AAG
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
PROXY STATEMENT
AND
FINANCIAL STATEMENTS
AND OTHER FINANCIAL DATA
Annual Meeting May 18, 1999
250 East Fifth Street
Cincinnati, Ohio 45202
TABLE OF CONTENTS
Page
Notice of Annual Meeting of Stockholders i
Proxy Statement P-1
Financial Statements and Other Financial Data
Report of Independent Auditors F-1
Audited Financial Statements F-2
Business Summary F-24
Market for AAG's Common Stock
Related Stockholder Matters F-25
Management's Discussion and Analysis of Financial Condition
and Results of Operations F-26
Selected Financial Data F-34
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a)
of the Securities Exchange Act of 1934
(Amendment No. ___)
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Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement
[ ]Confidential, for Use of the Commission Only (as permitted by Rule 14a-
6(a)(2))
[X]Definitive Proxy Statement
[ ]Definitive Additional Materials
[ ]Soliciting Material Pursuant to 240.14a-11(c) or 240.14a-12
American Annuity Group, Inc.
(Name of Registrant as Specified In Its Charter)
American Annuity Group, Inc.
(Name of Person(s) Filing Proxy Statement)
Payment of Filing Fee (Check the appropriate box):
[X]No fee required.
[ ]Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
Title of each class of securities to which transaction applies:
I. Aggregate number of securities to which transaction applies:
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pursuant to Exchange Act Rule 0-11:
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by
Exchange Act Rule 0-11(a)(2) and identity the filing for which the
offsetting fee was paid previously. Identify the previous filing by
registration statement number, or the Form or Schedule and the date of its
filing.
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4) Date Filed:
AMERICAN ANNUITY GROUP, INC.
250 East Fifth Street
Cincinnati, Ohio 45202
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
To Be Held on May 18, 1999
To Our Stockholders:
You are invited to attend the Annual Meeting of Stockholders of
American Annuity Group, Inc. ("AAG" or the "Company"). The meeting will be
held in the Filson Room of the Cincinnatian Hotel, Sixth and Vine Streets,
Cincinnati, Ohio at 10:00 A.M. Eastern Time on Tuesday, May 18, 1999.
The purposes of the meeting are:
1. To elect seven directors;
2. To transact such other business as may properly be brought before
the meeting or any adjournment thereof.
Only stockholders of record at the close of business on March 19, 1999
are entitled to receive notice of and to vote at the meeting or any
adjournment thereof.
You are invited to be present at the meeting so that you can vote in
person. Whether or not you plan to attend the meeting, please date, sign
and return the accompanying proxy form in the enclosed, postage-paid
envelope. If you do attend the meeting, you may either vote by proxy or
revoke your proxy and vote in person. You may also revoke your proxy at any
time before the vote is taken at the meeting by written revocation or by
submitting a later-dated proxy form.
Carl H. Lindner
Chairman of the Board
Dated: March 19, 1999
PROXY STATEMENT
AMERICAN ANNUITY GROUP, INC.
ANNUAL MEETING OF STOCKHOLDERS
MAY 18, 1999
INTRODUCTION
This Proxy Statement is furnished in connection with the solicitation
of proxies by the Board of Directors of AAG for use at the Annual Meeting of
Stockholders to be held at 10:00 A.M. on Tuesday, May 18, 1999, and any
adjournment thereof (the "Annual Meeting"). The Company will pay the cost
of soliciting proxies.
The approximate mailing date of this Proxy Statement and the
accompanying proxy form is March 31, 1999.
Outstanding Voting Securities of AAG
Holders of record of the common stock, $1.00 par value per share, of
AAG (the "Common Stock") at the close of business on March 19, 1999 (the
"Record Date") are entitled to notice of and to vote at the Annual Meeting
and at any adjournments thereof. At the Record Date, 42,485,191 shares of
Common Stock were issued and outstanding.
Holders of Common Stock are entitled to one vote per share on each
matter to be voted on at the Annual Meeting.
Principal Stockholders
As of the Record Date, the only person known to the Company to own
beneficially more than 5% of AAG's Common Stock was American Financial
Group, Inc. and its subsidiaries (collectively "AFG"), One East Fourth
Street, Cincinnati, Ohio 45202, which beneficially owned 35,059,995 shares,
or approximately 82.5% of the shares outstanding as of the Record Date.
Carl H. Lindner, Carl H. Lindner III, S. Craig Lindner, Keith E.
Lindner and trusts for the benefit of them and their families (collectively
the "Lindner Family"), the beneficial owners of approximately 44% of AFG's
voting stock, share voting and dispositive power with AFG with respect to
the shares of AAG Common Stock owned by AFG. AFG and the Lindner Family may
be deemed to be controlling persons of AAG.
Action to be Taken at the Meeting
All shares represented by a properly executed and unrevoked proxy will
be voted at the Annual Meeting or any adjournments thereof in accordance
with the directions on the proxy. Unless a contrary direction is indicated,
such shares will be voted for the seven nominees for director named herein.
Should any of the nominees for election as a director become unable to
stand for election, which is not anticipated, the proxy holders will vote
for the election of such other person as the Board of Directors may
recommend.
PROPOSAL 1: ELECTION OF DIRECTORS
Nominees for Director
Directors will be elected to hold office until the next annual meeting
and until their successors are elected and qualified.
The number of directors to be elected at the Annual Meeting is seven.
The seven directors so elected will, upon such election, constitute the
entire Board of Directors.
In accordance with AAG's Certificate of Incorporation, the only
candidates eligible for election at the Annual Meeting are candidates
nominated by the Board of Directors and candidates nominated at the meeting
by a stockholder who has complied with the procedures set forth in the
Certificate of Incorporation.
The persons nominated by the Board of Directors to serve as directors
for the ensuing year are CARL H. LINDNER, S. CRAIG LINDNER, ROBERT A.
ADAMS, RONALD G. JOSEPH, JOHN T. LAWRENCE III, WILLIAM R. MARTIN and RONALD
W. TYSOE. See "MANAGEMENT" for information relating to the nominees. The
seven nominees receiving the highest numbers of votes will be elected as
directors.
THE BOARD OF DIRECTORS RECOMMENDS THAT STOCKHOLDERS VOTE FOR THE
ELECTION OF THE SEVEN NOMINEES LISTED ABOVE. THE COMPANY HAS BEEN INFORMED
THAT AFG INTENDS TO VOTE ITS SHARES FOR THE ABOVE NOMINEES.
MANAGEMENT
The directors and executive officers of AAG are:
Director or
Name Age* Position Officer Since
Carl H. Lindner 79 Chairman of the Board and 1987
Chief Executive Officer
S. Craig Lindner 43 Director and President 1993
Robert A. Adams 53 Director, Executive Vice 1992
President and Chief Operating
Officer
Ronald G. Joseph 62 Director 1994
John T. Lawrence III 47 Director 1994
William R. Martin 69 Director 1994
Ronald W. Tysoe 45 Director 1999
John B. Berding 36 Senior Vice President, 1993
Investments
Keith A. Jensen 47 Senior Vice President 1997
William J. Maney 49 Senior Vice President, 1993
Treasurer and Chief
Financial Officer
Mark F. Muething 39 Senior Vice President, 1993
General Counsel and
Secretary
Jeffrey S. Tate 42 Senior Vice President 1993
Richard L. Magoteaux 38 Vice President 1996
Christopher P. Miliano 40 Vice President, Controller 1993
and Assistant Treasurer
* As of March 1, 1999
Carl H. Lindner has been Chairman of the Board since 1987. Mr. Lindner
also serves as Chairman of the Board and Chief Executive Officer of AFG, a
diversified financial services company, and Chairman of the Board of
Chiquita Brands International, Inc., a leading international marketer,
producer and distributor of bananas and other quality fresh and processed
food products. AFG owns a substantial beneficial interest (approximately
37%) in Chiquita. He also serves as a director of American Financial
Corporation ("AFC"), all of the Common Stock of which is owned by AFG. Carl
H. Lindner is the father of S. Craig Lindner.
S. Craig Lindner has been President and a director of AAG since March
1993. Mr. Lindner is President and has during the past five years been
Senior Executive Vice President of American Money Management Corporation
("AMM"), a subsidiary of AFG which provides investment services for AFG and
its affiliated companies, including AAG. He is also Co-President and a
director of AFG and AFC.
Robert A. Adams has been Executive Vice President and Chief Operating
Officer of the Company since December 1992 and a director since 1993.
Ronald G. Joseph has been a director of AAG since March 1994. For more
than five years, Mr. Joseph has been Chief Executive Officer and attorney of
various Cincinnati-based automobile dealerships and real estate holdings.
John T. Lawrence III has been a director of AAG since March 1994. Mr.
Lawrence has been a Senior Vice President with PaineWebber Incorporated, a
national investment banking firm, since January 1993.
William R. Martin has been a director of AAG since March 1994.
Although currently retired, Mr. Martin was previously President of both
Tominy, Inc. and M.B. Computing, Inc., which are privately held software
development companies. Mr. Martin is also a director of AFG and AFC.
Ronald W. Tysoe has been a director of AAG since February 1999. For
more than five years, Mr. Tysoe has been Vice Chairman of Federated
Department Stores, Inc. ("Federated"). From April 1990 until October 1997,
Mr. Tysoe also served as the Chief Financial Officer of Federated. Mr.
Tysoe also serves as a director of E. W. Scripps Company.
John B. Berding has been Senior Vice President - Investments of AAG
since March 1993. During the past five years, he has also been a Vice
President and effective January 1996 a Senior Vice President of AMM.
Keith A. Jensen was elected Senior Vice President of AAG in February
1997. Prior thereto for more than five years he was a partner with Deloitte
& Touche LLP, an independent accounting firm.
William J. Maney has been Senior Vice President, Treasurer and Chief
Financial Officer of AAG for over five years.
Mark F. Muething has been Senior Vice President, General Counsel and
Secretary of AAG for over five years.
Jeffrey S. Tate has been Senior Vice President of AAG for over five
years.
Richard L. Magoteaux was elected Vice President of AAG in May 1996.
Prior thereto for more than five years he was a Senior Manager with Ernst &
Young LLP, an independent accounting firm.
Christopher P. Miliano was elected Vice President and Controller of AAG
in February 1995 and Assistant Treasurer in February 1997. Prior thereto,
he served as an Assistant Vice President of AAG (since June 1993) and as a
Director of Accounting and Corporate Reporting of AFC (from October 1989 to
June 1993).
Holdings of Management
Information concerning AAG's Common Stock beneficially owned by each
director and executive officer and all directors and executive officers as a
group as of March 1, 1999, is shown in the following table:
Amount and Nature of
Beneficial Percent of
Name Ownership (a)(k) Class
Robert A. Adams 331,877 (b) *
Ronald G. Joseph 27,478 *
John T. Lawrence III 15,675 *
Carl H. Lindner 35,059,995 (c) 82.5%
S. Craig Lindner 35,148,222 (c)(d) 82.7
William R. Martin 13,575 *
Ronald W. Tysoe - -
John B. Berding 67,212 *
Keith A. Jensen 26,868 (e) *
William J. Maney 75,772 (f) *
Mark F. Muething 73,190 (g) *
Jeffrey S. Tate 79,467 (h) *
Richard L. Magoteaux 6,489 (i) *
Christopher P. Miliano 26,259 (j) *
All Directors and
Executive Officers as
a Group (14 persons) 35,865,216 83.7%
* Less than 1%
(a) Unless otherwise indicated, the persons named have sole voting and
dispositive power over the shares listed opposite their names.
Includes shares which may be acquired pursuant to options which are
exercisable within 60 days of the date hereof.
(b) Includes 3,424 shares allocated to Mr. Adams' account in the American
Annuity Group, Inc. Employee Stock Ownership Retirement Plan
("ESORP"), 49,194 share equivalents allocated to Mr. Adams' account
in the American Annuity Group, Inc. Deferred Compensation Plan
("Deferred Compensation Plan") and 254 shares held by Mr. Adams'
minor children.
(c) Messrs. Carl H. Lindner and S. Craig Lindner may be deemed to own
beneficially the shares set forth under "Principal Stockholders" for
AFG, of which Mr. Carl Lindner is Chairman of the Board and Chief
Executive Officer and a principal shareholder and Mr. S. Craig
Lindner is a director, officer and principal shareholder.
(d) Includes 44,100 shares held by his spouse as custodian or as trustee
for their minor children and 8,000 shares which are held in a trust
for the benefit of their minor children for which Keith E. Lindner
acts as trustee with voting and dispositive power. Also includes
19,219 shares allocated to Mr. Lindner's account in the Deferred
Compensation Plan.
(e) Includes 3,868 share equivalents allocated to Mr. Jensen's account in
the Deferred Compensation Account.
(f) Includes 3,424 shares allocated to Mr. Maney's account in the ESORP
and 7,546 share equivalents allocated to Mr. Maney's account in the
Deferred Compensation Plan.
(g) Includes 2,369 shares allocated to Mr. Muething's account in the
ESORP and 9,320 share equivalents allocated to Mr. Muething's account
in the Deferred Compensation Plan.
(h) Includes 3,327 shares allocated to Mr. Tate's account in the ESORP
and 5,228 share equivalents allocated to Mr. Tate's account in the
Deferred Compensation Plan.
(i) Includes 292 shares allocated to Mr. Magoteaux's account in the ESORP
and 661 share equivalents allocated to Mr. Magoteaux's account in the
Deferred Compensation Plan.
(j) Includes 2,857 shares allocated to Mr. Miliano's account in the
ESORP.
(k) Messrs. Adams, Joseph, Lawrence, Carl H. Lindner, S. Craig Lindner,
Martin, Berding, Tate and Miliano also beneficially own 634; 16,000;
4,000; 2,964,566; 4,611,499; 42,858; 9,246; 500 and 10 shares,
respectively, of common stock of AFG. Mr. Martin also beneficially
owns 40,126 shares of AFC preferred stock.
Committees and Meetings of the Board of Directors
AAG's Board of Directors held six meetings and took action in writing on
four occasions in 1998.
Audit Committee. The Audit Committee consists of three members: William
R. Martin (Chairman), John T. Lawrence III and Ronald W. Tysoe, none of
whom is an officer or employee of AAG or any of its subsidiaries. Mr. Tysoe
became a member of this Committee in February 1999. The Committee's
functions include: recommending to the Board of Directors the firm to be
appointed as independent accountants to audit the financial statements of
AAG and its subsidiaries and to provide other audit-related services and
recommending the terms of such firm's engagement; reviewing the scope and
results of the audit with the independent accountants; reviewing with
management and the independent accountants AAG's interim and year-end
operating results; reviewing the adequacy and implementation of the internal
accounting and auditing procedures of AAG; and reviewing the non-audit
services to be performed by the independent accountants and considering the
effect of such performance on the accountants' independence. The Audit
Committee held five meetings in 1998.
Executive Committee. The Executive Committee consists of three members:
S. Craig Lindner (Chairman), Carl H. Lindner and Robert A. Adams. The
Committee is generally authorized to exercise the powers of the Board of
Directors between meetings of the Board of Directors, except that the
Committee's authority does not extend to certain fundamental matters, such
as: amending the By-laws of AAG; filling vacancies in the Board of
Directors; declaring a dividend; electing or removing the Company's
principal officers; adopting or approving a plan of merger; consolidation or
sale of a substantial portion of the Company's assets; dissolution or
reorganization of AAG or establishing or designating any class or series of
AAG stock (or fixing or determining the relative rights and preferences
thereof). The Executive Committee did not meet in 1998 and took action in
writing on two occasions.
Organization and Policy Committee. The Organization and Policy Committee
consists of two members: Ronald G. Joseph and John T. Lawrence III, neither
of whom is an officer or employee of AAG or any of its subsidiaries. The
Committee's functions include: reviewing the duties and responsibilities of
the Company's principal officers; reviewing and making recommendations to
the Board of Directors with respect to the compensation of the Company's
principal officers; reviewing the Company's compensation and personnel
policies; administering bonus and stock option plans; reviewing and making
recommendations to the Board of Directors with respect to employee
retirement policies; and supervising, reviewing and reporting to the Board
of Directors on the performance of the management committee responsible for
the administration and investment management of the Company's pension and
savings plans. The Committee also reviews and advises the Board of
Directors with respect to the nomination of candidates for election to the
Board of Directors. The Organization and Policy Committee held one meeting
in 1998 and took action in writing on three occasions.
Compensation of Directors
Officers of AAG do not receive any additional compensation for serving as
members of the Board of Directors or any of its committees. Directors who
are not employees of AAG receive an annual retainer of $25,000 for Board
membership and an additional annual retainer of $5,000 for serving as
Chairman of a Board Committee. Under AAG's Directors' Compensation Plan,
non-employee directors will receive at least 50% of their retainers in
Common Stock. In addition, directors who are not employees of AAG are paid
a fee of $1,500 for attendance at each Board meeting, and $1,000 for
attendance at each committee meeting. All directors are reimbursed for
expenses incurred in attending board and committee meetings.
Pursuant to the Directors' Stock Option Plan, each March 1, each non-
employee director will receive a stock option to purchase 1,000 shares of
AAG Common Stock, with an exercise price based on the average market price
of AAG Common Stock for the ten trading days preceding the grant date. Each
new non-employee director will receive an option to purchase 10,000 shares
of AAG Common Stock, with an exercise price based on the average market
price of AAG Common Stock for the ten trading days preceding the date of
election as a director.
Compensation of Executive Officers
The following table sets forth information concerning the annual and long-
term compensation for services in all capacities to AAG and its subsidiaries
for the three years ended December 31, 1998 paid to the chief executive
officer and the other five most highly compensated executive officers of
AAG.
SUMMARY COMPENSATION TABLE
Long-Term Compensation
Annual Compensation Other Securities All
Name and Annual Underlying Other
Principal Compen- Options/ Compen-
Position Year Salary Bonus sation(b) SARs (c) sation(d)
Carl H. Linder 1998 $101,923 -- -- $4,061 -- --
Chairman of 1997 $101,959 -- -- $4,061 -- --
the Board 1996 $101,923 -- -- $5,685 -- --
and Chief
Executive
Officer (a)
S. Craig Linder 1998 $313,846 $275,000 $1,197 -- --
President 1997 $336,346 $277,500 $1,245 -- --
1996 $330,231 $407,000 $735 -- --
Robert A. Adams 1998 $530,000 $418,000 $55,723 40,000 $30,000
Executive 1997 $514,712 $453,600 $57,518 50,000 $30,000
Vice President 1996 $499,423 $445,500 $49,799 476,004 $29,965
and Chief
Operating
Officer
William J. 1998 $213,654 $114,000 $11,995 25,000 $20,271
Maney 1997 $193,654 $124,200 $10,922 25,000 $18,549
Senior Vice 1996 $184,481 $115,500 $3,284 127,145 $11,069
President
and Chief
Financial Officer
Jeffrey S. Tate 1998 $213,654 $114,000 $28,658 25,000 $19,659
Senior Vice 1997 $193,654 $124,200 $16,515 25,000 $26,001
President 1996 $184,481 $115,500 $7,853 127,145 $11,069
(a) In his capacity as Chief Executive Officer of AAG, Mr. Lindner is
paid a base annual salary of $100,000. Mr. Lindner did not
participate in any other compensation plans of AAG.
(b) The amounts listed under "Other Annual Compensation" for 1998 include
the value of automobile and homeowners insurance coverage provided
pursuant to the Executive Insurance Program and the premiums paid for
group life coverage in excess of $50,000 per individual, respective-
ly, for each person as follows: Mr. Adams - $10,815 and $5,472, Mr.
Maney - $8,351 and $1,287, and Mr. Tate - $5,676 and $754. The
amounts for 1998 also include spousal travel reimbursement of $22,928
for Mr. Adams, $1,410 for Mr. Maney and $21,115 for Mr. Tate. The
amount for Mr. Adams also includes an auto allowance of $14,400. The
amounts for Messrs. Carl Lindner and S. Craig Lindner reflect
premiums paid for group life coverage in excess of $50,000.
(c) Amounts for 1996 include options which were granted in connection
with a program whereby holders of SARs were given the opportunity to
exercise their SARs and were granted a stock option to purchase that
number of shares of AAG Common Stock as was equal to the number of
SARs exercised by such person less the number of shares of AAG Common
Stock issued to such person upon exercise of the SARs. The number of
options issued to each person pursuant to this program were as
follows: Mr. Adams -366,004, Mr. Maney - 82,145 and Mr. Tate -
82,145.
(d) Amounts listed under "All Other Compensation" for each of the named
persons reflect amounts contributed to the AAG ESORP and AAG
Auxiliary ESORP.
Stock option grants for the year ended December 31, 1998, for the
Executive Officers named in the Summary Compensation Table are as follows:
STOCK OPTION GRANTS IN 1998
Potential Realizable Value at
Assumed Annual Rates of Stock Price
Individual Grants Appreciation for Stock Option Term (a)
% of Total
Stock Options
Stock Granted to Exer- Expir-
Options Employees in cise ation
Name Granted Fiscal Price(b) Date(c) 0% 5% 10%
Carl H.
Lindner -- -- -- -- -- -- --
S. Craig
Lindner -- -- -- -- -- -- --
Robert A.
Adams 40,000 9.7% $22.50 12/23/ 0 $566,005 $1,434,400
2008
William J.
Maney 25,000 6.1% $22.50 12/23/ 0 $353,750 $896,500
2008
Jeffrey S.
Tate 25,000 6.1% $22.50 12/23/ 0 $353,750 $896,500
2008
(a) The Potential Realizable Value is calculated based on a market price
for AAG Common Stock on the date of grant of $22.50.
(b) The closing price for AAG Common Stock on December 22, 1998 was
$22.50.
(c) The stock options become exercisable to the extent of 20% on each of
the first five anniversaries of the date of grant.
The following table contains information on the value of unexercised
options as of December 31, 1998:
AGGREGATED OPTION EXERCISES IN 1998
AND OPTION VALUES AT DECEMBER 31, 1998
Number of Value of
Securities Unexercised
Underlying In-the-Money
Unexercised Options
Options at at Fiscal
Fiscal Year Year
End End
Options Value Exercisable\ Exercisable\
Name Exercised Realized(b) Unexercisable Unexercisable (a)
Carl H.
Lindner -- -- -- --
S. Craig
Lindner -- -- -- --
Robert A.
Adams 10,000 $97,500 170,401/335,603 $1,568,110/$2,558,929
William J.
Maney -- -- 47,858/109,287 $420,965/$664,199
Jeffrey S.
Tate -- -- 47,858/109,287 $420,965/$664,199
(a)The Value of Unexercised In-the-Money Options at Fiscal Year End is
calculated based on a market price for AAG Common Stock on December 31, 1998
of $23.00 per share.
(b)The value realized on the exercise of stock options is calculated by
subtracting the exercise price from the market value of AAG common stock on
the date of exercise.
Organization and Policy Committee Report
The Organization and Policy Committee of AAG's Board of Directors consists
of two directors, neither of whom is an employee of AAG or any of its
subsidiaries. The Committee's functions include reviewing and making
recommendations to the Board of Directors with respect to the compensation
of each officer of the Company whose annual base salary exceeds $200,000.
AAG's cash compensation for executive officers in 1998 was comprised
principally of annual base salaries and payments pursuant to the Corporate
Bonus Plan. The grant of stock options to executive officers provided long-
term incentive based compensation. In determining compensation for
executive officers, the Committee does not make comparisons with other
companies.
Annual Base Salaries. The Committee approves annual base salaries and
salary increases for executive officers that are appropriate for their
positions and levels of responsibilities. The Committee takes into
consideration the Company's long-term performance in establishing annual
base salaries for executive officers.
Corporate Bonus Plan. Each of the named executive officers, other than
Carl H. Lindner, was eligible to participate in the Corporate Bonus Plan.
The Bonus Plan compensated participants based on the financial and
operational performance of the Company. Under the Bonus Plan, the Organiza-
tion and Policy Committee established a target bonus for each participant
based on such person's duties and responsibilities with the Company and
expected contributions during the year. The Committee also established
financial and operational goals for the Company. In most cases, the
financial goals accounted for 75% of the bonus potential and the operational
goals accounted for the other 25%. Based on the attainment of these goals,
participants in the Bonus Plan could earn up to 125% of the target bonus
amounts. The bonuses reported in the Summary Compensation Table for 1998
are amounts awarded to participating executive officers in December 1998.
In some cases, bonuses were not paid until January 1999. In most cases,
bonuses were paid at the rate of 95% of the target bonus amounts and were
based on assessments of the achievement of the financial and operational
goals established by the Committee. The principal factors in evaluating the
Company's operational goals were the continued improvements in the Company's
capital structure as well as the growth in operating earnings.
Compensation of the Chief Executive Officer. In April 1992, the
Organization and Policy Committee approved an annual base salary of $100,000
for Carl H. Lindner, Chief Executive Officer of the Company. In
establishing this salary, the Committee considered the fact Mr. Lindner
would not be working full-time on AAG related matters as a result of his
numerous management responsibilities with AFG and its affiliates. In
establishing Mr. Lindner's salary, the Committee gave consideration to the
Company's long-term performance. During 1998, Mr. Lindner did not
participate in any other compensation plans or arrangements of AAG.
Stock Options. Stock options represent a performance-based portion of the
Company's compensation system. The Committee believes that stockholders'
interests are well served by aligning the interests of the Company's
executive officers with those of stockholders by the grant of stock options.
Incentive stock options are granted with an exercise price equal to the fair
market value of AAG Common Stock on the date of grant and become exercisable
at the rate of 20% per year. The Committee believes that these features
provide executive officers with substantial incentives to maximize AAG's
long-term success.
Internal Revenue Code Section 162. Provisions of the Internal Revenue
Code provide that compensation in excess of $1 million per year paid to the
Chief Executive Officer as well as other executive officers listed in the
compensation table will not be deductible unless the compensation is
"performance based" and the related compensation is approved by
stockholders. Section 162 was not considered by the Committee in determin-
ing 1998 compensation.
Members of the Organization and Policy Committee:
Ronald G. Joseph
John T. Lawrence III
Organization and Policy Committee Interlocks and Insider Participation. The
members of the Organization and Policy Committee are Ronald G. Joseph and
John T. Lawrence III. Neither has been an officer or employee of AAG, AFG
or any of their subsidiaries.
Performance Graph. The following graph compares the cumulative total
stockholder return on AAG Common Stock with the cumulative total return of
the Standard & Poor's 500 Stock Index ("S&P 500") and the Standard & Poor's
Insurance (Life/Health) - 500 Index ("S&P Life") from the end of 1993 to the
end of 1998. The graph assumes $100 invested on December 31, 1993 in AAG
Common Stock, the S&P 500 and the S&P Life, including reinvestment of divi-
dends. (The table below contains the data points used in the Performance
Graph which appears in the printed Proxy Statement.)
PERFORMANCE GRAPH INDEX
DECEMBER 31
1993 1994 1995 1996 1997 1998
AAG 100 97 122 144 226 237
S&P LIFE 100 83 119 146 182 192
S&P 500 100 101 139 171 229 294
Certain Transactions
AAG and AMM, a wholly-owned subsidiary of AFG, are parties to an
Investment Services Agreement pursuant to which AMM provides investment and
custodial services to AAG's insurance subsidiaries in accordance with
guidelines. AAG and its subsidiaries pay AMM an annual fee of .10% of total
invested assets (as defined), provided that such fee does not exceed the
actual cost to AMM of providing such services, and AMM is reimbursed for
certain expenses. Investment expenses charged by AMM to AAG and its
subsidiaries were $3.3 million in 1998. In connection with the purchase of
GALIC by AAG, Great American Insurance Company ("GAI"), the former parent of
GALIC and a wholly-owned subsidiary of AFG, agreed to neutralize the
financial impact on GALIC of the adoption of an actuarial guideline that was
under consideration at the time of the transaction. This actuarial
guideline was subsequently adopted with an effective date of December 31,
1995. AAG and GAI have agreed that the financial impact of the actuarial
guideline would be offset by reduction of investment management fees. The
amount paid in 1998 reflects this adjustment.
AAG, GALIC and certain of their subsidiaries are members of AFC's
consolidated tax group. AAG and GALIC have separate tax allocation
agreements with AFC which designate how tax payments are shared by members
of the tax group. In general, these 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 1993, AFC will pay to AAG an amount equal to the benefit received.
During 1998, AAG and its subsidiaries which are included in the AFC
consolidated tax group incurred income tax expense of $30.8 million. In
1998, AAG paid AFC $6.6 million in tax allocation payments.
GAI leases office space in a building owned by GALIC in Cincinnati, Ohio,
under a lease which expires in March 2009. GALIC recorded rental income of
approximately $900,000 from GAI in 1998. In 1998, AAG made payments of
approximately $303,000 to Chiquita for the use of cafeteria and other
facilities in Cincinnati, Ohio and for miscellaneous items. Chiquita paid
AAG approximately $359,000 as a rent differential in connection with the
termination of a sublease arrangement for office space in Cincinnati, Ohio.
It was determined in 1992 that the agreements governing the Company's 1987
spin-off from American Premier Underwriters, Inc. ("APU") obligate the
Company to reimburse APU for workers' compensation claim payments which
continue to be required with respect to the Company's operations from 1978
to 1987. The Company paid approximately $375,000 to APU with respect to
this liability during 1998.
In July 1997, AAG and Carl H. Lindner purchased 49% and 51%, respectively,
of the outstanding common stock of a newly incorporated entity formed to
acquire the assets of a company engaged in the production of ethanol. AAG
invested $4.9 million and Mr. Lindner invested $5.1 million; the asset
purchase was completed in December 1997. In connection with this
investment, AAG and Mr. Lindner entered into a Shareholders' Agreement which
provides, among other things, for restrictions on the transfer of the shares
of the entity and that Mr. Lindner will have the right to nominate a
majority of that company's directors. AAG and GAI each have a 50%
participation interest in a working capital credit facility under which the
company may borrow up to $10 million at a rate of prime plus 3%. There were
no borrowings outstanding under this facility in 1998. In September 1998,
AAG made a loan in the amount of $4 million to this company. This loan
bears interest at the rate of 14% and matures in September 2008. The
proceeds were used to pay a portion of a $6.3 million capital contribution,
including $3.1 million to AAG.
GALIC has a line of credit with American Heritage Holding Corporation, a
Florida-based home builder which is 49% owned by AFG and 11% owned by a
brother of Carl H. Lindner. Under this agreement, the company may borrow up
to $8 million at 13% per annum, with interest deferred and added to
principal. The highest outstanding balance owed to GALIC during 1998 and
the balance at year-end 1998 was $6.1 million.
AAG purchased various property and casualty insurance from GAI and paid
approximately $163,000 in premiums in 1998.
Proxies
Solicitation. Solicitation of proxies is being made by management at the
direction of AAG's Board of Directors, without additional compensation,
through the mail, in person and otherwise. The cost will be borne by AAG.
In addition, AAG will request brokers and other custodians, nominees and
fiduciaries to forward proxy soliciting material to the beneficial owners of
shares held of record by such persons, and AAG will reimburse them for their
expenses in so doing.
Revocation. The execution of a proxy does not affect the right to vote in
person at the meeting, and a proxy may be revoked by the person giving it
prior to the exercise of the powers conferred by it. A stockholder may
revoke a proxy by communicating in writing to the Secretary of AAG at the
Company's principal offices or by duly executing and delivering a proxy
bearing a later date. In addition, persons attending the meeting in person
may withdraw their proxies. Unless a proxy is revoked or withdrawn, the
shares represented thereby will be voted or the votes withheld at the Annual
Meeting or any adjournments thereof in the manner described in this Proxy
Statement.
Quorum and Vote Required for Approval
The presence at the Annual Meeting, in person or by proxy, of the holders
of at least a majority of the shares of AAG Common Stock outstanding at the
Record Date shall constitute a quorum to consider Proposal 1. If a quorum
does not attend the Annual Meeting, those stockholders who attend in person
or by proxy may adjourn the meeting to such time and place as they may
determine.
The seven nominees receiving the highest number of votes will be elected
as directors.
Abstentions and broker non-votes will have no effect on the election of
Directors.
Independent Auditors
The accounting firm of Ernst & Young LLP served as the Company's
independent auditors for the fiscal year ended December 31, 1998. Ernst &
Young LLP also serves as independent auditors for AFG and many of its
affiliates. Representatives of that firm will attend the annual meeting and
will be given the opportunity to comment, if they so desire, and to respond
to appropriate questions that may be asked by stockholders. No auditor has
yet been selected for the current year since it is generally the practice of
AFG and its subsidiaries not to select independent auditors prior to the
annual stockholders meeting.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires AAG's
officers, directors and persons who own more than ten percent of AAG's
Common Stock to file reports of ownership with the Securities and Exchange
Commission and to furnish AAG with copies of these reports. Based solely
upon its review of reports received by it, or upon written representation
from certain reporting persons that no reports were required, AAG believes
that during fiscal 1998 all filing requirements were met.
Nominations and Stockholder Proposals for 2000 Annual Meeting
The Organization and Policy Committee will consider stockholder
suggestions for nominees for director. Suggestions for director
consideration may be submitted to the Secretary of AAG at the Company's
principal executive offices. Suggestions received by the Secretary's office
by December 31 will be considered by the Committee for nomination at the
next Annual Meeting of Stockholders. Stockholders may also make nominations
for director by complying with the procedures described above under the
caption "Nominees for Director."
Other than the election of Directors, management knows of no other matters
to be presented at the Annual Meeting upon which a vote may be taken. The
Proxy Form used by the Company for the Annual Meeting typically grants
authority to management's proxies to vote in their discretion on any matters
that come before the Meeting as to which adequate notice has not been
received. In order for a notice to be deemed adequate for the 2000 Annual
Meeting, it must be received by February 15, 2000. In order for a proposal
to be considered for inclusion in the Company's proxy statement for that
Meeting, it must be received by January 17, 2000.
Annual Report and Form 10-K Report
An Annual Report for the year ended December 31, 1998, containing
financial and other information about the Company has previously been
provided or is being concurrently provided to all stockholders. In
addition, attached to this Proxy Statement is a copy of the Company's (i)
Audited Financial Statements, (ii) Management's Discussion and Analysis of
Financial Condition and Results of Operations, (iii) Business Summary and
(iv) Selected Financial Data.
THE COMPANY WILL SEND, WITHOUT CHARGE, A COPY OF ITS 1998 ANNUAL REPORT ON
FORM 10-K (EXCLUDING EXHIBITS), AS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION, TO ANY STOCKHOLDER UPON WRITTEN REQUEST. REQUESTS SHOULD BE
SENT TO MARK F. MUETHING, SENIOR VICE PRESIDENT, GENERAL COUNSEL AND
SECRETARY, P.O. BOX 120, CINCINNATI, OHIO 45201-0120.
Cincinnati, Ohio
March 19, 1999
AMERICAN ANNUITY GROUP, INC.
Proxy for Annual Meeting
Registration Name and Address
The undersigned hereby appoints William J. Maney and Mark F. Muething, and
each of them, proxies of the undersigned, each with the power of
substitution, to vote all shares of Common Stock which the undersigned would
be entitled to vote at the Annual Meeting of Shareholders of American
Annuity Group, Inc. to be held on May 18, 1999 at 10:00 a.m., Eastern Time,
and any adjournment of such meeting.
The Board of Directors recommends a vote FOR the following Proposal:
1. Election of Directors
/ / FOR AUTHORITY to elect the / / WITHHOLD AUTHORITY to
nominees listed below (except vote for every nominee
those whose names have been listed below
crossed out)
Robert A. Adams Ronald G. Joseph John T. Lawrence III
Carl H. Lindner S. Craig Lindner William R. Martin
Ronald W. Tysoe
DATE: ___________________, 1999 SIGNATURE:
________________________________________
SIGNATURE:
________________________________________
_
(if held jointly) Important: Please
sign exactly as name appears hereon
indicating, where proper, official
position or representative capacity. In
case of joint holders, all should sign.
This proxy when properly executed will be voted in the manner dictated
herein by the above signed shareholder. If no direction is made, this proxy
will be voted FOR the Proposal. To vote your shares, please mark, sign,
date and return this proxy form using the enclosed envelope.
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
American
Annuity
Group, Inc.
Financial Statements and Other Financial Data
REPORT OF INDEPENDENT AUDITORS
Board of Directors
American Annuity Group, Inc.
We have audited the accompanying consolidated balance sheet of American
Annuity Group, Inc. and subsidiaries as of December 31, 1998 and 1997, 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, 1998. 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,
1998 and 1997, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December 31,
1998, 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 19, 1999
F-1
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
December 31,
1998 1997
Assets
Investments:
Fixed maturities:
Available for sale - at market
(amortized cost - $5,782.8 and
$3,922.0) $6,023.1 $4,099.4
Held to maturity - at amortized cost
(market $0 and $2,340.6) - 2,276.4
Equity securities - at market (cost -
$46.7 and $30.9) 85.2 83.0
Investment in affiliate 15.9 16.8
Mortgage loans on real estate 40.1 52.1
Real estate 55.1 42.0
Policy loans 220.5 241.0
Short-term investments 73.6 13.9
Total investments 6,513.5 6,824.6
Cash 59.4 36.8
Accrued investment income 97.6 101.6
Unamortized insurance acquisition costs, net 247.4 261.6
Other assets 152.5 185.2
Assets held in separate accounts 120.0 300.5
$7,190.4 $7,710.3
Liabilities and Capital
Annuity benefits accumulated $5,449.6 $5,528.1
Life, accident and health
reserves 341.6 709.9
Notes payable 131.0 135.8
Payable to affiliates, net 54.1 35.8
Deferred taxes on unrealized gains 84.3 71.8
Accounts payable, accrued
expenses and other liabilities 96.1 119.5
Liabilities related to
separate accounts 120.0 300.5
Total liabilities 6,276.7 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
- 42,576,933 and 43,199,147 shares
outstanding 42.6 43.2
Capital surplus 354.1 368.0
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 344.5 252.1
Unrealized gains on marketable
securities, net 160.1 133.2
Total stockholders' equity 688.7 583.9
$7,190.4 $7,710.3
See Notes to Consolidated Financial Statements.
F-2
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Year ended December 31,
1998 1997 1996
Revenues:
Life, accident and health premiums $170.4 $121.5 $103.6
Net investment income 506.9 494.3 467.7
Realized gains on sales of investments 10.7 5.2 1.2
Gain on sale of subsidiaries 21.6 - -
Equity in net earnings (loss) of affiliate(0.4) 0.8 (2.2)
Other income 15.3 12.4 7.0
724.5 634.2 577.3
Costs and Expenses:
Annuity benefits 261.7 278.8 271.8
Life, accident and health benefits 131.7 110.1 92.3
Insurance acquisition expenses 65.0 36.3 34.1
Trust preferred distribution requirement 19.0 15.5 1.0
Interest and other debt expenses 10.8 8.9 14.3
Provision for relocation expenses - 4.0 -
Other expenses 92.8 76.4 85.3
581.0 530.0 498.8
Income from continuing operations before
income taxes 143.5 104.2 78.5
Provision for income taxes 46.0 32.8 17.4
Income from continuing operations 97.5 71.4 61.1
Extraordinary items, net of tax (0.8) (1.5) (6.0)
Net Income $ 96.7 $ 69.9 $ 55.1
Preferred dividend requirement - 1.0 1.4
Net income applicable to Common Stock $ 96.7 $ 68.9 $ 53.7
Average number of common shares:
Basic 43.0 43.2 43.1
Diluted 43.7 43.7 43.1
Basic earnings (loss) per common share:
Continuing operations $2.27 $1.63 $1.39
Extraordinary items (0.02) (0.03) (0.14)
Net income $2.25 $1.60 $1.25
Diluted earnings (loss) per common share:
Continuing operations $2.23 $1.61 $1.39
Extraordinary items (0.02) (0.03) (0.14)
Net income $2.21 $1.58 $1.25
Cash dividends per common share $0.10 $0.10 $0.08
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,
1998 1997 1996
Preferred Stock:
Balance at beginning of year $ - $ 49.0 $ 17.0
Preferred Stock issued - - 32.0
Preferred Stock retired - (49.0) -
Balance at end of year $ - $ - $ 49.0
Common Stock:
Balance at beginning of year $ 43.2 $ 43.3 $ 43.1
Common Stock issued - - 0.2
Common Stock retired (0.6) (0.1) -
Balance at end of year $ 42.6 $ 43.2 $ 43.3
Capital Surplus:
Balance at beginning of year $368.0 $358.5 $361.1
Capital contribution - 9.3 -
Common Stock issued 0.4 0.2 2.2
Common Stock retired (14.3) (1.0) -
Common dividends declared - - (3.4)
Preferred Stock retired - 2.0 -
Preferred dividends declared - (1.0) (1.4)
Balance at end of year $354.1 $368.0 $358.5
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of year $252.1 $186.5 $131.4
Net income 96.7 69.9 55.1
Common dividends declared (4.3) (4.3) -
Balance at end of year $344.5 $252.1 $186.5
Unrealized Gains, Net:
Balance at beginning of year $133.2 $ 61.8 $ 89.3
Change during year 26.9 71.4 (27.5)
Balance at end of year $160.1 $133.2 $ 61.8
Comprehensive Income:
Net Income $ 96.7 $ 69.9 $ 55.1
Other comprehensive income - change in net
unrealized gains on
marketable securities 26.9 71.4 (27.5)
Comprehensive income $123.6 $141.3 $ 27.6
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,
1998 1997 1996
Cash Flows from Operating Activities:
Net income $ 96.7 $ 69.9 $ 55.1
Adjustments:
Extraordinary loss on prepayment of debt 0.8 1.5 6.0
Increase in life, accident and
health reserves 47.1 36.3 28.4
Benefits to annuity policyholders 261.7 278.8 271.8
Amortization of insurance
acquisition costs 55.4 36.3 34.1
Depreciation and amortization 12.6 5.1 6.5
Realized gains on sales of investments (10.7) (5.2) (1.2)
Gain on sale of subsidiaries (21.6) - -
Increase in insurance acquisition costs (117.2) (72.6) (68.5)
Increase in accrued investment income (4.5) (4.8) (7.4)
Increase in other assets (27.1) (32.6) (10.4)
Increase (decrease) in other liabilities 27.9 19.8 (6.3)
Other, net (18.3) (21.4) (2.6)
302.8 311.1 305.5
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,121.9)(1,449.9)(1,010.1)
Equity securities (23.5) (12.5) -
Real estate, mortgage loans and
other assets (25.7) (16.1) (26.7)
Purchase of subsidiaries, net of
cash acquired (9.5) (48.7) -
Maturities and redemptions of
fixed maturity
investments 673.0 408.2 255.2
Sales and decreases in:
Subsidiaries 164.6 - -
Fixed maturity investments 369.5 747.6 261.0
Equity securities 6.3 5.8 1.3
Real estate, mortgage loans and
other assets 20.4 20.9 27.8
Cash and short-term investments
of subsidiaries sold (40.5) - -
Decrease (increase) in policy loans 1.5 (1.3) 5.4
14.2 (346.0) (486.1)
Cash Flows from Financing Activities:
Fixed annuity receipts 480.6 493.7 573.8
Annuity surrenders, benefits
and withdrawals (690.4) (607.2) (517.9)
Additions to notes payable 150.0 114.0 92.7
Reductions of notes payable (156.1) (94.9) (153.2)
Issuance of trust preferred securities - 149.3 72.4
Issuance of Common Stock 0.4 - -
Retirement of Common Stock (14.9) (1.1) -
Issuance of Preferred Stock - - 32.0
Retirement of Preferred Stock - (47.0) -
Cash dividends paid (4.3) (5.3) (4.5)
(234.7) 1.5 95.3
Net increase (decrease) in cash
and short-term investments 82.3 (33.4) (85.3)
Cash and short-term investments
at beginning of year 50.7 84.1 169.4
Cash and short-term investments
at end of year $ 133.0 $ 50.7$ 84.1
See Notes to Consolidated Financial Statements.
F-5
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO NOTES
A. Description of the Company J. Stockholders' Equity
B. Summary of Significant Accounting Policies K. Income Taxes
C. Acquisitions and Sale of Subsidiaries L. Leases
D. Segments of Operations M. Earnings Per Share
E. Investments N. Contingencies
F. Investment in Affiliate O. Statutory Information
G. Unamortized Insurance Acquisition Costs P. Additional Information
H. Notes Payable Q. Quarterly Financial Data
I. Mandatorily Redeemable Preferred (Unaudited)
Securities of Subsidiary Trusts
A. DESCRIPTION OF THE COMPANY
American Annuity Group, Inc. ("AAG" or "the Company") markets retirement
products, primarily fixed and variable annuities, and various forms of life
and supplemental health insurance through independent agents, payroll
deduction plans, financial institutions and in-home sales.
American Financial Group, Inc. ("AFG") and its subsidiaries owned 82% of
AAG's Common Stock at December 31, 1998.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The accompanying Consolidated Financial Statements
include the accounts of AAG and its subsidiaries. Certain reclassifications
have been made to prior years to conform to the current year's presentation.
Acquisitions and sales of subsidiaries have resulted in certain differences
in the financial statements and have affected comparability between years.
All significant intercompany balances and transactions have been eliminated.
All acquisitions have been treated as purchases. The results of operations
of companies since their formation or acquisition are included in the
Consolidated Financial Statements.
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.
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. At December 31, 1998, AAG
reclassified "held to maturity" securities with an amortized cost of $1.9
billion to "available for sale" to give management greater flexibility to
react to changing market conditions. This reclassification resulted in an
increase of $72.4 million in the carrying value of fixed maturity
investments and an increase of $39.4 million in stockholders' equity. The
transfer had no effect on net earnings.
F-6
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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. Premiums and discounts on mortgage-backed
securities are amortized over their expected average lives using the
interest method.
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.
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 and Expenses Insurance acquisition costs and
expenses consist primarily of deferred policy acquisition costs and the
present value of future profits on business in force of acquired insurance
companies. In addition, certain marketing and commission costs are expensed
as paid and included in insurance acquisition expenses.
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.
F-7
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
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 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.
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 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 variable annuity deposits
and, in 1997, include deposits maintained by several banks under a tax-
deferred annuity program previously offered by the Funeral Services
Division, which was sold in 1998. (See Note C.)
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.
F-8
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
If the AFC tax group utilizes any of AAG's net operating losses or
deductions that originated prior to AAG's entering AFC's consolidated tax
group, AFC will pay to AAG an amount equal to the benefit received.
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax basis and are measured using
enacted tax rates. The Company recognizes deferred tax assets if it is more
likely than not that a benefit will be realized. Current and deferred tax
assets and liabilities of companies in AFC's consolidated tax group are
aggregated with other amounts receivable from or payable to affiliates.
Stock-Based Compensation As permitted under Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," AAG accounts for stock options and other stock-based
compensation plans using the intrinsic value based method prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees."
Benefit Plans AAG sponsors an Employee Stock Ownership Retirement Plan
("ESORP") covering all employees who are qualified as to age and length of
service. The ESORP, which invests primarily in securities of AAG, is a
trusteed, noncontributory plan for the benefit of the employees of AAG and
its subsidiaries. Contributions are discretionary by the directors of AAG
and are charged against earnings in the year for which they are declared.
Qualified employees having vested rights in the plan are entitled to benefit
payments at age 60.
AAG and certain of its subsidiaries provide certain benefits to eligible
retirees. The projected future cost of providing these benefits is expensed
over the period the employees earn such benefits.
Start-Up Costs Certain costs associated with introducing new products and
distribution channels are deferred by AAG and are amortized on a straight-
line basis over five years. Statement of Position ("SOP") 98-5, "Reporting
on the Costs of Start-Up Activities," was issued during the second quarter
of 1998 and is effective for fiscal years beginning after December 15, 1998.
The SOP requires that (i) costs of start-up activities be expensed as
incurred and (ii) unamortized balances of previously deferred costs be
expensed no later than the first quarter of 1999 and reported as the
cumulative effect of a change in accounting principle. AAG had
approximately $7 million in capitalized start-up costs at December 31, 1998.
Derivatives The Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," during the
second quarter of 1998. SFAS No. 133 is effective for fiscal periods (both
years and quarters) beginning after June 15, 1999. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including
derivative instruments that are embedded in other contracts, and for hedging
activities. SFAS No. 133 requires the recognition of all derivatives (both
assets and liabilities) in the statement of financial position at fair
value. Changes in fair value of derivative instruments are included in
current income or as a component of comprehensive income (outside current
income) depending on the type of derivative. Implementation of SFAS No. 133
is not expected to have a material effect on AAG's financial position or
results of operations.
F-9
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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. Basic earnings per share is 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. Per share amounts for prior
periods were restated.
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 gain on marketable securities net of deferred
taxes. Implementation of this statement had no impact on net earnings or
stockholders' equity. Appropriate data for prior periods has been added 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.
Fair Value of Financial Instruments Methods and assumptions used in
estimating fair values are described in Note P to the financial statements.
These fair values represent point-in-time estimates of value that might not
be particularly relevant in predicting AAG's future earnings or cash flows.
C. ACQUISITIONS AND SALE OF SUBSIDIARIES
In February 1999, AAG acquired Old Republic Life Insurance Company of New
York for approximately $25 million in cash. This acquisition provides AAG
with the opportunity to offer its life and annuity products in all 50
states.
In December 1997, AAG acquired GAPR for approximately $50 million in cash.
On September 30, 1998, AAG sold its Funeral Services Division for
approximately $165 million in cash realizing a $14.8 million after-tax gain.
This division included American Memorial Life Insurance Company (acquired in
1995) and Arkansas National Life Insurance Company (acquired in 1998) and
had assets of approximately
$1 billion as of the sale date.
F-10
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
D. SEGMENTS OF OPERATIONS
AAG operates in three major segments: (i) retirement products, (ii) life,
accident and health insurance and (iii) corporate and other. AAG's
retirement product companies sell tax-deferred annuities to employees of
primary and secondary educational institutions, hospitals and in the non-
qualified markets. More than one-fourth of AAG's retirement annuity
premiums came from California in 1996 to 1998. No other state accounted for
more than 10% of premiums. Sales from AAG's top two Managing General
Agencies accounted for 14% and 5% of retirement annuity premiums in 1998.
AAG's life, accident and health businesses sell various forms of life and
supplemental health products in the United States and Puerto Rico. Sales in
Puerto Rico accounted for nearly one-half of AAG's life, accident and health
premiums in 1998.
Corporate and other consists primarily of AAG (parent), AAG Holding and the
Funeral Services Division.
Effective January 1, 1998, AAG implemented SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 requires
segment information to be reported based on how management internally
evaluates the operating performance of its business units. Implementation
of this standard had no impact on AAG's financial position or results of
operations.
The following tables (in millions) show AAG's assets, revenues and operating
profit (loss) by significant business segment. Operating profit (loss)
represents total revenues (excluding realized gains) less interest and
operating expenses.
Assets 1998 1997 1996
Retirement annuities $6,419.3 $6,142.9 $5,830.2
Life, accident & health 557.4 511.7 332.6
Corporate and other (a) 197.8 1,038.9 844.8
Investment in affiliate 15.9 16.8 16.5
Total assets per balance sheet $7,190.4 $7,710.3 $7,024.1
Revenues
Retirement annuities $442.9 $437.7 $419.2
Life, accident & health 119.6 63.6 60.9
Corporate and other 130.1 126.9 98.2
Total operating revenues 692.6 628.2 578.3
Realized gains (b) 32.3 5.2 1.2
Equity in net earnings
(loss) of affiliate (0.4) 0.8 (2.2)
Total revenues per
income statement $724.5 $634.2 $577.3
Operating profit (loss) - pretax
Retirement annuities $111.6 $101.5 $ 91.7
Life, accident & health 12.6 8.0 9.5
Corporate and other (12.6) (7.3) (21.7)
Total pretax operating income 111.6 102.2 79.5
Realized gains (b) 32.3 5.2 1.2
Equity in net earnings
(loss) of affiliate (0.4) 0.8 (2.2)
Provision for relocation expenses - (4.0) -
Total pretax income per
income statement $143.5 $104.2 $ 78.5
(a) Decrease in "Corporate and other" assets reflects sale of Funeral
Services Division in 1998.
(b) Includes gain on sale of subsidiaries in 1998.
F-11
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
E. INVESTMENTS
Fixed maturity investments at December 31, consisted of the following (in
millions):
1998
Available for Sale
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and
government agencies and
authorities $ 218.0 $ 233.9 $ 15.9 $ -
States, municipalities
and political
subdivisions 34.2 36.3 2.1 -
Foreign governments 25.8 28.0 2.2 -
Public Utilities 433.1 449.3 16.2 -
Mortgage-backed securities 1,800.6 1,877.4 82.8 (6.0)
All other corporate 3,257.4 3,383.6 143.9 (17.7)
Redeemable preferred stocks 13.7 14.6 1.0 (0.1)
$5,782.8 $6,023.1 $264.1 ($23.8)
1998
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and
government agencies and
authorities $ - $ - $ - $ -
States, municipalities
and political
subdivisions - - - -
Foreign governments - - - -
Public Utilities - - - -
Mortgage-backed securities - - - -
All other corporate - - - -
Redeemable preferred stocks - - - -
$ - $ - $ - $ -
As of December 31, 1998, $1.90 billion of fixed maturities investments formerly
classified as held to maturity were reclassed to available for sale at their
market price of $1.97 billion.
1997
Available for Sale
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
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 governments 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 2,169.2 2,274.9 105.7 -
Redeemable preferred stocks 16.6 18.9 2.3 -
$3,922.0 $4,099.4 $177.5 ($0.1)
1997
Held to Maturity
Amortized Market Gross Unrealized
Cost Value Gains Losses
Fixed maturities:
U. S. Government and
government agencies and
authorities $ - $ - $ - $ -
States, municipalities
and political
subdivisions 39.8 40.2 0.4 -
Foreign governments 8.3 8.9 0.6 -
Public Utilities 360.3 366.2 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)
Redeemable preferred stocks - - - -
$2,276.4 $2,340.6 $66.5 ($2.3)
"Investing activities" related to fixed maturity investments included in
AAG's Consolidated Statement of Cash Flows consisted of the following (in
millions):
1998
Available Held to
for Sale Maturity Total
Purchases ($1,121.9) $ - ($1,121.9)
Maturities and paydowns 394.7 278.3 673.0
Sales 336.2 33.3 369.5
Gross gains 8.9 3.4 12.3
Gross losses (9.3) (0.4) (9.7)
1997
Available Held to
for Sale Maturity Total
Purchases ($1,448.5) ($1.4) ($1,449.9)
Maturities and paydowns 195.5 212.7 408.2
Sales 742.4 5.2 747.6
Gross gains 19.8 0.2 20.0
Gross losses (13.9) - (13.9)
1996
Available Held to
for Sale Maturity Total
Purchases ($893.8) ($116.3) ($1,010.1)
Maturities and paydowns 148.6 106.6 255.2
Sales 251.7 9.3 261.0
Gross gains 8.3 1.1 9.4
Gross losses (8.3) (0.3) (8.6)
Securities classified as "held to maturity" were sold for gains of $0.5
million in 1998 due to significant deterioration in the issuers'
creditworthiness. In 1997 and 1996, gains (losses) on such sales were
insignificant.
F-12
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The table below sets forth the scheduled maturities of AAG's fixed maturity
investments based on market value as of December 31:
Maturity 1998
One year or less 5%
After one year through five years 25
After five years through ten years 25
After ten years 14
69
Mortgage-backed securities 31
100%
The distribution of maturities based on amortized cost is generally the
same. Mortgage-backed securities had an estimated average life of
approximately four and one-half years at December 31, 1998.
AAG had no investments in any issue in excess of 10% of stockholders' equity
at December 31, 1998, other than investments issued or guaranteed by the
U.S. Government or government agencies.
At December 31, 1998 and 1997, 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
1998
Realized $ 2.6 $ 1.8 $6.3 ($ 3.9) $ 6.8
Change in unrealized (1.3) (13.6) - 5.2 (9.7)
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)
F-13
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Major categories of net investment income were as follows (in millions):
1998 1997 1996
Fixed maturities* $502.1 $492.6 $463.4
Other 9.5 6.4 10.8
Total investment income 511.6 499.0 474.2
Investment expenses (4.7) (4.7) (6.5)
Net investment income $506.9 $494.3 $467.7
* 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 $3.3 million in 1998, $2.9 million in 1997 and $4.7 million in
1996. (See Note P - "Related Party Transactions".)
F. INVESTMENT IN AFFILIATE
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares;
carrying value of $15.9 million at December 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 $26
million and $44 million at December 31, 1998 and 1997, respectively.
In the fourth quarter of 1998, Chiquita recorded an after-tax charge of $74
million due to significant damage to its operations as a result of
widespread flooding caused by Hurricane Mitch. Accordingly, AAG recorded
its proportionate share (4%) of this after-tax write-off. Included in
equity in Chiquita's earnings are gains of $1.0 million in 1998 and $1.3
million in 1997 attributable to Chiquita's issuance of common stock.
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.
Included in AAG's retained earnings at December 31, 1998, was $8.7 million
applicable to equity in undistributed net losses of Chiquita.
G. UNAMORTIZED INSURANCE ACQUISITION COSTS
Unamortized insurance acquisition costs consisted of the following at
December 31, (in millions):
1998 1997
Deferred policy acquisition costs $320.1 $300.6
Present value of future profits
acquired 59.9 102.0
Unearned revenues (132.6) (141.0)
$247.4 $261.6
F-14
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
A progression of AAG's present value of future profits acquired ("PVFP") is
as follows (in millions):
1998 1997 1996
Beginning balance $102.0 $ 72.5 $73.4
Addition due to acquisition 3.6 37.5 -
Reduction due to sale (32.0) - -
Interest accrued 6.4 5.3 5.4
Amortization (17.0) (13.3)(14.1)
Other (3.1) - 7.8
$ 59.9 $102.0 $72.5
The interest accrual rates used range primarily from 5% to 7%. During each
of the next five years, the PVFP is expected to decrease at a rate of
approximately 9% of the balance at the beginning of each respective year.
H. NOTES PAYABLE
Notes payable consisted of the following at December 31, (in millions):
1998 1997
Direct obligations of AAG $ 1.2 $ 1.3
Obligations of AAG Holding
(guaranteed by AAG):
6-7/8% Senior Notes due 2008 100.0 -
Bank Credit Line 27.0 107.0
11-1/8% Senior Subordinated
Notes due 2003 - 24.1
Other subsidiary debt 2.8 3.4
Total $131.0 $135.8
In January 1998, AAG Holding replaced its existing bank lines with a
$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. In February 1998, AAG Holding borrowed under the new credit
line and retired its 11-1/8% Notes realizing a pretax extraordinary loss of
$1.2 million. In June 1998, AAG Holding sold $100 million principal amount
of 6-7/8% Senior Notes and used the net proceeds to repay outstanding
indebtedness under the unsecured bank credit line.
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.
At December 31, 1998, AAG and its subsidiaries had no material amounts of
scheduled principal payments due until final maturity of the bank credit
line in 2003.
F-15
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
At December 31, 1998 and 1997, the weighted-average interest rate on amounts
borrowed under AAG Holding's bank credit lines was 6.09% and 6.80%,
respectively. At March 1, 1999, the weighted-average interest rate on its
credit line was 5.44%.
Cash interest payments were $10.9 million in 1998, $9.4 million in 1997 and
$17.4 million in 1996.
I. 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 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.
J. 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, AAG sold 320,000 shares of newly issued Preferred Stock
for $32 million (see Note P - "Related Party Transactions"). In March 1997,
AAG repurchased all 490,000 shares of its Preferred Stock for approximately
$47 million.
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.
F-16
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The change in net unrealized gains on marketable securities included the
following (in millions):
1998
Pretax Taxes Net
Unrealized holding gains on
securities arising during
the period $ 6.6 ($1.0) $ 5.6
Unrealized gain on securities
transferred from held to
maturity 60.6 (21.2) 39.4
Reclassification adjustment
for investment losses (gains)
realized in net income and
unrealized gains of
subsidiaries sold (27.8) 9.7 (18.1)
Changes in net unrealized
gains on marketable
securities $39.4 ($12.5) $26.9
1997
Pretax Taxes Net
Unrealized holding gains on
securities arising during
the period $117.6 ($41.2) $ 76.4
Unrealized gain on securities
transferred from held to
maturity - - -
Reclassification adjustment
for investment losses (gains)
realized in net income and
unrealized gains of
subsidiaries sold (7.7) 2.7 (5.0)
Changes in net unrealized
gains on marketable
securities $109.9 ($38.5) $71.4
1996
Pretax Taxes Net
Unrealized holding gains on
securities arising during
the period ($42.1) $14.6 ($27.5)
Unrealized gain on securities
transferred from held to
maturity - - -
Reclassification adjustment
for investment losses (gains)
realized in net income and
unrealized gains of
subsidiaries sold - - -
Changes in net unrealized
gains on marketable
securities ($42.1) $14.6 ($27.5)
At December 31, 1998, there were 3.0 million shares of AAG Common Stock
reserved for issuance under AAG's stock option plans. Under the plans, the
exercise price of each option equals the market price of AAG Common Stock at
the date of grant. Options generally become exercisable at the rate of 20%
per year commencing one year after grant. All options expire ten years
after the date of grant.
Data for AAG's Stock Option Plan is presented below:
1998
Average
Exercise
Shares Price
Outstanding at
beginning of year 2,178,190 $15.21
Granted 417,000 $22.51
Forfeited (90,332) $16.57
Exercised (40,778) $13.80
Outstanding at
end of year 2,464,080 $16.42
Options exercisable
at year-end 701,561 $14.43
1997
Average
Exercise
Shares Price
Outstanding at
beginning of year 1,548,969 $13.38
Granted 633,070 $19.70
Forfeited (3,849) $13.51
Exercised - -
Outstanding at
end of year 2,178,190 $15.21
Options exercisable
at year-end 309,024 $13.38
1996
Average
Exercise
Shares Price
Outstanding at
beginning of year - -
Granted 1,557,759 $13.38
Forfeited (8,790) $13.25
Exercised - -
Outstanding at
end of year 1,548,969 $13.38
Options exercisable
at year-end - n/a
The average remaining life of AAG's options was 8.5 years at December 31,
1998. The exercise prices of options issued during the year ranged from
$22.13 to $24.38 in 1998; $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 $7.5
million ($0.18 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 4.7% - 5.7% for 1998; 5.7% - 6.5% for
1997 and 6.0% for 1996 and expected life of 7.5 years.
F-17
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).
1998 1997 1996
Income before income taxes:
Continuing operations $143.5 $104.2 $78.5
Extraordinary items (1.2) (2.3) (9.2)
Income before income taxes $142.3 $101.9 $69.3
Tax computed at statutory rate $ 49.8 $ 35.7 $24.3
Effect of:
Reduction of valuation allowance (6.6) (3.5) (10.0)
Book basis over tax basis of
subsidiaries sold 2.3 - -
Other, net 0.1 (0.2) (0.1)
Total provision (all current) 45.6 32.0 14.2
Amounts applicable to extraordinary items 0.4 0.8 3.2
Provision for income tax as shown on
the Consolidated Income Statement $ 46.0 $ 32.8 $17.4
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,
1998 1997
Deferred tax assets:
Net operating loss carryforwards $29.4 $39.8
Accrued expenses 5.1 8.4
Investment securities, including
affiliate 36.3 34.7
Valuation allowance for deferred
tax assets (26.4) (33.0)
Deferred tax liabilities:
Unamortized insurance
acquisition costs (68.8) (70.6)
Policyholder liabilities (17.2) (8.8)
Capitalized assets (8.6) -
At December 31, 1998, AAG had net operating loss carryforwards for federal
income tax purposes of approximately $84 million which are scheduled to
expire from 2003 through 2005.
F-18
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
L. LEASES
Future minimum lease payments under operating leases having initial or
remaining non-cancelable lease terms in excess of one year at December 31,
1998 are payable as follows: 1999 - $5.3 million; 2000 - $5.0 million; 2001
- $4.9 million; 2002 - $4.1 million; 2003 - $4.0 million; 2004 and beyond -
$13.5 million.
Rental expense for operating leases was $4.9 million in 1998, $2.9 million
in 1997 and $2.6 million in 1996.
M. EARNINGS PER SHARE
The number of common shares outstanding used in calculating diluted earnings
per share in 1998 and 1997 include 0.7 million shares and 0.5 million
shares, respectively, 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 $6.5 million to $14.5
million. AAG is actively pursuing recovery of a portion of the costs from
the companies which provided insurance coverage for the former manufacturing
operations. At December 31, 1998, AAG had settlement offers from certain of
these insurance companies totaling more than $4 million. In addition, the
Company's reserve for environmental costs was $4.7 million at December 31,
1998.
O. 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):
1998 1997 1996
Capital and surplus $350.4 $317.0 $285.0
Asset valuation reserve 62.6 64.7 91.4
Interest maintenance reserve 20.6 23.9 24.7
Pretax income from operations $111.2 $ 91.7 $ 87.1
Net income from operations 99.9 72.7 68.1
Net income 35.6 73.6 66.2
F-19
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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, 1998,
GALIC may pay $35.6 million in dividends in 1999 without prior approval.
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,
Income Statement 1998 1997 1996*
Revenues $ 665 $ 617 $91
Pretax income 130 92 8
Net income 84 60 5
* Since November 1, 1996
Balance Sheet 1998 1997
Investments $6,291 $6,634
Unamortized insurance
acquisition costs 208 225
Assets held in separate accounts 120 300
Other assets 281 284
Insurance reserves $5,692 $6,142
Notes payable:
Due parent 115 159
Due others 130 135
Liabilities related to
separate accounts 120 300
Other liabilities 167 165
Mandatorily redeemable
preferred securities
of subsidiary trusts $ 225 $ 225
Stockholder's equity $ 451 $ 317
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.
F-20
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
In a 1997 transaction, AAG purchased a minority ownership position in a
company engaged in the production of ethanol. AAG's Chairman purchased the
remaining ownership. During 1998, this company borrowed $4.0 million from
AAG under a subordinated note bearing interest at 14% and used the proceeds
to pay a portion of a $6.3 million capital distribution, including $3.1
million to AAG. AAG's equity investment in this company at December 31,
1998 was $1.8 million. In addition, AAG has extended a $5 million line of
credit to this company; no amounts have been borrowed under the credit line.
GALIC has a line of credit with a company owned in part by AFG and a brother
of AAG's Chairman. Under the agreement, this company may borrow up to $8
million at 13% with interest deferred and added to principal. At December
31, 1998, $6.1 million was due GALIC under the line.
Net investment income includes approximately $900,000 in 1998 and 1997 and
$1 million in 1996 of payments from a subsidiary of AFG for the rental of an
office building owned by GALIC.
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:
1998 1997
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
Assets
Fixed maturity investments $6,023.1 $6,023.1 $6,375.8 $6,440.0
Equity securities 85.2 85.2 83.0 83.0
Investment in affiliate 15.9 25.6 16.8 43.6
Liabilities
Annuity benefits accumulated $5,449.6 $5,307.2 $5,28.1 $5,319.1
Notes payable 131.0 130.4 135.8 136.6
Trust preferred securities $ 225.0 $ 231.4 $ 225.0 $ 230.3
Stockholders' equity $ 688.7 $ 979.3 $ 583.9 $ 950.4
When available, fair values are based on prices quoted in the most active
market for each security, including AAG Common Stock. 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-21
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
1998
Fixed maturities - available for sale $5,782.8 $240.3 $6,023.1
Equity securities 46.7 38.5 85.2
Unamortized insurance acquisition
costs, net 256.3 (8.9) 247.4
Annuity benefits accumulated (5,424.1) (25.5) (5,449.6)
Deferred taxes on unrealized gains - (84.3) (84.3)
Unrealized gains on marketable
securities, net $160.1
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
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.
F-22
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, 1998 and
1997 (in millions, except per share data).
First Second Third Fourth Total
1998 Quarter QuarterQuarter Quarter Year
Realized gains (losses) on
sales of investments $ 10.2 $ 1.5 $ 4.0 ($ 5.0)$ 10.7
Gain on sale of subsidiaries - - 21.6 - 21.6
Total revenues 189.6 186.9 209.6 138.4 724.5
Income from continuing operations 25.7 21.7 37.3 12.8 97.5
Extraordinary items (0.8) - - - (0.8)
Net income 24.9 21.7 37.3 12.8 96.7
Earnings (loss) per common share:
Basic:
Continuing operations $0.60 $0.50 $0.87 $0.30 $2.27
Extraordinary items (0.02) - - - (0.02)
Net income $0.58 $0.50 $0.87 $0.30 $2.25
Diluted:
Continuing operations $0.59 $0.49 $0.85 $0.30 $2.23
Extraordinary items (0.02) - - - (0.02)
Net income $0.57 $0.49 $0.85 $0.30 $2.21
Average common shares outstanding
Basic 43.1 43.1 43.0 42.7 43.0
Diluted 43.8 43.9 43.7 43.4 43.7
1997
Realized gains (losses) on
sales of investments $ 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
* In the third quarter of 1997, AAG recorded a $4 million ($2.6 million
after-tax) charge relating to the relocation of Loyal American Life
Insurance Company (a wholly-owned subsidiary of AAG) 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-23
Business Summary
American Annuity Group, Inc. ("AAG" or "the Company"), which was
incorporated as a Delaware corporation in 1987, is an 83%-owned subsidiary
of American Financial Group, Inc. ("AFG"). AAG is a holding company which
markets primarily retirement annuity products as well as life and
supplemental health insurance through the following subsidiaries (in
millions):
1998
Statutory
Subsidiary - year acquired Principal Products Premiums
Great American Life Insurance Traditional fixed annuities $301
Company ("GALIC") - 1992 Equity-indexed annuities 58
Annuity Investors Life Insurance Variable annuities 89
Company ("AILIC") - 1994 Traditional fixed annuities 73
Loyal American Life Insurance Supplemental health 20
Company ("Loyal") - 1995 Supplemental life 17
Great American Life Assurance Company Life 37
of Puerto Rico, Inc. ("GAPR") - 1997 Supplemental health 11
GALIC's Life Division (formed in 1997) Term and universal life 19
GALIC and AILIC are rated A+ (Strong) by Standard & Poor's. All of the
above insurance companies are rated A (Excellent) by A.M. Best and, except
for GAPR, all are rated AA- (very high claims paying ability) by Duff &
Phelps. GAPR has not been rated by Duff & Phelps.
Acquisitions in recent years have supplemented AAG's internal growth as the
assets of the holding company and its operating subsidiaries have increased
from $4.5 billion at the end of 1992 to over $7.1 billion at the end of
1998. Premiums over the last five years were as follows (in millions):
Premiums*
Insurance Product 1998 1997 1996 1995 1994
Retirement annuities $521 $489 $540 $457 $443
Life and health 104 42 43 2 2
$625 $531 $583 $459 $445
* Table does not include premiums of subsidiaries or divisions until their
first full year following acquisition or formation. All periods exclude
premiums of subsidiaries sold.
In September 1998, AAG sold its Funeral Services Division. This division,
which included American Memorial Life Insurance Company and Arkansas
National Life Insurance Company, had assets of approximately $1 billion as
of September 30, 1998 and 1997 premiums of $111 million.
F-24
Market for AAG's Common Stock
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, 1999, there were
approximately 7,400 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.
1998 1997
High Low High Low
First quarter $23.44 $21.75 $16.63 $13.75
Second quarter 25.38 22.38 20.00 15.25
Third quarter 24.50 21.88 22.13 18.00
Fourth quarter 23.81 22.06 23.88 19.75
The Company paid annual common dividends of $.10 per share in 1998 and 1997.
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 83% of AAG's Common Stock at March 1,
1999.
F-25
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.
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, the Year 2000 issue 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.
1998 1997 1996
Earnings to fixed charges 5.6 5.1 6.0
Consolidated debt to capital 23% 25% 18%
Proforma consolidated debt to capital 13% 17% 17%
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 consolidated debt, redeemable preferred securities of subsidiary
trusts and stockholders' equity (excluding unrealized gains on fixed
maturity investments). Proforma amounts assume unrestricted cash and
marketable investments on hand at AAG (parent) have been used to reduce
consolidated debt.
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, 1998, the capital ratio of
each of AAG's principal insurance subsidiaries was at least 4.8 times its
authorized control level RBC.
F-26
Sources and Uses of Funds To pay interest and principal on borrowings,
obligations related to discontinued manufacturing operations and other
holding company costs, AAG (parent) and AAG Holding use cash and investments
on hand as well as capital distributions from their principal subsidiary,
Great American Life Insurance Company ("GALIC"). At December 31, 1998, AAG
(parent) had nearly $100 million of cash and investments on hand. The
amount of capital distributions which can be paid by GALIC is subject to
restrictions relating to statutory surplus and earnings. In 1998, GALIC
made $72 million in such payments; the maximum amount of dividends payable
by GALIC in 1999 without prior regulatory approval is $35.6 million.
In 1998, AAG and AAG Holding retired $128 million of debt (including $24
million held by affiliates) and $15 million of Common Stock using proceeds
from a public debt offering 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 nearly $270 million of
liquidity at March 1, 1999. The September 1998 sale of its Funeral Services
Division netted approximately $165 million in cash ($145 million after-tax).
The majority of the proceeds were received by AAG's insurance subsidiaries.
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, 1998, 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, 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 December 31, 1998 and 1997, respectively, AAG had approximately $240
million and $242 million in net unrealized gains on its fixed maturity
portfolio. At December 31, 1998, all of AAG's fixed maturity investments
were classified as "available for sale" (See Note B).
At December 31, 1998, AAG's mortgage-backed securities ("MBSs") portfolio
represented less than one-third of its 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.
F-27
Uncertainties
Year 2000 Status AAG's Year 2000 Project is a corporate-wide
program designed to ensure that its computer hardware and software systems,
telecommunications and other business activities function properly in the
Year 2000. The project also encompasses communicating with agents, vendors,
financial institutions and others with which the Company conducts business
to determine their Year 2000 readiness and resulting effects on AAG. As
part of the project, the Company is also developing contingency plans for
the systems and procedures deemed most critical to the Company. AAG's Year
2000 Project is being coordinated by a team of individuals from a variety of
disciplines in the organization which monitors the work being performed by
the various business units and reports frequently to senior management. The
Company's internal audit staff reports at least quarterly to the Audit
Committee of the Board of Directors on the Company's Year 2000 progress.
To address its Year 2000 issue, AAG's operations have been divided into
separate systems groups. At December 31, 1998, these groups were in the
process of either (i) testing internally developed and third party software
applications believed to be Year 2000 compliant without need for any
modifications; (ii) modifying and testing other software applications or
(iii) replacing software with new applications that are Year 2000 compliant,
and testing those replacements for operational acceptance and Year 2000
compliance.
Approximately 40% of the operating units are currently on target with their
internal plans to be completed in the second quarter of 1999. Approximately
50% of the operating units have experienced some delay and their overall
projects are running behind schedule on internally established timelines.
These groups are expected to be complete in the third quarter of 1999. One
important replacement application experienced a significant delay from its
original targeted completion date. This project was reorganized and
restaffed in the fourth quarter of 1998, and management believes the project
has made significant progress. This application is currently involved in
testing and is expected to be completed and in operation in the third
quarter of 1999.
Contingency plans provide a documented order of actions necessary to keep
the Company's business functions operating and mitigate the extent of any
potential disruptions. The Company expects to complete its contingency
planning process for all mission critical software applications and
operational processes in the second quarter of 1999, and for less
significant software applications and operational processes in the third
quarter of 1999. These plans will be tested through the balance of the
year.
Many of the systems being replaced were planned replacements, which were
accelerated due to Year 2000 considerations. A significant portion of AAG's
Year 2000 Project is being completed using internal staff. Therefore, cost
estimates for the Year 2000 Project do not represent solely incremental
costs. Since the beginning of 1997, AAG has incurred an estimated $13
million in Year 2000 costs, including capitalized costs of $10 million for
new systems; the Company expensed $3.5 million in Year 2000 costs in 1998.
AAG estimates it will spend an additional $9 million in connection with the
Year 2000 Project in 1999, of which $5 million is expected to be expensed.
Projected Year 2000 costs and completion dates are based on management's
best estimates. There can be no assurance that these estimates will be
achieved.
F-28
AAG believes it has reasonable plans in place to ensure business activities
function properly in the Year 2000. However, should software modifications
and new software installations not be completed on a timely basis, the
resulting disruptions could have a material adverse impact on operations.
AAG's operations could also be materially adversely affected by the
inability of third parties such as agents, vendors and policyholders'
employers to also function properly in the Year 2000.
Exposure to Market Risk Market risk represents the potential
economic loss arising from adverse changes in the fair value of financial
instruments. AAG's exposures to market risk relate primarily to its fixed
maturity investment portfolio, annuity contracts and long-term debt which
are exposed to interest rate risk. AAG's investments in equity securities
and derivatives were not significant at December 31, 1998.
Fixed Maturity Portfolio The fair value of AAG's fixed maturity
portfolio ($6.02 billion at December 31, 1998) is directly impacted by
changes in market interest rates. AAG's fixed maturity portfolio is
comprised of substantially all fixed rate investments with primarily short-
term and intermediate-term maturities. This practice allows flexibility in
reacting to fluctuations of interest rates. AAG's portfolio is managed with
an attempt to achieve an adequate risk-adjusted return while maintaining
sufficient liquidity to meet policyholder obligations. AAG uses various
actuarial models in an attempt to align the duration of invested assets to
the projected cash flows of policyholder liabilities.
The following table provides information about AAG's fixed maturity
investments at December 31, 1998. The table shows (dollars in millions)
principal cash flows and related weighted-average interest rates by expected
maturity dates. Callable bonds and notes are included based on call date or
maturity date depending upon which date produces the most conservative
yield. Mortgage-backed securities and sinking fund issues are included
based on maturity year adjusted for expected payment patterns. Actual cash
flows may differ from those expected.
1999 2000 2001 2002 2003 Remain
Principal Cash Flows $480 $550 $660 $700 $780 $2,680
Wtd.-Avg. Interest Rate 8.2% 7.8% 8.3% 7.8% 7.5% 7.6%
Annuity Contracts Substantially all of AAG's fixed rate annuity
contracts permit AAG to change crediting rates (subject to minimum interest
rate guarantees of 3% to 4% per annum) enabling management to react to
changes in market interest rates and maintain an adequate spread. Sales of
variable rate annuities have not been significant. Projected payments of
AAG's fixed annuity liabilities at December 31, 1998, were as follows
(dollars in millions):
1999 2000 2001 2002 2003 Remain
Annuity Payments $660 $620 $560 $500 $450 $2,610
About half of AAG's fixed annuity liabilities at December 31, 1998, were
two-tier in nature in that policyholders can receive a higher amount if they
annuitize rather than surrender their policy, even if the surrender
period has expired.
Current stated crediting rates on AAG's principal fixed annuity products
range from 3% on equity-indexed annuities (before any equity participation)
to over 7% on certain new policies (including first year bonus amounts).
AAG estimates that its effective weighted-average crediting rate over the
next five years will range from 5% to 5.2%. This range reflects actuarial
assumptions as to: (i) deaths; (ii) the number of policyholders who
annuitize and receive higher credited amounts and (iii) the number of
policyholders who surrender. Actual experience and changes in actuarial
assumptions may result in different effective crediting rates than those
above.
F-29
Debt and Preferred Securities At December 31, 1998, AAG's debt
securities had a weighted-average interest rate of 6.7% and a weighted-
average life of approximately eight years. Variable debt comprised less
than 10% of AAG's total debt and preferred securities.
At December 31, 1998, AAG's preferred securities of its subsidiary trusts
had a weighted-average dividend rate of 8.5% and a weighted-average life of
approximately 34 years, based on final maturity dates. Based on initial
optional redemption dates, the trust preferred securities had an average
life of approximately four years. (See Notes H and I.)
Results of Operations
General The operations of Great American Life Assurance Company of Puerto
Rico, Inc. ("GAPR") and Arkansas National Life Insurance Company are
included in AAG's consolidated financial statements from their dates of
acquisition in December 1997 and March 1998, respectively. On September 30,
1998, the Company sold its Funeral Services Division, which included
American Memorial Life Insurance Company and Arkansas National. The results
contained herein include the results of this division for the first nine
months of 1998 and for 1997 and 1996. Accordingly, the 1998 income
statement components are not comparable to 1997 and 1996.
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. Diluted net operating earnings per share for 1998 and
1997 were up 10% and 13%, respectively, over the 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): 1998 1997 1996
Revenues per income statement $724.5 $634.2 $577.3
Less realized gains on sales of investments (10.7) (5.2) (1.2)
Less gain on sale of subsidiaries (21.6) - -
Less equity in net loss (earnings) of affiliate 0.4 (0.8) 2.2
Operating revenues 692.6 628.2 578.3
Expenses per income statement (581.0) (530.0) (498.8)
Less provision for relocation expenses - 4.0 -
Operating expenses (581.0) (526.0) (498.8)
Operating earnings before tax 111.6 102.2 79.5
Income tax expense 35.4 32.1 17.8
Net operating earnings $ 76.2 $ 70.1 $61.7
Net operating earnings
per common share (basic) $ 1.77 $ 1.60 $ 1.40
Net operating earnings per
common share (diluted) $ 1.74 $ 1.58 $ 1.40
F-30
The Company's principal products are its fixed annuities -- Single Premium
Deferred Annuities ("SPDAs") and Flexible Premium Deferred Annuities
("FPDAs"). The following table summarizes AAG's premiums for its retirement
annuities (in millions).
1998 1997 1996
Retirement Annuity Premiums:
SPDAs $260 $254 $319
FPDAs 172 192 217
Variable annuities - flexible premium 22 6 1
Variable annuities - single premium 67 37 3
Total retirement annuity premiums $521 $489 $540
The decrease in SPDA sales in 1997 reflects primarily the decrease of
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 Item 3 - "Legal Proceedings"). Management believes that
the success of the stock market and the recent interest rate environment
have also resulted in decreased sales and persistency of traditional fixed
annuities. Sales of annuity products linked to the performance of the stock
market (equity-indexed and variable annuities) helped offset this decrease.
Life, Accident and Health Premiums and Benefits
The following table summarizes AAG's life, accident and health premiums as
shown in the Consolidated Income Statement (in millions).
Premiums 1998 1997 1996
Life insurance (excluding Funeral
Services Division) $ 62 $ 23 $ 20
Accident and health insurance 30 21 21
92 44 41
Funeral Services Division 78 78 63
$170 $122 $104
Increases in life, accident and health premiums and benefits in 1998 reflect
primarily the acquisition of GAPR. Life, accident and health premiums and
benefits increased in 1997 due primarily to an increase in pre-need life
insurance sales by AAG's Funeral Services Division which was sold in
September 1998.
Net Investment Income Net investment income increased 3% in 1998 and 6% in
1997, reflecting an increase in the Company's average fixed maturity
investment base. This increase was partially offset by decreasing market
interest rates and the sale of AAG's Funeral Services Division. Investment
income is shown net of investment expenses of $4.7 million in 1998 and 1997
and $6.5 million in 1996. Lower investment expenses in 1998 and 1997
reflect a decrease in fees charged by an affiliate. (See Notes E and P.)
Realized Gains In September 1998, AAG sold its Funeral Services Division to
that Division's biggest customer, Service Corporation International. This
customer accounted for approximately one-half of American Memorial's sales
in 1997.
Individual securities are sold from time to time as market opportunities
appear to present optimal situations under AAG's investment strategies.
F-31
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 reported net income from continuing
operations before unusual items of $55 million in 1998, $0.3 million in 1997
and $43 million in 1996. Chiquita reported net income (loss) before
extraordinary items of ($18 million) in 1998, $0.3 million in 1997 and
($28 million) in 1996. Included in AAG's equity in Chiquita's 1998 and
1997 earnings are gains attributable to Chiquita's issuance of common
stock.
Other Income Other income increased in 1998 and 1997 due primarily to
increased revenues from certain non-insurance subsidiaries and additional
insurance fees.
Annuity Benefits Annuity benefits reflect amounts accrued on annuity
policyholders' funds accumulated. The majority of AAG's fixed rate annuity
products permit AAG 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. While management believes the
interest rate and stock market environment over the last several years has
contributed to an increase in annuitizations and surrenders, the Company's
persistency rate remains approximately 88%. However, a continuation of the
current interest rate environment could adversely affect this rate.
On its deferred annuities (annuities in the accumulation phase), AAG
generally credits interest to policyholders' accounts at their current
stated "surrender" interest rates. Furthermore, for "two-tier" deferred
annuities (annuities under which a higher interest amount can be earned if a
policy is annuitized rather than surrendered), AAG accrues an additional
liability to provide for expected deaths and annuitizations. Changes in
crediting rates, actual surrender and annuitization experience or
modifications in actuarial assumptions can affect this accrual.
On immediate annuities (annuities in the pay-out phase), interest is
credited based on discount rates used at the time the policies are
annuitized. Discount rates are generally based on interest rates in effect
at annuitization.
Annuity benefits decreased 6% in 1998 due primarily to decreases in
crediting rates and changes in actuarial assumptions. Annuity benefits
increased 3% in 1997 due primarily to an increase in average annuity
benefits accumulated, partially offset by decreases in crediting rates.
Insurance Acquisition Expenses Insurance acquisition expenses include
amortization of deferred acquisition costs ("DAC") as well as certain
marketing expenses and commissions on sales of life insurance products. The
increase in 1998 reflects the acquisition of GAPR, commissions and
amortization related to increased sales of pre-need life insurance products
and increased amortization of DAC on fixed annuities due to actual
experience and changes in actuarial assumptions. Insurance acquisition
expenses also include amortization of the present value of future profits of
businesses acquired amounting to $10.6 million in 1998, $8.1 million in 1997
and $8.7 million in 1996.
Preferred Distributions and Interest Expenses Trust preferred distribution
requirements and interest and other debt expenses increased 22% in 1998 and
59% in 1997 due to higher average amounts outstanding. Issuances of debt
and preferred securities have been used to fund acquisitions and to maintain
a portfolio of investments at AAG (parent) (See "Sources and Uses of
Funds").
F-32
Provision for Relocation Expenses In 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.
Other Expenses Other expenses increased 21% in 1998, reflecting primarily:
(i) operating expenses of GAPR, which was acquired in December 1997; (ii)
higher depreciation and amortization costs and (iii) increases in personnel
costs. In 1997, other expenses decreased 10%, reflecting primarily the
absence of a $15.7 million pretax charge in 1996 related to pension and
other liabilities of the Company's former manufacturing operations.
Income Taxes AAG's effective tax rate reflects reductions of the valuation
allowance associated with certain deferred tax assets (See Note K).
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.
Recent Accounting Standards The following accounting standards have been
implemented by AAG in 1997 or 1998 or will be implemented in 1999 or 2000.
Accounting
Standard Subject of Standard
- (Year Implemented) Reference (See Note B)
SFAS #128 Earnings Per Share (1997) "Earnings Per Share"
SFAS #130 Comprehensive Income (1998) "Comprehensive Income"
SFAS #131 Segment Information (1998) "Segment Information"
SFAS #133 Derivatives (2000) "Derivatives"
SOP 98-5 Start-Up Costs (1999) "Start-Up Costs"
Implementation of Statement of Position ("SOP") 98-5 in the first quarter of
1999 will result in a one-time after-tax charge of approximately $5 million
resulting from a change in accounting principle. Implementation of
Statement of Financial Accounting Standard ("SFAS") No. 133 in the first
quarter of 2000 is not expected to have a significant effect on AAG.
Other standards issued in recent years did not apply to AAG or had only
negligible effects on AAG.
F-33
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, GAPR in December 1997 and the sale of the Funeral
Services Division in September 1998 (in millions, except per share amounts).
Income Statement Data: 1998 1997 1996 1995 1994
Total revenues $724.5 $634.2 $577.3 $439.6 $372.7
Income from continuing operations $ 97.5 $ 71.4 $ 61.1 $ 58.7 $ 40.9
Loss from discontinued operations - - - (3.2) (2.6)
Extraordinary items (0.8) (1.5) (6.0) (0.2) (1.7)
Change in accounting principle - - - - (0.5)
Net income $ 96.7 $ 69.9 $ 55.1 $ 55.3 $ 36.1
Basic earnings per common share:
Continuing operations $2.27 $1.63 $1.39 $1.45 $1.05
Discontinued operations - - - (0.08) (0.07)
Extraordinary items (0.02) (0.03) (0.14) - (0.05)
Change in accounting principle - - - - (0.01)
Net income $2.25 $1.60 $1.25 $1.37 $0.92
Diluted earnings per common share:
Continuing operations $2.23 $1.61 $1.39 $1.45 $1.05
Discontinued operations - - - (0.08) (0.07)
Extraordinary items (0.02) (0.03) (0.14) - (0.05)
Change in accounting principle - - - - (0.01)
Net income $2.21 $1.58 $1.25 $1.37 $0.92
Cash dividends per common share $0.10 $0.10 $0.08 $0.07 $0.06
Balance Sheet Data at year end:
Total assets $7,190.4 $7,710.3$7,024.1$6,611.0 $5,089.9
Notes payable 131.0 135.8 114.9 167.7 183.3
Mandatorily redeemable preferred
securities of subsidiary trust 225.0 225.0 75.0 - -
Net unrealized gains (losses)
included in stockholders' equity 160.1 133.2 61.8 89.3 (29.0)
Total stockholders' equity 688.7 583.9 486.5 429.3 204.4
F-34
