SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended Commission File
December 31, 1997 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
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
American Annuity Group, Inc.:
Common Stock, Par Value $1.00 Per Share New York
American Annuity Group Capital Trust I (Guaranteed by Registrant):
9-1/4% Trust Originated Preferred Securities New York
Other Securities for which reports are submitted pursuant to Section 15(d)
of the Act:
American Annuity Group Capital Trust II (Guaranteed by Registrant):
8-7/8% Trust Preferred Securities
Securities Registered Pursuant to Section 12(g) of the Act: None
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
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and need not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this
Form 10-K. [X]
As of March 1, 1998, there were 43,092,957 shares of the Registrant's
Common Stock outstanding. The aggregate market value of Common Stock held
by non-affiliates at that date was approximately $178.7 million based upon
non-affiliate holdings of 8,032,962 shares and a market price of $22.25 per
share.
Documents Incorporated by Reference:
Proxy Statement for the 1998 Annual Meeting of Shareholders (portions of
which are incorporated by reference into Part III hereof).
AMERICAN ANNUITY GROUP, INC.
INDEX TO ANNUAL REPORT
ON FORM 10-K
Part I
Page
Item 1. Business
Introduction 1
Retirement Products 2
Pre-need Funding Products 6
Life, Accident and Health Products 7
Investments 9
Independent Ratings 10
Competition 11
Regulation 11
Discontinued Manufacturing Operations 12
Employees 13
New Tax Legislation 13
Item 2. Properties 13
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders (a)
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 15
Item 6. Selected Financial Data 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk(b)
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure (a)
Part III
Item 10. Directors and Executive Officers of the Registrant 23
Item 11. Executive Compensation 23
Item 12. Security Ownership of Certain Beneficial Owners and 23
Management
Item 13. Certain Relationships and Related Transactions 23
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K S-1
(a) The response to this item is "none".
(b) Not required - market capitalization on January 28, 1997 was less than
$2.5 billion.
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.
PART I
ITEM 1
Business
Introduction
American Annuity Group, Inc. ("AAG" or "the Company") was incorporated as a
Delaware corporation in 1987. AAG is a holding company which operates
through wholly-owned subsidiaries. AAG's primary subsidiary, Great American
Life Insurance Company, was acquired in 1992 and sells (i) flexible premium
and single premium annuities in the qualified (not-for-profit) market and
(ii) single premium annuities in the non-qualified market. AAG is an 81%-
owned subsidiary of American Financial Group, Inc. ("AFG").
In November 1995, AAG acquired Laurentian Capital Corporation ("LCC") and
its subsidiaries including (i) American Memorial Life Insurance Company,
which markets individual life insurance and annuity policies for the pre-
need funeral industry and (ii) Loyal American Life Insurance Company, which
specializes in supplemental life and health insurance sold through payroll
deduction plans and credit unions.
In December 1997, AAG acquired General Accident Life Assurance Company of
Puerto Rico, Inc. General Accident sells in-home service life and
supplemental health products through a network of agents employed by the
company. It also provides ordinary life and cancer products through
independent agents.
In March 1998, AAG acquired Arkansas National Life Insurance Company, which
specializes in pre-need funeral insurance. Its operations will become part
of the American Memorial group of companies.
The acquisitions in recent years have supplemented AAG's internal growth as
the Company's assets increased from $4.5 billion at year end 1992 to over
$7.7 billion at year end 1997. In addition, these acquisitions have
expanded AAG's focus from primarily traditional fixed annuity products to
three areas: (i) retirement products (fixed and variable annuities); (ii)
pre-need funding products (life insurance and fixed annuities) and (iii)
other life, accident and health insurance. Premiums over the last five
years were as follows (in millions):
Premiums*
Insurance Product 1997 1996 1995 1994 1993
Retirement $489 $540 $457 $443 $400
Pre-need funding 111 97 - - -
Other life, accident and health 42 43 2 2 3
$642 $680 $459 $445 $403
* The table does not include premiums of subsidiaries until their first
full year following acquisition.
1
Retirement Products
AAG's retirement products consist primarily of annuities which are long-term
retirement saving instruments that benefit from income accruing on a tax-
deferred basis. The issuer of the annuity collects premiums, credits
interest on the policy and pays out a benefit upon death, surrender or
annuitization.
Annuity contracts are generally classified as either fixed rate or variable.
With a fixed rate annuity, the interest crediting rate is initially set by
the issuer and thereafter may be changed from time to time by the issuer
subject to any guaranteed minimum interest crediting rates in the policy.
With a variable annuity, the value of the policy is tied to an underlying
securities portfolio or underlying mutual funds.
Employees of qualified not-for-profit organizations are eligible to save for
retirement through contributions made on a before-tax basis. Contributions
are made at the discretion of the participants through payroll deductions or
through tax-free "rollovers" of funds. Federal income taxes are not payable
on contributions or earnings until amounts are withdrawn.
Great American Life Insurance Company
Great American Life Insurance Company ("GALIC") entered the tax-deferred
annuity business in 1976 and currently sells fixed rate annuities - both
traditional and equity-indexed. GALIC is rated "A" (Excellent) by A.M. Best
and "AA-" (Very high claims paying ability) by Duff & Phelps.
The following table (in millions) presents financial information concerning
GALIC.
Statutory Accounting Principles Basis
1997 1996 1995 1994 1993
Total assets $5,917 $5,752 $5,414 $5,057 $4,758
Annuity reserves 5,446 5,298 4,974 4,655 4,299
Capital and surplus 317 285 273 256 251
Asset valuation reserve(a) 65 91 90 80 70
Interest maintenance reserve(a) 24 25 32 28 36
Annuity receipts:
Flexible premium:
First year $ 32 $ 35 $ 42 $ 39 $ 47
Renewal 160 182 196 208 223
192 217 238 247 270
Single premium 241 319 219 196 130
Total annuity receipts $ 433 $ 536 $ 457 $ 443 $ 400
(a) Allocation of surplus.
Generally Accepted Accounting Principles ("GAAP") Basis
1997 1996 1995 1994 1993
Total assets $6,223 $5,934 $5,608 $5,044 $4,883
Annuity benefits accumulated 5,330 5,205 4,917 4,596 4,257
Stockholder's equity 770 658 623 449 520
2
GALIC's single premium annuity receipts increased each year from 1993
through 1996 due primarily to sales of newly introduced products and, in
1995, the development of new distribution channels. This increase more than
offset the decline in flexible premium receipts during that period. Single
premium annuity receipts in 1997 reflect the decrease of business written by
a single agency from $99 million in 1996 to $23 million in 1997. GALIC is
no longer writing business through this agency (see "Management's Discussion
and Analysis - Contingencies"). Management also believes that the decrease
in GALIC's fixed annuity premiums is partially attributable to the growth in
alternative product offerings at Annuity Investors Life Insurance Company
(see below).
GALIC's Annuity Products GALIC's principal products are Flexible Premium
Deferred Annuities ("FPDAs") and Single Premium Deferred Annuities
("SPDAs"). FPDAs are characterized by premium payments that are flexible in
both amount and timing as determined by the policyholder. SPDAs are issued
in exchange for a one-time lump-sum premium payment.
GALIC's FPDAs are sold primarily to employees of qualified not-for-profit
organizations under Section 403(b) of the Internal Revenue Code. However,
over the last several years, sales of non-qualified annuities have
represented an increasing percentage of premiums as GALIC has developed
products and distribution channels targeted to the non-qualified markets.
The following table summarizes GALIC's written premiums and insurance
reserves on a statutory basis by product line (dollars in millions).
1997 Annuity Premiums Annuity Reserves
First % of December 31, 1997
Year Renewal Total Amount %
Flexible premium:
Qualified $ 28 $159 43.2% $3,281 60.2%
Non-qualified 4 1 1.1 14 0.3
Total 32 160 44.3 3,295 60.5
Single premium:
Qualified 109 - 25.2 1,004 18.4
Non-qualified 132 - 30.5 662 12.2
Total 241 - 55.7 1,666 30.6
Annuities in payout - - - 485 8.9
Total $273 $160 100.0% $5,446 100.0%
At December 31, 1997, all of GALIC's annuity reserves consisted of fixed
rate annuities which offered a minimum interest rate guarantee of 3% or 4%.
The majority of GALIC's annuity policies are traditional fixed rate
annuities which permit GALIC to change the crediting rate at any time
(subject to the minimum guaranteed interest rate). In determining the
frequency and extent of changes in the crediting rate, GALIC takes into
account the economic environment and the relative competitive position of
its products.
Over the last few years, traditional fixed rate annuities have met
substantial competition from mutual funds and other equity-based
investments. In response, GALIC developed an equity-indexed annuity which
provides policyholders with a crediting rate tied, in part, to the
performance of an existing stock market index while protecting them against
the related downside risk through a guarantee of principal. AAG hedges the
equity-based risk component of this product through the purchase of call
options on the appropriate index. These options are designed to offset
substantially all of the increases in the fair values of the equity-indexed
annuities. Sales of equity-indexed annuities accounted for 9% of GALIC's
premiums in 1997.
3
GALIC seeks to maintain a desired spread between the yield on its investment
portfolio and the rate it credits to its policies. GALIC accomplishes this
by: (i) offering crediting rates which it has the option to change; (ii)
designing annuity products that encourage persistency and (iii) maintaining
an appropriate matching of assets and liabilities. Qualified annuity
policyholders maintain access to their funds without incurring policy or IRS
penalties through provisions in the contracts which allow policy loans.
GALIC designs its products with certain surrender penalties to discourage
policyholders from surrendering or withdrawing funds during the first five
to ten years after issuance of a policy. Partly due to these features,
GALIC's annuity surrenders have averaged approximately 7% of statutory
reserves over the past five years.
Persistency rates reflect the proportion of reserves maintained by the
Company and not paid out in the form of surrenders, annuitizations or death
benefits. The following table illustrates GALIC's annual persistency rates
for its major product groups over the past five years.
Persistency Rates
Product Group 1997 1996 1995 1994 1993
Flexible premium 89% 90% 91% 93% 92%
Single premium 90 92 94 94 93
Persistency rates are affected by many of the same factors that affect
annuity sales (see "Marketing and Distribution"). Although the recent stock
market and interest rate environment have resulted in decreased persistency,
management believes that its persistency rate has benefited from the high
level of service offered to agents and policyholders and GALIC's interest
crediting policy. GALIC's persistency has also been affected by higher
accumulation values and benefit levels of the two-tier design of certain of
its products. Two account values are maintained for two-tier annuities --
the annuitization (or upper-tier) value and the surrender (or lower-tier)
value. The annuitization value is paid upon a policyholder's death or
election to annuitize (withdraw funds in a series of periodic payments for
at least the minimum number of years specified in the policy). If a lump
sum payment is chosen by the policyholder, the surrender benefit is paid.
GALIC's two-tier annuities are particularly attractive to policyholders who
intend to accumulate funds to provide retirement income since the
annuitization value is accumulated at a competitive long-term interest rate.
GALIC also offers single-tier products. After the initial surrender charges
have been reduced to zero, single-tier annuities carry one value whether the
policy is surrendered or annuitized. In 1997, approximately three-fourths
of first year FPDA premiums and SPDA premiums received were on single-tier
policies compared to approximately one-sixth in 1993.
GALIC's Marketing and Distribution Sales of fixed rate annuities are
affected by many factors, including: (i) competitive annuity products and
rates; (ii) the general level of interest rates; (iii) the favorable tax
treatment of annuities; (iv) commissions paid to agents; (v) services
offered; (vi) ratings from independent insurance rating agencies; (vii)
other alternative investments and (viii) general economic conditions.
GALIC markets its FPDAs principally to employees of educational institutions
in the kindergarten through high school ("K-12") segment. Written premiums
from the K-12 segment represented the majority of GALIC's total tax-
qualified premiums in 1997.
4
GALIC distributes its annuity products through approximately 80 managing
general agents ("MGAs") who, in turn, direct over 1,000 actively producing
independent agents. GALIC has developed its business on the basis of its
relationships with MGAs and independent agents primarily through a
consistent marketing approach and responsive service. No single MGA wrote
over six percent of GALIC's premiums in 1997.
GALIC seeks to attract and retain agents who are experienced, highly
motivated and who consistently sell a high volume of the types of annuities
offered by GALIC. Toward this end, GALIC maintains a "President's Advisory
Council" consisting of leading producers who market primarily GALIC
products. The President's Advisory Council serves as a major influence on
new product design and marketing strategy.
To extend the distribution of GALIC annuities to a broader customer base,
GALIC developed a personal producing general agent ("PPGA") distribution
system. Approximately 100 PPGAs are contracted to sell GALIC annuities
in those territories not served by an MGA.
GALIC is licensed to sell its products in all states (except New York) and
in the District of Columbia. The following table reflects the geographical
distribution of GALIC's annuity premiums in 1997 compared to 1993.
1997 1993 1997 1993
California 21.9% 21.8% New Jersey 3.8% 5.5%
Texas 8.0 3.3 Michigan 3.4 8.5
Washington 7.6 2.4 Indiana 2.9 *
Ohio 6.4 5.5 Connecticut 2.8 5.2
Florida 5.4 9.8 Iowa 2.5 *
Massachusetts 5.0 8.0 Illinois 2.2 3.3
North Carolina 4.4 3.3 Rhode Island * 2.2
Minnesota 3.9 * All others, each
less than 2% 19.8 21.2
100.0%100.0%
* less than 2%
At December 31, 1997, GALIC had more than 265,000 annuity policies in force.
Annuity Investors Life Insurance Company
Annuity Investors Life Insurance Company ("AILIC") was acquired by the
Company in 1994 to facilitate its entrance into the variable annuity market
in addition to selling fixed annuities. Industry sales of variable
annuities have increased substantially over the last ten years as investors
have sought to obtain the returns available in the equity markets while
enjoying the tax-deferred status of annuities. With a variable annuity, the
earnings credited to the policy vary based on the investment results of the
underlying investment options chosen by the policyholder. Policyholders may
also choose to direct all or a portion of their premiums to various fixed
rate options. Premiums directed to the variable options in policies issued
by AILIC are invested in funds managed by various independent investment
managers. Variable annuities can be either tax-qualified or non-qualified
and may be funded with either a single premium payment or flexible premiums.
Under federal law and the laws of many states, variable annuities are
considered securities. As a result, variable annuities can be sold only by
agents who possess the requisite securities licenses and are affiliated with
a broker-dealer. Accordingly, not all agents who market fixed annuities
also market variable annuities. AILIC markets its products through those
members of the GALIC agency force who possess the requisite licenses as well
as through additional agents not
5
currently licensed with GALIC, broker-dealers, financial institutions and
subsidiaries of AAG.
AILIC had variable annuity sales of $43 million in 1997 of which $14 million
was directed to the fixed rate option. It also sold $13 million of fixed
annuity products, primarily in California.
Other Retirement Product Operations
In the last several years, AAG has developed several organizations to
distribute its financial services and products to markets not previously
serviced by GALIC's distribution system. AAG Securities, Inc. is a
broker/dealer licensed to sell stocks, bonds, mutual funds and variable
insurance contracts through independent representatives and financial
institutions. AAG Securities also acts as the principal underwriter and
distributor for AILIC's variable annuity products. Retirement Resource
Group, Inc. was formed in 1995 to market annuities and investment products
to employees of hospitals and not-for-profit organizations.
Pre-need Funding Products
Through American Memorial Life Insurance Company, AAG offers a variety of
life insurance and annuity products to finance pre-arranged funerals. In a
typical arrangement, a consumer pays in advance for certain goods and
services to be provided by a funeral director. These payments may be used
by the funeral director to purchase a life insurance or annuity contract or
to invest in a trust fund. Approximately one-half of the premiums received
by American Memorial are from single payment funding and one-half are from
payment plans of three to ten years. The policy values increase at a rate
geared to offset effects of inflation and thus provide for funeral costs at
time of death.
American Memorial Life Insurance Company
American Memorial is located in Rapid City, South Dakota. The following
table (in millions) presents financial information concerning American
Memorial.
Statutory GAAP
1997 1996 1997 1996
Total assets $468 $412 $841 $738
Life insurance reserves 311 276 325 290
Annuity reserves 113 95 117 96
Separate accounts n/a n/a 263 244
Capital and surplus 26 26 107 89
Asset valuation reserve 4 4 n/a n/a
Interest maintenance reserve 2 2 n/a n/a
Premiums written:
Life $ 73 $ 57 $ 74 $ 59
Annuities 38 40 n/a n/a
Total $111 $ 97 $ 74 $ 59
6
American Memorial's Marketing and Distribution In 1997, American Memorial
sold its products through over 1,200 funeral homes nationwide. In addition
to a general agency force of approximately 200 agents, American Memorial has
approximately 800 actively-producing corporate and individual funeral home
operators who sell its products. Rapid consolidation is making large chains
an important segment of the funeral home industry. American Memorial is a
leader in this segment, working with several of the major corporations. In
1997, about one-half of American Memorial's premiums were generated by the
largest owner of funeral homes in the world. The remaining one-half was
split between other funeral homes and the general agency force. As the
funeral home industry continues to consolidate, increased reliance on large
funeral home operators may be required.
The following table reflects the geographical distribution of American
Memorial's premiums.
1997 1996 1997 1996
California 19.0% 11.2% Florida * 11.3%
Washington 9.4 10.5 Tennessee * 6.7
Alabama 6.3 * Missouri * 5.2
Minnesota 6.1 9.5 Louisiana * 4.4
North Carolina 4.7 10.4 All others, each
Texas 4.3 * less than 4% 50.2% 30.8
100.0% 100.0%
* less than 4%
At December 31, 1997, American Memorial had $815 million of life insurance
in force and over 280,000 life and annuity policies in force.
Other Pre-need Operations
Several non-insurance subsidiaries market additional funeral products and
services. One of these subsidiaries, International Funeral Associates
("IFA"), is a co-operative buying service organization with approximately
3,900 independent and corporate members at year-end 1997. IFA negotiates
discounts with organizations that service the funeral industry; members of
IFA are able to take advantage of these discounts, thereby enhancing their
profitability through lower cost of goods and services.
In addition to annuity and life insurance contracts, funeral contract funds
may also be held in trust. American DataSource, Inc. ("ADS") provides
administrative and financial services to funeral directors in managing funds
held in trust. ADS also provides other administrative services to funeral
homes, cemeteries, financial institutions and funeral home consolidators.
At March 1, 1998, ADS had more than $160 million under administration.
In March 1998, AAG acquired Arkansas National Life Insurance Company, which
also specializes in pre-arranged funeral insurance products. Arkansas
National had statutory assets of approximately $74 million at December 31,
1997 and 1997 premiums of $5 million.
Life, Accident and Health Products
AAG offers a variety of life, accident and health products through Loyal
American Life Insurance Company, General Accident Life Assurance Company of
Puerto Rico, Inc. and GALIC's life division, which began offering certain
term, universal and whole life insurance products in December 1997. Also in
1997, Loyal relocated its home office from Mobile, Alabama to Cincinnati,
Ohio to more closely coordinate its efforts with those of other AAG
operations.
7
Loyal American Life Insurance Company
Loyal offers a variety of supplemental life and health insurance products
that are normally sold on a fixed dollar amount per pay period program.
For products sold through payroll deduction plans, the premiums are
deducted from the individual's paycheck and remitted to Loyal on a periodic
basis. For products sold through credit unions, the premiums are paid on
a periodic basis through deductions from the member's credit union
account. The products currently being offered include traditional whole
life, universal life, term life, hospital indemnity, cancer and short-term
disability.
The following table (in millions) presents financial information concerning
Loyal.
Statutory GAAP
1997 1996 1997 1996
Total assets $258 $255 $330 $312
Life insurance reserves 167 167 178 184
Accident and health reserves 30 29 32 26
Capital and surplus 39 37 95 81
Asset valuation reserve 3 3 n/a n/a
Interest maintenance reserve 1 1 n/a n/a
Premiums written:
Life $ 19 $ 20 $ 16 $ 17
Accident and health 21 21 20 21
Total $ 40 $ 41 $ 36 $ 38
At December 31, 1997, Loyal had $1.9 billion of life insurance in force and
approximately 267,000 life, accident and health policies in force.
Loyal's Marketing and Distribution Loyal's marketing strategy emphasizes
third party sponsorship to assist in its selling process. In the payroll
deduction market, with the approval of the employer, Loyal's products are
presented by marketing companies who provide job-site presentation to the
employees; premium billings are sent directly to the employer for processing
and remittance. With credit unions, the products are offered with the
endorsement of the credit union management. The products are presented to
the membership by independent agents and marketing companies through in-home
sales, job-site or lobby enrollments and direct mail solicitation.
General Accident Life Assurance Company of Puerto Rico, Inc.
In December 1997, AAG acquired General Accident, which specializes in home
service life and supplemental health products as well as credit and ordinary
life products, including those utilized in the funeral industry. General
Accident had statutory assets of $110 million at December 31, 1997 and 1997
premiums of $46 million (excluding premiums of certain operations sold prior
to its acquisition by AAG). General Accident sells its in-home service life
and supplemental health products through a network of company agents. Its
ordinary life and cancer products are sold through independent agents.
8
Investments
Investments comprise nearly 90% of the Company's assets and are the
principal source of income. Fixed income investments (consisting of fixed
maturity investments, policy loans, mortgage loans and short-term
investments) comprise 98% of its investment portfolio. Risks inherent in
connection with fixed income securities include market price volatility and
loss upon default. Factors which can affect the market price of these
securities include: (i) changes in market interest rates;
(ii) creditworthiness of issuers; (iii) the number of market makers and
investors and (iv) defaults by major issuers of securities.
The Company's investment strategy emphasizes high quality fixed income
securities which management believes should produce a relatively consistent
and predictable level of investment income.
The insurance laws of each of AAG's life insurance subsidiaries' domiciliary
jurisdictions govern the types and amounts of investments which are
permissible. These rules are designed to ensure the safety and liquidity of
the insurers' investment portfolios by placing restrictions on the quality,
quantity and diversification of permitted investments.
The National Association of Insurance Commissioners ("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 at market
value by NAIC designation (and comparable Standard & Poor's Corporation
rating) at December 31.
NAIC
Rating Comparable S&P Rating 1997 1996
1 AAA, AA, A 66% 67%
2 BBB 27 27
Total investment grade 93 94
3 BB 4 3
4 B 3 3
5 CCC, CC, C * *
6 D - -
Total non-investment grade 7 6
Total fixed maturities 100% 100%
* less than 1%
AAG's primary investment objective in selecting securities for its fixed
maturity portfolio is to optimize interest yields while maintaining an
appropriate relationship of maturities between assets and expected
liabilities. The Company invests in bonds that have primarily intermediate-
term maturities. This practice provides flexibility to respond to
fluctuations in the marketplace.
9
At December 31, 1997, the average maturity of AAG's fixed maturity
investments was approximately six and one-half years (including mortgage-
backed securities, which also had an estimated average life of approximately
six and one-half years). The table below sets forth the maturities of the
Company's fixed maturity investments based on their carrying value.
Maturity 1997 1996
One year or less 3% 3%
After one year through five years 21 18
After five years through ten years 31 36
After ten years 14 10
69 67
Mortgage-backed securities 31 33
100% 100%
The following table shows the performance of AAG's investment portfolio,
excluding equity investments in an affiliate (dollars in millions).
1997 1996 1995
Average cash and investments
at cost $6,417 $6,014 $5,220
Gross investment income 499 474 411
Realized gains 5 1 16
Percentage earned:
Excluding realized gains 7.8% 7.9% 7.9%
Including realized gains 7.9% 7.9% 8.2%
Independent Ratings
The Company's principal insurance subsidiaries ("Insurance Companies") are
rated by A.M. Best and Duff & Phelps. Such ratings are generally based on
items of concern to policyholders and agents and are not directed toward the
protection of investors.
A.M. Best Duff & Phelps
GALIC A (Excellent) AA- (Very high claims paying
ability)
American Memorial A- (Excellent)AA- (Very high
claims paying ability)
Loyal A (Excellent) AA- (Very high claims paying
ability)
AILIC A (Excellent) Not currently rated
General Accident A (Excellent) Not currently rated
In 1997, A.M. Best increased its ratings of American Memorial (up two
levels) and Loyal (up one level); none of the Insurance Companies received a
downgrade from either agency.
In evaluating a company, independent rating agencies review such factors as
the company's: (i) profitability; (ii) leverage and liquidity; (iii) book of
business; (iv) quality and estimated market value of assets; (v) adequacy of
policy reserves; (vi) experience and competency of management and (vii)
operating profile. The increased ratings of American Memorial and Loyal
reflect their improved financial operating position as well as the
continuing improved financial strength and capital structure of AAG and its
affiliates.
Management believes that the ratings assigned by independent insurance
rating agencies are important because potential policyholders often use a
company's rating as an initial screening device in considering annuity
products. Management believes that a rating in the "A" category by at least
one rating agency is necessary for GALIC to successfully market tax-deferred
annuities to public education employees and other not-for-profit groups.
10
American Memorial, Loyal and General Accident compete in markets other than
the sale of tax-deferred annuities. While ratings are an important
competitive factor in their markets, management believes that these
companies can successfully compete in these markets with their respective
ratings.
Ratings are less of a competitive factor in the variable annuity market in
which AILIC competes, in part because a substantial portion of the insurers'
assets are invested in the mutual funds which underlie the variable
annuities rather than in the insurers' general accounts.
Although management of AAG believes that its Insurance Companies' ratings
are very stable, those companies' operations could be materially adversely
affected by a downgrade in ratings.
Competition
The Insurance Companies operate in highly competitive markets. They compete
with other insurers and financial institutions based on many factors,
including:
(i) ratings; (ii) financial strength; (iii) reputation; (iv) service to
policyholders; (v) product design (including interest rates credited and
premium rates charged); (vi) commissions and (vii) service to agents. Since
policies are marketed and distributed primarily through independent agents
(except at General Accident), the Insurance Companies must also compete for
agents. Management believes that consistently targeting the same market and
emphasizing service to agents and policyholders provides a competitive
advantage.
No single insurer dominates the annuity marketplace. Competitors include:
(i) individual insurers and insurance groups; (ii) mutual funds and (iii)
other financial institutions of varying sizes. In a broader sense, AAG's
Insurance Companies compete for retirement savings with a variety of
financial institutions offering a full range of financial services.
Financial institutions have demonstrated a growing interest in marketing
investment and savings products other than traditional deposit accounts. In
addition, recent judicial and regulatory decisions have expanded powers of
financial institutions in this regard. It is too early to predict what
impact, if any, these developments will have on the Insurance Companies.
Regulation
The Insurance Companies are subject to comprehensive regulation under the
insurance laws of their states of domicile and the other states in which
they operate. These laws, in general, require approval of the particular
insurance regulators prior to certain actions such as the payment of
dividends in excess of statutory limitations, continuing service
arrangements with affiliates and certain other transactions. Regulation and
supervision are administered by a state insurance commissioner who has broad
statutory powers with respect to granting and revoking licenses, approving
forms of insurance contracts and determining types and amounts of business
which may be conducted in light of the financial strength and size of the
particular company.
State insurance departments periodically examine the business and accounts
of the Insurance Companies and require such companies to submit detailed
annual financial statements prepared in accordance with statutory
requirements. State insurance laws also regulate the character of each
insurance company's investments, reinsurance and security deposits.
Proposed federal legislation is being discussed which would revise, and in
some cases eliminate, existing restrictions on affiliations among banks,
insurance companies and securities firms. The legislation would also impact
the way these entities are regulated. It is too early to predict whether
this legislation will be adopted and if so, its impact on the Company and
its operations.
11
The Insurance Companies may be required, under the solvency or guaranty laws
of most states in which they do business, to pay assessments (up to certain
prescribed limits) to fund policyholder losses or liabilities of insurance
companies that become insolvent. These assessments may be deferred or
forgiven under most guaranty laws if they would threaten an insurer's
financial strength and, in certain instances, may be offset against future
premium taxes. The Insurance Companies paid $2.5 million and $2.7 million
in assessments in 1997 and 1996, respectively.
The NAIC is an organization comprised of the chief insurance regulators for
each of the 50 states, the District of Columbia and the four U.S.
territories. One of its major roles is to develop model laws and
regulations affecting insurance company operations and encourage uniform
regulation through the adoption of such model laws in all states. As part
of the overall insurance regulatory process, the NAIC forms numerous task
forces to review, analyze and recommend changes to a variety of areas
affecting both the operating and financial aspects of insurance companies.
Recently, increased scrutiny has been placed upon the insurance regulatory
framework, and a number of state legislatures have considered or
enacted legislative proposals that alter, and in many cases increase, state
authority to regulate insurance companies and their holding company systems.
In light of recent legislative developments, the NAIC and state insurance
regulators have also become involved in a process of re-examining existing
laws and regulations and their application to insurance companies.
Legislation has also been introduced in Congress which could result in the
federal government's assuming some role in the insurance industry, although
none has been enacted to date.
The maximum amount of dividends which can be paid in any 12 month period to
stockholders by life insurance companies domiciled in the State of Ohio
without prior approval of the Ohio Insurance Commissioner is the greater of
10% of policyholder surplus or prior year's "net income," but only to the
extent of earned surplus as of the preceding December 31.
The NAIC has under consideration numerous proposals related to the marketing
and sale of annuity products. In September 1996, the NAIC adopted a model
investment law. The law will not be a requirement of the NAIC accreditation
standards. However, each state may adopt all, any part, or none of the
model investment law to regulate the investment policies of their insurance
companies. At this time it is not possible to determine the impact, if any,
this will have on AAG's insurance subsidiaries.
Many of the Company's other subsidiaries are subject to regulation by
various state, federal and other regulatory authorities. Several
subsidiaries are insurance agencies and as such are regulated by state
insurance departments. AAG Securities is subject to the rules of the
National Association of Security Dealers, Inc. and the securities laws of
the states in which it transacts business. AILIC's variable insurance
products are subject to the rules and regulations of the Securities and
Exchange Commission and "Blue Sky" laws of the states in which their
products are sold.
Discontinued Manufacturing Operations
AAG is the successor to STI Group, Inc., formerly known as Sprague
Technologies, Inc. ("STI"). STI was formed in May 1987 by an affiliate,
American Premier Underwriters, Inc., formerly known as The Penn Central
Corporation, for the purpose of divesting its electronics components
businesses. STI subsequently sold substantially all of its operating assets
and retired its debt, netting approximately $100 million in cash and cash
equivalents.
12
Employees
As of December 31, 1997, AAG and its subsidiaries employed approximately
1,700 persons. None of the employees is represented by a labor union. AAG
believes that its employee relations are satisfactory.
New Tax Legislation
New federal tax legislation was signed into law in August 1997. Management
believes that such tax legislation, as it relates to AAG, primarily impacts
variable annuity products which the Company did not offer until 1996, and
the sales of which do not comprise a material portion (less than 10%) of
AAG's premiums. As a result, AAG does not believe that such legislation
will have a material effect on the Company's business.
The federal administration's 1999 budget proposal contains provisions to
change the taxation of annuities in that certain exchanges of annuity
contracts would be taxable. Enactment of these provisions is not assured;
it is too early to predict the effect on the Company's business if this
proposal is adopted.
ITEM 2
Properties
Location
AAG, GALIC and Loyal rent office space in Cincinnati, Ohio totaling nearly
200,000 square feet under leases expiring primarily in 2006 through 2008.
Several of the Company's non-insurance subsidiaries lease marketing and
administrative offices in locations throughout the United States.
Loyal's former home office building in Mobile, Alabama, contains
approximately 82,000 square feet, of which approximately one-third is leased
to unaffiliated tenants and approximately one-fifth is utilized by Loyal for
certain administrative functions which remain in Mobile. The remainder of
the space is vacant and the building is being marketed for lease or sale.
American Memorial's home office buildings in Rapid City, South Dakota,
contain approximately 52,000 square feet, of which approximately three-
fourths is utilized for American Memorial's purposes. The remainder of the
buildings are leased to unaffiliated tenants. American Memorial also leases
marketing and administrative space in several locations throughout the
United States.
General Accident rents office space in Puerto Rico totaling approximately
70,000 square feet under leases expiring primarily in 2000 through 2002.
Management believes that its corporate offices are generally well maintained
and adequate for the Company's present needs.
AAG owns facilities related to its former manufacturing operations totaling
approximately 200,000 square feet in North Adams, Massachusetts and 60,000
square feet in Longwood, Florida. These facilities are currently being
leased to companies using them for manufacturing and other operations.
13
Environmental Matters
See "Item 3: Legal Proceedings" for a discussion concerning certain
environmental claims and litigation against the Company.
ITEM 3
Legal Proceedings
Federal and state laws and regulations, including the Federal Comprehensive
Environmental Response, Compensation, and Liability Act and similar state
laws, impose liability on the Company (as the successor to STI) for the
investigation and clean-up of hazardous substances disposed of or spilled by
its former manufacturing operations at facilities still owned by the Company
and facilities transferred in connection with the sales of certain
operations, as well as at disposal sites operated by third parties. In
addition, the Company has indemnified the purchasers of its former
operations for the cost of such activities. At several sites, the Company
is conducting clean-up activities of soil and ground water contamination in
accordance with consent agreements between the Company and state
environmental agencies. The Company has also conducted or is aware of
investigations at a number of other locations of its former operations that
have disclosed environmental contamination that could cause the Company to
incur additional investigative, remedial and legal costs. The Company has
also been identified by state and federal regulators as a potentially
responsible party at a number of other disposal sites.
Based on the costs incurred by the Company over the past several years and
discussions with its independent environmental consultants, management
believes that reserves recorded are sufficient in all material respects to
satisfy the estimated liabilities. However, the regulatory standards for
clean-up are continually evolving and may impose more stringent
requirements. In addition, many of the environmental investigations at the
Company's former operating locations and third-party sites are still
preliminary, and where clean-up plans have been proposed, they have not yet
received full approval from the relevant regulatory agencies. Further, the
presence of Company-generated wastes at third-party disposal sites exposes
the Company to joint and several liability for the potential additional
costs of cleaning up wastes generated by others. Accordingly, there can be
no assurance that the costs of environmental clean-up for the Company may
not be significantly higher in future years, possibly necessitating
additional charges.
There are certain other claims involving the Company, including claims
relating to the generation, disposal or release into the environment of
allegedly hazardous substances. In management's opinion, the outcome of
these claims will not, individually or in the aggregate, have a material
adverse effect on the Company's financial condition or results of
operations.
In 1991, the Company identified possible deficiencies in procedures for
reporting quality assurance information to the Defense Electronics Supply
Center with respect to the Company's former manufacturing operations. In
September 1997, the United States Government resolved these claims in
exchange for a payment of $3.5 million. The Company's previously
established liability for these claims was sufficient to cover this
settlement.
14
A managing general agency which produced approximately one-fifth of GALIC's
premiums in 1996 and less than six percent of its premiums in 1997 was named
defendant in a lawsuit filed in July 1996 by two regulatory agencies in
California. The managing general agency 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 annuities. GALIC is engaged in discussions with the
regulatory agencies to resolve this matter. The ultimate outcome is not
expected to have a material adverse impact on the financial condition of the
Company.
AAG is subject to other litigation and arbitration in the normal course of
business. AAG is not a party to any material pending litigation or
arbitration.
PART II
ITEM 5
Market for Registrant's Common Equity
and Related Stockholder Matters
AAG's Common Stock is listed and traded principally on the New York Stock
Exchange ("NYSE") under the symbol AAG. On March 1, 1998, there were
approximately 7,800 holders of record of Common Stock. The following table
sets forth the range of high and low sales prices for the Common Stock on
the NYSE Composite Tape.
1997 1996
High Low High Low
First quarter $16.63 $13.75 $12.75 $11.63
Second quarter 20.00 15.25 13.25 11.50
Third quarter 22.13 18.00 13.63 11.88
Fourth quarter 23.88 19.75 14.50 12.13
The Company paid annual common dividends of $.10 per share in 1997 and $.08
per share in 1996. Although no future dividend policy has been determined,
management believes the Company will continue to have the capability to pay
similar dividend amounts.
AFG beneficially owned approximately 81% of AAG's Common Stock at March 1,
1998.
15
ITEM 6
Selected Financial Data
The following financial data has been summarized from, and should be read in
conjunction with, the Company's Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The data reflects the acquisitions of American Memorial and
Loyal in November 1995 and General Accident in December 1997 (in millions,
except per share amounts).
Income Statement Data: 1997 1996 1995 1994 1993
Total revenues $634.2 $577.3 $439.6 $372.7 $388.9
Income from continuing operations $ 71.4 $ 61.1 $ 58.7 $ 40.9 $ 53.0
Loss from discontinued operations - - (3.2) (2.6) (9.6)
Extraordinary items (1.5) (6.0) (0.2) (1.7) (3.4)
Change in accounting principle - - - (0.5) -
Net income $ 69.9 $ 55.1 $ 55.3 $ 36.1 $ 40.0
Basic earnings per common share:
Continuing operations $1.63 $1.39 $1.45 $1.05 $1.41
Discontinued operations - - (0.08) (0.07) (0.27)
Extraordinary items (0.03) (0.14) - (0.05) (0.10)
Change in accounting principle - - - (0.01) -
Net income $1.60 $1.25 $1.37 $0.92 $1.04
Diluted earnings per common share:
Continuing operations $1.61 $1.39 $1.45 $1.05 $1.41
Discontinued operations - - (0.08) (0.07) (0.27)
Extraordinary items (0.03) (0.14) - (0.05) (0.10)
Change in accounting principle - - - (0.01) -
Net income $1.58 $1.25 $1.37 $0.92 $1.04
Cash dividends per common share $0.10 $0.08 $0.07 $0.06 $0.05
Balance Sheet Data at year end:
Total assets $7,710.3 $7,024.1 $6,611.0 $5,089.9 $4,913.8
Notes payable 135.8 114.9 167.7 183.3 225.9
Mandatorily redeemable preferred
securities of subsidiary trusts 225.0 75.0 - - -
Net unrealized gains (losses)
included in stockholders' equity 133.2 61.8 89.3 (29.0) 56.9
Total stockholders' equity 583.9 486.5 429.3 204.4 250.3
16
ITEM 7
Management's Discussion and Analysis
of Financial Condition and Results of Operations
General
Following is a discussion and analysis of the financial statements and other
statistical data that management believes will enhance the understanding of
the financial condition and results of operations of American Annuity Group,
Inc. ("AAG" or "the Company"). This discussion should be read in
conjunction with the financial statements beginning on page F-1.
AAG 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 shareholder dividends.
Liquidity and Capital Resources
Ratios The following ratios may be considered relevant indicators of AAG's
liquidity and are typically presented by AAG in its prospectuses and similar
documents.
1997 1996 1995
Earnings to fixed charges 5.1 6.0 6.0
Earnings to fixed charges plus
preferred dividends 4.8 5.4 6.0
Consolidated debt to capital,
excluding unrealized gains 26% 19% 33%
For purposes of the calculations of consolidated debt to capital,
consolidated debt includes the Company's notes payable and its Remarketed
Par Securities ("ROPES") which were issued in May 1997. Capital represents
the sum of notes payable, redeemable preferred securities of subsidiary
trusts (including ROPES), preferred stock and common equity.
At December 31, 1997, AAG (parent) had approximately $75 million of
unrestricted cash and marketable investments on hand. If AAG had used this
amount to retire outstanding indebtedness, its consolidated debt to capital
ratio would have been 18% at December 31, 1997.
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 December 31, 1997, the capital ratios of
each of AAG's insurance subsidiaries was at least 4.3 times its authorized
control level RBC.
17
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 the Company's 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. The maximum amount of dividends payable by GALIC in
1998 without prior regulatory approval is $73.6 million. In 1997, GALIC
made $45 million in such payments, net of capital contributions received
from AAG Holding.
Since year end 1993 (through February 1998), AAG has retired $225 million
principal amount of its public debentures and $79 million of preferred
stock. In addition, AAG acquired General Accident Life Assurance Company of
Puerto Rico, Inc. for approximately $50 million in December 1997 and
acquired Laurentian Capital Corporation for approximately $150 million in
November 1995. AAG funded these outlays with issuances of common and
preferred securities, bank borrowings, dividends from GALIC and cash on
hand.
Including cash and investments on hand and the unused availability under a
bank line of credit, AAG and AAG Holding had more than $140 million of
liquidity at March 1, 1998. The March 1998 acquisition of Arkansas National
Life Insurance Company was completed using cash on hand at GALIC. 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. At December 31, 1997, 93% of AAG's fixed maturity
portfolio was comprised of investment grade bonds (NAIC rating of "1" or
"2"). Management believes that the high credit quality of AAG's investment
portfolio should generate a stable and predictable investment return.
AAG invests primarily in fixed income investments which, including loans and
short-term investments, comprised 98% of its investment portfolio at
December 31, 1997. 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 December 31, 1997 and 1996, respectively, AAG had approximately $242
million and $100 million in net unrealized gains on its fixed maturity
portfolio. This increase, representing approximately 2% of the carrying
value of AAG's fixed maturity portfolio, resulted from price increases
related to a decrease in the general level of interest rates.
18
At December 31, 1997, AAG had less than 2% of total assets invested in
mortgage loans and real estate, the majority of which had been purchased
within the last five years.
At December 31, 1997, 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.
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
approximately one-fifth of GALIC's premiums in 1996 and less than six
percent of its premiums in 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. The ultimate outcome is not expected to have a
material adverse impact on the financial condition of the Company.
Year 2000 Issue The Company has determined that it will need to modify
or replace significant portions of its software so that its computer systems
will function properly with respect to dates in the year 2000 and beyond.
The Company also has initiated discussions with its business associates and
financial institutions to assess the extent to which its operations are
vulnerable should those organizations fail to properly remediate their
computer systems.
The Company's comprehensive Year 2000 initiative is being managed by a team
of internal staff and outside consultants. The team's activities are
designed to ensure that there is no adverse effect on the Company's core
business operations. These efforts are scheduled to be completed in early
1999. The cost of the Year 2000 initiatives is not expected to be material
to the Company's results of operations or financial position.
Estimated Year 2000 costs and completion dates are based on management's
best estimate. However, there can be no assurance that these estimates will
be achieved. Factors such as the availability of trained personnel could
affect the successful completion of the project. Should software
modifications and new software installation not be completed on a timely
basis, the resulting disruptions could have a material adverse impact on
operations.
19
Results of Operations
General The operations of American Memorial Life Insurance Company and
Loyal American Life Insurance Company are included in AAG's financial
statements from the date of their acquisition in November 1995.
Accordingly, the 1997 and 1996 income statement components are not
comparable to 1995.
Management believes the concept of net operating earnings (or "core"
earnings) is helpful in comparing the operating performance of AAG with that
of similar companies. Net operating earnings per share for 1997 and 1996
were up 14% and 17%, respectively, over the comparable prior years.
However, net operating earnings should not be considered a substitute for
net income as an indication of AAG's overall performance. The following
table (in millions, except per share amounts) compares the Company's net
operating earnings over the past three years.
AAG (Consolidated): 1997 1996 1995
Revenues per income statement $634.2 $577.3 $439.6
Less realized gains (5.2) (1.2) (15.7)
Less equity in net (earnings) loss of
affiliate (0.8) 2.2 (0.1)
Operating revenues 628.2 578.3 423.8
Expenses per income statement (530.0) (498.8) (348.9)
Less provision for relocation expenses 4.0 - -
Operating expenses (526.0) (498.8) (348.9)
Operating earnings before tax 102.2 79.5 74.9
Income tax expense 32.1 17.8 26.5
Net operating earnings $ 70.1 $ 61.7 $ 48.4
Net operating earnings per common
share (basic) $ 1.60 $ 1.40 $ 1.20
The Company's principal products are Single Premium Deferred Annuities
("SPDAs") and Flexible Premium Deferred Annuities ("FPDAs"). The following
table summarizes AAG's premiums (in millions).
1997 1996 1995
Retirement Annuities:
SPDAs $254 $319 $219
FPDAs - renewal 160 182 196
FPDAs - first year 32 35 42
Variable annuities 43* 4 -
Pre-need annuities 38 40 -
Pre-need life insurance 73 57 -
Other life insurance 22 22 2
Accident and health insurance 20 21 -
Total premiums $642 $680 $459
* Includes $14 million of premiums which were directed toward the fixed
rate option of the variable product.
The table does not include premiums of subsidiaries until their first
full year following acquisition. American Memorial's 1995 pre-need
annuity receipts were $28 million and its pre-need life insurance
premiums were $52 million; Loyal's 1995 life premiums were $21 million
and its accident and health premiums were $20 million.
20
The decrease in fixed annuity sales in 1997 reflects primarily the decrease
of SPDA business written by GALIC's largest premium producing agency in 1996
(from $99 million to $23 million). GALIC is no longer writing business
through this agency (see "Management's Discussion and Analysis -
Contingencies"). Management believes that the success of the stock market
and the recent interest rate environment have also resulted in decreased
sales and increased surrenders and annuitizations of GALIC's fixed
annuities. This trend has continued into January and February of 1998.
Annuity Investors Life Insurance Company's increased sales of variable
annuities helped offset the decrease in GALIC's production.
Life, Accident and Health Premiums and Benefits Life, accident and health
premiums and benefits increased in 1997 due primarily to an increase in pre-
need life insurance sales through the largest owner of funeral homes in the
world. This customer accounted for approximately one-half of American
Memorial's life and annuity sales in 1997. The increase in life, accident
and health premiums and expenses in 1996 reflects the acquisition of
American Memorial and Loyal.
Net Investment Income Net investment income increased 6% in 1997 and 15% in
1996 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 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 $4.7 million in 1997, $6.5
million in 1996 and $5.4 million in 1995. Lower investment expenses in 1997
reflect a decrease in fees charged by an affiliate. (See Notes D and P.)
Equity in Net Earnings (Loss) of Affiliate Equity in net earnings (loss) of
affiliate represents AAG's proportionate share of the results of Chiquita
Brands International. Chiquita's income from continuing operations before
unusual items was $0.3 million in 1997, $43 million in 1996 and $9 million
in 1995. Chiquita's income (loss) before extraordinary items was $0.3
million in 1997, ($28 million) in 1996 and $17 million in 1995. Included in
equity in Chiquita's 1997 earnings is a gain attributable to Chiquita's
issuance of common stock.
Other Income Other income increased in 1997 due primarily to increased
revenues from certain non-insurance subsidiaries and additional annuity
fees. Other income increased in 1996 reflecting (i) policy fees, primarily
at American Memorial and Loyal and (ii) higher revenues at AAG's agency
subsidiaries.
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% to 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. Annuity benefits increased 3% in 1997 and 7% in 1996
due primarily to an increase in average annuity benefits accumulated,
partially offset by decreases in crediting rates on GALIC's annuities.
Amortization of Insurance Acquisition Costs Amortization of insurance
acquisition costs includes certain commissions on sales of life insurance
products and reflects the effect of the November 1995 acquisition of
American Memorial and Loyal. The costs in 1997 and 1996 also reflect $8.1
million and $8.7 million, respectively, of amortization of the present value
of future profits.
21
Trust Preferred Distribution Requirement Trust preferred distribution
requirement represents amounts accrued on $225 million of 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 Interest expense on borrowings decreased
38% in 1997 and 19% in 1996 due primarily to the retirement of debt during
both years, as well as the use of lower cost bank borrowings to finance
purchases of higher cost debt. (See Note G.)
Provision for Relocation Expenses In the third quarter of 1997, AAG began
relocating most of the operations of Loyal from Mobile, Alabama to
Cincinnati, Ohio to more closely coordinate its efforts with those of other
AAG operations. The estimated cost of the relocation ($4.0 million) was
expensed in the third quarter of 1997. The relocation was substantially
complete in the first quarter of 1998.
Other Expenses In 1996, other expenses increased 68%, reflecting: (i) a
full year of operating expenses of American Memorial and Loyal; (ii) pretax
charges of $15.7 million related to pension and other liabilities of the
Company's former manufacturing operations and (iii) operating expenses of
AAG's agency subsidiaries. Other expenses decreased 10% in 1997, reflecting
primarily the absence of the $15.7 million pretax charge mentioned above.
Income Taxes AAG's effective tax rate decreased in 1997 and 1996 from 1995
due to a reduction of the valuation allowance associated with certain
deferred tax assets.
Discontinued Operations The Company has sold all of its former
manufacturing operations. Certain properties utilized in those former
operations continue to be held for sale and are currently leased to non-
affiliated companies.
Extraordinary Items Extraordinary items reflect AAG's losses, net of tax,
on retirements of its debt and, in 1996, also includes AAG's proportionate
share of Chiquita's extraordinary loss on the retirement of certain of its
debt.
New Accounting Standards to be Implemented During 1997, the Financial
Accounting Standards Board issued the following Statements of Financial
Accounting Standards ("SFAS").
SFAS # Subject of Standard Period to be Implemented
130 Comprehensive Income 1st quarter of 1998
131 Segment Information 4th quarter of 1998
SFAS No. 130 establishes standards for the reporting of a company's change
in equity during the period from non-owner sources. For AAG, comprehensive
income will consist principally of net income and the change in net
unrealized gains on marketable securities. SFAS No. 131 establishes
standards for the way companies report information about operating segments,
products and services, geographic areas and major customers. Implementation
of these standards will not have a significant effect on AAG's financial
position, net income or reported segments.
22
ITEM 8
Financial Statements and Supplementary Data
PAGE
Report of Independent Auditors F-1
Consolidated Balance Sheet:
December 31, 1997 and 1996 F-2
Consolidated Income Statement:
Years Ended December 31, 1997, 1996 and 1995 F-3
Consolidated Statement of Changes in Stockholders' Equity:
Years Ended December 31, 1997, 1996 and 1995 F-4
Consolidated Statement of Cash Flows:
Years Ended December 31, 1997, 1996 and 1995 F-5
Notes to Consolidated Financial Statements F-6
"Selected Quarterly Financial Data" has been included in Note Q to the
Consolidated Financial Statements.
PART III
The information required by the following Items will be included in AAG's
definitive Proxy Statement for the 1998 Annual Meeting of Stockholders which
will be filed with the Securities and Exchange Commission within 120 days of
the Company's fiscal year end and is herein incorporated by reference:
ITEM 10 Directors and Executive Officers of the Registrant
ITEM 11 Executive Compensation
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management
ITEM 13 Certain Relationships and Related Transactions
23
REPORT OF INDEPENDENT AUDITORS
Board of Directors
American Annuity Group, Inc.
We have audited the accompanying consolidated balance sheets of American
Annuity Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of income, changes in stockholders'
equity and cash flows for each of the three years in the period ended
December 31, 1997. Our audits also included the financial statement
schedules listed in the Index at Item 14(a). These financial statements and
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 consolidated financial
position of American Annuity Group, Inc. and subsidiaries at December 31,
1997 and 1996, and the consolidated results of their operations and their
cash flows for each of the three years in the 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 financial statements taken as a whole, present fairly
in all material respects the information set forth therein.
Ernst & Young LLP
Cincinnati, Ohio
March 2, 1998
F-1
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
December 31,
1997 1996
Assets
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,340.6 and $2,524.6) $2,276.4 $2,495.7
Available for sale - at market
(amortized cost - $3,922.0 and $3,254.9) 4,099.4 3,325.6
Equity securities - at market (cost - $30.9
and $16.1) 83.0 51.0
Investment in affiliate 16.8 16.5
Mortgage loans on real estate 52.1 68.1
Real estate 42.0 37.6
Policy loans 241.0 236.0
Short-term investments 13.9 41.4
Total investments 6,824.6 6,271.9
Cash 36.8 42.7
Accrued investment income 101.6 94.8
Unamortized insurance acquisition costs, net 261.6 194.7
Other assets 185.2 172.4
Assets held in separate accounts 300.5 247.6
$7,710.3 $7,024.1
Liabilities and Capital
Annuity benefits accumulated $5,528.1 $5,365.6
Life, accident and health reserves 709.9 575.4
Notes payable 135.8 114.9
Payable to affiliates, net 35.8 14.5
Deferred taxes on unrealized gains 71.8 33.3
Accounts payable, accrued expenses and other
liabilities 119.5 111.3
Liabilities related to separate accounts 300.5 247.6
Total liabilities 6,901.4 6,462.6
Mandatorily redeemable preferred securities
of subsidiary trusts 225.0 75.0
Stockholders' Equity:
Preferred Stock (at redemption value) - 49.0
Common Stock, $1 par value
-100,000,000 shares authorized
- 43,199,147 and 43,255,705 shares
outstanding 43.2 43.3
Capital surplus 368.0 358.5
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 252.1 186.5
Unrealized gains on marketable securities,
net 133.2 61.8
Total stockholders' equity 583.9 486.5
See Notes to Consolidated Financial Statements. $7,710.3 $7,024.1
F-2
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Year ended December 31,
1997 1996 1995
Revenues:
Net investment income $494.3 $467.7 $405.5
Realized gains on sales of investments 5.2 1.2 15.7
Life, accident and health premiums 121.5 103.6 15.7
Equity in net earnings (loss) of
affiliate 0.8 (2.2) 0.1
Other income 12.4 7.0 2.6
634.2 577.3 439.6
Costs and Expenses:
Annuity benefits 278.8 271.8 254.7
Life, accident and health benefits 110.1 92.3 13.2
Amortization of insurance acquisition
costs 36.3 34.1 12.7
Trust preferred distribution requirement 15.5 1.0 -
Interest and other debt expenses 8.9 14.3 17.6
Provision for relocation expenses 4.0 - -
Other expenses 76.4 85.3 50.7
530.0 498.8 348.9
Income from continuing operations before
income taxes 104.2 78.5 90.7
Provision for income taxes 32.8 17.4 32.0
Income from continuing operations 71.4 61.1 58.7
Discontinued operations, net of tax - - (3.2)
Income before extraordinary items 71.4 61.1 55.5
Extraordinary items, net of tax (1.5) (6.0) (0.2)
Net Income $ 69.9 $ 55.1 $ 55.3
Preferred dividend requirement 1.0 1.4 -
Net income applicable to Common Stock $ 68.9 $ 53.7 $ 55.3
Average number of common shares:
Basic 43.2 43.1 40.5
Diluted 43.7 43.1 40.5
Basic earnings (loss) per common share:
Continuing operations $1.63 $1.39 $1.45
Discontinued operations - - (0.08)
Extraordinary items (0.03) (0.14) -
Net income $1.60 $1.25 $1.37
Diluted earnings (loss) per common share:
Continuing operations $1.61 $1.39 $1.45
Discontinued operations - - (0.08)
Extraordinary items (0.03) (0.14) -
Net income $1.58 $1.25 $1.37
Cash dividends per common share $0.10 $0.08 $0.07
See Notes to Consolidated Financial Statements.
F-3
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Year ended December 31,
1997 1996 1995
Preferred Stock:
Balance at beginning of year $ 49.0 $ 17.0 $ -
Preferred Stock issued - 32.0 17.0
Preferred Stock retired (49.0) - -
Balance at end of year $ - $ 49.0 $ 17.0
Common Stock:
Balance at beginning of year $ 43.3 $ 43.1 $ 39.1
Common Stock issued - 0.2 4.0
Common Stock retired (0.1) - -
Balance at end of year $ 43.2 $ 43.3 $ 43.1
Capital Surplus:
Balance at beginning of year $358.5 $361.1 $330.8
Capital contribution 9.3 - -
Common Stock issued 0.2 2.2 33.3
Common Stock retired (1.0) - -
Common dividends declared - (3.4) (3.0)
Preferred Stock retired 2.0 - -
Preferred dividends declared (1.0) (1.4) -
Balance at end of year $368.0 $358.5 $361.1
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6)($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of year $186.5 $131.4 $ 76.1
Net income 69.9 55.1 55.3
Common dividends declared (4.3) - -
Balance at end of year $252.1 $186.5 $131.4
Unrealized Gains, Net:
Balance at beginning of year $ 61.8 $ 89.3 ($ 29.0)
Change during year 71.4 (27.5) 118.3
Balance at end of year $133.2 $ 61.8 $ 89.3
See Notes to Consolidated Financial Statements.
F-4
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Year ended December 31,
1997 1996 1995
Cash Flows from Operating Activities:
Net income $ 69.9 $ 55.1 $ 55.3
Adjustments:
Discontinued operations - - 3.2
Extraordinary losses on retirement of debt 1.5 6.0 0.2
Increase in life, accident and
health reserves 36.3 28.4 17.5
Benefits to annuity policyholders 278.8 271.8 254.7
Amortization of insurance acquisition
costs 36.3 34.1 12.7
Equity in net (earnings) loss of affiliate(0.8) 2.2 (0.1)
Realized gains on investing activities (5.2) (1.2) (15.7)
Increase in insurance acquisition costs (72.6) (68.5) (34.9)
Increase in accrued investment income (4.8) (7.4) (3.0)
Increase in other assets (32.6) (10.4) (12.4)
Increase (decrease) in other liabilities 19.8 (6.3) 17.9
Other, net (15.5) 1.7 (3.5)
311.1 305.5 291.9
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,449.9) (1,010.1)(1,107.5)
Equity securities (12.5) - -
Real estate, mortgage loans and
other assets (16.1) (26.7) (22.6)
Purchase of subsidiaries, net of
cash acquired (48.7) - (55.2)
Maturities and redemptions of fixed maturity
investments 408.2 255.2 147.1
Sales of:
Fixed maturity investments 747.6 261.0 768.5
Equity securities 5.8 1.3 2.0
Real estate, mortgage loans and
other assets 20.9 27.8 8.2
Decrease (increase) in policy loans (1.3) 5.4 (6.1)
(346.0) (486.1) (265.6)
Cash Flows from Financing Activities:
Fixed annuity receipts 493.7 573.8 457.5
Annuity surrenders, benefits and
withdrawals (607.2) (517.9) (412.8)
Additions to notes payable 114.0 92.7 33.5
Reductions of notes payable (94.9) (153.2) (49.1)
Issuance of trust preferred securities 149.3 72.4 -
Issuance of Common Stock - - 37.3
Retirement of Common Stock (1.1) - -
Issuance of Preferred Stock - 32.0 17.0
Retirement of Preferred Stock (47.0) - -
Cash dividends paid (5.3) (4.5) (3.0)
1.5 95.3 80.4
Net increase (decrease) in cash and
short-term investments (33.4) (85.3) 106.7
Cash and short-term investments
at beginning of year 84.1 169.4 62.7
Cash and short-term investments
at end of year $ 50.7 $ 84.1 $ 169.4
See Notes to Consolidated Financial Statements.
F-5
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
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 with the
sponsorship of state associations of funeral directors as well as individual
and large operators of funeral homes and (iii) various forms of supplemental
life and health insurance through payroll deduction plans, financial
institutions and in-home sales.
American Financial Group, Inc. ("AFG") and its subsidiaries owned 35,059,995
shares (81%) of AAG's Common Stock at December 31, 1997.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The accompanying Consolidated Financial Statements
include the accounts of AAG and its subsidiaries. All significant
intercompany transactions and balances have been eliminated in
consolidation. Certain reclassifications have been made to prior periods to
conform to the current year's presentation.
The preparation of the financial statements in conformity with generally
accepted accounting principles 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.
AAG's acquisitions of General Accident Life Assurance Company of Puerto
Rico, Inc. in December 1997 and Laurentian Capital Corporation ("LCC") in
November 1995 have been recorded as purchases; their results of operations
have been included in AAG's Consolidated Financial Statements since their
acquisition.
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.
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.
F-6
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Investment in Affiliate AAG's investments in equity securities of
companies that are 20% to 50% owned by AFG and its subsidiaries are 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.
Present Value of Future Profits Included in insurance acquisition costs are
amounts representing the present value of future profits on business in
force of the 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.
F-7
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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 (primarily 7%), 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, Great American Life
Insurance Company ("GALIC"), have separate tax allocation agreements with
American Financial Corporation ("AFC"), a subsidiary of AFG, which designate
how tax payments are shared by members of the tax group. In general, both
companies compute taxes on a separate return basis. GALIC is obligated to
make payments to (or receive benefits from) AFC based on taxable income
without regard to temporary differences. If GALIC's taxable income
(computed on a statutory accounting basis) exceeds a current period net
operating loss of AAG, the taxes payable by GALIC associated with the excess
are payable to AFC. If the AFC tax group utilizes any of AAG's net
operating losses or deductions that originated prior to AAG's entering AFC's
consolidated tax group, AFC will pay to AAG an amount equal to the benefit
received.
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax basis and are measured using
enacted tax rates. The Company recognizes deferred tax assets if it is more
likely than not that a benefit will be realized. Current and deferred tax
assets and liabilities of companies in AFC's consolidated tax group are
aggregated with other amounts receivable from or payable to affiliates.
F-8
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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 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 diluted common stock
options. Implementation of SFAS No. 128 did not affect AAG's reported
earnings per share amounts for prior years.
Statement of Cash Flows For cash flow purposes, "investing activities" are
defined as making and collecting loans and acquiring and disposing of debt
or equity instruments and property and equipment. "Financing activities"
include annuity receipts, benefits and withdrawals and obtaining resources
from owners and providing them with a return on their investments. All
other activities are considered "operating." Short-term investments having
original maturities of three months or less when purchased are considered to
be cash equivalents for purposes of the financial statements.
C. ACQUISITIONS
In December 1997, AAG acquired General Accident for approximately $50
million in cash. AAG funded the purchase with borrowings under its bank
lines of credit.
In November 1995, AAG acquired all of the outstanding shares of LCC. Its
principal insurance subsidiaries were American Memorial Life Insurance
Company and Loyal American Life Insurance Company. AAG paid approximately
$106 million for the outstanding common stock of LCC and repaid $45 million
of LCC indebtedness concurrently with the acquisition. GALIC provided
approximately $90 million of the purchase price in exchange for American
Memorial and Loyal. AAG funded the balance of the cost of acquiring LCC
with the proceeds from a Common Stock rights offering completed in August
1995, bank borrowings and cash on hand.
F-9
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
D. INVESTMENTS
Fixed maturity investments at December 31, consisted of the following (in
millions):
1997
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
U. S. Government and government
agencies and authorities $ - $ - $ - $ -
States, municipalities and political
subdivisions 39.8 40.2 0.4 -
Foreign government 8.3 8.9 0.6 -
Public utilities 360.8 366.2 6.7 (1.3)
Mortgage-backed securities 659.2 684.6 25.6 (0.2)
All other corporate 1,208.3 1,240.7 33.2 (0.8)
$2,276.4 $2,340.6 $66.5 ($2.3)
1997
Available for Sale
Amortized Market Gross Unrealized
Cost Value Gains Losses
U. S. Government and government
agencies and authorities $ 303.1 $ 312.8 $ 9.8 ($0.1)
States, municipalities and
political subdivisions 26.8 27.6 0.8 -
Foreign government 20.1 21.0 0.9 -
Public utilities 135.6 141.7 6.1 -
Mortgage-backed securities 1,250.6 1,302.5 51.9 -
All other corporate 2,185.8 2,293.8 108.0 -
$3,922.0 $4,099.4 $177.5 ($0.1)
1996
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
U. S. Government and government
agencies and authorities $ - $ - $ - $ -
States, municipalities and political
subdivisions 40.6 39.8 - (0.8)
Foreign government 8.3 8.8 0.5 -
Public utilities 383.9 383.5 5.2 (5.6)
Mortgage-backed securities 679.6 688.9 14.8 (5.5)
All other corporate 1,383.3 1,403.6 27.1 (6.8)
$2,495.7 $2,524.6 $47.6 ($18.7)
1996
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
U. S. Government and government
agencies and authorities $184.6 $186.1 $3.4 ($1.9)
States, municipalities and political
subdivisions 12.1 12.2 0.2 (0.1)
Foreign government 17.5 17.3 - (0.2)
Public utilities 175.2 180.5 5.9 (1.1)
Mortgage-backed securities 1,222.0 1,234.7 24.1 (11.4)
All other corporate 1,643.5 1,695.3 62.5 (10.7)
$3,254.9 $3,325.6 $96.1 ($25.4)
"Investing activities" related to fixed maturity investments included in
AAG's Consolidated Statement of Cash Flows consisted of the following (in
millions):
1997
Held to Available
Maturity For Sale Total
Purchases ($ 1.4) ($1,448.5) ($1,449.9)
Maturities and paydowns 212.7 195.5 408.2
Sales 5.2 742.4 747.6
Gross gains 0.2 19.8 20.0
Gross losses - (13.9) (13.9)
1996
Held to Available
Maturity for Sale Total
Purchases ($116.3) ($893.8) ($1,010.1)
Maturities and paydowns 106.6 148.6 255.2
Sales 9.3 251.7 261.0
Gross gains 1.1 8.3 9.4
Gross losses (0.3) (8.3) (8.6)
1995
Held to Available
Maturity for Sale Total
Purchases ($280.7) ($826.8) ($1,107.5)
Maturities and paydowns 50.5 96.6 147.1
Sales 1.4 767.1 768.5
Gross gains 0.8 23.2 24.0
Gross losses (0.6) (8.3) (8.9)
Securities classified as "held to maturity" were sold due to significant
deterioration in the issuers' creditworthiness; gains/(losses) on such sales
were insignificant.
The table below sets forth the scheduled maturities of AAG's fixed maturity
investments based on carrying value as of December 31:
1997
Held to Available 1996
Maturity Maturity for Sale Total Total
One year or less 1% 2% 3% 3%
After one year through five
years 12 9 21 18
After five years through ten
years 10 21 31 36
After ten years 2 12 14 10
25 44 69 67
Mortgage-backed securities 10 21 31 33
35% 65% 100% 100%
F-10
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The distribution of maturities based on market value is generally the same.
Mortgage-backed securities had an estimated average life of approximately
six and one-half years at December 31, 1997.
The carrying values of investments in any issue in excess of 10% of
stockholders' equity at December 31, 1997, other than investments issued or
guaranteed by the U.S. Government or government agencies, consisted of the
following investments (in millions):
Issuer Amount
Outboard Marine Corporation (1 issue) $62.5
Provident Financial Group (common and preferred stock) 59.1
At December 31, 1997 and 1996, AAG had no unrealized losses on its
marketable equity securities. Realized gains and changes in unrealized
appreciation on fixed maturity and equity security investments are
summarized as follows (in millions):
Fixed Equity Tax
Maturities Securities Other Effects Total
1997
Realized $ 6.1 $ 1.7 ($2.6) ($ 1.8) $ 3.4
Change in unrealized 142.0 17.2 - (55.7) 103.5
1996
Realized $ 0.8 $ - $0.4 ($ 0.4)$ 0.8
Change in unrealized (142.2) 16.4 - 44.0 (81.8)
1995
Realized $ 15.1 $ 0.6 - ($ 5.5)$ 10.2
Change in unrealized 520.9 7.5 - (184.9) 343.5
Major categories of net investment income were as follows (in millions):
1997 1996 1995
Fixed maturities* $492.6 $463.4 $405.2
Other 6.4 10.8 5.7
Total investment income 499.0 474.2 410.9
Investment expenses (4.7) (6.5) (5.4)
Net investment income $494.3 $467.7 $405.5
*Includes income on fixed maturities, mortgage loans, policy
loans and short-term investments.
AAG's investment portfolio is managed by a subsidiary of AFG. Investment
expenses included investment management charges from this subsidiary
amounting to $2.9 million in 1997 and $4.7 million in 1996 and 1995. (See
Note P.)
F-11
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
E. INVESTMENT IN AFFILIATE
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares;
carrying value of $16.8 million at December 31, 1997) of the common stock of
Chiquita Brands International which is accounted for under the equity
method. AFG and its other subsidiaries own an additional 35% interest in
the common stock of Chiquita. Chiquita is a leading international marketer,
producer and distributor of bananas and other quality fresh and processed
food products. The market value of AAG's investment in Chiquita was
approximately $44 million and $34 million at December 31, 1997 and 1996,
respectively, and $36 million at March 1, 1998.
Included in equity in Chiquita's earnings in 1997 is a $1.3 million gain
attributable to Chiquita's issuance of common stock.
Included in AAG's retained earnings at December 31, 1997, was $8.1 million
applicable to equity in undistributed net losses of Chiquita. In 1996 AAG
recorded a pretax extraordinary charge of $1.1 million representing its
proportionate share of Chiquita's loss on the retirement of debt.
F. UNAMORTIZED INSURANCE ACQUISITION COSTS
Unamortized insurance acquisition costs consisted of the following at
December 31, (in millions):
1997 1996
Deferred policy acquisition costs $300.6 $272.2
Present value of future profits
acquired 102.0 72.5
Unearned revenues (141.0) (150.0)
$261.6 $194.7
A progression of AAG's present value of future profits acquired ("PVFP") is
as follows (in millions):
1997 1996 1995
Beginning balance $ 72.5 $73.4 $ -
Additions due to acquisitions 37.5 - 74.2
Interest accrued 5.3 5.4 -
Amortization (13.3) (14.1) (0.8)
Other - 7.8 -
$102.0 $72.5 $73.4
The interest accrual rates used range primarily from 7.25% to 7.50%. During
each of the next five years, the PVFP is expected to decrease at a rate of
approximately 10% of the balance at the beginning of each respective year.
F-12
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
G. NOTES PAYABLE
Notes payable consisted of the following at December 31, (in millions):
1997 1996
Direct obligations of AAG $ 1.3 $ 1.3
Obligations of AAG Holding
(guaranteed by AAG):
Secured Bank Credit Line due 1999 75.0 44.7
Unsecured Bank Credit Line due 1998 32.0 -
9-1/2% Senior Notes due 2001 - 40.8
11-1/8% Senior Subordinated Notes
due 2003 24.1 24.1
Other subsidiary debt 3.4 4.0
Total $135.8 $114.9
On January 28, 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. On February 2, 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.
At March 1, 1998, scheduled principal payments on debt for the remainder of
1998 and the subsequent four years, adjusted to reflect the above
transactions, were as follows (in millions):
1998 1999 2000 2001 2002
$0.7 $0.8 $0.8 $37.6 $60.5
In August 1997, AAG Holding retired its 9-1/2% Senior Notes, realizing a
pretax extraordinary loss of $2.4 million. During 1996, a pretax
extraordinary loss of $8.2 million was realized on the repurchase of $78.0
million principal amount of Notes (including $21.3 million purchased by
GALIC). During 1995, AAG repurchased $4.9 million principal amount of its
Notes realizing a pretax extraordinary loss of $231,000.
At December 31, 1997 and 1996, the weighted average interest rate on amounts
borrowed under AAG Holding's bank credit lines was 6.80% and 6.68%,
respectively. At March 1, 1998, the weighted average interest rate on its
new credit line was
6.15%.
Cash interest payments were $9.4 million in 1997, $17.4 million in 1996 and
$17.2 million in 1995.
F-13
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
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
Issue 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 December 1997, AAG merged its underfunded pension plan with two pension
plans of affiliates (see Note P - "Pension Plan"). The net overfunded
amount of the affiliates' plans was recorded as a capital contribution.
In December 1996 and 1995, AAG sold 320,000 shares and 170,000 shares,
respectively, of newly issued Preferred Stock for $32 million and $17
million, respectively (see Note P). In March 1997, AAG repurchased all of
its Preferred Stock for approximately $47 million.
In August 1995, AAG sold 3.92 million shares of common stock at $9.50 per
share under a rights offering to existing shareholders.
AAG's dividend paying capability is limited by certain customary debt
covenants to amounts based on cumulative earnings and losses, debt ratios
and other items.
"Retained earnings since January 1, 1993," reflects accumulated changes in
AAG's retained earnings since its acquisition of GALIC.
At December 31, 1997, there were 2.5 million shares of AAG Common Stock
reserved for issuance under AAG's 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.
F-14
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Data for AAG's Stock Option Plan is presented below:
1997 1996
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding at beginning
of year 1,548,969 $13.38 - -
Granted 633,070 $19.70 1,557,759 $13.38
Forfeited (3,849) $13.51 (8,790) $13.25
Outstanding at end of year 2,178,190 $15.21 1,548,969 $13.38
Options exercisable at year-end 309,024 $13.38 - n/a
The average remaining life of AAG's options was 9.2 years at December 31,
1997. The exercise prices of options issued during the year ranged from
$14.00 to $21.75 in 1997 and $13.25 to $13.75 in 1996.
No compensation cost has been recognized for stock option grants. Had
compensation cost been determined for stock option awards based on the fair
values at grant dates consistent with the method prescribed by SFAS No. 123,
AAG's net income and earnings per share would have been approximately $4
million ($0.09 per share) lower. For SFAS No. 123 purposes, calculations
were determined using the Black-Scholes option pricing model and the
following assumptions: dividend yield of less than 1%; expected volatility
of 20%; risk-free interest rates of 5.7% - 6.5% for 1997 and 6.0% for 1996
and expected life of 7.5 years.
J. DISCONTINUED OPERATIONS
AAG's charge for discontinued operations in 1995 represented primarily
additional reserves related to possible deficiencies by AAG's predecessor in
reporting quality assurance information in connection with certain military
related sales prior to 1991. In September 1997, the United States
Government resolved these claims in exchange for a payment of $3.5 million.
F-15
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
K. INCOME TAXES
The following is a reconciliation of income taxes at the statutory rate of
35% and income taxes as shown in the Consolidated Income Statement (in
millions).
1997 1996 1995
Income (loss) before income taxes:
Continuing operations $104.2 $78.5 $90.7
Discontinued operations - - (4.9)
Extraordinary items (2.3) (9.2) (0.3)
Income before income taxes $101.9 $69.3 $85.5
Tax computed at statutory rate $ 35.7 $24.3 $29.9
Effect of:
Reduction of valuation allowance(3.5) (10.0) -
Other, net (0.2) (0.1) 0.3
Total provision 32.0 14.2 30.2
Amounts applicable to:
Discontinued operations - - 1.7
Extraordinary items 0.8 3.2 0.1
Provision for income tax as shown on
the Consolidated Income Statement $ 32.8 $17.4 $32.0
Provision for income taxes consisted of (in millions):
1997 1996 1995
Federal:
Current $32.0 $14.2 $31.9
Deferred - - (1.7)
Total $32.0 $14.2 $30.2
The significant components of deferred tax assets and liabilities, excluding
the effects of unrealized gains and losses on marketable securities,
included in the Consolidated Balance Sheet were as follows (in millions):
December 31,
1997 1996
Deferred tax assets:
Net operating loss carryforwards $39.8 $45.5
Accrued expenses 4.6 13.8
Investment securities, including
affiliate 32.7 31.9
Valuation allowance for deferred
tax assets (33.0) (36.5)
Deferred tax liabilities:
Unamortized insurance
acquisition costs (70.6) (61.8)
Policyholder liabilities (8.8) (14.5)
At December 31, 1997, AAG had net operating loss carryforwards for federal
income tax purposes of approximately $114 million which are scheduled to
expire from 2002 through 2005.
F-16
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
L. LEASES
Future minimum lease payments, net of sublease revenues, under operating
leases having initial or remaining non-cancelable lease terms in excess of
one year at December 31, 1997 are payable as follows: 1998 - $3.5 million;
1999 - $4.5 million; 2000 - $4.1 million; 2001 - $4.0 million; 2002 - $3.8
million; 2003 and beyond - $16.7 million.
Rental expense for operating leases was $2.9 million in 1997, $2.6 million
in 1996 and $1.6 million in 1995.
M. EARNINGS PER SHARE
The number of common shares outstanding used in calculating diluted earnings
per share in 1997 includes 0.5 million shares for the effect of the assumed
exercise of AAG's stock options.
N. 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. Based on prior
costs and discussions with independent environmental consultants, the
Company believes the remaining aggregate cost of environmental work at all
sites for which it has responsibility will range from $6 million to $10
million. The reserve for environmental work was $8.5 million at December
31, 1997.
0. STATUTORY INFORMATION; RESTRICTIONS ON TRANSFERS OF FUNDS AND ASSETS OF
SUBSIDIARIES
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):
1997 1996 1995
Capital and surplus $317.0 $285.0 $272.8
Asset valuation reserve 64.7 91.4 90.2
Interest maintenance reserve 23.9 24.7 32.2
Pretax income from operations $ 91.7 $ 87.1 $ 85.8
Net income from operations 72.7 68.1 60.5
Net income 73.6 66.2 71.4
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 at December 31, 1997,
GALIC may pay $73.6 million in dividends in 1998 without prior approval.
F-17
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
P. ADDITIONAL INFORMATION
Summary Financial Information of AAG Holding AAG has guaranteed all of the
outstanding debt of AAG Holding. Summarized consolidated financial
information for AAG Holding is as follows (in millions):
December 31,
Balance Sheet 1997 1996
Investments $6,634 $6,272
Unamortized insurance
acquisition costs 225 195
Assets held in separate accounts 300 247
Other assets 284 278
Insurance reserves $6,142 $5,942
Notes payable:
Due parent 159 166
Due others 135 114
Liabilities related to
separate accounts 300 247
Other liabilities 165 92
Mandatorily redeemable preferred securities
of subsidiary trusts $ 225 $ 75
Stockholder's equity $ 317 $ 356
Income Statement 1997 1996*
Revenues $ 617 $ 91
Pretax income 92 8
Net income 60 5
* Since November 1, 1996
Related Party Transactions In connection with AAG's purchase of GALIC from
Great American Insurance Company ("GAI"), a subsidiary of AFG, in 1992, GAI
agreed to neutralize the financial effects on GALIC of the adoption of an
actuarial guideline with respect to non-traditional life insurance and
annuity products. In satisfaction of this obligation, (i) GAI had agreed to
purchase, at AAG's option, up to $57 million of AAG Preferred Stock and (ii)
terms of GALIC's investment management services contract with AFG were
modified to reduce the fees owed under certain circumstances. In December
1996 and 1995, AAG sold $21.7 million and $17.0 million, respectively, of
its Series B Preferred Stock to GAI; the proceeds were contributed to GALIC.
Also in December 1996, AAG sold $10.3 million of its Series B Preferred
Stock to AFC. In March 1997, AAG repurchased all the Series B Preferred
Stock for approximately $47 million. In 1997, AAG and GAI agreed that no
additional shares of AAG Preferred Stock would be issued pursuant to this
arrangement and that the financial impact of the actuarial guideline would
be offset solely by reduction of investment management fees.
Net investment income includes approximately $900,000 in 1997, and $1
million in 1996 and 1995 of payments from a subsidiary of AFG for the rental
of an office building owned by GALIC.
F-18
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Fair Value of Financial Instruments The following table shows (in millions)
the carrying value and estimated fair value of AAG's financial instruments
at December 31:
1997 1996
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
Assets
Fixed maturity investments $6,375.8 $6,440.0 $5,821.3 $5,850.2
Equity securities 83.0 83.0 51.0 51.0
Investment in affiliate 16.8 43.6 16.5 34.1
Liabilities
Annuity benefits accumulated $5,528.1 $5,319.1 $5,365.6 $5,180.0
Notes payable 135.8 136.6 114.9 119.0
Mandatorily redeemable preferred
securities of subsidiary
trusts $ 225.0 $ 230.3 $ 75.0 $ 76.5
When available, fair values are based on prices quoted in the most active
market for each security. If quoted prices are not available, fair value is
estimated based on present values, discounted cash flows, fair value of
comparable securities or similar methods. The fair value of short-term
investments, mortgage loans on real estate and policy loans approximate
their carrying value. The fair value of the liability for annuities in the
payout phase is assumed to be the present value of the anticipated cash
flows, discounted at current interest rates. Fair value of annuities in the
accumulation phase is assumed to be the policyholders' cash surrender
amount.
F-19
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Unrealized Gains on Marketable Securities, Net The components of the
Consolidated Balance Sheet caption "Unrealized gains on marketable
securities, net" in stockholders' equity are summarized as follows (in
millions):
Unadjusted
Asset Effect of Reported
(Liability) SFAS 115 Amount
1997
Fixed maturities - available for sale $3,922.0 $177.4 $4,099.4
Equity securities 30.9 52.1 83.0
Unamortized insurance acquisition
costs, net 268.0 (6.4) 261.6
Annuity benefits accumulated (5,510.0) (18.1) (5,528.1)
Deferred taxes on unrealized gains - (71.8) (71.8)
Unrealized gains on marketable
securities, net $133.2
1996
Fixed maturities - available for sale $3,254.9 $ 70.7 $3,325.6
Equity securities 16.1 34.9 51.0
Unamortized insurance acquisition
costs, net 197.5 (2.8) 194.7
Annuity benefits accumulated (5,357.9) (7.7) (5,365.6)
Deferred taxes on unrealized gains - (33.3) (33.3)
Unrealized gains on marketable
securities, net $ 61.8
Pension Plan The Company has a defined benefit pension plan (the "Plan")
covering former U.S. employees of its discontinued manufacturing operations.
Pension benefits are based upon past service with the Company and
compensation levels. Contributions are made by the Company in amounts
necessary to satisfy requirements of ERISA. Effective December 31, 1997,
the Plan was merged with two other defined benefit plans which had been
sponsored by affiliates of the Company. The Plan is the surviving plan of
the merger and is no longer underfunded as a result of the merger.
F-20
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Q. QUARTERLY FINANCIAL DATA (Unaudited)
Quarterly results necessarily rely heavily on estimates. These estimates
and certain other factors, such as the seasonal nature of the Company's
affiliate and certain other operations and the discretionary sales of
assets, cause the quarterly results not to be necessarily indicative of
results for longer periods of time. The following table represents
quarterly results of operations for the years ended December 31, 1997 and
1996 (in millions, except per share data).
First Second Third Fourth Total
1997 Quarter Quarter Quarter Quarter Year
Realized gains (losses) $ 0.3($ 0.1) $ 1.5 $ 3.5 $ 5.2
Total revenues 149.7 154.5 161.7 168.3 634.2
Income from continuing operations 18.0 17.7 16.4* 19.3 71.4
Extraordinary items - - (1.5) - (1.5)
Net income 18.0 17.7 14.9* 19.3 69.9
Earnings (loss) per common share:
Basic:
Continuing operations $0.39 $0.41 $0.38* $0.45 $1.63
Extraordinary items - - (0.03) - (0.03)
Net income $0.39 $0.41 $0.35* $0.45 $1.60
Diluted:
Continuing operations $0.39 $0.41 $0.37* $0.44 $1.61
Extraordinary items - - (0.03) - (0.03)
Net income $0.39 $0.41 $0.34* $0.44 $1.58
Average common shares outstanding
Basic 43.2 43.2 43.2 43.2 43.2
Diluted 43.4 43.6 43.8 43.8 43.7
1996
Realized gains (losses) $ 0.3 $ 0.6 $ 0.5($ 0.2) $ 1.2
Total revenues 139.0 150.9 145.9 141.5 577.3
Income from continuing operations 14.7 16.3 17.1 13.0 61.1
Extraordinary items (1.6) (2.7) (1.7) - (6.0)
Net income 13.1 13.6 15.4 13.0 55.1
Basic and diluted earnings (loss)
per common share:
Continuing operations $0.33 $0.37 $0.39 $0.30 $1.39
Extraordinary items (0.04) (0.06) (0.04) - (0.14)
Net income $0.29 $0.31 $0.35 $0.30 $1.25
Average common shares outstanding
Basic and diluted 43.1 43.1 43.1 43.1 43.1
* In the third quarter of 1997, AAG recorded a $4 million ($2.6 million
after tax) charge relating to the relocation of Loyal from Mobile, Alabama
to Cincinnati, Ohio. Excluding this charge, third quarter 1997 basic and
diluted earnings per share would have been $0.06 higher.
F-21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. Financial Statements are Included in Part II, Item 8.
2. Financial Statement Schedules:
Selected Quarterly Financial Data is included in Note Q to the
Consolidated Financial Statements.
Schedules filed herewith:
For 1997, 1996 and 1995 Page
II - Condensed Financial Information of Registrant S-2
All other schedules for which provisions are made in the
applicable regulation of the Securities and Exchange
Commission have been omitted as they are not applicable, not
required, or the information required thereby is set forth in
the Financial Statements or the notes thereto.
3. Exhibits - See Exhibit Index on Page E-1.
(b) Reports on Form 8-K: None
S-1
AMERICAN ANNUITY GROUP, INC. - PARENT ONLY
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In millions)
Condensed Balance Sheet
December 31,
Assets: 1997 1996
Investments:
Fixed maturities:
Available for sale - at market
(amortized cost - $61.3) $ 62.5 $ -
Equity securities - at market
(cost - $11.5) 11.5 -
Cash and short-term investments 3.6 1.9
Investment in subsidiaries (a) 396.0 384.8
Note receivable from AAG Holding 115.7 122.0
Other assets 53.9 47.8
$643.2 $556.5
Liabilities and Capital:
Accounts payable, accrued expenses and
other liabilities $ 24.3 $ 44.6
Payables to affiliates 33.7 24.2
Notes payable 1.3 1.2
Stockholders' equity (b) 583.9 486.5
$643.2 $556.5
Condensed Income Statement
Year ended December 31,
1997 1996 1995
Revenues:
Net investment income and other income $ 34.2 $ 10.6 $ 1.7
Equity in undistributed earnings of
subsidiaries (92.9) 47.6 64.7
Capital distributions from subsidiaries 181.1 61.2 54.2
122.4 119.4 120.6
Costs and Expenses:
Interest and other financing expenses 0.2 15.2 19.0
Provision for relocation expenses 4.0 - -
Other expenses 14.0 25.7 10.9
18.2 40.9 29.9
Income from continuing operations before
income taxes 104.2 78.5 90.7
Provision for income taxes 32.8 17.4 32.0
Income from continuing operations 71.4 61.1 58.7
Discontinued operations, net of tax - - (3.2)
Income before extraordinary items 71.4 61.1 55.5
Extraordinary items, net of tax (1.5) (6.0) (0.2)
Net Income $ 69.9 $ 55.1 $ 55.3
(a) Includes unrealized gains of $132.4 million and $61.8 million in
1997 and 1996, respectively.
(b) Includes unrealized gains of $133.2 million and $61.8 million in 1997
and 1996, respectively.
S-2
AMERICAN ANNUITY GROUP, INC. - PARENT ONLY
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In millions)
Condensed Statement of Cash Flows
Year Ended December 31,
1997 1996 1995
Operating Activities:
Net income $ 69.9 $55.1 $55.3
Adjustments:
Discontinued operations - - 3.2
Extraordinary items 1.5 6.0 0.2
Equity in net earnings of subsidiaries (58.8) (70.8) (77.0)
Realized gains on investing activities (0.1) - -
Depreciation and amortization 2.2 1.6 0.9
Decrease (increase) in other assets (1.9) (8.5) 0.1
Increase (decrease) in balances with
affiliates 9.5 (26.5) 13.5
Increase (decrease) in other liabilities (11.2) 0.1 2.5
Capital distributions from subsidiaries 181.2 61.2 54.2
Contributions to subsidiaries (3.1) (12.7) (33.0)
Other, net (0.7) 1.3 -
188.5 6.8 19.9
Investing Activities:
Purchase of investments (104.8) - -
Decrease (increase) in intercompany notes 0.7 (46.9) -
Purchase of subsidiaries (51.7) - (63.6)
Maturities and redemptions of fixed maturity
investments 0.5 - -
Sales of investments 22.0 - -
Sales of real estate and other assets - 0.2 -
Sale of AILIC to GALIC - - 6.5
(133.3) (46.7) (57.1)
Financing Activities:
Additions to notes payable - 87.7 33.5
Reductions of notes payable (0.1) (74.8) (48.1)
Issuance of Common Stock - - 37.3
Retirement of Common Stock (1.1) - -
Issuance of Preferred Stock - 32.0 17.0
Retirement of Preferred Stock (47.0) - -
Cash dividends paid (5.3) (4.5) (3.0)
(53.5) 40.4 36.7
Net Increase (Decrease) in Cash
and Short-term Investments 1.7 0.5 (0.5)
Cash and short-term investments at beginning
of period 1.9 1.4 1.9
Cash and short-term investments at end of period $ 3.6 $ 1.9 $ 1.4
S-3
AMERICAN ANNUITY GROUP, INC.
INDEX TO EXHIBITS
Number Exhibit Description
3.1 Certificate of Incorporation of Registrant
3.2 By-laws of Registrant
4 Registrant has no outstanding debt issues exceeding 10% of
the assets of Registrant and consolidated subsidiaries.
10.1 Agreement of Allocation of Payment of Federal Income Taxes ("American
Annuity Tax Allocation Agreement"), dated December 31, 1992, between
American Financial Corporation and the Registrant incorporated herein
by reference to Exhibit 10.12 to the Registrant's Registration
Statement on Form S-2 dated January 7, 1993.
10.2 Assignment of Tax Allocation Payments dated December 31, 1992,
between American Financial Corporation and the Registrant
incorporated herein by reference to Exhibit 10.15 to the Registrant's
Registration Statement on Form S-2 dated January 7, 1993.
10.3 Agreement for the Allocation of Federal Income Taxes dated May 13,
1974, between American Financial Corporation and Great American Life
Insurance Company, as supplemented on January 1, 1987 incorporated
herein by reference to Exhibit 10.16 to the Registrant's Registration
Statement on Form S-2 dated January 7, 1993.
10.4 Investment Services Agreement, dated December 31, 1992, between Great
American Life Insurance Company and American Money Management
Corporation incorporated herein by reference to Exhibit 10.17 to the
Registrant's Registration Statement on Form S-2 dated January 7,
1993.
10.5 Common Stock Registration Agreement, dated December 31, 1992, between
the Registrant and American Financial Corporation and its wholly
owned subsidiary Great American Insurance Company incorporated herein
by reference to Exhibit 10.22 to the Registrant's Registration
Statement on Form S-2 dated January 7, 1993.
10.6 Common Stock Registration Agreement, dated December 31, 1992 between
Chiquita Brands International, Inc. and Great American Life Insurance
Company incorporated herein by reference to Exhibit 10.24 to the
Registrant's Registration Statement on Form S-2 dated January 7,
1993.
12 Earnings to fixed charges.
21 Subsidiaries of the Registrant.
23 Consent of Independent Auditors.
27.1 Financial Data Schedule for 1997 - included in Report filed
electronically with the Securities and Exchange Commission.
27.2 Restated Financial Data Schedule for nine months ended September 30,
1997 - included in Report filed electronically with the Securities and
Exchange Commission.
E-1
Signatures
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, American Annuity Group, Inc. has duly caused this
Report to be signed on its behalf by the undersigned, duly authorized.
American Annuity Group, Inc.
Signed: March 27, 1998 BY: CARL H. LINDNER
Carl H. Lindner
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated:
Signature Capacity Date
CARL H. LINDNER Chairman of the Board March 27, 1998
of Directors
S. CRAIG LINDNER Director March 27, 1998
ROBERT A. ADAMS Director March 27, 1998
WILLIAM R. MARTIN* Director March 27, 1998
WILLIAM J. MANEY Senior Vice President, March 27, 1998
Treasurer and Chief
Financial Officer
(Principal Accounting Officer)
* Chairman of Audit Committee
<TABLE> <S> <C>
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225,000<F1>
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121,500
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<INCOME-PRETAX> 104,200
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AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
EXHIBIT 12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
AND FIXED CHARGES AND PREFERRED DIVIDENDS
(In millions)
Year Ended December 31,
1997 1996 1995
Income from continuing operations before
income taxes $104.2 $78.5 $ 90.7
Less equity in (earnings) loss of affiliate (0.8) 2.2 (0.1)
Plus dividends from affiliate 0.5 0.5 0.5
Plus minority interest in subsidiaries
having fixed charges 0.2 0.5 -
Fixed charges:
Interest and other debt expenses 8.9 14.3 17.6
Preferred dividends of subsidiary trusts 15.5 1.0 -
One-third of rentals 1.0 0.9 0.5
Earnings $129.5 $97.9 $109.2
Fixed charges:
Interest and other debt expenses $ 8.9 $14.3 $ 17.6
Preferred dividends of subsidiary trusts 15.5 1.0 -
One-third of rentals 1.0 0.9 0.5
Fixed charges $ 25.4 $16.2 $ 18.1
Fixed charges and preferred dividends:
Fixed charges - per above $ 25.4 $16.2 $ 18.1
Preferred dividends (*) 1.4 1.8 -
Fixed charges and preferred dividends $ 26.8 $18.0 $ 18.1
Ratio of earnings to fixed charges 5.1 6.0 6.0
Earnings in excess of fixed charges $104.1 $81.7 $ 91.1
Ratio of earnings to fixed charges and
preferred dividends 4.8 5.4 6.0
Earnings in excess of fixed charges and
preferred dividends $102.7 $79.9 $ 91.1
(*) Amounts represent preferred dividend requirements of AAG (parent)
multiplied by the ratio that pretax earnings bears to net earnings.
E-2
AMERICAN ANNUITY GROUP, INC.
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
The following is a list of subsidiaries of AAG at December 31, 1997. All
corporations are subsidiaries of AAG and, if indented, subsidiaries of the
company under which they are listed.
Name of Company
AAG Holding Company, Inc. Ohio 100%
Great American Life Insurance Company Ohio 100
Annuity Investors Life Insurance Company Ohio 100
Loyal American Life Insurance Company Alabama 100
Prairie National Life Insurance Company South Dakota 100
American Memorial Life Insurance Company South Dakota 100
American Annuity Group Capital Trust I Delaware 100
American Annuity Group Capital Trust II Delaware 100
American Annuity Group Capital Trust III Delaware 100
General Accident Life Assurance Company of
Puerto Rico, Inc. Puerto Rico 99.9
The names of certain subsidiaries are omitted, as such subsidiaries in the
aggregate would not constitute a significant subsidiary.
See Part I, Item 1 of this Report for a description of certain companies in
which AAG owns a significant portion and accounts for under the equity
method.
E-3
AMERICAN ANNUITY GROUP, INC.
EXHIBIT 23 - CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements pertaining to the Employee Stock Purchase Plan of
American Annuity Group, Inc. (Form S-8 No. 33-55189), the Agent
Stock Purchase Plan of American Annuity Group, Inc. (Form S-2 No.
33-57259), the American Annuity Group, Inc. Deferred Compensation
Plan (Form S-8 No. 333-17383), the American Annuity Group, Inc.
Directors' Compensation Plan (Form S-8 No. 333-13777) and the
1994 Stock Option Plan (Form S-8 No. 333-41091) of our report
dated March 2, 1998, with respect to the consolidated financial
statements and schedules of American Annuity Group, Inc. included
in this Annual Report (Form 10-K) for the year ended December 31,
1997.
Ernst & Young LLP
Cincinnati, Ohio
March 27, 1998
E-4
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