SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
March 31, 1999 No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer
I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of May 1, 1999, there were 42,380,622 shares of the Registrant's Common
Stock outstanding.
Page 1 of 21
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
March 31, December 31,
1999 1998
Assets
Investments:
Fixed maturities - at market
(amortized cost - $5,931.3 and $5,782.8) $6,092.1 $6,023.1
Equity securities - at market
(cost - $44.1 and $46.7) 82.0 85.2
Investment in affiliate 17.5 15.9
Mortgage loans on real estate 21.3 40.1
Real estate 59.0 55.1
Policy loans 219.3 220.5
Short-term investments 86.8 73.6
Total investments 6,578.0 6,513.5
Cash 24.7 59.4
Accrued investment income 99.4 97.6
Unamortized insurance acquisition costs, net 271.2 247.4
Other assets 150.5 152.5
Assets held in separate accounts 162.2 120.0
$7,286.0 $7,190.4
Liabilities and Capital
Annuity benefits accumulated $5,482.3 $5,449.6
Life, accident and health reserves 350.8 341.6
Notes payable 149.9 131.0
Payable to affiliates, net 60.0 54.1
Deferred taxes on unrealized gains 61.1 84.3
Accounts payable, accrued expenses and other
liabilities 143.4 96.1
Liabilities related to separate accounts 162.2 120.0
Total liabilities 6,409.7 6,276.7
Mandatorily redeemable preferred securities
of subsidiary trusts 219.6 225.0
Stockholders' Equity:
Common Stock, $1 par value
-100,000,000 shares authorized
- 42,379,991 and 42,576,933 shares
outstanding 42.4 42.6
Capital surplus 350.0 354.1
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 362.2 344.5
Unrealized gains on marketable
securities, net 114.7 160.1
Total stockholders' equity 656.7 688.7
$7,286.0 $7,190.4
2
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Three months ended
March 31,
1999 1998
Revenues:
Life, accident and health premiums $ 25.6 $ 46.8
Net investment income 119.9 127.0
Realized gains on sales of investments 4.0 10.2
Equity in net earnings of affiliate 1.8 2.4
Other income 3.7 3.2
155.0 189.6
Costs and Expenses:
Annuity benefits 64.9 71.1
Life, accident and health benefits 18.9 38.1
Insurance acquisition expenses 8.2 14.0
Trust preferred distribution requirement 4.7 4.8
Interest and other debt expenses 2.4 2.5
Other expenses 23.4 21.0
122.5 151.5
Income before income taxes, extraordinary item and
cumulative effect of accounting change 32.5 38.1
Provision for income taxes 10.1 12.4
Income before extraordinary item and cumulative effect
of accounting change 22.4 25.7
Extraordinary item - loss on prepayment of debt - (0.8)
Cumulative effect of accounting change (4.7) -
Net Income $ 17.7 $ 24.9
Average number of common shares:
Basic 42.5 43.1
Diluted 43.2 43.8
Basic earnings (loss) per common share:
Before extraordinary item and cumulative effect
of accounting change $0.53 $0.60
Loss on prepayment of debt - (0.02)
Cumulative effect of accounting change (0.11) -
Net income $0.42 $0.58
Diluted earnings (loss) per common share:
Before extraordinary item and cumulative effect
of accounting change $0.52 $0.59
Loss on prepayment of debt - (0.02)
Cumulative effect of accounting change (0.11) -
Net income $0.41 $0.57
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Three months ended
March 31,
1999 1998
Common Stock:
Balance at beginning of period $ 42.6 $ 43.2
Common Stock retired (0.2) (0.1)
Balance at end of period $ 42.4 $ 43.1
Capital Surplus:
Balance at beginning of period $354.1 $368.0
Common Stock issued 0.2 -
Common Stock retired (4.3) (1.7)
Balance at end of period $350.0 $366.3
Accumulated Deficit at December 31, 1992 ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Balance at beginning of period $344.5 $252.1
Net income 17.7 24.9
Balance at end of period $362.2 $277.0
Unrealized Gains, Net:
Balance at beginning of period $160.1 $133.2
Change during period (45.4) 2.7
Balance at end of period $114.7 $135.9
Comprehensive Income (Loss):
Net income $ 17.7 $ 24.9
Other comprehensive income - change in net
unrealized gains on marketable securities (45.4) 2.7
Comprehensive income (loss) ($ 27.7) $ 27.6
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Three months ended
March 31,
1999 1998
Cash Flows from Operating Activities:
Net income $ 17.7 $ 24.9
Adjustments:
Extraordinary loss on prepayment of debt - 0.8
Cumulative effect of accounting change 4.7 -
Increase in life, accident and health reserves 9.0 16.2
Benefits to annuity policyholders 64.9 71.1
Amortization of insurance acquisition costs 8.2 14.0
Equity in net earnings of affiliate (1.8) (2.4)
Depreciation and amortization 3.2 1.9
Realized gains on sales of investments (4.0) (10.2)
Increase in insurance acquisition costs (28.2) (24.3)
Increase in accrued investment income (0.7) (1.0)
Increase in other assets (6.5) (5.8)
Increase (decrease) in other liabilities 7.5 (2.3)
Other, net (3.1) (1.2)
70.9 81.7
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (405.0) (285.7)
Equity securities (4.3) (4.4)
Real estate, mortgage loans and other assets (6.8) (4.7)
Purchase of subsidiaries (26.6) (31.0)
Cash and short-term investments of
acquired subsidiaries 31.1 21.7
Maturities and redemptions of fixed
maturity investments 203.0 157.4
Sales of:
Fixed maturity investments 163.8 97.7
Equity securities 7.0 2.0
Real estate, mortgage loans and other
assets 18.8 12.5
Decrease in policy loans 1.2 0.6
(17.8) (33.9)
Cash Flows from Financing Activities:
Fixed annuity receipts 107.5 107.8
Annuity surrenders, benefits and withdrawals (191.1) (164.0)
Additions to notes payable 19.0 50.0
Reductions of notes payable (0.2) (25.5)
Issuance of Common Stock 0.2 -
Retirement of Common Stock (4.5) (1.8)
Repurchase of trust preferred securities (5.5) -
(74.6) (33.5)
Net increase (decrease) in cash and
short-term investments (21.5) 14.3
Cash and short-term investments at
beginning of period 133.0 50.7
Cash and short-term investments at
end of period $111.5 $ 65.0
5
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Description of the Company
American Annuity Group, Inc. ("AAG" or "the Company") markets 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 83% of
AAG's Common Stock at May 1, 1999.
B. Accounting Policies
Basis of Presentation The accompanying Consolidated Financial
Statements for AAG and its subsidiaries are unaudited, but management
believes that all adjustments (consisting only of normal recurring
accruals unless otherwise disclosed herein) necessary for fair
presentation have been made. The results of operations for interim
periods are not necessarily indicative of results to be expected for the
year. The financial statements have been prepared in accordance with
the instructions to Form 10-Q and therefore do not include all
information and footnotes necessary to be in conformity with generally
accepted accounting principles.
The preparation of the financial statements requires management to make
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Changes in circumstances
could cause actual results to differ materially from those estimates.
Investments All fixed maturity securities are "available for sale" and
reported at fair value with unrealized gains and losses reported as a
separate component of stockholders' equity.
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.
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Deferred Policy Acquisition Costs ("DPAC") DPAC (principally
commissions, advertising, underwriting, policy issuance and sales
expenses that vary with and are primarily related to the production of
new business) is deferred to the extent that such costs are deemed
recoverable.
DPAC related to annuities and universal life insurance products is
amortized, with interest, in relation to the present value of expected
gross profits on the policies. These expected gross profits consist
principally of estimated future net investment income and surrender,
mortality and other policy charges, less estimated future interest on
policyholders' funds, policy administration expenses and death benefits
in excess of account values. DPAC is reported net of unearned revenue
relating to certain policy charges that represent compensation for
future services. These unearned revenues are recognized as income using
the same assumptions and factors used to amortize DPAC.
To the extent that realized gains and losses result in adjustments to
the amortization of DPAC, such adjustments are reflected as components
of realized gains.
To the extent that unrealized gains (losses) from securities classified
as "available for sale" would result in adjustments to DPAC, unearned
revenues and policyholder liabilities had those gains (losses) actually
been realized, such balance sheet amounts are adjusted, net of deferred
taxes.
DPAC related to traditional life and health insurance is amortized over
the expected premium paying period of the related policies, in
proportion to the ratio of annual premium revenues to total anticipated
premium revenues. Such anticipated premium revenues were estimated
using the same assumptions used for computing liabilities for future
policy benefits.
Present Value of Future Profits Included in insurance acquisition costs
are amounts representing the present value of future profits on business
in force of 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.
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Assets Held In and Liabilities Related To Separate Accounts Separate
account assets and related liabilities represent variable annuity
deposits.
Life, Accident and Health Premiums and Benefits For traditional life,
accident and health products, premiums are recognized as revenue when
legally collectible from policyholders. Policy reserves have been
established in a manner which allocates policy benefits and expenses on
a basis consistent with the recognition of related premiums and
generally results in the recognition of profits over the premium-paying
period of the policies.
For interest-sensitive life and universal life products, premiums are
recorded in a policyholder account which is reflected as a liability.
Revenue is recognized as amounts are assessed against the policyholder
account for mortality coverage and contract expenses. Surrender
benefits reduce the account value. Death benefits are expensed when
incurred, net of the account value.
Income Taxes AAG and its principal subsidiary, Great American Life
Insurance Company ("GALIC"), have separate tax allocation agreements
with American Financial Corporation ("AFC"), a subsidiary of AFG, which
designate how tax payments are shared by members of the tax group. In
general, both companies compute taxes on a separate return basis. GALIC
is obligated to make payments to (or receive benefits from) AFC based on
taxable income without regard to temporary differences. If GALIC's
taxable income (computed on a statutory accounting basis) exceeds a
current period net operating loss of AAG, the taxes payable by GALIC
associated with the excess are payable to AFC. If the AFC tax group
utilizes any of AAG's net operating losses or deductions that originated
prior to AAG's entering AFC's consolidated tax group, AFC will pay to
AAG an amount equal to the benefit received.
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax basis and are measured
using enacted tax rates. The Company recognizes deferred tax assets if
it is more likely than not that a benefit will be realized. Current and
deferred tax assets and liabilities of companies in AFC's consolidated
tax group are aggregated with other amounts receivable from or payable
to affiliates.
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.
8
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Start-Up Costs Certain costs associated with introducing new products
and distribution channels had been deferred by AAG and were being
amortized on a straight-line basis over five years. In 1999, AAG
implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs
of Start-Up Activities". The SOP requires that (i) costs of start-up
activities be expensed as incurred and (ii) unamortized balances of
previously deferred costs be expensed and reported as the cumulative
effect of a change in accounting principle. Accordingly, effective
January 1, 1999, AAG expensed previously capitalized start-up costs
of $4.7 million (net of tax) or $0.11 per diluted share, effective
January 1, 1999.
Derivatives The Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities,"
during the second quarter of 1998. AAG must implement SFAS No. 133 by
no later than January 1, 2000. 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 in the balance sheet
of all derivatives (both assets and liabilities) 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.
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.
Comprehensive Income Comprehensive income represents 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.
Statement of Cash Flows For cash flow purposes, "investing
activities" are defined as making and collecting loans and acquiring
and disposing of debt or equity instruments and property and
equipment. "Financing activities" include annuity receipts, benefits
and withdrawals and obtaining resources from owners and providing
them with a return on their investments. All other activities are
considered "operating." Short-term investments having original
maturities of three months or less when purchased are considered to
be cash equivalents for purposes of the financial statements.
C. Acquisitions and Sale of Subsidiaries
In February 1999, AAG acquired Old Republic Life Insurance Company of
New York for approximately $27 million in cash.
In September 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.
9
AMERICAN ANNUITY GROUP, INC. 10-Q
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 the first quarter of
1999. No other state accounted for more than 10% of premiums. Sales
from AAG's top two Managing General Agencies accounted for 12% and 4% of
retirement annuity premiums in the first quarter of 1999.
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 the first quarter of 1999.
Corporate and other consists primarily of AAG (parent), AAG Holding and,
in 1998, the Funeral Services Division.
In the first quarter of 1999, 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 revenues and operating
profit (loss) by significant business segment. Operating profit (loss)
represents total revenues (excluding realized gains) less interest and
operating expenses.
Three months ended March 31,
1999 1998
Revenues
Retirement annuities $110.6 $107.8
Life, accident & health 33.4 30.6
Corporate and other 5.2 38.6
Total operating revenues 149.2 177.0
Realized gains 4.0 10.2
Equity in net earnings of affiliate 1.8 2.4
Total revenues per income statement $155.0 $189.6
Operating profit (loss) - pretax
Retirement annuities $ 30.2 $ 24.7
Life, accident & health 2.3 3.8
Corporate and other (5.8) (3.0)
Total pretax operating income 26.7 25.5
Realized gains 4.0 10.2
Equity in net earnings of affiliate 1.8 2.4
Total pretax income per income
statement $ 32.5 $ 38.1
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
E. Investments
"Investing activities" related to fixed maturity investments in AAG's
Statement of Cash Flows, for the three months ending March 31, consisted
of the following (in millions):
Held to Available
Maturity for Sale Total
1999
Purchases $ - ($405.0) ($405.0)
Maturities and paydowns - 203.0 203.0
Sales - 163.8 163.8
1998
Purchases $ - ($285.7) ($285.7)
Maturities and paydowns 75.0 82.4 157.4
Sales 18.3* 79.4 97.7
* Sold at a gain of $0.4 million in the first quarter of 1998 due to
significant deterioration of the issuers' creditworthiness.
At March 31, 1999, AAG's fixed maturity portfolio was comprised of
corporate bonds (57%), mortgage-backed securities (31%), public
utilities (7%) and government securities (5%).
F. Investment in Affiliate
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares;
carrying value of $17.5 million at March 31, 1999) 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 $27
million at March 31, 1999 and $26 million at December 31, 1998.
Included in equity in Chiquita's earnings for the first quarter of 1998
is a $0.9 million gain attributable to Chiquita's issuance of common
stock.
G. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
March 31, December 31,
1999 1998
Deferred policy acquisition costs $347.7 $320.1
Present value of future profits acquired 58.6 59.9
Unearned revenues (135.1) (132.6)
$271.2 $247.4
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
H. Notes Payable
Notes payable consisted of the following (in millions):
March 31, December 31,
1999 1998
Direct obligations of AAG $ 1.2 $ 1.2
Obligations of AAG Holding (guaranteed by AAG):
6-7/8% Senior Notes due 2008 100.0 100.0
Bank Credit Line 46.0 27.0
Other subsidiary debt 2.7 2.8
Total $149.9 $131.0
AAG Holding has a $200 million revolving credit agreement with several
banks. Loans under the bank credit agreement mature from 2000 to 2003
and bear interest at floating rates based on prime or Eurodollar. At
March 31, 1999, and December 31, 1998, the weighted-average interest
rate on amounts borrowed under AAG Holding's bank credit line was 5.46%
and 6.09%, respectively.
In February 1998, AAG Holding borrowed $50 million under the credit line
and retired its 11-1/8% Notes realizing a pretax extraordinary loss of
$1.2 million.
At March 31, 1999, AAG and its subsidiaries had no material amounts of
scheduled principal payments due until final maturity of the bank credit
line in 2003.
I. Mandatorily Redeemable Preferred Securities of Subsidiary Trusts
Wholly-owned subsidiary trusts of AAG Holding issued $225 million of
preferred securities and, in turn, purchased a like amount of AAG
Holding subordinated debt which provides 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:
Optional
Date of Issue Redemption
Issuance (Maturity Date) 3/31/99 12/31/98 Dates
November 1996 9-1/4% TOPrS* $74,600,000 $75,000,000 On or after
(2026) 11/7/2001
March 1997 8-7/8% Preferred
Securities (2027) 70,000,000 75,000,000 On or after
3/1/2007
May 1997 7-1/4% ROPES**
(2041) 75,000,000 75,000,000 Prior to
9/28/2000 and
after 9/28/2001
* Trust Originated Preferred Securities
** Remarketed Par Securities
In the first quarter of 1999 AAG repurchased $5.4 million of its preferred
securities for $5.5 million in cash.
AAG and AAG Holding effectively provide an unconditional guarantee of the
Trusts' obligations.
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred
Stock, par value $1.00 per share.
At March 31, 1999, 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.
"Retained earnings since January 1, 1993" reflects
accumulated changes in AAG's retained earnings since its
acquisition of GALIC.
The change in net unrealized gains on marketable securities for the
three months ended March 31 included the following (in millions):
1999 1998
Pretax Taxes Net Pretax Taxes Net
Unrealized holding
gains (losses) on
securities arising
during the period ($64.6) $21.8 ($42.8) $5.9 ($2.0) $3.9
Reclassification adjustment
for investment
gains realized in
net income (4.0) 1.4 (2.6) (1.8) 0.6 (1.2)
Change in net unrealized
gains on marketable
securities ($68.6) $23.2 ($45.4) $4.1 ($1.4) $2.7
K. Earnings Per Share
The number of common shares outstanding used in calculating diluted
earnings per share in the first quarter of 1999 and 1998,
respectively, includes 0.7 million shares for the effect of the
assumed exercise of AAG's outstanding stock options.
L. 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. AAG is
actively pursuing recovery of a portion of the costs from the
companies which provided insurance coverage for the former
manufacturing operations. No assurance can be given as to the
ultimate amount which may be recovered.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
M. Additional Information
Statutory Information of Great American Life Insurance
Company Insurance companies are required to file financial
statements with state insurance regulatory authorities
prepared on an accounting basis prescribed or permitted by
such authorities (statutory basis). Certain statutory
amounts for GALIC, AAG's primary insurance subsidiary, were
as follows (in millions):
March 31, December 31,
1999 1998
Capital and surplus $352.4 $350.4
Asset valuation reserve 67.2 62.6
Interest maintenance reserve 20.8 20.6
Three months ended March 31,
1999 1998
Pretax income from operations $11.1 $20.1
Net income from operations 8.3 16.2
Net income 8.4 16.0
The amount of dividends which can be paid by GALIC without prior approval of
regulatory authorities is subject to restrictions relating to capital and
surplus and statutory net income. Based on net income for the year ended
December 31, 1998, GALIC may pay $35.6 million in dividends in 1999 without
prior approval.
14
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
American Annuity Group, Inc. ("AAG" or "the Company") and its subsidiary,
AAG Holding Company, Inc., are organized as holding companies with nearly
all of their operations being conducted by their subsidiaries. These
companies, however, have continuing expenditures for administrative
expenses, corporate services, satisfaction of liabilities in connection with
discontinued operations and for the payment of interest and principal on
borrowings and stockholder dividends.
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 March 31, 1999, 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 complete in the second quarter of 1999. Approximately
60% of the operating units have experienced some delay and their overall
projects are running behind schedule on internally established timelines.
Substantially all of these systems have been remediated and testing is
expected to be completed 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 $17
million in Year 2000 costs, including
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
capitalized costs of $12 million for new systems; the Company expensed $3.5
million in Year 2000 costs in 1998 and $1.7 million in the first quarter of
1999. AAG estimates it will spend an additional $6 million in connection
with the Year 2000 Project during the remainder of 1999, of which $4 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.
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.
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 AAG's earnings to fixed charges continue to exceed 5 times; its
consolidated debt to capital ratio remains under 25%. Consolidated debt
includes the Company's notes payable and its Remarketed Par Securities
("ROPES"). Capital represents the sum of consolidated debt, redeemable
preferred securities of subsidiary trusts and stockholders' equity
(excluding unrealized gains on fixed maturity investments).
AAG's proforma consolidated debt to capital ratio remains well under 20%.
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 March 31, 1999, the capital ratios of
each of AAG's principal insurance subsidiaries was at least 4.8 times its
authorized control level RBC.
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 March 31, 1999, 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. The maximum amount
of dividends payable by GALIC during the remainder of 1999 without prior
regulatory approval is $35.6 million.
In the first quarter of 1999, AAG repurchased $5 million of its preferred
securities and $4 million of Common Stock using cash on hand and bank
borrowings.
Including cash and investments on hand and the unused availability under a
bank line of credit, AAG and AAG Holding had approximately $250 million of
liquidity at March 31, 1999. 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.
AAG invests primarily in fixed income investments which, including loans and
short-term investments, comprised 98% of its investment portfolio at March
31, 1999. AAG generally invests in securities with intermediate-term
maturities with an objective of optimizing interest yields while maintaining
an appropriate relationship of maturities between AAG's assets and expected
liabilities.
At March 31, 1999, 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.
The NAIC assigns quality ratings to publicly traded as well as privately
placed securities. At March 31, 1999, 92% 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.
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
RESULTS OF OPERATIONS
General In September 1998, AAG sold its Funeral Services Division.
Accordingly, certain 1999 income statement components are not comparable to
1998.
Pretax earnings from operations (before realized gains, equity in results of
affiliate, extraordinary item and accounting change) for the first quarter
of 1999 and 1998 were $26.7 million and $25.5 million, respectively. On a
diluted basis, net earnings from operations (before realized gains, equity
in earnings of affiliate, extraordinary item and accounting change) for the
same periods were $0.43 per share and $0.40 per share, respectively.
Retirement Products The following table summarizes AAG's premiums for its
retirement annuities (in millions).
Three months ended
March 31,
1999 1998
Retirement Annuity Premiums:
Single premium deferred annuities $ 52 $ 52
Flexible premium deferred annuities 41 45
Variable annuities - single premium 35 13
Variable annuities - flexible premium 12 4
Total $140 $114
Management believes that the performance of the stock market and the recent
interest rate environment have 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 The following table summarizes AAG's
life, accident and health premiums as shown in the Consolidated Income
Statement (in millions).
Life, Accident and Health Premiums: 1999 1998
Life insurance (excluding Funeral
Services Division) $18 $17
Accident and health insurance 8 6
26 23
Funeral Services Division - 24
$26 $47
Net Investment Income Net investment income decreased 6% in 1999 from the
comparable three month period in 1998 resulting primarily from less invested
assets due to the sale of the Funeral Services Division.
Realized Gains Individual securities are sold from time to time as market
opportunities appear to present optimal situations under AAG's investment
strategies.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Equity in Net Earnings of Affiliate Equity in net earnings of affiliate
represents AAG's proportionate share of the results of Chiquita Brands
International. Chiquita reported net income for the first quarter of 1999
and 1998 of $49 million and $41 million, respectively. Included in equity
in Chiquita's first quarter 1998 earnings is a gain attributable to
Chiquita's issuance of common stock.
Annuity Benefits Annuity benefits reflect 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% or 4% per annum). As a result,
management has been able to react to changes in market interest rates and
maintain a desired interest rate spread.
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 9% in the first quarter of 1999 compared to the
same period in 1998 due primarily to (i) decreases in crediting rates, (ii)
changes in actuarial assumptions, (iii) the sale of the Funeral Services
Division and (iv) decreased sales and persistency of fixed annuities.
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.
Insurance acquisition expenses also include amortization of the present
value of future profits of businesses acquired. The decrease in the first
quarter of 1999 compared to the same period in 1998 reflects primarily the
sale of the Funeral Services Division.
Preferred Distributions and Interest Expenses Trust preferred distribution
requirements and interest and other debt expenses decreased 3% in the first
quarter of 1999 compared to the same period in 1998 due primarily to lower
preferred amounts and average borrowings outstanding.
Other Expenses Increases in other expenses reflect (i) higher depreciation
and amortization expenses and (ii) operating expenses of relatively recent
start-up activities. AAG had previously deferred such operating expenses
(see "Accounting Change" below).
Extraordinary Item Extraordinary item reflects AAG's losses, net of tax,
on retirements of its debt.
19
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Accounting Change In the first quarter of 1999, AAG implemented Statement
of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities."
The SOP requires that costs of start-up activities be expensed as incurred
and that unamortized balances of previously deferred costs be expensed and
reported as the cumulative effect of a change in accounting principle.
Accordingly, AAG expensed previously capitalized start-up costs of $4.7
million (net of tax) in the first quarter of 1999.
ITEM 3
Qualitative and Quantitative Disclosure About Market Risk
As of March 31, 1999, there were no material changes to the information
provided in AAG's Form 10-K for 1998 under the caption "Exposure to Market
Risk" in Management's Discussion and Analysis of Financial Condition and
Results of Operations.
20
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 1
Legal Proceedings
In January 1999, GALIC was named a defendant in a purported class action
lawsuit (Woodward v. Great American Life Insurance Company, Hamilton County
Court of Common Pleas, Case No. A9900587, filed February 2, 1999). The
complaint seeks unspecified damages based on alleged (i) failure of GALIC to
allow the tax-free transfer of the annuity value of certain annuities to
other product providers, and (ii) misleading disclosures concerning GALIC's
interest crediting practices. The Company has not completed its review of
the complaint but believes it has meritorious defenses. However, it is too
early to predict the ultimate outcome of this action and its impact on the
Company.
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of March 31, 1999. For
submission in electronic filing only.
(b) Report on Form 8-K - None
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned duly authorized.
American Annuity Group, Inc.
May 14, 1999 BY:/s/William J. Maney
William J. Maney
Senior Vice President, Treasurer
and Chief Financial Officer
21
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