SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
March 31, 1998 No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer
I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of May 1, 1998, there were 43,123,033 shares of the Registrant's Common
Stock outstanding.
Page 1 of 19
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
March 31, December 31,
1998 1997
Assets
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,246.2 and $2,340.6) $2,184.4 $2,276.4
Available for sale - at market
(amortized cost - $4,134.9 and $3,922.0) 4,311.9 4,099.4
Equity securities - at market
(cost - $35.3 and $30.9) 91.7 83.0
Investment in affiliate 19.1 16.8
Mortgage loans on real estate 49.6 52.1
Real estate 43.4 42.0
Policy loans 240.3 241.0
Short-term investments 32.3 13.9
Total investments 6,972.7 6,824.6
Cash 32.7 36.8
Accrued investment income 102.6 101.6
Unamortized insurance acquisition costs, net 272.1 261.6
Other assets 194.8 185.2
Assets held in separate accounts 315.9 300.5
$7,890.8 $7,710.3
Liabilities and Capital
Annuity benefits accumulated $5,540.3 $5,528.1
Life, accident and health reserves 778.0 709.9
Notes payable 161.6 135.8
Payable to affiliates, net 43.7 35.8
Deferred taxes on unrealized gains 73.2 71.8
Accounts payable, accrued expenses and other
liabilities 143.4 119.5
Liabilities related to separate accounts 315.9 300.5
Total liabilities 7,056.1 6,901.4
Mandatorily redeemable preferred securities
of subsidiary trusts 225.0 225.0
Stockholders' Equity:
Common Stock, $1 par value
-100,000,000 shares authorized
- 43,122,157 and 43,199,147 shares
outstanding 43.1 43.2
Capital surplus 366.3 368.0
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 277.0 252.1
Unrealized gains on marketable securities,
net 135.9 133.2
Total stockholders' equity 609.7 583.9
$7,890.8 $7,710.3
2
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Three months ended
March 31,
1998 1997
Revenues:
Net investment income $127.0 $119.6
Realized gains on sales of investments 10.2 0.3
Life, accident and health premiums 46.8 25.4
Equity in net earnings of affiliate 2.4 1.8
Other income 3.2 2.6
189.6 149.7
Costs and Expenses:
Annuity benefits 71.1 68.8
Life, accident and health benefits 38.1 24.2
Amortization of insurance acquisition costs 14.0 7.7
Trust preferred distribution requirement 4.8 2.1
Interest and other debt expenses 2.5 2.6
Other expenses 21.0 18.1
151.5 123.5
Income before income taxes and extraordinary
item 38.1 26.2
Provision for income taxes 12.4 8.2
Income before extraordinary item 25.7 18.0
Extraordinary item - loss on prepayment of debt (0.8) -
Net Income $ 24.9 $ 18.0
Preferred dividend requirement - 1.0
Net income applicable to Common Stock $ 24.9 $ 17.0
Average number of common shares:
Basic 43.1 43.2
Diluted 43.8 43.4
Basic earnings (loss) per common share:
Before extraordinary item $0.60 $0.39
Loss on prepayment of debt (0.02) -
Net income $0.58 $0.39
Diluted earnings (loss) per common share:
Before extraordinary item $0.59 $0.39
Loss on prepayment of debt (0.02) -
Net income $0.57 $0.39
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Three months ended
March 31,
1998 1997
Preferred Stock:
Balance at beginning of period $ - $ 49.0
Preferred Stock retired - (49.0)
Balance at end of period $ - $ -
Common Stock:
Balance at beginning of period $ 43.2 $ 43.3
Common Stock retired (0.1) (0.1)
Balance at end of period $ 43.1 $ 43.2
Capital Surplus:
Balance at beginning of period $368.0 $358.5
Common Stock retired (1.7) (0.7)
Preferred Stock retired - 2.0
Preferred dividends declared - (1.0)
Balance at end of period $366.3 $358.8
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of period $252.1 $186.5
Net income 24.9 18.0
Balance at end of period $277.0 $204.5
Unrealized Gains, Net:
Balance at beginning of period $133.2 $ 61.8
Change during period 2.7 (39.3)
Balance at end of period $135.9 $ 22.5
Comprehensive Income (Loss):
Net income $ 24.9 $ 18.0
Other comprehensive income - change in net
unrealized gains on marketable securities 2.7 (39.3)
Comprehensive income (loss) $ 27.6 ($ 21.3)
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Three months ended
March 31,
1998 1997
Cash Flows from Operating Activities:
Net income $ 24.9 $ 18.0
Adjustments:
Extraordinary loss on prepayment of debt 0.8 -
Increase in life, accident and health reserves 16.2 6.1
Benefits to annuity policyholders 71.1 68.8
Amortization of insurance acquisition costs 14.0 7.7
Equity in net earnings of affiliate (2.4) (1.8)
Depreciation and amortization 1.9 1.1
Realized gains on investing activities (10.2) (0.3)
Increase in insurance acquisition costs (24.3) (17.3)
Increase in accrued investment income (1.0) (3.1)
Increase in other assets (5.8) (10.2)
Increase (decrease) in other liabilities (2.3) 14.8
Other, net (1.2) (2.0)
81.7 81.8
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (285.7) (381.2)
Equity securities (4.4) (7.1)
Real estate, mortgage loans and other assets (4.7) (2.9)
Purchase of subsidiaries, net of cash acquired (9.3) -
Maturities and redemptions of fixed maturity
investments 157.4 79.7
Sales of:
Fixed maturity investments 97.7 172.9
Equity securities 2.0 3.6
Real estate, mortgage loans and other assets 12.5 2.4
Decrease in policy loans 0.6 1.0
(33.9) (131.6)
Cash Flows from Financing Activities:
Fixed annuity receipts 107.8 133.4
Annuity surrenders, benefits and withdrawals (164.0) (134.7)
Additions to notes payable 50.0 7.0
Reductions of notes payable (25.5) (0.1)
Issuance of trust preferred securities - 74.7
Retirement of Common Stock (1.8) (0.8)
Retirement of Preferred Stock - (47.0)
Cash dividends paid - (1.0)
(33.5) 31.5
Net decrease in cash and short-term investments 14.3 (18.3)
Cash and short-term investments at beginning
of period 50.7 84.1
Cash and short-term investments at end of period $ 65.0 $ 65.8
5
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A.Description of the Company
American Annuity Group, Inc. ("AAG" or "the Company") markets the following
nationwide: (i) retirement products - primarily fixed and variable
annuities; (ii) individual life insurance and annuity policies through the
sponsorship of state associations of funeral directors as well as individual
and large operators of funeral homes and (iii) various forms of life and
supplemental health insurance through payroll deduction plans, financial
institutions and in-home sales.
American Financial Group, Inc. ("AFG") and its subsidiaries owned 35,059,995
shares (81%) of AAG's Common Stock at May 1, 1998.
B.Accounting Policies
Basis of Presentation The accompanying Consolidated Financial Statements
for AAG and its subsidiaries are unaudited, but management believes that all
adjustments (consisting only of normal recurring accruals unless otherwise
disclosed herein) necessary for fair presentation have been made. The
results of operations for interim periods are not necessarily indicative of
results to be expected for the year. The financial statements have been
prepared in accordance with the instructions to Form 10-Q and therefore do
not include all information and footnotes necessary to be in conformity with
generally accepted accounting principles.
The preparation of the financial statements requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Changes in circumstances could cause
actual results to differ materially from those estimates.
AAG's acquisition of Great American Life Assurance Company of Puerto Rico,
Inc. ("GA Life", formerly General Accident Life Assurance Company of Puerto
Rico, Inc.) in December 1997 was recorded as a purchase. The results of GA
Life's operations have been included in AAG's Consolidated Financial
Statements since its 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.
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Gains or losses on sales of securities are recognized at the time of
disposition with the amount of gain or loss determined on the specific
identification basis. When a decline in the value of a specific investment
is considered to be other than temporary, a provision for impairment is
charged to earnings and the carrying value of that investment is reduced.
Premiums and discounts on mortgage-backed securities are amortized over
their expected average lives using the interest method.
Investment in Affiliate AAG's investments in equity securities of companies
that are 20% to 50% owned by AFG and its subsidiaries are generally carried
at cost, adjusted for a proportionate share of their undistributed earnings
or losses. Changes in AAG's equity in its affiliate caused by issuances of
the affiliate's stock are recognized in earnings when such issuances are not
part of a broader reorganization.
Insurance Acquisition Costs Unamortized insurance acquisition costs consist
primarily of deferred policy acquisition costs and the present value of
future profits on business in force of acquired insurance companies.
Certain commission costs are expensed as paid and are included in
amortization of life insurance acquisition costs.
Deferred Policy Acquisition Costs ("DPAC") DPAC (principally commissions,
advertising, underwriting, policy issuance and sales expenses that vary with
and are primarily related to the production of new business) is deferred to
the extent that such costs are deemed recoverable.
DPAC related to annuities and universal life insurance products is
amortized, with interest, in relation to the present value of expected gross
profits on the policies. These expected gross profits consist principally
of estimated future net investment income and surrender, mortality and other
policy charges, less estimated future interest on policyholders' funds,
policy administration expenses and death benefits in excess of account
values. DPAC is reported net of unearned revenue relating to certain policy
charges that represent compensation for future services. These unearned
revenues are recognized as income using the same assumptions and factors
used to amortize DPAC.
To the extent that realized gains and losses result in adjustments to the
amortization of DPAC, such adjustments are reflected as components of
realized gains.
To the extent that unrealized gains (losses) from securities classified as
"available for sale" would result in adjustments to DPAC, unearned revenues
and policyholder liabilities had those gains (losses) actually been
realized, such balance sheet amounts are adjusted, net of deferred taxes.
DPAC related to traditional life and health insurance is amortized over the
expected premium paying period of the related policies, in proportion to the
ratio of annual premium revenues to total anticipated premium revenues.
Such anticipated premium revenues were estimated using the same assumptions
used for computing liabilities for future policy benefits.
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Present Value of Future Profits Included in insurance acquisition costs are
amounts representing the present value of future profits on business in
force of acquired insurance companies, which represent the portion of the
costs to acquire such companies that is allocated to the value of the right
to receive future cash flows from insurance contracts existing at the date
of acquisition.
These amounts are amortized with interest over the estimated remaining life
of the acquired policies for annuities and universal life products and over
the expected premium paying period for traditional life and health insurance
products.
Annuity Benefits Accumulated Annuity receipts and benefit payments are
recorded as increases or decreases in "annuity benefits accumulated" rather
than as revenue and expense. Increases in this liability for interest
credited are charged to expense and decreases for surrender charges are
credited to other income.
Life, Accident and Health Reserves Liabilities for future policy benefits
under traditional ordinary life, accident and health policies are computed
using the net level premium method. Computations are based on anticipated
investment yields, mortality, morbidity and surrenders and include
provisions for unfavorable deviations. Reserves are modified as necessary
to reflect actual experience and developing trends.
The liability for future policy benefits for interest sensitive life
policies is equal to the sum of the accumulated fund balances under such
policies.
Assets Held In and Liabilities Related To Separate Accounts Separate
account assets and related liabilities represent deposits maintained by
several banks under a previously offered tax-deferred annuity program and,
to a lesser extent, variable annuity deposits. The Company receives an
annual fee from each bank for sponsoring the program; if depositors elect to
purchase an annuity from the Company, funds are transferred to the Company.
Life, Accident and Health Premiums and Benefits For traditional life,
accident and health products, premiums are recognized as revenue when
legally collectible from policyholders. Policy reserves have been
established in a manner which allocates policy benefits and expenses on a
basis consistent with the recognition of related premiums and generally
results in the recognition of profits over the premium-paying period of the
policies.
For interest-sensitive life and universal life products, premiums are
recorded in a policyholder account which is reflected as a liability.
Revenue is recognized as amounts are assessed against the policyholder
account for mortality coverage and contract expenses. Surrender benefits
reduce the account value. Death benefits are expensed when incurred, net of
the account value.
Income Taxes AAG and its principal subsidiary, 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
8
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
group utilizes any of AAG's net operating losses or deductions that
originated prior to AAG's entering AFC's consolidated tax group, AFC will
pay to AAG an amount equal to the benefit received.
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax basis and are measured using
enacted tax rates. The Company recognizes deferred tax assets if it is more
likely than not that a benefit will be realized. Current and deferred tax
assets and liabilities of companies in AFC's consolidated tax group are
aggregated with other amounts receivable from or payable to affiliates.
Stock-Based Compensation As permitted under Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation", AAG accounts for stock options and other stock-based
compensation plans using the intrinsic value based method prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees."
Benefit Plans AAG sponsors an Employee Stock Ownership Retirement Plan
("ESORP") covering all employees who are qualified as to age and length of
service. The ESORP, which invests primarily in securities of AAG, is a
trusteed, noncontributory plan for the benefit of the employees of AAG and
its subsidiaries. Contributions are discretionary by the directors of AAG
and are charged against earnings in the year for which they are declared.
Qualified employees having vested rights in the plan are entitled to benefit
payments at age 60.
AAG and certain of its subsidiaries provide certain benefits to eligible
retirees. The projected future cost of providing these benefits is expensed
over the period the employees earn such benefits.
Earnings Per Share In 1997, AAG implemented SFAS No. 128, "Earnings Per
Share." This standard requires the presentation of basic and diluted
earnings per share for entities with potentially dilutive securities. Basic
earnings per share are calculated using the weighted average number of
shares of common stock outstanding during the period. Diluted earnings per
share include the effect of the assumed exercise of dilutive common stock
options.
Comprehensive Income Effective January 1, 1998, AAG implemented SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 uses the term
"comprehensive income" to describe the total of net earnings plus other
comprehensive income. For AAG, other comprehensive income represents the
change in net unrealized gains on marketable securities net of deferred
taxes and a reclassification adjustment for gains and losses included in net
earnings. Implementation of this statement had no impact on net earnings or
stockholders' equity. Prior periods have been restated to conform to the
current presentation.
Statement of Cash Flows For cash flow purposes, "investing activities" are
defined as making and collecting loans and acquiring and disposing of debt
or equity instruments and property and equipment. "Financing activities"
include annuity receipts, benefits and withdrawals and obtaining resources
from owners and providing them with a return on their investments. All
other activities are 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.
9
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
C. Acquisitions
In March 1998, GALIC acquired Arkansas National Life Insurance Company for
approximately $30 million using cash on hand.
In December 1997, AAG acquired GA Life for approximately $50 million in
cash. AAG funded the purchase with borrowings under its bank lines of
credit.
D.Investments
The carrying value of AAG's fixed maturity portfolio was comprised of the
following at March 31, 1998:
Held to Available
Maturity for Sale Total
U. S. Government and government
agencies and authorities - 6% 6%
States, municipalities and political
subdivisions 1% - 1
Public utilities 5 2 7
Mortgage-backed securities 10 21 31
All other corporate 18 37 55
34% 66% 100%
"Investing activities" related to fixed maturity investments in AAG's
Statement of Cash Flows for the three months ending March 31, consisted of
the following (in millions):
Held toAvailable
Maturity for Sale Total
1998
Purchases - ($285.7) ($285.7)
Maturities and paydowns $75.0 82.4 157.4
Sales 18.3* 79.4 97.7
1997
Purchases ($0.2) ($381.0) ($381.2)
Maturities and paydowns 40.6 39.1 79.7
Sales - 172.9 172.9
* Sold (at a gain of $0.4 million) due to significant deterioration of the
issuers' creditworthiness.
E. Investment in Affiliate
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares;
carrying value of $19.1 million at March 31, 1998) of the common stock of
Chiquita Brands International which is accounted for under the equity
method. AFG and its other subsidiaries own an additional 33% interest in
the common stock of Chiquita. Chiquita is a leading international marketer,
producer and distributor of bananas and other quality fresh and processed
food products. The market value of AAG's investment in Chiquita was
approximately $37 million at March 31, 1998 and $44 million at December 31,
1997.
Included in equity in Chiquita's earnings for the first quarter of 1998 is a
$0.9 million gain attributable to Chiquita's issuance of common stock.
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
March 31, December 31,
1998 1997
Deferred policy acquisition costs $311.2 $300.6
Present value of future profits acquired 100.9 102.0
Unearned revenues (140.0) (141.0)
$272.1 $261.6
G.Notes Payable
Notes payable consisted of the following (in millions):
March 31, December 31,
1998 1997
Direct obligations of AAG $ 1.3 $ 1.3
Obligations of AAG Holding (guaranteed by AAG):
Unsecured Bank Credit Line due 2003 157.0 -
Secured Bank Credit Line due 1999 - 75.0
Unsecured Bank Credit Line due 1998 - 32.0
11-1/8% Senior Subordinated Notes
due 2003 - 24.1
Other subsidiary debt 3.3 3.4
Total $161.6 $135.8
In January 1998, AAG Holding replaced its existing bank lines with a new
$200 million unsecured credit agreement. Loans under the credit agreement
mature from 2000 to 2003 and bear interest at floating rates based on prime
or Eurodollar rates. 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 31, 1998, scheduled principal payments on debt for the remainder of
1998 and the subsequent five years were as follows (in millions):
1998 1999 2000 2001 2002 2003
$0.6 $0.8 $0.8 $37.6 $60.5 $60.5
At March 31, 1998 and December 31, 1997, the weighted average interest rate
on amounts borrowed under AAG Holding's bank credit lines was 6.19% and
6.80%, respectively.
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
H. Mandatorily Redeemable Preferred Securities of Subsidiary Trusts
Wholly-owned subsidiary trusts of AAG Holding have issued $225
million of preferred securities and, in turn, purchased $225 million
of newly-issued AAG Holding subordinated debt which provide interest
and principal payments to fund the Trusts' obligations. The
preferred securities are mandatorily redeemable upon maturity or
redemption of the subordinated debt. The three preferred securities
issues are summarized as follows:
Date of Optional
Issuance Issue (Maturity Date) Amount Redemption Dates
November 1996 9-1/4% TOPrS* (2026) $75,000,000 On or after
11/7/2001
March 1997 8-7/8% Preferred
Securities (2027) 75,000,000 On or after
3/1/2007
May 1997 7-1/4% ROPES** (2041) 75,000,000 Prior to
9/28/2000 and
after 9/28/2001
* Trust Originated Preferred Securities
** Remarketed Par Securities
AAG and AAG Holding effectively provide an unconditional guarantee of the
Trusts' obligations.
I. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred Stock, par
value $1.00 per share.
In March 1997, AAG retired all of its outstanding Series B Preferred Stock
for approximately $47 million.
At March 31, 1998, there were 3.0 million shares of AAG Common Stock
reserved for issuance under AAG's Employee Stock Option Plan. Under the
Stock Option Plan, the exercise price of each option equals the market price
of AAG Common Stock at the date of grant. Options become exercisable at the
rate of 20% per year commencing one year after grant. All options expire
ten years after the date of grant.
"Retained earnings since January 1, 1993" reflects
accumulated changes in AAG's retained earnings since its
acquisition of GALIC.
The change in net unrealized gains on marketable securities for the three
months ended March 31 included the following (in millions):
1998 1997
Pretax Taxes Net Pretax Taxes Net
Unrealized holding gains
(losses) on securities
arising during the period $5.9 ($2.0) $3.9 ($60.2) $21.1 ($39.1)
Less reclassification
adjustment for gains realized
in net income (1.8) 0.6 (1.2) (0.3) 0.1 (0.2)
Change in net unrealized gains
on marketable securities $4.1 ($1.4) $2.7 ($60.5) $21.2 ($39.3)
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. Earnings Per Share
The number of common shares outstanding used in calculating diluted earnings
per share in the first quarter of 1998 and 1997, respectively, includes 0.7
million shares and 0.2 million shares for the effect of the assumed exercise
of AAG's outstanding stock options.
K. 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.
L. Additional Information
Statutory Information of Great American Life Insurance Company Insurance
companies are required to file financial statements with state insurance
regulatory authorities prepared on an accounting basis prescribed or
permitted by such authorities (statutory basis). Certain statutory amounts
for GALIC, AAG's primary insurance subsidiary, were as follows (in
millions):
March 31, December 31,
1998 1997
Capital and surplus $325.5 $317.0
Asset valuation reserve 61.3 64.7
Interest maintenance reserve 24.2 23.9
Three months ended March 31,
1998 1997
Pretax income from operations $20.1 $21.3
Net income from operations 16.2 16.8
Net income 16.0 18.2
The amount of dividends which can be paid by GALIC without prior
approval of regulatory authorities is subject to restrictions relating to
capital and surplus and statutory net income. Based on net income for the
year ended December 31, 1997, GALIC may pay $73.6 million in dividends in
1998 without prior approval. In the first three months of 1998, AAG
received $8.0 million in capital distributions from GALIC.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
American Annuity Group, Inc. ("AAG" or "the Company") and its subsidiary,
AAG Holding Company, Inc., are organized as holding companies with nearly
all of their operations being conducted by their subsidiaries. These
companies, however, have continuing expenditures for administrative
expenses, corporate services, satisfaction of liabilities in connection with
discontinued operations and for the payment of interest and principal on
borrowings and shareholder dividends.
Forward-Looking Statements The Private Securities Litigation Reform Act of
1995 encourages corporations to provide investors with information about the
company's anticipated performance and provides protection from liability if
future results are not the same as management's expectations. This document
contains certain forward-looking statements that are based on assumptions
which management believes are reasonable, but, by their nature, inherently
uncertain. Future results could differ materially from those projected.
Factors that could cause such differences include, but are not limited to:
changes in economic conditions, regulatory actions and competitive
pressures. AAG undertakes no obligation to update any forward-looking
statements.
LIQUIDITY AND CAPITAL RESOURCES
Ratios The following ratios may be considered relevant indicators of AAG's
liquidity and are typically presented by AAG in its prospectuses and similar
documents.
Three months ended
March 31,
1998 1997
Earnings to fixed charges 5.7 5.9
Earnings to fixed charges plus
preferred dividends 5.7 4.6
March 31,December 31,
1998 1997
Consolidated debt to capital,
excluding unrealized gains on
fixed maturity investments 26% 25%
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 March 31, 1998, AAG (parent) had approximately $90 million of
unrestricted cash and marketable investments on hand. If AAG had used this
amount to retire outstanding bank debt, its consolidated debt to capital
ratio would have been 18% at March 31, 1998.
14
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 March 31, 1998, the capital ratios of
each of AAG's principal insurance subsidiaries was at least 4.3 times its
authorized control level RBC.
Sources and Uses of Funds The ability of AAG and AAG Holding to pay
interest and principal on debt, dividends on preferred securities,
obligations related to discontinued manufacturing operations and other
holding company costs is largely dependent upon payments from its principal
subsidiary, Great American Life Insurance Company ("GALIC"), in the form of
capital distributions. The amount of capital distributions which can be
paid by GALIC is subject to restrictions relating to statutory surplus and
earnings. In the first quarter of 1998, GALIC made $6 million in such
payments, net of capital contributions received from AAG Holding.
The maximum amount of dividends payable by GALIC during the remainder of
1998 without prior regulatory approval is $66 million.
Since year end 1996 (through March 1998), AAG has retired $65 million
principal amount of its public debentures and $49 million of preferred
stock. In addition, AAG acquired Great American Life Assurance Company of
Puerto Rico, Inc. ("GA Life") for approximately $50 million in December
1997. AAG funded these outlays with issuances of trust preferred
securities, bank borrowings, dividends from GALIC and cash on hand.
Including cash and investments on hand and the unused availability under a
bank line of credit, AAG and AAG Holding had more than $130 million of
liquidity at May 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. These ratings range from Class 1 (highest quality) to
Class 6 (lowest quality). The following table shows the Company's fixed
maturity portfolio by NAIC designation (and comparable Standard & Poor's
Corporation rating) as of March 31, 1998:
NAIC % of Total
Rating Comparable S&P Rating Market Value
1 AAA, AA, A 66%
2 BBB 26
Total investment grade 92
3 BB 4
4 B 3
5 CCC, CC, C 1
6 D -
Total non-investment grade 8
Total fixed maturities 100%
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 March
31, 1998. AAG generally invests in securities with intermediate-term
maturities with an objective of optimizing interest yields while maintaining
an appropriate relationship of maturities between AAG's assets and expected
liabilities.
At March 31, 1998, 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 March 31, 1998, AAG's mortgage-backed securities ("MBSs") portfolio
represented less than one-third of fixed maturity investments. AAG invests
primarily in MBSs which have a lower risk of prepayment. In addition, the
majority of MBSs held by AAG were purchased at a discount. Management
believes that the structure and discounted nature of the MBSs will reduce
the effect of prepayments on earnings over the anticipated life of the MBS
portfolio.
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-sixth of GALIC's premiums in the first quarter of 1997 was named a
defendant in a lawsuit filed in July 1996 by two regulatory agencies in
California. The managing general agency has settled the allegations brought
against it by agreeing, among other things, to modify certain sales
practices. The regulatory agencies have taken a position that GALIC may be
responsible for certain acts of its insurance agents in connection with the
sale of GALIC's annuities. GALIC is engaged in discussions with the
regulatory agencies to resolve this matter. This agent no longer markets
products for GALIC. The ultimate outcome is not expected to have a material
adverse impact on the financial condition of the Company.
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
RESULTS OF OPERATIONS
General The operations of GA Life are included in AAG's consolidated
financial statements from the date of acquisition in December 1997.
The Company's principal products are Single Premium Deferred Annuities
("SPDAs") and Flexible Premium Deferred Annuities ("FPDAs"). The following
table summarizes AAG's premiums for annuities and other forms of life and
health insurance (in millions):
Three months ended
March 31,
1998 1997
Retirement Annuities:
SPDAs $ 52 $ 70
FPDAs - renewal 38 43
FPDAs - first year 7 8
Variable annuities - flexible premium 4 1
Variable annuities - single premium 13 6
Pre-need life insurance 23 13
Pre-need annuities 8 12
Other life insurance 18 6
Accident and health insurance 5 5
Total premiums $168 $164
The decrease in fixed annuity sales reflects primarily the decrease of SPDA
business written by GALIC's former largest premium producing agency which
wrote $20 million of business in the first quarter of 1997. GALIC ceased
writing business through this agency in 1997 (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.
Premiums from GA Life and increased sales of variable annuities helped
offset the decrease in GALIC's sales.
Pretax Operating Earnings Pretax earnings from operations (before realized
gains and equity in net earnings of affiliate) for the first quarter of 1998
and 1997 were $25.5 million and $24.1 million, respectively.
Net Investment Income Net investment income increased 6% in 1998 over the
comparable three month period in 1997 due primarily to an increase in the
Company's average fixed maturity investment base. This increase was
partially offset by decreasing market interest rates. Investment growth
resulted from acquisitions, internal cash flow generated by AAG's insurance
operations and the investment of a portion of the proceeds from the issuance
of trust preferred securities. Investment income is shown net of investment
expenses of $800,000 in 1998 and $1.0 million in 1997. Lower investment
expenses in 1998 reflect a decrease in fees charged by an affiliate.
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Life, Accident and Health Premiums and Benefits Increases in life,
accident and health premiums and benefits reflect the acquisition of GA Life
and increased sales of pre-need life insurance through the largest owner of
funeral homes in the world.
Equity in Net Earnings of Affiliate Equity in net earnings of affiliate
represents AAG's proportionate share of the results of Chiquita Brands
International. Chiquita reported net income for the first quarter of 1998
and 1997 of $41 million and $43 million, respectively. Included in equity
in Chiquita's first quarter 1998 earnings is a gain attributable to
Chiquita's issuance of common stock.
Annuity Benefits Annuity benefits reflect interest credited to annuity
policyholders' funds accumulated. The majority of GALIC's fixed rate
annuity products permit GALIC to change the crediting rate at any time
(subject to minimum interest rate guarantees of 3% or 4% per annum). As a
result, management has been able to react to changes in market interest
rates and maintain a desired interest rate spread without a substantial
effect on persistency. Annuity benefits increased 3% in the first quarter
of 1998 compared to the same period in 1997 due primarily to an increase in
average annuity benefits accumulated.
Amortization of Insurance Acquisition Costs Amortization of insurance
acquisition costs includes certain commissions on sales of life insurance
products. The increase in 1998 reflects the acquisition of GA Life as well
as increased sales of pre-need life insurance products. The costs in 1998
and 1997 also include $2.4 million and $1.9 million, respectively, of
amortization of the present value of future profits.
Trust Preferred Distribution Requirement Trust preferred distribution
requirement represents amounts accrued on preferred securities issued by
subsidiaries of AAG Holding in 1997 and 1996. A portion of the proceeds
from these issuances was used to retire debt.
Interest and Other Debt Expenses Interest expense decreased in the first
quarter of 1998 compared to the same period in 1997 despite an increase in
average debt outstanding. In 1997 and 1998, AAG retired its 9-1/2% Notes
and 11-1/8% Notes, replacing them with bank borrowings having a
significantly lower interest rate.
Other Expenses Other expenses increased in the first quarter of 1998
compared to the same period in 1997 reflecting primarily the acquisition of
GA Life.
Extraordinary Item Extraordinary item reflects AAG's losses, net of tax,
on prepayment of its debt.
New Accounting Standard to be Implemented The Financial Accounting
Standards Board issued Statement of Financial Accounting Standard ("SFAS")
No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which is scheduled to become effective during the fourth
quarter of 1998. The implementation of SFAS No. 131 will have no effect on
AAG's financial position or net income.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of March 31, 1998. For
submission in electronic filing only.
(b) Report on Form 8-K - None.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned duly authorized.
American Annuity Group, Inc.
May 15, 1998 BY:/s/William J. Maney
William J. Maney
Senior Vice President, Treasurer
and Chief Financial Officer
19
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<FISCAL-YEAR-END> DEC-31-1998
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0
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<EPS-PRIMARY> 0.58
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