.53% 5/01/96
Merrill Lynch Variable Series
Funds, Inc.
Prime Bond Portfolio 4.02% 15.13% 57.57% 4/20/82
American Balanced Portfolio 12.36% 37.75% 85.26% 6/01/88
High Current Income Portfolio 6.35% 34.73% 121.56% 4/20/82
Special Value Focus Portfolio 7.06% 59.08% 110.68% 4/20/82
International Equity Focus
Portfolio -8.98% N/A -3.65% 7/01/93
</TABLE>
FEDERAL TAX STATUS
NOTE: THE FOLLOWING DESCRIPTION IS BASED UPON THE COMPANY'S UNDERSTANDING OF
CURRENT FEDERAL INCOME TAX LAW APPLICABLE TO ANNUITIES IN GENERAL. THE COMPANY
CANNOT PREDICT THE PROBABILITY THAT ANY CHANGES IN SUCH LAWS WILL BE MADE.
PURCHASERS ARE CAUTIONED TO SEEK COMPETENT TAX ADVICE REGARDING THE POSSIBILITY
OF SUCH CHANGES. THE COMPANY DOES NOT GUARANTEE THE TAX STATUS OF THE POLICIES.
PURCHASERS BEAR THE COMPLETE RISK THAT THE POLICIES MAY NOT BE TREATED AS
"ANNUITY CONTRACTS" UNDER FEDERAL INCOME TAX LAWS. IT SHOULD BE FURTHER
UNDERSTOOD THAT THE FOLLOWING DISCUSSION IS NOT EXHAUSTIVE AND THAT SPECIAL
RULES NOT DESCRIBED HEREIN MAY BE APPLICABLE IN CERTAIN SITUATIONS. MOREOVER, NO
ATTEMPT HAS BEEN MADE TO CONSIDER ANY APPLICABLE STATE OR OTHER TAX LAWS.
GENERAL
Section 72 of the Internal Revenue Code of 1986, as amended ("Code") governs
taxation of annuities in general. An Owner is not taxed on increases in the
value of a Policy until distribution occurs, either in the form of a lump sum
payment or as annuity payments under the Annuity Option elected. For a lump sum
payment received as a total surrender (total redemption) or death benefit, the
recipient is taxed on the portion of the payment that exceeds the cost basis of
the Policy. For Non-Qualified Policies, this cost basis is generally the
Purchase Payments, while for Qualified Policies there may be no cost basis. The
taxable portion of the lump sum payment is taxed at ordinary income tax rates.
For annuity payments, a portion of each payment in excess of an exclusion amount
is includible in taxable income. The exclusion amount for payments based on a
fixed annuity option is determined by multiplying the payment by the ratio that
the cost basis of the Policy (adjusted for any period certain or refund feature)
bears to the expected return under the Policy. The exclusion amount for payments
based on a variable annuity option is determined by dividing the cost basis of
the Policy (adjusted for any period certain or refund feature) by the number
of years over which the annuity is expected to be paid. Payments received after
the investment in the Policy has been recovered (i.e. when the total of the
excludable amounts equal the investment in the Policy) are fully taxable. The
taxable portion is taxed at ordinary income rates. For certain types of
Qualified Plans there may be no cost basis in the Policy within the meaning of
Section 72 of the Code. Owners, Annuitants and Beneficiaries under the Policies
should seek competent financial advice about the tax consequences of any
distributions.
The Company is taxed as a life insurance company under the Code. For federal
income tax purposes, the Separate Account is not a separate entity from the
Company, and its operations form a part of the Company.
DIVERSIFICATION
Section 817(h) of the Code imposes certain diversification standards on the
underlying assets of variable annuity contracts. The Code provides that a
variable annuity contract will not be treated as an annuity contract for any
period (and any subsequent period) for which the investments are not adequately
diversified in accordance with regulations prescribed by the United States
Treasury Department ("Treasury Department"). Disqualification of the Policy as
an annuity contract would result in imposition of federal income tax to the
Policy Owner with respect to earnings allocable to the Policy prior to the
receipt of payments under the Policy. The Code contains a safe harbor provision
which provides that annuity contracts such as the Policies meet the
diversification requirements if, as of the end of each quarter, the underlying
assets meet the diversification standards for a regulated investment company and
no more than fifty-five percent (55%) of the total assets consist of cash, cash
items, U.S. government securities and securities of other regulated investment
companies.
On March 2, 1989, the Treasury Department issued regulations (Treas. Reg.
1.817-5) which established diversification requirements for the investment
portfolios underlying variable contracts such as the Policies. The regulations
amplify the diversification requirements for variable contracts set forth in the
Code and provide an alternative to the safe harbor provision described above.
Under the regulations, an investment portfolio will be deemed adequately
diversified if: (1) no more than 55% of the value of the total assets of the
portfolio is represented by any one investment; (2) no more than 70% of the
value of the total assets of the portfolio is represented by any two
investments; (3) no more than 80% of the value of the total assets of the
portfolio is represented by any three investments; and (4) no more than 90% of
the value of the total assets of the portfolio is represented by any four
investments.
The Code provides that for purposes of determining whether or not the
diversification standards imposed on the underlying assets of variable contracts
by Section 817(h) of the Code have been met, "each United States government
agency or instrumentality shall be treated as a separate issuer."
The Company intends that all Funds underlying the Policies will be managed by
the investment advisers in such a manner as to comply with these diversification
requirements.
The Treasury Department has indicated that the diversification Regulations do
not provide guidance regarding the circumstances in which owner control of the
investments of the Separate Account will cause the owner to be treated as the
owner of the assets of the Separate Account, thereby resulting in the loss of
favorable tax treatment for the Policy. At this time it cannot be determined
whether additional guidance will be provided and what standards may be contained
in such guidance.
The amount of Owner control which may be exercised under the Policy is different
in some respects from the situations addressed in published rulings issued by
the Internal Revenue Service in which it was held that the policy owner was not
the owner of the assets of the separate account. It is unknown whether these
differences, such as the Owner's ability to transfer among investment choices or
the number and type of investment choices available, would cause the Owner to be
considered as the owner of the assets of the Separate Account resulting in the
imposition of federal income tax to the Owner with respect to earnings allocable
to the Policy prior to receipt of payments under the Policy.
In the event any forthcoming guidance or ruling is considered to set forth a new
position, such guidance or ruling will generally be applied only prospectively.
However, if such ruling or guidance was not considered to set forth a new
position, it may be applied retroactively resulting in the Owner being
retroactively determined to be the owner of the assets of the Separate Account.
Due to the uncertainty in this area, the Company reserves the right to modify
the Policy in an attempt to maintain favorable tax treatment.
MULTIPLE POLICIES
The Code provides that multiple non-qualified annuity contracts which are issued
within a calendar year period to the same contract owner by one company or its
affiliates are treated as one annuity contract for purposes of determining the
tax consequences of any distribution. Such treatment may result in adverse tax
consequences, including more rapid taxation of the distributed amounts from such
combination of contracts. Owners should consult a tax adviser prior to
purchasing more than one non-qualified annuity contract in any calendar year
period.
POLICIES OWNED BY OTHER THAN NATURAL PERSONS
Under Section 72(u) of the Code, the investment earnings on purchase payments
for the Policies will be taxed currently to the Owner if the Owner is a
non-natural person, e.g., a corporation or certain other entities. Such Policies
generally will not be treated as annuities for federal income tax purposes.
However, this treatment is not applied to Policies held by a trust or other
entity as an agent for a natural person nor to Policies held by qualified plans.
Purchasers should consult their own tax counsel or other tax adviser before
purchasing a Policy to be owned by a non-natural person.
TAX TREATMENT OF ASSIGNMENTS
An assignment or pledge of a Policy may be a taxable event. Owners should
therefore consult competent tax advisers should they wish to assign or pledge
their Policies.
INCOME TAX WITHHOLDING
All distributions or the portion thereof which is includible in the gross income
of the Owner are subject to federal income tax withholding. Generally, amounts
are withheld from periodic payments at the same rate as wages and at the rate of
10% from non-periodic payments. However, the Owner, in most cases, may elect not
to have taxes withheld or to have withholding done at a different rate.
Effective January 1, 1993, certain distributions from retirement plans qualified
under Section 401 or Section 403(b) of the Code, which are not directly rolled
over to another eligible retirement plan or individual retirement account or
individual retirement annuity, are subject to a mandatory 20% withholding for
federal income tax. The 20% withholding requirement generally does not apply to:
a) a series of substantially equal payments made at least annually for the life
or life expectancy of the participant or joint and last survivor expectancy of
the participant and a designated beneficiary, or for a specified period of 10
years or more; or b) distributions which are required minimum distributions; or
(c) the portion of the distributions not includible in gross income (i.e.
returns of after-tax contributions). Participants should consult their own tax
counsel or other tax adviser regarding withholding requirements.
TAX TREATMENT OF WITHDRAWALS - NON-QUALIFIED POLICIES
Section 72 of the Code governs the treatment of distributions from annuity
contracts. It provides that if the contract value exceeds the aggregate purchase
payments made, any amount withdrawn will be treated as coming first from the
earnings and then, only after the income portion is exhausted, as coming from
the principal. Withdrawn earnings are includible in gross income. It further
provides that a ten percent (10%) penalty will apply to the income portion of
any distribution. However, the penalty is not imposed on amounts received: (a)
after the taxpayer reaches age 59 1/2; (b) after the death of the Owner; (c) if
the taxpayer is totally disabled (for this purpose disability is as defined in
Section 72(m)(7) of the Code); (d) in a series of substantially equal periodic
payments made not less frequently than annually for the life (or life
expectancy) of the taxpayer or for the joint lives (or joint life expectancies)
of the taxpayer and his Beneficiary; (e) under an immediate annuity; or (f)
which are allocable to purchase payments made prior to August 14, 1982.
The Policy provides that upon the death of the Annuitant prior to the Annuity
Date, the death benefit will be paid to the named Beneficiary. Such payments
made upon the death of the Annuitant who is not the Owner of the Policy do not
qualify for the death of Owner exception described above, and will be subject to
the ten percent (10%) distribution penalty unless the Beneficiary is 59 1/2
years old or one of the other exceptions to the penalty applies.
The above information does not apply to Qualified Policies. However, separate
tax withdrawal penalties and restrictions may apply to such Qualified Policies.
(See "Tax Treatment of Withdrawals - Qualified Policies.")
QUALIFIED PLANS
The Policies offered by the Prospectus are designed to be suitable for use under
various types of Qualified Plans. Because of the minimum Purchase Payment
requirements, the Policies may not be appropriate for some periodic payment
retirement plans. Taxation of participants in each Qualified Plan varies with
the type of plan and terms and conditions of each specific plan. Owners,
Annuitants and Beneficiaries are cautioned that benefits under a Qualified Plan
may be subject to the terms and conditions of the plan regardless of the terms
and conditions of the Policies issued pursuant to the plan. Some retirement
plans are subject to distribution and other requirements that are not
incorporated into the Company's administrative procedures. Owners, participants
and Beneficiaries are responsible for determining that contributions,
distributions and other transactions with respect to the Policies comply with
applicable law. Following are general descriptions of the types of Qualified
Plans with which the Policies may be used. Such descriptions are not exhaustive
and are for general informational purposes only. The tax rules regarding
Qualified Plans are very complex and will have differing applications, depending
on individual facts and circumstances. Each purchaser should obtain competent
tax advice prior to purchasing a Policy issued under a Qualified Plan.
Policies issued pursuant to Qualified Plans include special provisions
restricting Policy provisions that may otherwise be available and described in
this Statement of Additional Information. Generally, Policies issued pursuant to
Qualified Plans are not transferable except upon surrender or annuitization.
Various penalty and excise taxes may apply to contributions or distributions
made in violation of applicable limitations. Furthermore, certain withdrawal
penalties and restrictions may apply to surrenders from Qualified Policies. (See
"Tax Treatment of Withdrawals - Qualified Policies.")
a. Tax-Sheltered Annuities
Section 403(b) of the Code permits the purchase of "tax-sheltered annuities" by
public schools and certain charitable, educational and scientific organizations
described in Section 501(c)(3) of the Code. These qualifying employers may make
contributions to the Policies for the benefit of their employees. Such
contributions are not includable in the gross income of the employee until the
employee receives distributions from the Policy. The amount of contributions to
the tax-sheltered annuity is limited to certain maximums imposed by the Code.
Furthermore, the Code sets forth additional restrictions governing such items as
transferability, distributions, nondiscrimination and withdrawals. (See "Tax
Treatment of Withdrawals - Qualified Policies" and "Tax-Sheltered Annuities -
Withdrawal Limitations.") Employee loans are allowed under these Policies. Any
employee should obtain competent tax advice as to the tax treatment and
suitability of such an investment and the tax consequences of loans.
b. Individual Retirement Annuities
Section 408(b) of the Code permits eligible individuals to contribute to an
individual retirement program known as an "Individual Retirement Annuity"
("IRA"). Under applicable limitations, certain amounts may be contributed to an
IRA which may be deductible from the individual's gross income. These IRAs are
subject to limitations on eligibility, contributions, transferability and
distributions. (See "Tax Treatment of Withdrawals - Qualified Policies.") Under
certain conditions, distributions from other IRAs and other Qualified Plans may
be rolled over or transferred on a tax-deferred basis into an IRA. Sales of
Policies for use with IRAs are subject to special requirements imposed by the
Code, including the requirement that certain informational disclosure be given
to persons desiring to establish an IRA. Purchasers of Policies to be qualified
as Individual Retirement Annuities should obtain competent tax advice as to the
tax treatment and suitability of such an investment.
ROTH IRAs
Beginning in 1998, individuals may purchase a new type of non-deductible IRA,
known as a Roth IRA. Purchase payments for a Roth IRA are limited to a maximum
of $2,000 per year. Lower maximum limitations apply to individuals with adjusted
gross incomes between $95,000 and $110,000 in the case of single taxpayers,
between $150,000 and $160,000 in the case of married taxpayers filing joint
returns, and between $0 and $10,000 in the case of married taxpayers filing
separately. An overall $2,000 annual limitation continues to apply to all of a
taxpayer's IRA contributions, including Roth IRA and non-Roth IRAs.
Qualified distributions from Roth IRAs are free from federal income tax. A
qualified distribution requires that an individual has held the Roth IRA for at
least five years and, in addition, that the distribution is made either after
the individual reaches age 59 1/2, on the individual's death or disability, or
as a qualified first-time home purchase, subject to a $10,000 lifetime maximum,
for the individual, a spouse, child, grandchild, or ancestor. Any distribution
which is not a qualified distribution is taxable to the extent of earnings in
the distribution. Distributions are treated as made from contributions first and
therefore no distributions are taxable until distributions exceed the amount of
contributions to the Roth IRA. The 10% penalty tax and the regular IRA
exceptions to the 10% penalty tax apply to taxable distributions from a Roth
IRA.
Amounts may be rolled over from one Roth IRA to another Roth IRA. Furthermore,
an individual may make a rollover contribution from a non-Roth IRA to a Roth
IRA, unless the individual has adjusted gross income over $100,000 or the
individual is a married taxpayer filing a separate return. The individual must
pay tax on any portion of the IRA being rolled over that represents income or a
previously deductible IRA contribution. However, for rollovers in 1998, the
individual may pay that tax ratably over the four taxable year periods beginning
with tax year 1998.
Purchasers of Policies to be qualified as a Roth IRA should obtain competent tax
advice as to the tax treatment and suitability of such an investment.
c. H.R. 10 Plans
Section 401 of the Code permits self-employed individuals to establish Qualified
Plans for themselves and their employees, commonly referred to as "H.R. 10" or
"Keogh" plans. Contributions made to the Plan for the benefit of the employees
will not be included in the gross income of the employees until distributed from
the Plan. The tax consequences to participants may vary depending upon the
particular Plan design. However, the Code places limitations and restrictions on
all plans including on such items as: amount of allowable contributions; form,
manner and timing of distributions; transferability of benefits; vesting and
nonforfeitability of interests; nondiscrimination in eligibility and
participation; and the tax treatment of distributions, withdrawals and
surrenders. (See "Tax Treatment of Withdrawals - Qualified Policies.")
Purchasers of Policies for use with an H.R. 10 Plan should obtain competent tax
advice as to the tax treatment and suitability of such an investment.
d. Corporate Pension and Profit-Sharing Plans
Sections 401(a) and 401(k) of the Code permit corporate employers to establish
various types of retirement plans for employees. These retirement plans may
permit the purchase of the Policies to provide benefits under the plan.
Contributions to the plan for the benefit of employees will not be includible in
the gross income of the employees until distributed from the plan. The tax
consequences to participants may vary depending upon the particular plan design.
However, the Code places limitations and restrictions on all plans including on
such items as: amount of allowable contributions; form, manner and timing of
distributions; transferability of benefits; vesting and nonforfeitability of
interests; nondiscrimination in eligibility and participation; and the tax
treatment of distributions, withdrawals and surrenders. (See "Tax Treatment of
Withdrawals - Qualified Policies.") Purchasers of Policies for use with
Corporate Pension or Profit Sharing Plans should obtain competent tax advice as
to the tax treatment and suitability of such an investment.
TAX TREATMENT OF WITHDRAWALS - QUALIFIED POLICIES
In the case of a withdrawal under a Qualified Policy, a ratable portion of the
amount received is taxable, generally based on the ratio of the individual's
cost basis to the individual's total accrued benefit under the retirement plan.
Special tax rules may be available for certain distributions from a Qualified
Policy. Section 72(t) of the Code imposes a 10% penalty tax on the taxable
portion of any distribution from qualified retirement plans, including Policies
issued and qualified under Code Sections 403(b) (Tax-Sheltered Annuities),
408(b) (Individual Retirement Annuities) and 401 (H.R. 10 and Corporate Pension
and Profit-Sharing Plans). To the extent amounts are not includible in gross
income because they have been properly rolled over to an IRA or to another
eligible Qualified Plan, no tax penalty will be imposed. The tax penalty will
not apply to the following distributions: (a) if distribution is made on or
after the date on which the Owner or Annuitant (as applicable) reaches age 59
1/2; (b) distributions following the death or disability of the Owner or
Annuitant (as applicable) (for this purpose disability is as defined in Section
72(m)(7) of the Code); (c) after separation from service, distributions that are
part of substantially equal periodic payments made not less frequently than
annually for the life (or life expectancy) of the Owner or Annuitant (as
applicable) or the joint lives (or joint life expectancies) of such Owner or
Annuitant (as applicable) and his designated beneficiary; (d) distributions to
an Owner or Annuitant (as applicable) who has separated from service after he
has attained age 55; (e) distributions made to the Owner or Annuitant (as
applicable) to the extent such distributions do not exceed the amount allowable
as a deduction under Code Section 213 to the Owner or Annuitant (as applicable)
for amounts paid during the taxable year for medical care; (f) distributions
made to an alternate payee pursuant to a qualified domestic relations order; (g)
distributions from an Individual Retirement Annuity for the purchase of medical
insurance (as described in Section 213(d)(1)(D) of the Code) for the Owner or
Annuitant (as applicable) and his or her spouse and dependents if the Owner or
Annuitant (as applicable) has received unemployment compensation for at least 12
weeks (this exception will no longer apply after the Owner or Annuitant (as
applicable) has been re-employed for at least 60 days); (h) distributions from
an Individual Retirement Annuity made to the Owner or Annuitant (as applicable)
to the extent such distributions do not exceed the qualified higher education
expenses (as defined in Section 72(t)(7) of the Code) of the Owner or Annuitant
(as applicable) for the taxable year; and (i) distributions from an Individual
Retirement Annuity made to the Owner or Annuitant (as applicable) which are
qualified first-time home buyer distributions (as defined in Section 72(t)(8) of
the Code). The exceptions stated in items (d) and (f) above do not apply in the
case of an Individual Retirement Annuity. The exception stated in item (c)
applies to an Individual Retirement Annuity without the requirement that there
be a separation from service.
Generally, distributions from a Qualified Plan must commence no later than April
1 of the calendar year following the later of: (a) the year in which the
employee attains age 70 1/2 or (b) the calendar year in which the employee
retires. The date set forth in (b) does not apply to an Individual Retirement
Annuity. Required distributions must be over a period not exceeding the life
expectancy of the individual or the joint lives or life expectancies of the
individual and his or her designated beneficiary. If the required minimum
distributions are not made, a 50% penalty tax is imposed as to the amount not
distributed.
TAX-SHELTERED ANNUITIES - WITHDRAWAL LIMITATIONS
The Code limits the withdrawal of amounts attributable to contributions made
pursuant to a salary reduction agreement (as defined in Section 403(b)(11) of
the Code) to circumstances only when the Owner: (1) attains age 59 1/2 ; (2)
separates from service; (3) dies; (4) becomes disabled (within the meaning of
Section 72(m)(7) of the Code); or (5) in the case of hardship. However,
withdrawals for hardship are restricted to the portion of the Owner's Policy
value which represents contributions by the Owner and does not include any
investment results. The limitations on withdrawals apply only to salary
reduction contributions made after the end of the plan year beginning in 1988,
and to income attributable to such contributions and to income attributable to
amounts held as of the end of the plan year beginning in 1988. The limitations
on withdrawals do not affect rollovers and transfers between certain Qualified
Plans. Owners should consult their own tax counsel or other tax adviser
regarding any distributions.
ANNUITY PROVISIONS
VARIABLE ANNUITY PAYOUT
An Owner may elect a variable annuity payout. Variable annuity payments reflect
the investment performance of the Portfolios in accordance with the allocation
of the value of the Policy to the Portfolios during the Annuity Period. Variable
annuity payments are not guaranteed as to dollar amount.
The Company will determine the number of Annuity Units payable for each payment
by dividing the dollar amount of the first annuity payment by the Annuity Unit
value for each applicable Portfolio on the Annuity Date. This sets the number of
Annuity Units for each applicable Portfolio. The number of Annuity Units payable
remains the same unless an Owner transfers a portion of the annuity benefit to
another Portfolio or to a fixed annuity. The dollar amount is not fixed and will
change from month to month.
The dollar amount of the variable annuity payments for each applicable Portfolio
after the first payment is determined by multiplying the fixed number of Annuity
Units per payment in each Portfolio by the Annuity Unit value for the last
valuation period of the month preceding the month for which the payment is due.
This result is the dollar amount of the payment for each applicable Portfolio.
The total dollar amount of each variable annuity payment is the sum of all
variable annuity payments reduced by the applicable portion of the policy
maintenance charge.
VARIABLE ANNUITY UNIT
The value of any annuity unit for each Portfolio was arbitrarily set initially
at $10. The Annuity Unit value at the end of any subsequent valuation period is
determined as follows:
1. The net investment factor for the current valuation period is multiplied
by the value of the Annuity Unit for the Fund for the immediately preceding
valuation period.
2. The result is then divided by the assumed investment rate factor which
equals 1.00 plus the assumed investment rate for the number of days since the
preceding valuation date.
An Owner can choose either a 3%, 4%, or 5% assumed investment rate. If one is
not chosen, the assumed investment rate will be 3%.
The assumed investment rate is the assumed rate of return used to determine the
first annuity payment for a variable annuity option. A higher assumed investment
rate will result in a higher first payment. Choice of a lower assumed investment
rate will result in a lower first payment. Payments will increase whenever the
actual return exceeds the chosen rate. Payments will decrease whenever the
actual return is less than the chosen rate.
FIXED ANNUITY PAYOUT
The dollar amount of each fixed annuity payment will be at least as great as
that determined in accordance with the 3% Annuity Table. The fixed annuity
provides a 3% annual guaranteed interest rate on all Annuity Options. The
Company may pay or credit excess interest on a fixed annuity at its discretion.
FINANCIAL STATEMENTS
The financial statements of the Company included herein should be considered
only as bearing upon the ability of the Company to meet its obligations under
the Policies.
AMERICAN FIDELITY ASSURANCE COMPANY
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996, AND FOR
EACH OF THE YEARS IN THE THREE-YEAR
PERIOD ENDED DECEMBER 31, 1997
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
INDEPENDENT AUDITORS' REPORT
Board of Directors
American Fidelity Assurance Company:
We have audited the accompanying consolidated balance sheets of American
Fidelity Assurance Company and subsidiaries (the Company) as of December 31,
1997 and 1996, and the related consolidated statements of income, stockholder's
equity and cash flows for each of the years in the three-year period ended
December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of American Fidelity
Assurance Company and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Also, in our opinion, the related financial statement schedules, when considered
in relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/S/ KPMG PEAT MARWICK LLP
March 16, 1998
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Assets 1997 1996
------ ---- ----
Investments:
Fixed maturities held-to-maturity, at amortized cost
(fair value $241,863 and $251,034 in 1997 and
<S> <C> <C> <C>
1996, respectively) $ 234,799 251,944
Fixed maturities available-for-sale, at fair value
(amortized cost of $622,712 and $551,856
in 1997 and 1996, respectively) 642,577 559,121
Equity securities, at fair value:
Common stocks (cost $11,023 and $9,692 in
1997 and 1996, respectively) 11,736 12,046
Mortgage loans on real estate, net 135,122 130,508
Investment real estate, at cost (less accumulated
depreciation of $1,350 and $7,047 in 1997
and 1996, respectively) 9,070 18,954
Policy loans 8,668 8,359
Short-term and other investments 20,770 12,763
----------- -----------
1,062,742 993,695
--------- ----------
Cash 8,427 15,962
Accrued investment income 14,357 14,248
Accounts receivable:
Uncollected premiums 20,571 21,665
Reinsurance receivable 57,503 36,794
Other 15,248 12,341
----------- -----------
93,322 70,800
----------- -----------
Deferred policy acquisition costs 177,737 162,497
Other assets 5,761 6,954
Separate account assets 137,090 98,896
---------- -----------
Total assets $ 1,499,436 1,363,052
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
<CAPTION>
Liabilities and Stockholder's Equity 1997 1996
------------------------------------ ---- ----
Policy liabilities:
Reserves for future policy benefits:
<S> <C> <C>
Life and annuity $ 105,663 102,820
Accident and health 140,530 121,097
Unearned premiums 2,686 2,376
Benefits payable 35,347 33,178
Funds held under deposit administration contracts 580,499 556,665
Other policy liabilities 92,144 85,068
----------- -----------
956,869 901,204
---------- ----------
Other liabilities:
Net deferred income tax liability 59,198 48,278
General expenses, taxes, licenses and fees payable
and other liabilities 36,099 34,125
----------- -----------
95,297 82,403
----------- -----------
Notes payable 50,719 19,839
Separate account liabilities 137,090 98,896
---------- -----------
Total liabilities 1,239,975 1,102,342
--------- ---------
Stockholder's equity:
Common stock, par value $10 per share. 250,000
shares authorized, issued and outstanding 2,500 2,500
Additional paid-in capital 23,244 19,916
Net unrealized holding gain on investments
available-for-sale, net of deferred tax expense
of $7,207 and $3,367 in 1997 and
1996, respectively 13,371 6,252
Retained earnings 220,346 232,042
---------- ----------
Total stockholder's equity 259,461 260,710
Commitments and contingencies (notes 9, 10, 11, 13 and 14)
Total liabilities and stockholder's equity $ 1,499,436 1,363,052
========= =========
</TABLE>
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997 1996 1995
---- ---- ----
Revenues:
Premiums:
<S> <C> <C> <C>
Life and annuity $ 25,282 24,187 24,514
Accident and health 181,944 166,057 156,960
------- ------- -------
207,226 190,244 181,474
Net investment income 69,175 67,502 65,326
Other 13,190 11,250 12,190
-------- -------- --------
Total revenues 289,591 268,996 258,990
------- ------- -------
Benefits:
Benefits paid or provided:
Life and annuity 18,045 18,539 18,849
Accident and health 105,594 93,858 74,219
Interest credited to funded contracts 30,207 28,386 27,635
Increase in reserves for future policy benefits:
Life and annuity (net of increase (decrease) in reinsurance reserves ceded
of $55, $(3), and $53 in 1997,
1996, and 1995, respectively) 2,788 4,336 4,619
Accident and health (net of increase (decrease) in
reinsurance reserves ceded of $9,838, $6,704, and
$(250), in 1997, 1996, and 1995, respectively) 10,250 13,259 15,535
-------- -------- --------
166,884 158,378 140,857
------- ------- -------
Expenses:
Selling costs 56,835 47,105 48,784
Other operating, administrative and general expenses 43,241 44,942 42,586
Taxes, other than federal income taxes, and licenses and fees 7,251 6,535 6,250
Increase in deferred policy acquisition costs (15,240) (10,082) (11,902)
-------- -------- --------
92,087 88,500 85,718
-------- -------- --------
Total benefits and expenses 258,971 246,878 226,575
------- ------- -------
Income before income taxes 30,620 22,118 32,415
Income taxes:
Current 2,680 4,421 10,443
Deferred 5,802 4,650 554
--------- --------- ----------
8,482 9,071 10,997
--------- --------- --------
Net income $ 22,138 13,047 21,418
======== ======== ========
Basic net income per share $ 88.55 52.19 85.67
===== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS)
Net
Additional Unrealized
Common Paid-in Holding Retained
Stock Capital Gain Earnings
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ 2,500 13,633 949 201,777
Net income - - - 21,418
Investments transferred to available-
for-sale, net of deferred taxes - - 8,828 -
Increase in unrealized holding gain,
net of deferred taxes - - 6,251 -
Capital contributed by parent on
sale of AFI - 4,085 - -
-------- ------- ---------- ------
Balance at December 31, 1995 2,500 17,718 16,028 223,195
Net income - - - 13,047
Decrease in unrealized holding gain,
net of deferred taxes - - (9,776) -
Capital contributed by parent - 2,198 - -
Dividends - - - (4,200)
-------- ---------- ---------- ---------
Balance at December 31, 1996 2,500 19,916 6,252 232,042
Net income - - - 22,138
Increase in unrealized holding gain,
net of deferred taxes - - 7,119 -
Capital contributed by parent - 3,328 - -
Dividends - - - (33,834)
-------- ---------- ---------- --------
Balance at December 31, 1997 $ 2,500 23,244 13,371 220,346
===== ====== ====== =======
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS)
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
<S> <C> <C> <C>
Net income $ 22,138 13,047 21,418
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for depreciation on investment real estate 653 935 876
Accretion of discount on investments (546) (469) (605)
Realized gains on investments (1,823) (1,793) (2,423)
Increase in deferred policy acquisition costs (15,240) (10,082) (11,902)
Increase in accrued investment income (218) (478) (1,819)
(Increase) decrease in accounts receivable (23,254) (15,006) 847
Increase in policy liabilities 56,043 36,130 66,489
Increase in general expenses, taxes, licenses and
fees payable and other liabilities 2,656 4,257 256
Deferred income taxes 5,802 4,650 554
Other 949 840 471
----------- ----------- -----------
Total adjustments 25,022 18,984 52,744
--------- --------- ---------
Net cash provided by operating activities 47,160 32,031 74,162
--------- --------- ---------
Cash flows from investing activities: Sale, maturity or repayment of
investments:
Fixed maturities held-to-maturity 20,940 26,867 73,984
Fixed maturities available-for-sale 133,727 166,678 36,640
Equity securities 11,673 5,708 5,635
Mortgage loans on real estate 20,200 15,736 12,426
Real estate 9,221 9,101 7,677
Net (increase) decrease in short-term and other investments (11,013) (3,416) 3,283
Purchase of investments:
Fixed maturities held-to-maturity (4,349) (45,961) (60,439)
Fixed maturities available-for-sale (211,464) (171,753) (164,417)
Equity securities (19,489) (4,580) (4,249)
Mortgage loans on real estate (24,793) (24,671) (14,328)
Real estate (1,403) (907) (2,820)
Policy loans, net (309) (194) (305)
Cash received from sale of AFI to AFC, net of cash transferred - - 21,005
------------- ------------- ---------
Net cash used in investing activities (77,059) (27,392) (85,908)
--------- --------- ---------
</TABLE>
(Continued)
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(IN THOUSANDS)
1997 1996 1995
---- ---- ----
Cash flows from financing activities:
<S> <C> <C>
Dividends paid to parent $ (14,156) (4,200) -
Capital contribution from parent 3,328 - 4,085
Proceeds from notes payable 109,775 9,075 7,095
Repayment of notes payable (76,583) (8,278) (5,849)
-------- ---------- ----------
Net cash provided by (used in) financing activities 22,364 (3,403) 5,331
-------- ---------- --------
Net (decrease) increase in cash (7,535) 1,236 (6,415)
Cash at beginning of year 15,962 14,726 21,141
-------- --------- ---------
Cash at end of year $ 8,427 15,962 14,726
========= ========= =========
Supplemental disclosure of cash flow information: Cash paid during the year for:
Interest on notes payable $ 2,076 1,340 1,478
========= ========== ==========
Federal income taxes $ 4,800 7,100 12,500
========= ========== =========
Supplemental disclosure of noncash investing activities:
Change in unrealized holding gain on investments
available-for-sale, net of deferred tax expense (benefit) of
$3,840, $(6,289), and $15,554, in 1997, 1996, and 1995,
respectively. $ 7,119 (9,776) 15,079
========= ========== =========
Investments transferred to available-for-sale $ - - 300,850
============= ============== ========
</TABLE>
(Continued)
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(IN THOUSANDS)
1997 1996 1995
---- ---- ----
Supplemental disclosure of noncash financing activities:
Capital contribution from parent through forgiveness
<S> <C> <C>
of deferred tax liability $ - 2,198 -
============ ========== =======
Amounts transferred to Parent through dividend of common stock of affiliated
companies:
Fixed maturities $ 8,567 - -
========= ============== =======
Real estate, net $ 2,632 - -
========= ============== =======
Short-term and other investments $ 3,006 - -
========= ============== =======
Accounts receivable $ 732 - -
========== ============== =======
Accrued investment income $ 109 - -
========== ============== =======
Other assets $ 241 - -
========== ============== =======
Policy liabilities $ 378 - -
========== ============== =======
Notes payable $ 2,312 - -
========= ============== =======
Deferred tax liability $ 683 - -
========== ============== =======
Other liabilities $ 682 - -
========== ============== =======
</TABLE>
Amounts transferred to Parent through dividend of common stock of
non-affiliated companies:
<TABLE>
<CAPTION>
<S> <C>
Common stock $ 6,485 - -
========= ============== =======
Deferred tax liability assumed by the Company $ (1,961) - -
========= ============== =======
</TABLE>
See accompanying notes to consolidated financial statements.
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(1) SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
American Fidelity Assurance Company (AFA or the Company) and
subsidiaries provide a variety of financial services. AFA is a wholly
owned subsidiary of American Fidelity Corporation (AFC), a Nevada
insurance holding company. The principal subsidiary of AFA for the
years ended December 31, 1996 and 1995, is Security General Life
Insurance Company (SGLI), a life insurance company. The Company and its
insurance subsidiaries are subject to state insurance regulations and
periodic examinations by state insurance departments.
AFA is licensed in 49 states and the District of Columbia with
approximately 34% of direct premiums written in Oklahoma, Texas, and
Georgia. AFA is represented by approximately 235 salaried managers and
agents, and over 3,500 brokers. Activities of AFA are largely
concentrated in the group disability income, group and individual
annuity, and individual medical markets. In addition, individual and
group life business is also conducted. The main thrust of AFA's sales
is worksite marketing of voluntary products through the use of payroll
deduction. The Company sells these voluntary products through a
salaried sales force that is broken down into two divisions: the
Association Group Division (AGD) and American Fidelity Educational
Services (AFES). AGD specializes in voluntary disability income
insurance programs aimed at selected groups and associations whose
premiums are funded by employees through payroll deductions. AFES
focuses on marketing to public school employees with ancillary
insurance products such as disability income, tax sheltered annuities,
life insurance, dread disease, and accidental death and dismemberment.
These premiums are also funded by employees through payroll deductions.
The expertise gained by the Company in worksite marketing of voluntary
products is used by the Brokerage Division in developing products to
meet special situations and focuses on marketing to a broad range of
employers through independent broker agencies and agents interested in
getting into or enhancing their payroll deduction capability.
A significant portion of the Company's business consists of group and
individual annuities. The Company's earnings related to these products
are impacted by conditions in the overall interest rate environment.
Additionally, the Company has taken measures to reduce its involvement
with major medical products in order to concentrate on its more
profitable lines of business.
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements have been prepared in conformity
with generally accepted accounting principles, which vary in some
respects from statutory accounting practices prescribed or permitted by
state insurance departments. (See note 2.) The consolidated financial
statements include the accounts and operations of AFA and its wholly
owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in the consolidated financial
statements.
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities to prepare these
consolidated financial statements in conformity with generally accepted
accounting principles. Actual results could differ from those
estimates. Principal estimates that could change in the future are the
actuarial assumptions used in establishing deferred policy acquisition
costs and policy liabilities.
INVESTMENTS
Management determines the appropriate classification of investments at
the time of purchase. If management has the intent and the Company has
the ability at the time of purchase to hold the investments until
maturity, they are classified as held-to-maturity and carried at
amortized cost. Investments to be held for indefinite periods of time
and not intended to be held-to-maturity are classified as
available-for-sale and carried at fair value. Fair value of investments
available-for-sale are based on quoted market prices.
The effect of any unrealized holding gains or losses on securities
available-for-sale are reported as a separate component of
stockholder's equity, net of deferred taxes. Transfers of securities
between categories are recorded at fair value at the date of transfer.
Fixed maturities held-to-maturity and short-term investments (bonds,
notes, and redeemable preferred stocks) are reported at cost, adjusted
for amortization of premium or accretion of discount because it is
management's intent to hold these investments to maturity. Equity
securities (common and nonredeemable preferred stocks) are reported at
current fair value. Mortgage loans on real estate are reported at the
unpaid balance less an allowance for possible losses. Investment in
real estate is carried at cost less accumulated depreciation.
Investment in real estate, excluding land, is depreciated on a
straight-line basis using estimated lives ranging from 6 to 35 years.
Policy loans are reported at the unpaid balance.
Realized gains or losses on disposal of investments are determined on a
specific-identification basis and are included in the accompanying
consolidated statements of income.
Because the Company's primary business is in the insurance industry,
the Company holds a significant amount of assets that are matched with
its liabilities in relation to maturity and interest margin. In order
to maximize earnings and minimize risk, the Company invests in a
diverse portfolio of investments. The portfolio is diversified by
geographic region, investment type, underlying collateral, maturity,
and industry. Management does not believe the Company has any
significant concentrations of credit risk in its investments.
The investment portfolio includes fixed maturities, equity securities,
mortgage loans, real estate, policy loans, and short-term investments.
The Company's portfolio does not include any fixed maturities that are
low investment-grade and have a high-yield ("junk bonds"). The Company
limits its risks by investing in fixed maturities and equity securities
of rated companies; mortgage loans adequately collateralized by real
estate; selective real estate supported by appraisals; and policy loans
collateralized by policy cash values. In addition, the Company performs
due diligence procedures prior to making mortgage loans. These
procedures include evaluations of the creditworthiness of the
mortgagees and/or tenants and independent appraisals. Certain fixed
maturities are guaranteed by the United States government.
The Company periodically reviews its investment portfolio to determine
if allowances for possible losses are necessary. In connection with
this determination, management reviews published market values, credit
ratings, independent appraisals, and other valuation information. While
management believes that the allowances are adequate, adjustments may
be necessary in the future due to changes in economic conditions. In
addition, regulatory agencies periodically review investment valuation
as an integral part of their examination process. Such agencies may
require the Company to recognize adjustments to the losses based upon
available information and judgments of the regulatory examiners at the
time of their examination.
RECOGNITION OF PREMIUM REVENUE AND COSTS
Revenues from life, payout annuity (with life contingencies), and
accident and health policies represent premiums recognized over the
premium-paying period and are included in life, annuity, and accident
and health premiums. Expenses are associated with earned premiums to
result in recognition of profits over the life of the policies.
Expenses include benefits paid to policyholders and the change in the
reserves for future policy benefits.
Revenues from accumulation policies, which are included in other
revenues, represent amounts assessed against policyholders. Such
assessments are principally surrender charges. Policyholder account
balances for accumulation annuities consist of premiums received, plus
credited interest, less accumulated policyholder assessments.
Policyholder account balances are reported in the consolidated balance
sheets as funds held under deposit administration contracts. Expenses
for accumulation annuities represent interest credited to policyholder
account balances.
Revenues from most universal life policies, which are included in other
revenues, represent amounts assessed against policyholders. Such
assessments are principally mortality charges, surrender charges, and
policy service fees. Policyholder account balances consist of premiums
received plus credited interest, less accumulated policyholder
assessments. Policyholder account balances are reported in the
consolidated balance sheets as other policy liabilities. Expenses
include interest credited to policyholder account balances and benefits
in excess of account balances returned to policyholders.
POLICY ACQUISITION COSTS
The Company defers costs which vary with and are primarily related to
the production of new business. Deferred costs associated with life,
annuity, universal life, and accident and health insurance policies
consist principally of field sales compensation, direct response costs,
underwriting and issue costs, and related expenses. Deferred costs
associated with life policies are amortized (with interest) over the
anticipated premium paying period of the policies using assumptions
that are consistent with the assumptions used to calculate policy
reserves. Deferred costs associated with annuities and universal life
policies are amortized over the life of the policies at a constant rate
based on the present value of the estimated gross profit to be
realized. Deferred costs related to accident and health insurance
policies are amortized over the anticipated premium paying period of
the policies based on the Company's experience. Deferred policy
acquisition costs are subject to recoverability testing at time of
policy issue and at the end of each accounting period, and are written
off if determined to be unrecoverable.
POLICY LIABILITIES
Life and annuity and accident and health policy benefit reserves are
primarily calculated using the net level reserve method. The net level
reserve method includes assumptions as to future investment yields,
withdrawal rates, mortality rates, and other assumptions based on the
Company's experience. These assumptions are modified as necessary to
reflect anticipated trends and include provisions for possible
unfavorable deviation.
Reserves for benefits payable are determined using case-basis
evaluations and statistical analyses. These reserves represent the
estimate of all benefits incurred but unpaid. The estimates are
periodically reviewed and, as adjustments become necessary, they are
reflected in current operations. Although such estimates are the
Company's best estimate of the ultimate value, the actual results may
vary from these values in either direction.
REINSURANCE
The Company accounts for reinsurance transactions as prescribed by
Statement of Financial Accounting Standards No. 113, "Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts" (Statement 113). Statement 113 requires the reporting of
reinsurance transactions relating to the balance sheet on a gross basis
and precludes immediate gain recognition on reinsurance contracts.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred income tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change
in tax rates is recognized in income in the period that includes the
enactment date.
EQUIPMENT
Equipment, which is included in other assets, is stated at cost and is
depreciated on a straight-line basis using estimated lives of 3 to 10
years. Additions, renewals, and betterments are capitalized.
Expenditures for software, maintenance, and repairs generally are
expensed. Upon retirement or disposal of an asset, the asset and
related accumulated depreciation are eliminated and any related gain or
loss is included in income.
SEPARATE ACCOUNT
The Company maintains a separate account under Oklahoma insurance law
designated as American Fidelity Variable Annuity Fund A (the Fund). The
Fund is an open-end, diversified management investment company under
the Investment Company Act of 1940, as amended. Under Oklahoma law, the
assets of the Fund are segregated from the Company's assets. The Fund's
assets primarily consist of equity securities, cash, and cash
equivalents. The Company acts as investment manager of the Fund,
assumes certain expense risks, and provides sales and administrative
services.
BASIC NET INCOME PER SHARE
Basic net income per share is based on the weighted average number of
shares outstanding. During the years ended December 31, 1997, 1996, and
1995, the weighted average number of shares was 250,000. There are no
dilutive securities outstanding.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to be consistent with
the current year presentation.
(2) STATUTORY FINANCIAL INFORMATION
The Company is required to file statutory financial statements with
state insurance regulatory authorities. Accounting principles used to
prepare these statutory financial statements differ from financial
statements prepared on the basis of generally accepted accounting
principles. The Company reported statutory net income for the years
ended December 31, 1997 (unaudited), 1996, and 1995, of approximately
$16,276,000, $13,227,000, and $30,510,000, respectively. The Company
reported statutory capital and surplus at December 31, 1997 (unaudited)
and 1996, of approximately $119,523,000 and $146,033,000, respectively.
Retained earnings of the Company and its insurance subsidiaries are
restricted as to payment of dividends by statutory limitations
applicable to insurance companies. Without prior approval of the state
insurance department, dividends that can be paid by the Company or an
insurance subsidiary are generally limited to the greater of (a) 10% of
statutory capital and surplus, or (b) the statutory net gain from
operations. These limitations are based on the amounts reported for the
previous calendar year.
The Oklahoma Insurance Department has adopted risk based capital (RBC)
requirements for life insurance companies. These requirements are
applicable to the Company and its principal subsidiary, SGLI. The RBC
calculation serves as a benchmark for the regulation of life insurance
companies by state insurance regulators. RBC provides for surplus
formulas similar to target surplus formulas used by commercial rating
agencies. The formulas specify various weighting factors that are
applied to statutory financial balances or various levels of activity
based on the perceived degree of risk, and are set forth in the RBC
requirements. The amount determined under such formulas is called the
authorized control level RBC (ACLC).
The RBC guidelines define specific capital levels based on a company's
ACLC that are determined by the ratio of the company's total adjusted
capital (TAC) to its ACLC. TAC is equal to statutory capital, plus the
Asset Valuation Reserve and any voluntary investment reserves, 50% of
dividend liability, and certain other specified adjustments. Companies
where TAC is less than or equal to 2.0 times ACLC are subject to
certain corrective actions, as set forth in the RBC requirements.
At December 31, 1997 and 1996, the statutory TAC of the Company
significantly exceeds the level requiring corrective action. At
December 31, 1996, the statutory TAC of SGLI significantly exceeded the
level requiring corrective action.
(3) INVESTMENTS
<TABLE>
<CAPTION>
Investment income for the years ended December 31 is summarized below (in
thousands):
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Interest on fixed maturities $ 61,556 58,271 53,931
Dividends on equity securities 25 44 139
Interest on mortgage loans 12,091 11,747 11,543
Investment real estate income 2,285 3,295 4,055
Interest on policy loans 1,411 1,281 1,200
Interest on short-term investments 244 120 571
Net realized gains on investments 1,823 1,793 2,423
Other 787 1,186 1,071
--------- -------- -------
80,222 77,737 74,933
Less investment expenses (11,047) (10,235) (9,607)
------- ------- -------
Net investment income $ 69,175 67,502 65,326
======= ======= ======
</TABLE>
Net realized gains (losses) and the changes in unrealized gains
(losses) on investments for the years ended December 31 are as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
Realized Unrealized Realized Unrealized Realized Unrealized
Fixed maturities
<S> <C> <C> <C>
held-to-maturity $ 173 - (1,127) - 581 -
Fixed maturities
available-for-sale 449 12,600 573 (19,051) 271 31,529
Equity securities - (1,641) 27 2,986 611 (896)
Real estate 1,219 - 2,398 - 1,436 -
Mortgage loans (15) - (68) - (196) -
Other (3) - (10) - (280) -
-------- ---------- ------- ------------ ----- -----
$ 1,823 10,959 1,793 (16,065) 2,423 30,633
===== ====== ===== ======= ===== ======
</TABLE>
Included in the above realized gains (losses) is the increase
(decrease) in the allowance for possible losses on mortgage loans of
$16,000, $(790,000), and $235,000 in 1997, 1996, and 1995,
respectively, and the increase in the allowance for losses on
investment real estate of $117,000 in 1996. In addition, the Company
realized net gains (losses) of approximately $1,000, and $(11,000)
during 1996, and 1995, respectively, on investments in fixed maturities
that were called or prepaid.
In December 1995, the Company transferred investments with an estimated
fair value and an amortized cost of approximately $300,850,000 and
$287,269,000, respectively, from the held to-maturity portfolio to the
available-for-sale portfolio at their estimated fair value in response
to the guidance included in the Financial Accounting Standards Board
Special Report, "A Guide to Implementation of Statement 115." This
guidance offered a one-time reassessment opportunity, without calling
into question the intent of the Company to hold other securities to
maturity in the future. At the date of transfer, the net unrealized
gain on the transferred securities was approximately $13,581,000 and
was included as an increase in stockholder's equity, net of deferred
taxes.
HELD-TO-MATURITY
The amortized cost and estimated fair value of investments in fixed
maturities held-to-maturity are as follows (in thousands):
<TABLE>
<CAPTION>
December 31, 1997
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities and obli-
gations of U.S. government
<S> <C> <C> <C>
corporations and agencies $ 9,001 659 - 9,660
Corporate securities 131,251 4,826 (354) 135,723
Mortgage-backed securities 94,547 2,037 (104) 96,480
Totals $ 234,799 7,522 (458) 241,863
======= ===== ==== =======
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. Treasury securities and obli-
gations of U.S. government
<S> <C> <C> <C>
corporations and agencies $ 9,925 365 - 10,290
Corporate securities 142,209 1,078 (2,271) 141,016
Mortgage-backed securities 99,810 1,146 (1,228) 99,728
-------- ----- ------ --------
Totals $ 251,944 2,589 (3,499) 251,034
======= ===== ====== =======
</TABLE>
The amortized cost and estimated fair value of investments in fixed
maturities held-to-maturity at December 31 are shown below (in
thousands) by contractual maturity. Expected maturities will differ
from contractual maturities because the issuers of such securities may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
1997
Estimated
Amortized Fair
Cost Value
<S> <C> <C>
Due after one year through five years $ 11,635 11,878
Due after five years through ten years 45,957 47,624
Due after ten years 82,660 85,881
-------- --------
140,252 145,383
Mortgage-backed securities 94,547 96,480
-------- --------
$ 234,799 241,863
======= =======
</TABLE>
Proceeds from sales of investments in fixed maturities held-to-maturity
during 1997, 1996, and 1995 were approximately $9,006,000, $7,948,000,
and $33,685,000, respectively. Gross gains of approximately $173,000,
$33,000, and $1,022,000, respectively, were realized on those sales. In
1996 and 1995, gross losses of approximately $1,161,000 and $430,000,
respectively, were realized on those sales. In 1997, 1996, and 1995,
changes in circumstances caused the Company to change its intent to
hold these securities to maturity. These changes primarily consisted of
the significant deterioration in the issuers' creditworthiness in 1997,
1996, and 1995.
AVAILABLE-FOR-SALE
The gross unrealized holding gains on equity securities
available-for-sale were $779,000 and $2,369,000 in 1997 and 1996,
respectively. Gross unrealized holding losses on equity securities
available-for-sale were $66,000 and $15,000 in 1997 and 1996,
respectively.
The amortized cost and estimated fair value of investments in fixed
maturities available-for-sale are as follows (in thousands):
<TABLE>
<CAPTION>
December 31, 1997
Gross Gross
Unrealized Unrealized Estimated
Amortized Holding Holding Fair
Cost Gains Losses Value
U.S. Treasury securities and
obligations of U.S. government
<S> <C> <C> <C> <C>
corporations and agencies $ 89,182 2,249 (65) 91,366
Corporate securities 382,599 14,128 (195) 396,532
Mortgage-backed securities 150,931 3,909 (161) 154,679
------- ------- ---- -------
Totals $ 622,712 20,286 (421) 642,577
======= ====== ==== =======
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
Gross Gross
Unrealized Unrealized Estimated
Amortized Holding Holding Fair
Cost Gains Losses Value
U.S. Treasury securities and
obligations of U.S. government
<S> <C> <C> <C> <C>
corporations and agencies $ 86,884 1,627 (674) 87,837
Corporate securities 353,707 7,074 (2,414) 358,367
Mortgage-backed securities 111,265 2,135 (483) 112,917
------- ------- ------- -------
Totals $ 551,856 10,836 (3,571) 559,121
======= ====== ====== =======
</TABLE>
The amortized cost and estimated fair value of investments in fixed
maturities available-for-sale at December 31 are shown below (in
thousands) by contractual maturity. Expected maturities will differ
from contractual maturities because the issuers of such securities may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
1997
Estimated
Amortized Fair
Cost Value
<S> <C> <C>
Due in one year or less $ 22,964 23,140
Due after one year through five years 157,919 162,717
Due after five years through ten years 202,614 209,128
Due after ten years 88,284 92,913
-------- --------
471,781 487,898
Mortgage-backed securities 150,931 154,679
------- -------
$ 622,712 642,577
======= =======
</TABLE>
Proceeds from sales of investments in fixed maturities
available-for-sale were approximately $100,220,000, $136,577,000, and
$31,944,000 in 1997, 1996, and 1995, respectively. Gross gains of
approximately $1,152,000, $1,257,000, and $359,000 and gross losses of
approximately $703,000, $684,000, and $88,000 were realized on those
sales in 1997, 1996, and 1995, respectively.
At December 31, 1997 and 1996, investments with carrying values of
approximately $2,497,000 and $5,282,000, respectively, were on deposit
with state insurance departments as required by statute.
(4) FAIR VALUE OF FINANCIAL INSTRUMENTS
A summary of the Company's financial instruments (in thousands) and the
fair value estimates, methods, and assumptions are set forth below:
<TABLE>
<CAPTION>
1997 1996
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
Financial assets:
<S> <C> <C> <C> <C>
Cash $ 8,427 8,427 15,962 15,962
Short-term and other investments 20,770 20,770 12,763 12,763
Accounts receivable 35,819 35,819 34,006 34,006
Accrued investment income 14,357 14,357 14,248 14,248
Reinsurance receivables on paid and
unpaid benefits 57,503 57,503 36,794 36,794
Policy loans 8,668 8,668 8,359 8,359
Fixed maturities held-to-maturity 234,799 241,863 251,944 251,034
Fixed maturities available-for-sale 642,577 642,577 559,121 559,121
Equity securities 11,736 11,736 12,046 12,046
Mortgage loans 135,122 145,763 130,508 137,978
Financial liabilities:
Certain policy liabilities 639,272 620,976 613,151 596,386
Other liabilities 36,099 36,099 34,125 34,125
Notes payable 50,719 51,247 19,839 19,758
</TABLE>
CASH, SHORT-TERM AND OTHER INVESTMENTS, ACCOUNTS RECEIVABLE, ACCRUED
INVESTMENT INCOME, REINSURANCE RECEIVABLES ON PAID AND UNPAID
BENEFITS, AND OTHER LIABILITIES
The carrying amount of these financial instruments approximates fair
value because they mature within a relatively short period of time and
do not present unanticipated credit concerns.
POLICY LOANS
Policy loans have average interest rates of 6.95% and 6.60% as of
December 31, 1997 and 1996, respectively, and have no specified
maturity dates. The aggregate fair value of policy loans approximates
the carrying value reflected on the consolidated balance sheets. These
loans typically carry an interest rate that is tied to the crediting
rate applied to the related policy and contract reserves. Policy loans
are an integral part of the life insurance policies which the Company
has in force and cannot be valued separately.
FIXED MATURITY INVESTMENTS
The fair value of fixed maturity investments is estimated based on bid
prices published in financial newspapers or bid quotations received
from securities dealers. The fair value of certain securities is not
readily available through market sources other than dealer quotations,
so fair value estimates are based on quoted market prices of similar
instruments, adjusted for the differences between the quoted
instruments and the instruments being valued.
The fair value of equity securities investments of the Company is based
on bid prices published in financial newspapers or bid quotations
received from securities dealers.
MORTGAGE LOANS
Fair values are estimated for portfolios of loans with similar
characteristics. Mortgage loans are segregated into either commercial
or residential categories, and have average net yield rates of 8.70%
and 8.92% for December 31, 1997 and 1996, respectively. The fair value
of mortgage loans was calculated by discounting scheduled cash flows to
maturity using estimated market discount rates of 7.29% and 7.71% for
December 31, 1997 and 1996, respectively. These rates reflect the
credit and interest rate risk inherent in the loan. Assumptions
regarding credit risk, cash flows, and discount rates are judgmentally
determined using available market information and specific borrower
information. The fair value of certain residential loans is based on
the approximate fair value of the underlying real estate securing the
mortgages.
CERTAIN POLICY LIABILITIES
Certain policies sold by the Company are investment-type contracts.
These liabilities are segregated into two categories: deposit
administration funds and immediate annuities which do not have life
contingencies. The fair value of the deposit administration funds is
estimated as the cash surrender value of each policy less applicable
surrender charges. The fair value of the immediate annuities without
life contingencies is estimated as the discounted cash flows of
expected future benefits less the discounted cash flows of expected
future premiums, using the current pricing assumptions. The carrying
amount of all other policy liabilities approximates fair value.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
(in thousands) (in thousands)
Funds held under deposit
<S> <C> <C> <C> <C>
administration contracts $ 580,499 562,961 556,665 540,105
Annuities 58,773 58,015 56,486 56,281
</TABLE>
NOTES PAYABLE
The fair value of the Company's notes payable is estimated by
discounting the scheduled cash flows of each instrument through the
scheduled maturity. The discount rates used are similar to those used
for the valuation of the Company's commercial mortgage loan portfolio,
except for the Company's notes payable to the Federal Home Loan Bank of
Topeka, which are valued using discount rates at or near the carried
rates because the notes have relatively short lives or carry the option
of conversion to an adjustable rate.
LIMITATIONS
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time the Company's entire
holdings of a particular financial instrument, nor do they reflect
income taxes on differences between fair value and tax basis of the
assets. Because no established exchange exists for a significant
portion of the Company's financial instruments, fair value estimates
are based on judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment
and therefore cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.
(5) DEFERRED POLICY ACQUISITION COSTS
Deferred policy acquisition costs principally represent field sales
compensation, direct response costs, underwriting and issue costs, and
related expenses. Information relating to the increase in deferred
policy acquisition costs, is summarized as follows (in thousands):
<TABLE>
<CAPTION>
Life Accident
and Annuity and Health Total
Year ended December 31, 1997:
<S> <C> <C> <C>
Deferred costs $ 8,600 28,734 37,334
Amortization (5,581) (16,513) (22,094)
------ ------- -------
Net increase $ 3,019 12,221 15,240
====== ======= =======
Year ended December 31, 1996:
Deferred costs 7,088 22,145 29,233
Amortization (6,437) (12,714) (19,151)
------ ------- -------
Net increase $ 651 9,431 10,082
======= ======== =======
Year ended December 31, 1995:
Deferred costs 9,234 17,516 26,750
Amortization (3,385) (11,463) (14,848)
------ ------- -------
Net increase $ 5,849 6,053 11,902
====== ======== =======
</TABLE>
(6) RESERVES FOR FUTURE POLICY BENEFITS
Reserves for life and annuity future policy benefits as of December 31
are principally based on the interest assumptions set forth below (in
thousands):
<TABLE>
<CAPTION>
Interest
1997 1996 Assumptions
---- ---- -----------
Life and annuity reserves:
<S> <C> <C> <C> <C>
Issued prior to 1970 $ 3,308 3,305 4.75%
Issued 1970 through 1980 28,796 28,792 6.75% to 5.25%
Issued after 1982 (indeterminate premium products) 559 530 10.00% to 8.50%
Issued through 1987 (SGLI acquisition) 1,360 1,423 11.00%
Issued 1981 - 1994 (all other) 28,018 27,357 8.50% to 7.00%
Issued after 1994 (all other) 2,892 1,701 7.00%
Life contingent annuities 30,894 30,151 Various *
Group term life waiver of premium disabled lives 5,311 5,105 6.00%
All other life reserves 4,525 4,456 Various
--------- ---------
$ 105,663 102,820
======= =======
</TABLE>
* These reserves are revalued as limited-pay contracts. As a result, the
reserve is somewhat greater than the present value of future benefits
and expenses at these interest rates, i.e., the actual interest rates
required to support the reserves are somewhat lower than the rates
shown.
Assumptions as to mortality are based on the Company's prior
experience. This experience approximates the 1955-60 Select and
Ultimate Table (individual life issued prior to 1981), the 1965-70
Select and Ultimate Table (individual life issued in 1981 and after)
and the 1960 Basic Group Table (all group issues). Assumptions for
withdrawals are based on the Company's prior experience. All
assumptions used are adjusted to provide for possible adverse
deviations.
(7) LIABILITY FOR BENEFITS PAYABLE
The provision for benefits pertaining to prior years did not change
significantly in 1997. The provisions for benefits pertaining to prior
years decreased in 1996 by approximately $1,850,000 primarily due to
the improvement in the loss ratios of life and cancer products.
(8) NOTES PAYABLE
Notes payable as of December 31 is summarized as follows:
<TABLE>
<CAPTION>
1997 1996
(in thousands)
<S> <C> <C> <C> <C>
5.91% line of credit, due in 1998, interest due monthly $ 3,500 3,500
5.97% line of credit, due in 1998, interest due monthly 5,000 5,000
5.54% line of credit, due in 1998, interest due monthly 3,500 -
5.56% line of credit, due in 1998, interest due monthly 5,000 -
5.66% line of credit, due in 1999, interest due monthly 3,000 -
5.62% line of credit, due in 1999, interest due monthly 10,000 -
6.84% line of credit, due in 2000, interest due monthly 4,000 4,000
5.81% line of credit, due in 2002, interest due monthly 10,000 -
5.78% line of credit, due in 2002, interest due monthly 3,000 -
8.4% mortgage loan, due in monthly installments of
$22,000 (including interest) to 2027 2,881 2,902
Other 838 2,054
Various notes payable, paid in 1997 - 2,383
---------- -----
$ 50,719 19,839
====== ======
</TABLE>
The promissory notes are guaranteed by AFC. The mortgage loan is
secured by a mortgage on other investment real estate. The mortgage
loan is also secured by an assignment of the leases on investment real
estate.
AFA has a $50,000,000 line of credit with the Federal Home Loan Bank of
Topeka. The line of credit is secured by investment securities pledged
as collateral by AFA with a carrying value of approximately $61,954,000
at December 31, 1997. The collateral required for this line of credit
at December 31, 1997, was $57,500,000. The pledged securities are held
in the Company's name in a custodial account at Bank of Oklahoma to
secure current and future borrowings. To participate in this available
credit, AFA has purchased 114,916 shares of Federal Home Loan Bank of
Topeka common stock with a total carrying value of approximately
$11,491,600 at December 31, 1997.
The Company has unused lines of credit of $3,000,000 at December 31,
1997.
Interest expense for the years ended December 31, 1997, 1996, and 1995,
totaled approximately $2,076,000, $1,319,000, and $1,482,000,
respectively.
Scheduled maturities (excluding interest) of the above indebtedness at
December 31, 1997, are as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
1998 $ 17,070
1999 13,078
2000 4,084
2001 92
2002 13,100
Thereafter 3,295
$ 50,719
</TABLE>
(9) INCOME TAXES
Total income tax expense in the accompanying consolidated statements of
income differs from the federal statutory rate of 35% of income before
income taxes principally due to the recapture of certain tax reserve
benefits on reinsurance recaptured by the ceding company in 1997, loss
on the disposition of a subsidiary in 1997, payments made to AFC in
1997 treated as management fees for tax purposes, and the correction of
prior year estimates of deferred taxes in 1997 and 1996.
The tax effects of temporary differences that give rise to the deferred
tax assets and deferred tax liabilities at December 31, are presented
below (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
Deferred tax assets:
<S> <C> <C>
Investment real estate $ - 311
Other investments 522 428
Life and health reserves 12,783 12,956
Other liabilities - 1,433
---------- --------
Total gross deferred tax assets 13,305 15,128
------ -------
Deferred tax liabilities:
Fixed maturities (7,602) (3,010)
Equity securities (250) (824)
Deferred policy acquisition costs (57,151) (51,937)
Investment real estate (39) -
Other assets (6,863) (7,635)
Other liabilities (598) -
---------- ------
Total gross deferred tax liabilities (72,503) (63,406)
------- -------
Net deferred tax liability $ (59,198) (48,278)
======= =======
</TABLE>
Management believes that it is more likely than not that the results of
operations will generate sufficient taxable income to realize the
deferred tax assets reported on the consolidated balance sheets.
The Company and its subsidiaries are included in AFC's consolidated
federal income tax return. Income taxes are reflected in the
accompanying consolidated financial statements as if the Company and
its subsidiaries were separate tax paying entities. At December 31,
1997 and 1996, other accounts receivable includes income taxes
receivable from AFC and other members of the consolidated group of
approximately $6,550,000 and $4,988,000, respectively.
Prior to 1984, life insurance companies were taxed under the 1959 Tax
Act on the lesser of taxable income or gain from operations plus
one-half of any excess of gain from operations over taxable investment
income. The one-half of the excess of the gain from operations was
accumulated in a special memorandum tax account known as the
"policyholders surplus account" (PSA). Accumulations at December 31,
1997 were approximately $8,161,000 for AFA. Pursuant to the Tax Reform
Act of 1984, the PSA was "frozen" at the December 31, 1983, amount and,
accordingly, no further additions to the PSA will be made. These excess
amounts in the PSA will become taxable at the regular corporate tax
rate, if distributions to stockholders exceed certain stated amounts or
if certain criteria are not met. No provision for deferred federal
income taxes applicable to the PSA has been made because management is
of the opinion that no distribution of the PSA will be made in the
foreseeable future.
(10) REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations
to policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the
financial condition of its reinsurers and monitors concentrations of
credit risk arising from similar geographic regions, activities, or
economic characteristics of the reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. Management believes
that all reinsurers presently used are financially sound and will be
able to meet their contractual obligations; therefore, no allowance for
uncollectible amounts has been included in the financial statements. At
December 31, 1997 and 1996, reinsurance receivables with a carrying
value of approximately $18,183,000 and $11,688,000, respectively were
associated with two reinsurers.
During 1997, the Company entered into litigation with one of its
reinsurance carriers. The litigation is still in process. Management
and legal counsel do not expect the anticipated result to have a
material financial impact on the Company.
Reinsurance agreements in effect for life insurance policies vary
according to the age of the insured and the type of risk. Retention
amounts for life insurance range from $500,000 on group life to
$250,000 on individual life coverages, with slightly lower limits on
accidental death benefits. At December 31, 1997 and 1996, the face
amounts of life insurance in force that are reinsured amounted to
approximately $307,000,000 (approximately 4.6% of total life insurance
in force) and approximately $403,000,000 (approximately 6.3% of total
life insurance in force), respectively.
Reinsurance agreements in effect for accident and health insurance
policies vary with the type of coverage. Retention limits range from
$50,000 for individual cancer coverage to $250,000 for major medical
coverage.
The effects of reinsurance agreements on earned and written premiums,
prior to deductions for benefits and commission allowances, were
approximately $(92,731,000), $(83,947,000), and $(76,143,000) for life
and accident and health reinsurance ceded, and $416,000, $2,897,000,
and $2,750,000 for life and accident and health reinsurance assumed,
for the years ended December 31, 1997, 1996 and 1995, respectively.
Reinsurance agreements reduced benefits paid for life and accident and
health policies by approximately $72,522,000, $61,730,000, and
$52,318,000 for the years ended December 31, 1997, 1996, and 1995,
respectively.
Since 1990, the Company has been involved in a reinsurance agreement
with SGLI. This agreement was amended in 1994 which allowed SGLI to
cede most of its individual major medical business to an unaffiliated
company. This transaction consists of a coinsurance agreement. The
transaction was approved by the Oklahoma Insurance Department.
In 1995, AFA and SGLI entered into an assumption agreement whereby AFA
assumed all of SGLI's remaining rights and insurance liability in
force. The assumption is pending policyholder approval, as certain
states allow as much as three years for policyholders to reject an
assumption.
In 1997, AFA and SGLI entered into an assumption agreement whereby SGLI
assumed a small block of life business and a block of stop-loss medical
business from AFA.
(11) EMPLOYEE BENEFIT PLANS
The Company and its subsidiaries participate in a pension plan (the
Plan) covering all employees who have satisfied longevity and age
requirements. The Company's funding policy is to contribute annually
the maximum amount that can be deducted for federal income tax
purposes. Contributions are intended to provide not only for benefits
attributed to service to date but also for those expected to be earned
in the future.
The Plan's funded status as of December 31 is summarized as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
Actuarial present value of benefit obligation:
<S> <C> <C>
Vested benefits $ 14,455 11,248
Nonvested benefits 1,850 1,420
------- -------
Total accumulated benefit obligation $ 16,305 12,668
====== ======
Projected benefit obligation for service rendered to date 19,466 14,679
Plan assets, at fair value 21,839 16,864
------ ------
Plan assets in excess of projected benefit obligation 2,373 2,185
Unrecognized transition amount (298) (443)
Unrecognized prior service cost due to plan amendment 449 521
Unrecognized net loss 205 370
-------- -------
Prepaid pension cost included in other assets $ 2,729 2,633
======= =======
</TABLE>
In determining the projected benefit obligation, the weighted average
assumed discount rate used was 7.0% and 7.5% in 1997 and 1996,
respectively. The rate of increase in future salary levels was 5.0% in
1997 and 1996. The expected long-term rate of return on assets used in
determining net periodic pension cost was 9.5% in 1997 and 1996. Plan
assets are invested in fixed maturities, equity securities, short-term
investments and in an unallocated deposit administration contract with
the Company.
Net periodic pension cost for the years ended December 31 included the
following (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Service costs - benefits earned during period $ 1,284 1,237 1,025
Interest cost 1,193 1,054 919
Return on plan assets (4,065) (3,711) (2,455)
Net amortization and deferral 2,332 2,421 1,366
------- ------ ------
Net periodic pension cost $ 744 1,001 855
======== ====== =======
</TABLE>
The Company participates in a defined contribution thrift and profit
sharing plan as provided under section 401(a) of the Internal Revenue
Code, which includes the tax deferral feature for employee
contributions provided by section 401(k) of the Internal Revenue Code.
The Company contributed approximately $881,000, $822,000, and $831,000
to this plan during the years ended December 31, 1997, 1996, and 1995,
respectively.
(12) DISCONTINUED OPERATIONS
Effective January 1, 1995, AFA sold its subsidiary American Fidelity
Insurance Company (AFI), a property and casualty insurance company, to
AFC for approximately $28,717,000. In connection with this sale, AFC
contributed capital of approximately $4,085,000 to AFA as reflected in
the accompanying consolidated statement of stockholder's equity.
(13) COMMITMENTS AND CONTINGENCIES
Rent expense for the years ended December 31, 1997, 1996, and 1995, was
approximately $6,163,000, $5,674,000, and $5,133,000, respectively. A
portion of rent expense relates to leases that expire or are cancelable
within one year. The aggregate minimum annual rental commitments as of
December 31, 1997, under noncancellable long-term leases for office
space are as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
1998 $ 2,863
1999 1,756
2000 798
2001 370
2002 308
Thereafter 331
</TABLE>
The Company has pledged approximately $31,423,000 of its treasury notes
as collateral on lines of credit held by affiliated companies.
The Company has outstanding mortgage loan commitments of approximately
$8,165,000 and $13,182,000 at December 31, 1997 and 1996, respectively.
In the normal course of business, there are various legal actions and
proceedings pending against the Company and its subsidiaries. In
management's opinion, the ultimate liability, if any, resulting from
these legal actions will not have a material adverse effect on the
Company's financial position.
(14) LEASES
The Company leases various real estate properties to nonaffiliates
under operating lease agreements, with lease expiration dates ranging
from 1998 through 2003. The properties leased are included in the
consolidated balance sheets as investment real estate with the related
debt included in notes payable. Rental income on these properties is
included in the consolidated statements of income as net investment
income.
Investments in real estate held for lease can be summarized as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Land and buildings $ 3,325 4,857
Less accumulated depreciation 685 1,567
------ -----
Net investment 2,640 3,290
Less indebtedness 839 884
------ ------
Investment net of indebtedness $ 1,801 2,406
===== =====
</TABLE>
<TABLE>
<CAPTION>
Future minimum rentals on noncancellable operating leases can be
summarized as follows (in thousands):
Year ended December 31,
<S> <C> <C>
1998 $ 392
1999 253
2000 181
2001 133
2002 117
Thereafter 31
-------
Total future minimum rentals $ 1,107
=====
</TABLE>
(15) RELATED PARTY TRANSACTIONS
The Company and its subsidiaries lease automobiles, furniture, and
equipment from a partnership that owns a controlling interest in AFC.
These operating leases are cancelable upon one month's notice. During
the years ended December 31, 1997, 1996, and 1995, rentals paid under
these leases were approximately $3,577,000, $2,966,000, and $2,955,000,
respectively.
During the year ended December 31, 1997, the Company paid investment
advisory fees to a partnership that owns a controlling interest in AFC
totaling approximately $3,232,000. During the years ended December 31,
1997, 1996, and 1995, the Company and its subsidiaries paid management
fees and investment advisory fees to AFC totaling approximately
$2,848,000, $16,536,000, and $17,885,000, respectively.
The Company and its subsidiaries lease office space from a subsidiary
of AFC. The rent payments associated with the lease will be
approximately $2,100,000 per year for the next 15 years.
During 1997, the Company paid a dividend of approximately $33,834,000
to AFC. This dividend was in the form of cash payments of approximately
$8,800,000, common stock in affiliated companies (including SGLI) of
approximately $16,588,000 (including deferred tax liabilities assumed
by AFC of $683,000), and common stock in non-affiliated companies of
approximately $8,446,000 (including a deferred tax liability retained
by the Company of $1,961,000). This transaction was approved by the
Oklahoma Insurance Department.
Short-term and other investments at December 31, 1997 includes a note
receivable from AFC of approximately $3,328,000, maturing in 1998.
During 1997, the Company entered into a three-year software lease
agreement with AFC. Lease expense related to this agreement was
approximately $569,000 and is included in selling costs and other
operating, administrative and general expenses.
Short-term and other investments at December 31, 1995 include notes
receivable from AFC totaling approximately $6,485,000 which were repaid
in 1996. During the years ended December 31, 1996 and 1995, the Company
recorded investment income on the notes from AFC of approximately
$481,000, and $699,000, respectively.
AFC and several of its subsidiaries rented office space in the home
office building from the Company until the home office building was
sold in 1997. During the years ended December 31, 1997, 1996, and 1995,
the Company received rental income from AFC and several of its
subsidiaries of approximately $299,000, $1,280,000, and $1,281,000,
respectively.
During 1996, AFC contributed capital of approximately $2,198,000
through forgiveness of a deferred tax liability owed by AFA to AFC.
An officer of AFC serves on the board of directors of a financial
institution in which the Company maintains cash balances.
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE III - BUSINESS SEGMENT INFORMATION
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
The Company's reportable segments are its strategic business units. The
components of operations for the years ended December 31, 1997, 1996, and 1995
are included in the table below.
Assets and related investment income are allocated based upon related insurance
reserves which are backed by such assets. Other operating expenses are allocated
in relation to the mix of related revenues.
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
TOTAL REVENUES:
<S> <C> <C> <C>
American Fidelity Education Services Division $ 152,021 142,493 129,628
Association Group Division 105,784 99,979 96,140
Brokerage Division 32,290 24,558 31,898
Non insurance operations (504) 1,966 1,324
------------- ------------ ------------
$ 289,591 268,996 258,990
========== ========== ==========
PRETAX EARNINGS:
American Fidelity Education Services Division 24,621 14,275 16,034
Association Group Division 10,683 9,349 5,751
Brokerage Division (2,344) (1,903) 10,113
Non insurance operations (2,340) 397 517
------------ ------------- -------------
$ 30,620 22,118 32,415
=========== =========== ===========
TOTAL ASSETS:
American Fidelity Education Services Division 1,029,976 922,671 885,216
Association Group Division 192,507 197,225 181,426
Brokerage Division 274,818 239,986 231,774
Non insurance operations 2,135 3,170 1,891
------------ ------------ -------------
$ 1,499,436 1,363,052 1,300,307
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
AMERICAN FIDELITY ASSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
Ceded Assumed Percentage
Gross to Other From Other Net of Amount
Amount Companies Companies Amount Assumed to Net
Year ended December 31, 1997
<S> <C> <C> <C> <C>
Life insurance in force $ 6,872,047 306,917 10 6,565,140 - %
========= ======= ========== =========
Premiums:
Life insurance 26,756 1,474 - 25,282 - %
Accident and health insurance 272,785 91,257 416 181,944 - %
---------- ------- --------- ----------
Total premiums $ 299,541 92,731 416 207,226 - %
========== ======= ========= ==========
Year ended December 31, 1996
Life insurance in force $ 6,276,241 403,148 125,101 5,998,194 2.09%
========= ======= ======= =========
Premiums:
Life insurance 23,240 1,907 2,854 24,187 11.80%
Accident and health insurance 248,054 82,040 43 166,057 0.00%
---------- -------- ----------- ----------
Total premiums $ 271,294 83,947 2,897 190,244 1.52%
========== ======== ========= ==========
Year ended December 31, 1995
Life insurance in force $ 5,679,074 277,982 131,621 5,532,713 2.38%
========= ======= ======= =========
Premiums:
Life insurance 23,527 1,758 2,745 24,514 11.20%
Accident and health insurance 231,340 74,385 5 156,960 - %
---------- -------- ------------ ----------
Total premiums $ 254,867 76,143 2,750 181,474 1.52%
========== ======== ========= ==========
- -----------------------------------------------------
</TABLE>
See accompanying independent auditors' report.
