SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
June 30, 1998 No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer
I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days. Yes X
No
As of August 1, 1998, there were 43,036,202 shares of the Registrant's
Common Stock outstanding.
Page 1 of 20
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
June 30,December 31,
1998 1997
Assets
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,141.6 and $2,340.6) $2,073.0 $2,276.4
Available for sale - at market
(amortized cost - $4,222.1 and
$3,922.0) 4,414.2 4,099.4
Equity securities - at market
(cost - $37.3 and $30.9) 85.7 83.0
Investment in affiliate 21.1 16.8
Mortgage loans on real estate 47.9 52.1
Real estate 45.9 42.0
Policy loans 241.0 241.0
Short-term investments 51.4 13.9
Total investments 6,980.2 6,824.6
Cash 43.0 36.8
Accrued investment income 103.8 101.6
Unamortized insurance acquisition costs, net 286.0 261.6
Other assets 199.7 185.2
Assets held in separate accounts 343.6 300.5
$7,956.3 $7,710.3
Liabilities and Capital
Annuity benefits accumulated $5,589.1 $5,528.1
Life, accident and health reserves 752.7 709.9
Notes payable 161.4 135.8
Payable to affiliates, net 50.1 35.8
Deferred taxes on unrealized gains 75.2 71.8
Accounts payable, accrued expenses and other
liabilities 123.9 119.5
Liabilities related to separate accounts 343.6 300.5
Total liabilities 7,096.0 6,901.4
Mandatorily redeemable preferred securities
of subsidiary trusts 225.0 225.0
Stockholders' Equity:
Common Stock, $1 par value
-100,000,000 shares authorized
- 43,135,364 and 43,199,147 shares
outstanding 43.1 43.2
Capital surplus 366.5 368.0
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 298.7 252.1
Unrealized gains on marketable
securities, net 139.6 133.2
Total stockholders' equity 635.3 583.9
$7,956.3 $7,710.3
2
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
Revenues:
Net investment income $130.9 $123.1 $257.9 $242.7
Realized gains (losses)
on sales of investments 1.5 (0.1) 11.7 0.2
Life, accident and health premiums 48.5 27.3 95.3 52.7
Equity in net earnings of affiliate 2.2 1.5 4.6 3.3
Other income 3.8 2.7 7.0 5.3
186.9 154.5 376.5 304.2
Costs and Expenses:
Annuity benefits 69.1 70.6 140.2 139.4
Life, accident and health benefits 36.6 25.8 74.7 50.0
Amortization of insurance
acquisition costs 15.9 8.5 29.9 16.2
Trust preferred distribution
requirement 4.7 3.9 9.5 6.0
Interest and other debt expenses 2.7 2.4 5.2 5.0
Other expenses 25.6 17.4 46.6 35.5
154.6 128.6 306.1 252.1
Income before income taxes
and extraordinary item 32.3 25.9 70.4 52.1
Provision for income taxes 10.6 8.2 23.0 16.4
Income before extraordinary item 21.7 17.7 47.4 35.7
Extraordinary item - loss on
prepayment of debt - - (0.8) -
Net Income $ 21.7 $ 17.7 $ 46.6 $ 35.7
Preferred dividend requirement - - - 1.0
Net income applicable to Common
Stock $ 21.7 $ 17.7 $ 46.6 $ 34.7
Average number of common shares:
Basic 43.1 43.2 43.1 43.2
Diluted 43.9 43.6 43.9 43.5
Basic earnings (loss) per common share:
Before extraordinary item $0.50 $0.41 $1.10 $0.80
Loss on prepayment of debt - - (0.02) -
Net income $0.50 $0.41 $1.08 $0.80
Diluted earnings (loss) per common share:
Before extraordinary item $0.49 $0.41 $1.08 $0.80
Loss on prepayment of debt - - (0.02) -
Net income $0.49 $0.41 $1.06 $0.80
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Six months ended
June 30,
1998 1997
Preferred Stock:
Balance at beginning of period $ - $ 49.0
Preferred Stock retired - (49.0)
Balance at end of period $ - $ -
Common Stock:
Balance at beginning of period $ 43.2 $ 43.3
Common Stock retired (0.1) (0.1)
Balance at end of period $ 43.1 $ 43.2
Capital Surplus:
Balance at beginning of period $368.0 $358.5
Common Stock issued 0.2 0.2
Common Stock retired (1.7) (0.7)
Preferred Stock retired - 2.0
Preferred dividends declared - (1.0)
Balance at end of period $366.5 $359.0
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of period $252.1 $186.5
Net income 46.6 35.7
Balance at end of period $298.7 $222.2
Unrealized Gains, Net:
Balance at beginning of period $133.2 $ 61.8
Change during period 6.4 11.2
Balance at end of period $139.6 $ 73.0
Comprehensive Income:
Net income $ 46.6 $ 35.7
Other comprehensive income - change in net
unrealized gains on marketable securities 6.4 11.2
Comprehensive income $ 53.0 $ 46.9
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Six months ended
June 30,
1998 1997
Cash Flows from Operating Activities:
Net income $ 46.6 $ 35.7
Adjustments:
Extraordinary loss on prepayment of debt 0.8 -
Increase in life, accident and health
reserves 29.2 14.1
Benefits to annuity policyholders 140.2 139.4
Amortization of insurance acquisition costs 29.9 16.2
Equity in net earnings of affiliate (4.6) (3.3)
Depreciation and amortization 4.5 2.6
Realized gains on investing activities (11.7) (0.2)
Increase in insurance acquisition costs (48.9) (34.8)
Increase in accrued investment income (1.5) -
Increase in other assets (16.2) (15.3)
Increase in other liabilities 11.6 16.8
Other, net (9.3) (6.7)
170.6 164.5
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (598.8) (780.9)
Equity securities (5.9) (7.5)
Real estate, mortgage loans and other assets (12.7) (5.7)
Affiliates - (4.9)
Purchase of subsidiaries, net of cash acquired (9.5) -
Maturities and redemptions of fixed
maturity investments 398.0 197.4
Sales of:
Fixed maturity investments 177.9 393.9
Equity securities 2.0 3.9
Real estate, mortgage loans and other assets 15.6 4.8
Decrease in policy loans 0.6 0.1
(32.8) (198.9)
Cash Flows from Financing Activities:
Fixed annuity receipts 238.2 259.7
Annuity surrenders, benefits and withdrawals (354.8) (288.5)
Additions to notes payable 150.0 7.0
Reductions of notes payable (125.7) (52.0)
Issuance of trust preferred securities - 149.3
Retirement of Common Stock (1.8) (0.8)
Retirement of Preferred Stock - (47.0)
Cash dividends paid - (1.0)
(94.1) 26.7
Net increase (decrease) in cash and
short-term investments 43.7 (7.7)
Cash and short-term investments
at beginning of period 50.7 84.1
Cash and short-term investments
at end of period $ 94.4 $ 76.4
5
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Description of the Company
American Annuity Group, Inc. ("AAG" or "the Company") markets the
following nationwide: (i) retirement products - primarily fixed
and variable annuities; (ii) individual life insurance and
annuity policies through the sponsorship of state associations of
funeral directors as well as individual and large operators of
funeral homes and (iii) various forms of life and supplemental
health insurance through payroll deduction plans, financial
institutions and in-home sales. In July 1998, AAG announced an
agreement to sell its funeral services division. (See Note L.)
American Financial Group, Inc. ("AFG") and its subsidiaries owned
35,059,995 shares (81%) of AAG's Common Stock at August 1, 1998.
B. Accounting Policies
Basis of Presentation The accompanying Consolidated Financial
Statements for AAG and its subsidiaries are unaudited, but
management believes that all adjustments (consisting only of
normal recurring accruals unless otherwise disclosed herein)
necessary for fair presentation have been made. The results of
operations for interim periods are not necessarily indicative of
results to be expected for the year. The financial statements
have been prepared in accordance with the instructions to Form 10-
Q and therefore do not include all information and footnotes
necessary to be in conformity with generally accepted accounting
principles.
The preparation of the financial statements requires management to
make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Changes in
circumstances could cause actual results to differ materially from
those estimates.
All acquisitions subsequent to the 1992 acquisition of Great
American Life Insurance Company ("GALIC") have been treated as
purchases. The results of operations of companies since their
acquisition have been included in AAG's Consolidated Financial
Statements.
Investments Debt securities are classified as "held to maturity"
and reported at amortized cost if AAG has the positive intent and
ability to hold them to maturity. Debt and equity securities are
classified as "available for sale" and reported at fair value with
unrealized gains and losses reported as a separate component of
stockholders' equity if the securities are not classified as held
to maturity or bought and held principally for selling in the near
term. Only in certain limited circumstances, such as significant
issuer credit deterioration or if required by insurance or other
regulators, may a company change its intent to hold a certain
security to maturity without calling into question its intent to
hold other debt securities to maturity in the future.
Short-term investments are carried at cost; mortgage loans on real
estate are generally carried at amortized cost; policy loans are
stated at the aggregate unpaid balance.
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Gains or losses on sales of securities are recognized at the time
of disposition with the amount of gain or loss determined on the
specific identification basis. When a decline in the value of a
specific investment is considered to be other than temporary, a
provision for impairment is charged to earnings and the carrying
value of that investment is reduced. Premiums and discounts on
mortgage-backed securities are amortized over their expected
average lives using the interest method.
Investment in Affiliate AAG's investments in equity securities of
companies that are 20% to 50% owned by AFG and its subsidiaries
are generally carried at cost, adjusted for a proportionate share
of their undistributed earnings or losses. Changes in AAG's
equity in its affiliate caused by issuances of the affiliate's
stock are recognized in earnings when such issuances are not part
of a broader reorganization.
Insurance Acquisition Costs Unamortized insurance acquisition
costs consist primarily of deferred policy acquisition costs and
the present value of future profits on business in force of
acquired insurance companies. Certain commission costs are
expensed as paid and are included in amortization of life
insurance acquisition costs.
Deferred Policy Acquisition Costs ("DPAC") DPAC (principally
commissions, advertising, underwriting, policy issuance and sales
expenses that vary with and are primarily related to the
production of new business) is deferred to the extent that such
costs are deemed recoverable.
DPAC related to annuities and universal life insurance products is
amortized, with interest, in relation to the present value of
expected gross profits on the policies. These expected gross
profits consist principally of estimated future net investment
income and surrender, mortality and other policy charges, less
estimated future interest on policyholders' funds, policy
administration expenses and death benefits in excess of account
values. DPAC is reported net of unearned revenue relating to
certain policy charges that represent compensation for future
services. These unearned revenues are recognized as income using
the same assumptions and factors used to amortize DPAC.
To the extent that realized gains and losses result in adjustments
to the amortization of DPAC, such adjustments are reflected as
components of realized gains.
To the extent that unrealized gains (losses) from securities
classified as "available for sale" would result in adjustments to
DPAC, unearned revenues and policyholder liabilities had those
gains (losses) actually been realized, such balance sheet amounts
are adjusted, net of deferred taxes.
DPAC related to traditional life and health insurance is amortized
over the expected premium paying period of the related policies,
in proportion to the ratio of annual premium revenues to total
anticipated premium revenues. Such anticipated premium revenues
were estimated using the same assumptions used for computing
liabilities for future policy benefits.
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Present Value of Future Profits Included in insurance acquisition
costs are amounts representing the present value of future profits
on business in force of acquired insurance companies, which
represent the portion of the costs to acquire such companies that
is allocated to the value of the right to receive future cash
flows from insurance contracts existing at the date of
acquisition.
These amounts are amortized with interest over the estimated
remaining life of the acquired policies for annuities and
universal life products and over the expected premium paying
period for traditional life and health insurance products.
Start-up Costs Costs associated with introducing new products and
distribution channels are deferred until normal operations are
reached. These deferred costs are amortized on a straight-line
basis over five years.
Annuity Benefits Accumulated Annuity receipts and benefit
payments are recorded as increases or decreases in "annuity
benefits accumulated" rather than as revenue and expense.
Increases in this liability for interest credited are charged to
expense and decreases for surrender charges are credited to other
income.
Life, Accident and Health Reserves Liabilities for future policy
benefits under traditional ordinary life, accident and health
policies are computed using the net level premium method.
Computations are based on anticipated investment yields,
mortality, morbidity and surrenders and include provisions for
unfavorable deviations. Reserves are modified as necessary to
reflect actual experience and developing trends.
The liability for future policy benefits for interest sensitive
life policies is equal to the sum of the accumulated fund balances
under such policies.
Assets Held In and Liabilities Related To Separate Accounts
Separate account assets and related liabilities represent deposits
maintained by several banks under a previously offered tax-
deferred annuity program and, to a lesser extent, variable annuity
deposits. The Company receives an annual fee from each bank for
sponsoring the program; if depositors elect to purchase an annuity
from the Company, funds are transferred to the Company.
Life, Accident and Health Premiums and Benefits For traditional
life, accident and health products, premiums are recognized as
revenue when legally collectible from policyholders. Policy
reserves have been established in a manner which allocates policy
benefits and expenses on a basis consistent with the recognition
of related premiums and generally results in the recognition of
profits over the premium-paying period of the policies.
For interest-sensitive life and universal life products, premiums
are recorded in a policyholder account which is reflected as a
liability. Revenue is recognized as amounts are assessed against
the policyholder account for mortality coverage and contract
expenses. Surrender benefits reduce the account value. Death
benefits are expensed when incurred, net of the account value.
Income Taxes AAG and its principal subsidiary, GALIC, have
separate tax allocation agreements with American Financial
Corporation ("AFC"), a subsidiary of AFG, which designate how tax
payments are shared by members of the tax group. In general, both
companies compute taxes on a separate return basis. GALIC is
obligated to make payments to (or receive benefits from) AFC based
8
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
on taxable income without regard to temporary differences.
If GALIC's taxable income (computed on a statutory accounting
basis) exceeds a current period net operating loss of AAG, the
taxes payable by GALIC associated with the excess are payable
to AFC. If the AFC tax group utilizes any of AAG's net operating
losses or deductions that originated prior to AAG's entering
AFC's consolidated tax group, AFC will pay to AAG an amount
equal to the benefit received.
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax basis and are
measured using enacted tax rates. The Company recognizes deferred
tax assets if it is more likely than not that a benefit will be
realized. Current and deferred tax assets and liabilities of
companies in AFC's consolidated tax group are aggregated with
other amounts receivable from or payable to affiliates.
Stock-Based Compensation As permitted under Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation", AAG accounts for stock options
and other stock-based compensation plans using the intrinsic
value based method prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees."
Benefit Plans AAG sponsors an Employee Stock Ownership
Retirement Plan ("ESORP") covering all employees who are
qualified as to age and length of service. The ESORP, which
invests primarily in securities of AAG, is a trusteed,
noncontributory plan for the benefit of the employees of AAG
and its subsidiaries. Contributions are discretionary by the
directors of AAG and are charged against earnings in the year
for which they are declared. Qualified employees having vested
rights in the plan are entitled to benefit payments at age 60.
AAG and certain of its subsidiaries provide certain benefits to
eligible retirees. The projected future cost of providing these
benefits is expensed over the period the employees earn such
benefits.
Earnings Per Share In 1997, AAG implemented SFAS No. 128,
"Earnings Per Share." This standard requires the presentation of
basic and diluted earnings per share for entities with potentially
dilutive securities. Basic earnings per share are calculated
using the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per share include
the effect of the assumed exercise of dilutive common stock
options.
Comprehensive Income Effective January 1, 1998, AAG implemented
SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 uses
the term "comprehensive income" to describe the total of net
earnings plus other comprehensive income. For AAG, other
comprehensive income represents the change in net unrealized gains
on marketable securities net of deferred taxes and a
reclassification adjustment for gains and losses included in net
earnings. Implementation of this statement had no impact on net
earnings or stockholders' equity. Prior periods have been
restated to conform to the current presentation.
Statement of Cash Flows For cash flow purposes, "investing
activities" are defined as making and collecting loans and
acquiring and disposing of debt or equity instruments and property
and equipment. "Financing activities" include annuity receipts,
benefits and withdrawals and obtaining resources from owners and
providing them with a return on their investments. All other
activities are
9
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
considered "operating." Short-term investments having original
maturities of three months or less when purchased are considered
to be cash equivalents for purposes of the financial statements.
C. Acquisitions
In March 1998, GALIC acquired Arkansas National Life Insurance
Company for approximately $30 million using cash on hand.
In December 1997, AAG acquired Great American Life Assurance
Company of Puerto Rico, Inc. ("GA Life", formerly General Accident
Life Assurance Company of Puerto Rico, Inc.) for approximately $50
million in cash.
D. Investments
The carrying value of AAG's fixed maturity portfolio was comprised
of the following at June 30, 1998:
Held to Available
Maturity for Sale Total
U. S. Government and government
agencies and authorities -% 6% 6%
States, municipalities and political
subdivisions - 1 1
Public utilities 5 2 7
Mortgage-backed securities 10 21 31
All other corporate 17 38 55
32% 68% 100%
"Investing activities" related to fixed maturity investments in
AAG's Statement of Cash Flows consisted of the following (in
millions):
Held to Available
Maturity for Sale Total
1998
Purchases $ - ($598.8) ($598.8)
Maturities and paydowns 178.1 219.9 398.0
Sales 26.3* 151.6 177.9
1997
Purchases $ - ($780.9) ($780.9)
Maturities and paydowns 105.6 91.8 197.4
Sales - 393.9 393.9
* Sold (at a gain of $0.1 million) due to significant deterioration of
the issuers' creditworthiness.
E. Investment in Affiliate
Investment in affiliate reflects AAG's 4% ownership (2.7 million
shares; carrying value of $21.1 million at June 30, 1998) of the
common stock of Chiquita Brands International which is accounted
for under the equity method. AFG and its other subsidiaries own
an additional 33% interest in the common stock of Chiquita.
Chiquita is a leading international marketer, producer and
distributor of bananas and other quality fresh and processed food
products.
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The market value of AAG's investment in Chiquita was approximately
$38 million at June 30, 1998 and $44 million at December 31, 1997.
Included in equity in Chiquita's 1998 earnings is a $1.0 million
gain attributable to Chiquita's issuance of common stock.
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following
(in millions):
June 30, December 31,
1998 1997
Deferred policy acquisition costs $321.2 $300.6
Present value of future profits acquired 102.1 102.0
Unearned revenues (137.3) (141.0)
$286.0 $261.6
G. Notes Payable
Notes payable consisted of the following (in millions):
June 30, December 31,
1998 1997
Direct obligations of AAG $ 1.3 $ 1.3
Obligations of AAG Holding (guaranteed by AAG):
6-7/8% Senior Notes due 2008 100.0 -
Unsecured Bank Credit Line due 2003 57.0 -
Secured Bank Credit Line due 1999 - 75.0
Unsecured Bank Credit Line due 1998 - 32.0
11-1/8% Senior Subordinated Notes due 2003- 24.1
Other subsidiary debt 3.1 3.4
Total $161.4 $135.8
In January 1998, AAG Holding replaced its existing bank lines with
a new $200 million unsecured credit agreement. Loans under the
credit agreement mature from 2000 to 2003 and bear interest at
floating rates based on prime or Eurodollar rates. In February
1998, AAG Holding borrowed $50 million under the new credit line
and retired its 11-1/8% Notes realizing a pretax extraordinary
loss of $1.2 million; included in the Notes retired by AAG Holding
was approximately $24.3 million principal amount of 11-1/8% Notes
previously acquired by AAG and GALIC.
In June 1998, AAG Holding sold $100 million principal amount of
6-7/8% Senior Notes due 2008 and used the net proceeds to repay
outstanding indebtedness under the unsecured bank credit line.
At June 30, 1998, scheduled principal payments on debt for the
remainder of 1998 and the subsequent five years were as follows
(in millions):
1998 1999 2000 2001 2002 2003
$0.4 $0.8 $0.8 $0.6 $0.5 $57.5
At June 30, 1998 and December 31, 1997, the weighted average
interest rate on amounts borrowed under AAG Holding's bank credit
lines was 6.16% and 6.80%, respectively.
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
H. Mandatorily Redeemable Preferred Securities of Subsidiary Trusts
Wholly-owned subsidiary trusts of AAG Holding have issued $225
million of preferred securities and, in turn, purchased $225
million of newly-issued AAG Holding subordinated debt which
provide interest and principal payments to fund the Trusts'
obligations. The preferred securities are mandatorily
redeemable upon maturity or redemption of the subordinated
debt. The three preferred securities issues are summarized as
follows:
Date of Optional
Issuance Issue (Maturity Date) Amount Redemption
Dates
November 1996 9-1/4% TOPrS* (2026) 75,000,000 On or after
11/7/2001
March 1997 8-7/8% Preferred
Securities (2027) 75,000,000 On or after
3/1/2007
May 1997 7-1/4% ROPES** (2041) 75,000,000 Prior to
9/28/2000 and
after
9/28/2001
* Trust Originated Preferred Securities
** Remarketed Par Securities
AAG and AAG Holding effectively provide an unconditional guarantee of
the Trusts' obligations.
I. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred
Stock, par value $1.00 per share.
In March 1997, AAG retired all of its outstanding Series B
Preferred Stock for approximately $47 million.
At June 30, 1998, there were 3.0 million shares of AAG Common
Stock reserved for issuance under AAG's Employee Stock Option
Plan. Under the Stock Option Plan, the exercise price of each
option equals the market price of AAG Common Stock at the date of
grant. Options become exercisable at the rate of 20% per year
commencing one year after grant. All options expire ten years
after the date of grant.
"Retained earnings since January 1, 1993" reflects accumulated
changes in AAG's retained earnings since its acquisition of
GALIC.
The change in net unrealized gains on marketable securities for
the six months ended June 30 included the following (in millions):
1998 1997
Pretax Taxes Net Pretax Taxes Net
Unrealized holding
gains (losses) on
securities arising
during the period $12.4 ($4.3) $8.1 $17.4 ($6.1)$11.3
Less reclassification
adjustment for gains
realized in
net income (2.6) 0.9 (1.7) (0.2) 0.1 (0.1)
Change in net
unrealized gains on
marketable securities $9.8 ($3.4) $6.4 $17.2 ($6.0) $11.2
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. Contingencies
The Company is continuing its clean-up activities at certain of
its former manufacturing operations and third-party sites, in some
cases in accordance with consent agreements with federal and state
environmental agencies. Changes in regulatory standards and
further investigations could affect estimated costs in the future.
Management believes that reserves recorded are sufficient to
satisfy the known liabilities and that the ultimate cost will not,
individually, or in the aggregate, have a material adverse effect
on the financial condition or results of operations of AAG.
K. Additional Information
Statutory Information of Great American Life Insurance Company
Insurance companies are required to file financial statements
with state insurance regulatory authorities prepared on an
accounting basis prescribed or permitted by such authorities
(statutory basis). Certain statutory amounts for GALIC, AAG's
primary insurance subsidiary, were as follows (in millions):
June 30, December 31,
1998 1997
Capital and surplus $324.6 $317.0
Asset valuation reserve 61.7 64.7
Interest maintenance reserve 23.1 23.9
Six months ended June 30,
1998 1997
Pretax income from operations $38.7 $45.5
Net income from operations 30.8 34.4
Net income 29.1 35.5
The amount of dividends which can be paid by GALIC without prior
approval of regulatory authorities is subject to restrictions relating
to capital and surplus and statutory net income. Based on net income
for the year ended December 31, 1997, GALIC may pay $73.6 million in
dividends in 1998 without prior approval. In the first six months of
1998, AAG received $16.0 million in capital distributions from GALIC.
L. Subsequent Events
In July 1998, AAG reached a definitive agreement to sell its
funeral services division to Service Corporation International for
$164 million in cash. This division includes American Memorial
Life Insurance Company and Arkansas National. At June 30, 1998,
the carrying value of the funeral services division was
approximately $125 million. In August 1998, AAG executed an
agreement to acquire Old Republic Life Insurance Company of New
York for approximately $25 million. Completion of these
transactions which are expected to occur in the fourth quarter of
1998, are subject to certain conditions, including receipt of
regulatory approvals.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
American Annuity Group, Inc. ("AAG" or "the Company") and its
subsidiary, AAG Holding Company, Inc., are organized as holding
companies with nearly all of their operations being conducted by their
subsidiaries. These companies, however, have continuing expenditures
for administrative expenses, corporate services, satisfaction of
liabilities in connection with discontinued operations and for the
payment of interest and principal on borrowings and stockholder
dividends.
Forward-Looking Statements The Private Securities Litigation Reform
Act of 1995 encourages corporations to provide investors with
information about the Company's anticipated performance and provides
protection from liability if future results are not the same as
management's expectations. This document contains certain forward-
looking statements that are based on assumptions which management
believes are reasonable, but, by their nature, inherently uncertain.
Future results could differ materially from those projected. Factors
that could cause such differences include, but are not limited to:
changes in economic conditions, regulatory actions and competitive
pressures. AAG undertakes no obligation to update any forward-looking
statements.
LIQUIDITY AND CAPITAL RESOURCES
Ratios AAG's ratio of earnings to fixed charges exceeds 5 times. Its
proforma ratio of consolidated debt to capital at June 30, 1998 was
17%. Proforma consolidated debt includes the Company's notes payable
and its Remarketed Par Securities ("ROPES"), net of approximately $95
million of unrestricted cash and marketable investments on hand at AAG
(parent). Capital represents the sum of proforma consolidated debt,
redeemable preferred securities of subsidiary trusts and stockholders'
equity (excluding unrealized gains).
The National Association of Insurance Commissioners' ("NAIC") risk-
based capital ("RBC") formulas determine the amount of capital that an
insurance company needs to ensure that it has an acceptable
expectation of not becoming financially impaired. At June 30, 1998,
the capital ratios of each of AAG's principal insurance subsidiaries
was at least 4.3 times its authorized control level RBC.
Sources and Uses of Funds The ability of AAG and AAG Holding to pay
interest and principal on debt, dividends on preferred securities,
obligations related to discontinued manufacturing operations and other
holding company costs is largely dependent upon payments from its
principal subsidiary, Great American Life Insurance Company ("GALIC"),
in the form of capital distributions. The amount of capital
distributions which can be paid by GALIC is subject to restrictions
relating to statutory surplus and earnings. In the first six months
of 1998, GALIC made $16 million in such payments; the maximum amount
of dividends payable by GALIC during the remainder of 1998 without
prior regulatory approval is $58 million.
Since year end 1996 (through June 1998), AAG has retired $65 million
principal amount of its public debentures and $49 million of preferred
stock. In addition, AAG acquired Great American Life Assurance
Company of Puerto Rico, Inc. ("GA Life") for approximately $50 million
in December 1997. AAG funded these outlays with issuances of trust
preferred securities, bank borrowings, dividends from GALIC and cash
on hand. The March 1998 acquisition of Arkansas National Life
Insurance Company was completed using cash on hand at GALIC.
14
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
In June 1998, AAG Holding retired $100 million of its bank line using
proceeds from a public debt offering.
Including cash and investments on hand and the unused availability
under a bank line of credit, AAG and AAG Holding had more than $230
million of liquidity at August 1, 1998. In July 1998, AAG announced
an agreement to sell its funeral services division for $164 million in
cash. The majority of the proceeds will be received by AAG's
insurance subsidiaries. The ultimate use of these proceeds has not
been determined. Based upon the current level of operations and
anticipated growth, AAG believes that it will have sufficient
resources to meet its liquidity requirements.
Investments Insurance laws restrict the types and amounts of
investments which are permissible for life insurers. These
restrictions are designed to ensure the safety and liquidity of
insurers' investment portfolios. The NAIC has developed a model
investment law which management believes will not have a material
impact on AAG's operations.
The NAIC assigns quality ratings to publicly traded as well as
privately placed securities. These ratings range from Class 1
(highest quality) to Class 6 (lowest quality). The following table
shows the Company's fixed maturity portfolio by NAIC designation (and
comparable Standard & Poor's Corporation rating) as of June 30, 1998:
NAIC % of Total
Rating Comparable S&P Rating Market Value
1 AAA, AA, A 67%
2 BBB 25
Total investment grade 92
3 BB 4
4 B 3
5 CCC, CC, C 1
6 D -
Total non-investment grade 8
Total fixed maturities 100%
Management believes that the high credit quality of AAG's investment
portfolio should generate a stable and predictable investment return.
AAG invests primarily in fixed income investments which, including
loans and short-term investments, comprised 98% of its investment
portfolio at June 30, 1998. AAG generally invests in securities with
intermediate-term maturities with an objective of optimizing interest
yields while maintaining an appropriate relationship of maturities
between AAG's assets and expected liabilities.
At June 30, 1998, AAG had less than 2% of total assets invested in
mortgage loans and real estate, the majority of which had been
acquired within the last five years.
At June 30, 1998, AAG's mortgage-backed securities ("MBSs") portfolio
represented less than one-third of fixed maturity investments. AAG
invests primarily in MBSs which have a lower risk of prepayment. In
addition, the majority of MBSs held by AAG were purchased at a
discount. Management believes that the structure and discounted
nature of the MBSs will reduce the effect of prepayments on earnings
over the anticipated life of the MBS portfolio.
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Nearly 90% of AAG's MBSs are rated "AAA" with substantially all being
investment grade quality. The market in which these securities trade
is highly liquid. Aside from interest rate risk, AAG does not believe
a material risk (relative to earnings or liquidity) is inherent in
holding such investments.
Uncertainties
Contingencies A managing general agency which produced less than
10% of GALIC's premiums in the first six months of 1997 was named a
defendant in a lawsuit filed in July 1996 by two regulatory agencies
in California. The managing general agency has settled the
allegations brought against it by agreeing, among other things, to
modify certain sales practices. The regulatory agencies have taken a
position that GALIC may be responsible for certain acts of its
insurance agents in connection with the sale of GALIC's annuities.
GALIC is engaged in discussions with the regulatory agencies to
resolve this matter. This agent no longer markets products for GALIC.
The ultimate outcome is not expected to have a material adverse impact
on the financial condition of the Company.
RESULTS OF OPERATIONS
General The operations of GA Life and Arkansas National are
included in AAG's consolidated financial statements from their dates
of acquisition in December 1997 and March 1998, respectively.
The Company's principal products are its fixed annuities Single
Premium Deferred Annuities ("SPDAs") and Flexible Premium Deferred
Annuities ("FPDAs"). The following table summarizes AAG's premiums
for annuities and other forms of life and health insurance (in
millions):
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
Retirement Annuities:
SPDAs $ 69 $ 57 $121 $127
FPDAs - renewal 41 46 79 89
FPDAs - first year 10 10 17 18
Variable annuities
- flexible premium 4 - 8 1
Variable annuities
- single premium 16 9 29 15
Pre-need life insurance 26 16 49 29
Pre-need annuities 7 11 15 23
Other life insurance 17 5 35 11
Accident and health insurance 5 5 10 10
Total premiums $195 $159 $363 $323
AAG's growth in total premiums is attributable to acquisitions as well
as the introduction of new fixed and variable products.
Pretax Operating Earnings Pretax earnings from operations (before
realized gains (losses) and equity in net earnings of affiliate) for
the second quarter and first six months of 1998 were $28.6 million and
$54.1 million, respectively, compared to $24.5 million and $48.6
million for the same periods in 1997.
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Net Investment Income Net investment income increased 6% in both the
second quarter and first six months of 1998 compared to the same
periods in 1997 due primarily to an increase in the Company's average
fixed maturity investment base. This increase was partially offset by
decreasing market interest rates. Investment growth resulted from
acquisitions, internal cash flow generated by AAG's insurance
operations and the investment of a portion of the proceeds from the
issuance of trust preferred securities. Investment income is shown
net of investment expenses of $1.5 million in 1998 and $2.0 million in
1997. Lower investment expenses in 1998 reflect a decrease in fees
charged by an affiliate.
Life, Accident and Health Premiums and Benefits Increases in life,
accident and health premiums and benefits reflect primarily the
acquisition of GA Life and increased sales of pre-need life insurance.
Equity in Net Earnings of Affiliate Equity in net earnings of
affiliate represents AAG's proportionate share of the results of
Chiquita Brands International. Chiquita reported net income for the
second quarter and first six months of 1998 of $53 million and $94
million, respectively, compared to $41 million and $84 million for the
same periods in 1997. Included in equity in Chiquita's 1998 earnings
are gains attributable to Chiquita's issuance of common stock.
Annuity Benefits Annuity benefits reflect interest credited to
annuity policyholders' funds accumulated. The majority of GALIC's
fixed rate annuity products permit GALIC to change the crediting rate
at any time (subject to minimum interest rate guarantees of 3% or 4%
per annum). As a result, management has been able to react to changes
in market interest rates and maintain a desired interest rate spread
without a substantial effect on persistency.
Amortization of Insurance Acquisition Costs Amortization of
insurance acquisition costs includes certain commissions on sales of
life insurance products. The increase in 1998 reflects the
acquisition of GA Life as well as increased sales of pre-need life
insurance products. The costs in the second quarter and the first six
months of 1998 also include amortization of the present value of
future profits of businesses acquired amounting to $2.4 million and
$4.8 million, respectively, compared to $1.8 million and $3.7 million
for the same periods in 1997.
Trust Preferred Distribution Requirement Trust preferred distribution
requirement represents amounts accrued on preferred securities issued
by subsidiaries of AAG Holding in 1997 and 1996. A portion of the
proceeds from these issuances was used to retire debt.
Interest and Other Debt Expenses AAG's interest expense increased
slightly in 1998. During 1997 and 1998 the Company replaced higher
coupon public debt with significantly lower interest rate bank debt.
This decrease in average rates was offset by higher average debt,
which resulted primarily from funds borrowed to acquire GA Life.
Other Expenses Increases in other expenses reflect (i) the
acquisitions of GA Life and Arkansas National, (ii) higher
depreciation and amortization costs and (iii) increases in personnel
costs.
Extraordinary Item Extraordinary item reflects AAG's losses, net of
tax, on prepayment of its debt.
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
New Accounting Standards to be Implemented The Financial Accounting
Standards Board issued Statement of Financial Accounting Standard
("SFAS") No. 131, "Disclosures about Segments of an Enterprise and
Related Information," which is scheduled to become effective during
the fourth quarter of 1998. The implementation of SFAS No. 131 will
have no effect on AAG's financial position or net income.
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-
Up Activities," was issued during the second quarter of 1998. The SOP
is effective for fiscal years beginning after December 15, 1998, and
requires that costs of start-up activities be expensed as incurred.
The SOP requires that unamortized balances of previously deferred
costs be expensed no later than the first quarter of 1999 and reported
as the cumulative effect of a change in accounting principle. AAG had
$11 million in capitalized start-up costs at June 30, 1998.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 4
Submissions of Matters to a Vote of Security Holders
The Registrant's Annual Stockholders' Meeting was held May 19, 1998.
Proxies were solicited pursuant to Regulation 14A under the Securities
Exchange Act of 1934. All of the nominees for director proposed by
the Registrant were elected to the Board of Directors.
In addition to the election of directors, stockholders also voted to
approve an amendment to the AAG 1994 Stock Option Plan to increase the
maximum number of options to be granted from 2,000,000 to 3,000,000
[Proposal 2]. The votes cast for, against, and the number withheld or
abstentions as to each matter voted on at the 1998 Annual Meeting is
set forth below:
Withheld/
For Against Abstain
Election of Directors:
Carl H. Lindner 41,214,965 NA 13,786
S. Craig Lindner 41,215,003 NA 13,748
Robert A. Adams 41,217,839 NA 10,912
John T. Lawrence III41,219,705 NA 9,046
A. Leon Fergenson 41,217,522 NA 11,229
Ronald G. Joseph 41,219,965 NA 8,786
William R. Martin 41,218,887 NA 9,864
Proposal 2 39,818,864 1,384,263 25,624
NA - Not Applicable
ITEM 5
Other Information
Stockholder Proposals
The Proxy Form used by the Company for its Annual Meeting of
Stockholders typically grants authority to management's proxies to
vote in their discretion on any matters that come before the Meeting
as to which adequate notice has not been received. In order for a
notice to be deemed adequate for the 1999 Annual Meeting, it must be
received by February 15, 1999. In order for a proposal to be
considered for inclusion in the Company's proxy statement for that
Meeting, it must be received by December 1, 1998.
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of June 30, 1998. For
submission in electronic filing only.
(b) Report on Form 8-K - None.
19
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf
by the undersigned duly authorized.
American Annuity Group, Inc.
August 14, 1998 BY:/s/William J. Maney
William J. Maney
Senior Vice President, Treasurer
and Chief Financial Officer
20
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<DEBT-HELD-FOR-SALE> 4,414,200
<DEBT-CARRYING-VALUE> 2,073,000
<DEBT-MARKET-VALUE> 2,141,600
<EQUITIES> 85,700
<MORTGAGE> 47,900
<REAL-ESTATE> 45,900
<TOTAL-INVEST> 6,980,200
<CASH> 43,000
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 286,000
<TOTAL-ASSETS> 7,956,300
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 752,700
<POLICY-HOLDER-FUNDS> 5,589,100
<NOTES-PAYABLE> 161,400
225,000<F1>
0
<COMMON> 43,100
<OTHER-SE> 592,200
<TOTAL-LIABILITY-AND-EQUITY> 7,956,300
95,300
<INVESTMENT-INCOME> 257,900
<INVESTMENT-GAINS> 11,700
<OTHER-INCOME> 7,000
<BENEFITS> 214,900
<UNDERWRITING-AMORTIZATION> 29,900
<UNDERWRITING-OTHER> 46,600
<INCOME-PRETAX> 70,400
<INCOME-TAX> 23,000
<INCOME-CONTINUING> 47,400
<DISCONTINUED> 0
<EXTRAORDINARY> (800)
<CHANGES> 0
<NET-INCOME> 46,600
<EPS-PRIMARY> 1.08
<EPS-DILUTED> 1.06
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>(A) Mandatorily Redeemable Preferred Securities of subsidiary trusts
</FN>
</TABLE>
