SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
June 30, 2000 No. 1-11632
GREAT AMERICAN FINANCIAL RESOURCES, INC.
(formerly American Annuity Group, Inc.)
Incorporated under IRS Employer
I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of August 1, 2000, there were 42,289,406 shares of the Registrant's
Common Stock outstanding.
Page 1 of 20
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
PART I
FINANCIAL INFORMATION
GREAT AMERICAN FINANCIAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
June 30, December 31,
2000 1999
Assets
Investments:
Fixed maturities - at market
(amortized cost - $6,114.7 and $6,073.2) $5,954.8 $5,946.7
Equity securities - at market
(cost - $39.5 and $43.6) 48.3 72.3
Investment in affiliate 13.8 12.3
Mortgage loans on real estate 24.2 16.0
Real estate 72.6 73.6
Policy loans 214.6 217.2
Short-term investments 22.0 80.2
Total investments 6,350.3 6,418.3
Cash 37.0 39.4
Accrued investment income 98.1 98.0
Unamortized insurance acquisition costs, net 454.0 406.2
Deferred taxes on unrealized losses 44.2 27.2
Other assets 229.8 214.4
Variable annuity assets (separate accounts) 529.6 354.4
$7,743.0 $7,557.9
Liabilities and Capital
Annuity benefits accumulated $5,473.5 $5,519.5
Life, accident and health reserves 546.8 520.6
Notes payable 202.8 201.3
Payable to affiliates, net 72.7 69.8
Accounts payable, accrued expenses and other
liabilities 190.3 147.0
Variable annuity liabilities
(separate accounts) 529.6 354.4
Total liabilities 7,015.7 6,812.6
Mandatorily redeemable preferred securities
of subsidiary trusts 217.9 219.6
Stockholders' Equity:
Common Stock, $1 par value
-100,000,000 shares authorized
-42,288,084 and 42,374,086 shares
outstanding 42.3 42.4
Capital surplus 348.5 349.7
Retained earnings 202.0 186.5
Unrealized losses on marketable
securities, net (83.4) (52.9)
Total stockholders' equity 509.4 525.7
$7,743.0 $7,557.9
2
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
GREAT AMERICAN FINANCIAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(In millions, except per share amounts)
Three Six
months ended months ended
June 30, June 30,
2000 1999 2000 1999
Revenues:
Life, accident and health premiums $ 49.7 $ 24.0 $ 99.6 $ 48.7
Net investment income 126.5 122.9 249.8 242.8
Realized gains (losses) on investments (0.8) (2.3) (3.7) 1.7
Other income 12.8 5.1 23.7 10.0
188.2 149.7 369.4 303.2
Costs and Expenses:
Annuity benefits 65.4 63.6 131.6 128.5
Life, accident and health benefits 36.9 16.0 73.6 34.9
Insurance acquisition expenses 18.8 10.5 34.0 18.7
Trust preferred distribution requirement 4.6 4.5 9.2 9.2
Interest and other debt expenses 3.7 2.7 7.3 5.1
Provision for litigation costs 32.5 - 32.5 -
Other expenses 32.4 26.0 64.2 49.7
194.3 123.3 352.4 246.1
Operating earnings (loss) before income taxes (6.1) 26.4 17.0 57.1
Provision (credit) for income taxes (4.0) 8.0 2.5 17.5
Net operating earnings (loss) (2.1) 18.4 14.5 39.6
Equity in earnings of affiliate, net of tax 0.2 - 1.0 1.2
Income (loss) before accounting change (1.9) 18.4 15.5 40.8
Cumulative effect of accounting change,
net of tax - - - (4.7)
Net Income (Loss) ($ 1.9)$ 18.4 $ 15.5 $ 36.1
Basic earnings (loss) per common share:
Income (loss) before accounting change ($0.04) $0.43 $0.37 $0.96
Accounting change - - - (0.11)
Net income (loss) ($0.04) $0.43 $0.37 $0.85
Diluted earnings (loss) per common share:
Income (loss) before accounting change ($0.05) $0.43 $0.36 $0.95
Accounting change - - - (0.11)
Net income (loss) ($0.05) $0.43 $0.36 $0.84
Average number of common shares:
Basic 42.3 42.4 42.3 42.5
Diluted 42.6 43.1 42.6 43.1
3
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
GREAT AMERICAN FINANCIAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Six months ended
June 30,
2000 1999
Common Stock:
Balance at beginning of period $ 42.4 $ 42.6
Common Stock retired (0.1) (0.2)
Balance at end of period $ 42.3 $ 42.4
Capital Surplus:
Balance at beginning of period $349.7 $354.1
Common Stock issued 0.6 0.2
Common Stock retired (1.8) (4.3)
Balance at end of period $348.5 $350.0
Retained Earnings:
Balance at beginning of period $186.5 $131.9
Net income 15.5 36.1
Balance at end of period $202.0 $168.0
Unrealized Gains (Losses), Net:
Balance at beginning of period ($ 52.9) $160.1
Change during period (30.5) (113.3)
Balance at end of period ($ 83.4) $ 46.8
Comprehensive Income (Loss):
Net income $ 15.5 $ 36.1
Other comprehensive loss - change in net
unrealized losses on marketable securities (30.5) (113.3)
Comprehensive loss ($ 15.0) ($ 77.2)
4
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
GREAT AMERICAN FINANCIAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Six months ended
June 30,
2000 1999
Cash Flows from Operating Activities:
Net income $ 15.5 $ 36.1
Adjustments:
Cumulative effect of accounting change - 4.7
Equity in earnings of affiliate, net of tax (1.0) (1.2)
Increase in life, accident and health reserves 26.2 16.3
Benefits to annuity policyholders 131.6 128.5
Amortization of insurance acquisition costs 34.0 18.7
Depreciation and amortization 5.5 4.1
Realized losses (gains) 3.7 (1.7)
Increase in insurance acquisition costs (70.6) (59.2)
Other, net (8.4) 14.6
136.5 160.9
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (439.9) (797.8)
Equity securities (3.1) (6.1)
Real estate, mortgage loans and other assets (11.3) (13.0)
Purchase of subsidiaries - (26.6)
Cash and short-term investments of acquired
subsidiaries - 31.1
Maturities and redemptions of fixed maturity
investments 199.9 369.4
Sales of:
Fixed maturity investments 216.9 324.8
Equity securities 9.4 7.6
Real estate, mortgage loans and other assets 0.3 23.5
Decrease in policy loans 2.6 2.8
(25.2) (84.3)
Cash Flows from Financing Activities:
Fixed annuity receipts 251.1 219.2
Annuity surrenders, benefits and withdrawals (387.6) (358.1)
Net transfers to variable annuity assets (34.2) (8.7)
Additions to notes payable 2.0 48.1
Reductions of notes payable (0.5) (0.4)
Issuance of Common Stock 0.6 0.2
Retirement of Common Stock (1.9) (4.5)
Repurchase of trust preferred securities (1.4) (5.5)
(171.9) (109.7)
Net decrease in cash and short-term investments (60.6) (33.1)
Beginning cash and short-term investments 119.6 133.0
Ending cash and short-term investments $ 59.0 $ 99.9
5
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Description of the Company
Great American Financial Resources, Inc. ("GAFRI" or "the Company"),
formerly known as American Annuity Group, Inc., 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
GAFRI's Common Stock at August 1, 2000.
B. Accounting Policies
Basis of Presentation The accompanying Consolidated Financial
Statements for GAFRI and its subsidiaries are unaudited; however,
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.
Certain reclassifications have been made to prior periods to conform to
the current period's presentation. 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 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 considered "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 GAFRI'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 GAFRI'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.
6
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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 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,
7
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
mortality, morbidity and surrenders and include provisions for
unfavorable deviations. Reserves established for accident and health
claims are modified as necessary to reflect actual experience and
developing trends.
The liability for future policy benefits for interest sensitive life and
universal life policies is equal to the sum of the accumulated fund
balances under such policies.
Variable Annuity Assets and Liabilities Separate accounts related to
variable annuities represent deposits invested in underlying investment
funds on which GAFRI earns a fee. The investment funds are selected and
may be changed only by the policyholder.
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 GAFRI and 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 or loss without regard to temporary differences. If
GALIC's taxable income (computed on a statutory accounting basis)
exceeds a current period net operating loss of GAFRI, the taxes payable
or recoverable by GALIC associated with the excess are payable to or
receivable from AFC. If the AFC tax group utilizes any of GAFRI's net
operating losses or deductions that originated prior to GAFRI's entering
AFC's consolidated tax group, AFC will pay to GAFRI 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", GAFRI 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."
8
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Benefit Plans GAFRI 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 GAFRI, is a trusteed, noncontributory plan for the benefit of the
employees of GAFRI and its subsidiaries. Contributions are
discretionary by the directors of GAFRI 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.
GAFRI 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 Prior to 1999, certain costs associated with
introducing new products and distribution channels had been deferred and
amortized on a straight-line basis over five years. In 1999, GAFRI
implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs
of Start-Up Activities." The SOP required 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, GAFRI 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. SFAS No. 133 establishes accounting
and reporting standards for derivative instruments, including derivative
instruments that are embedded in other contracts, and for hedging
activities and must be implemented no later than January 1, 2001. SFAS
No. 133 requires the recognition of all derivatives (both assets and
liabilities) in the balance sheet 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 GAFRI'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.
Statement of Cash Flows For cash flow purposes, "investing activities"
are defined as making and collecting loans and acquiring and disposing
of debt or equity instruments and property and equipment. "Financing
activities" include annuity receipts, benefits and withdrawals and
obtaining resources from owners and
providing them with a return on their investments. All other activities
are considered "operating." Short-term investments having original
maturities of three months or less when purchased are considered to be
cash equivalents for purposes of the financial statements.
9
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
C. Acquisitions and Sale of Subsidiaries
In October 1999, GAFRI acquired United Teacher Associates Insurance
Company for $81 million in cash, pending post-closing adjustments under
which GAFRI may receive as much as several million dollars.
In July 1999, GAFRI acquired Consolidated Financial Corporation, an
insurance agency, for approximately $21 million in cash.
In February 1999, GAFRI acquired Great American Life Insurance Company
of New York (formerly known as Old Republic Life Insurance Company of
New York) for approximately $27 million in cash.
D. Segments of Operations
GAFRI operates in three major segments: (i) retirement products, (ii)
life, accident and health insurance and (iii) corporate and other.
GAFRI's retirement product companies sell tax-deferred annuities to
employees of primary and secondary educational institutions, hospitals
and in the non-qualified markets. Approximately one-fourth of GAFRI's
retirement annuity premiums came from California in the first six months
of 2000. No other state accounted for more than 10% of premiums. Sales
from GAFRI's top two Managing General Agencies accounted for one-seventh
of retirement annuity premiums in the first six months of 2000.
GAFRI'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 approximately 25% of GAFRI's life,
accident and health premiums in the first six months of 2000.
Corporate and other consists primarily of GAFRI (parent) and AAG
Holding.
10
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The following table shows GAFRI's revenues and operating profit (loss) by
significant business segment (in millions):
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
Revenues
Retirement products $119.7 $113.9 $235.1 $225.8
Life, accident & health:
U.S. 52.9 21.8 104.7 42.3
Puerto Rico 14.4 13.3 29.0 27.1
Corporate and other 2.0 3.0 4.3 6.3
Total operating revenues 189.0 152.0 373.1 301.5
Realized gains (losses) (0.8) (2.3) (3.7) 1.7
Total revenues per statement
of operations $188.2 $149.7 $369.4 $303.2
Operating profit (loss) - pretax
Retirement products $ 39.1 $ 29.4 $ 72.3 $ 60.7
Life, accident & health:
U.S. (1.6) 1.9 0.9 4.1
Puerto Rico 2.2 2.4 4.2 4.3
Corporate and other (12.5) (5.0) (24.2) (13.7)
Pretax earnings from operations 27.2 28.7 53.2 55.4
Provision for litigation costs (32.5) - (32.5) -
Realized gains (losses) (0.8) (2.3) (3.7) 1.7
Total pretax income (loss) per
statement of operations ($ 6.1)$ 26.4 $ 17.0 $ 57.1
11
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
E. Investment in Affiliate
Investment in affiliate reflects GAFRI's 4% ownership (2.7 million
shares; carrying value of $13.8 million at June 30, 2000) of the common
stock of Chiquita Brands International which is accounted for under the
equity method. AFG and its other subsidiaries own an additional 32%
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 GAFRI's investment in Chiquita was approximately $11
million at June 30, 2000 and $13 million at December 31, 1999.
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
June 30, December 31,
2000 1999
Deferred policy acquisition costs $492.7 $435.7
Present value of future profits acquired 111.3 115.1
Unearned revenues (150.0) (144.6)
$454.0 $406.2
G. Notes Payable
Notes payable consisted of the following (in millions):
June 30, December 31,
2000 1999
Direct obligations of GAFRI $ 2.1 $ 2.2
Obligations of AAG Holding
(guaranteed by GAFRI):
6-7/8% Senior Notes due 2008 100.0 100.0
Bank Credit Line 99.0 97.0
Other subsidiary debt 1.7 2.1
Total $202.8 $201.3
AAG Holding has a floating rate revolving credit agreement with several
banks under which it may borrow a maximum of $200 million through
September 29, 2000. The maximum amount available reduces quarterly
between September 30, 2000 and December 31, 2003. At June 30, 2000, and
December 31, 1999, the weighted-average interest rate on amounts
borrowed under AAG Holding's bank credit line was 7.34% and 6.76%,
respectively.
At June 30, 2000, scheduled principal payments on debt for the remainder
of 2000 and the subsequent five years were as follows (in millions):
2000 2001 2002 2003 2004 2005
$0.5 $0.7 $37.7 $62.6 $0.2 $0.2
12
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
H. 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) 6/30/00 12/31/99 Dates
November 1996 9-1/4% TOPrS* (2026) $72,912,500 $74,600,000 On or after
11/7/2001
March 1997 8-7/8% Preferred
Securities (2027) 70,000,000 70,000,000 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 six months of 2000, GAFRI repurchased $1.7 million of
its preferred securities for $1.4 million in cash.
In the first quarter of 1999, GAFRI repurchased $5.4 million of its
preferred securities for $5.5 million in cash.
GAFRI and AAG Holding effectively provide an unconditional guarantee
of the Trusts' obligations.
I. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred
Stock, par value $1.00 per share.
At June 30, 2000, there were 4.0 million shares of GAFRI Common
Stock reserved for issuance under GAFRI's stock option plans. Under
the plans, the exercise price of each option equals the market price
of GAFRI 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.
The change in net unrealized losses on marketable securities for the
six months ended June 30 included the following (in millions):
2000 1999
Pretax Taxes Net Pretax Taxes Net
Unrealized holding
losses on securities
arising during the period ($51.2) $18.3 ($32.9) ($170.7) $58.4 ($112.3)
Reclassification adjustment
for investment
losses (gains) realized
in net income 3.7 (1.3) 2.4 (1.5) 0.5 (1.0)
Change in net unrealized
losses on
marketable securities ($47.5) $17.0 ($30.5) ($172.2) $58.9 ($113.3)
13
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. Earnings Per Share
The number of common shares outstanding used in calculating diluted
earnings per share in both the second quarter and first six months
of 2000 includes 0.3 million shares compared to 0.7 million shares
for the second quarter of 1999 and 0.6 million shares for the first
six months of 1999 for the effect of the assumed exercise of GAFRI's
stock options.
K. Contingencies; Litigation Costs
In the second quarter of 2000, the Company recorded a charge of
$32.5 million for liabilities related to various litigation in which
the Company or one of its subsidiaries is a defendant. The charge
represents amounts that the Company has already agreed to pay and
estimates of the ultimate liability in certain cases not yet
finalized. Other than as disclosed in "Legal Proceedings" in Part
II of this report, there have been no significant changes to the
matters discussed and referred to in Note N "Contingencies" of
GAFRI's Annual Report on Form 10K for 1999.
L. Additional Information
Statutory Information of Great American Life Insurance
Company Insurance companies are required to file financial
statements with state insurance regulatory authorities
prepared on an accounting basis prescribed or permitted by
such authorities (statutory basis). Certain statutory
amounts for GALIC, GAFRI's primary insurance subsidiary,
were as follows (in millions):
June 30, December 31,
2000 1999
Capital and surplus $392.2 $403.8
Asset valuation reserve 61.6 66.5
Interest maintenance reserve 4.5 9.8
Six months ended June 30,
2000 1999
Pretax income from operations $38.2 $19.5
Net income from operations 29.7 14.8
Net income 32.1 15.0
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, 1999, GALIC may pay $40.4
million in dividends in 2000 without prior approval. In the first
six months of 2000, GALIC paid $20 million in dividends.
14
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
Great American Financial Resources, Inc. ("GAFRI" or "the Company") and its
subsidiary, AAG Holding Company, Inc., are organized as holding companies
with nearly all of their operations being conducted by their subsidiaries.
These companies, however, have continuing expenditures for administrative
expenses, corporate services, satisfaction of liabilities in connection with
discontinued operations and for the payment of interest and principal on
borrowings and stockholder dividends.
Forward-Looking Statements The Private Securities Litigation Reform Act of
1995 encourages corporations to provide investors with information about the
Company's anticipated performance and provides protection from liability if
future results are not the same as management's expectations. This document
contains certain forward-looking statements that are based on assumptions
which management believes are reasonable, but, by their nature, inherently
uncertain. Future results could differ materially from those projected.
Factors that could cause such differences include, but are not limited to:
changes in economic conditions, regulatory actions and competitive
pressures. GAFRI undertakes no obligation to update any forward-looking
statements.
IT Initiative In 1999, AFG initiated an enterprise-wide study of its
Information Technology ("IT") resources, needs and opportunities (including
those of GAFRI). GAFRI expects that the initiative will entail extensive
effort and costs and may lead to substantial changes in the area, which
should result in significant cost savings, efficiencies and effectiveness in
the future. While the costs (most of which will be expensed) will precede
any savings to be realized, management expects benefits to greatly exceed
the costs incurred, all of which will be funded through available working
capital.
LIQUIDITY AND CAPITAL RESOURCES
Ratios GAFRI's ratio of earnings to fixed charges before the provision for
litigation costs continues to exceed 3 times; its consolidated debt to
capital ratio is 27%. 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 (losses) on
marketable securities).
The National Association of Insurance Commissioners' ("NAIC") risk-based
capital ("RBC") formulas determine the amount of capital that an insurance
company needs to ensure that it has an acceptable expectation of not
becoming financially impaired. At June 30, 2000, the capital ratio of
GAFRI's principal insurance subsidiary exceeded 4.5 times its authorized
control level RBC.
Sources and Uses of Funds To pay interest and principal on borrowings,
obligations related to discontinued manufacturing operations and other
holding company costs, GAFRI (parent) and AAG Holding use cash and
investments on hand, capital distributions from their principal subsidiary,
Great American Life Insurance Company ("GALIC") and bank borrowings. At
August 1, 2000, GAFRI (parent) had over $100 million available under its
bank credit line. 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
2000 without prior regulatory approval is $20.4 million.
15
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Based upon the current level of operations and anticipated growth, GAFRI
believes that it will have sufficient resources to meet its liquidity
requirements.
Investments GAFRI invests primarily in fixed income investments which,
including loans and short-term investments, comprised 98% of its investment
portfolio at June 30, 2000. GAFRI generally invests in securities with
intermediate-term maturities with an objective of optimizing interest yields
while maintaining an appropriate relationship of maturities between GAFRI's
assets and expected liabilities.
The NAIC assigns quality ratings to publicly traded as well as privately
placed securities. At June 30, 2000, 91% of GAFRI's fixed maturity
portfolio was comprised of investment grade bonds (NAIC rating of "1" or
"2"). Management believes that the high credit quality of GAFRI's
investment portfolio should generate a stable and predictable investment
return.
At June 30, 2000, GAFRI's mortgage-backed securities ("MBSs") portfolio
represented approximately one-third of its fixed maturity investments.
GAFRI invests primarily in MBSs which have a lower risk of prepayment. In
addition, the majority of MBSs held by GAFRI 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.
Approximately 90% of GAFRI'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, GAFRI does not believe a
material risk (relative to earnings or liquidity) is inherent in holding
such investments.
RESULTS OF OPERATIONS
General The comparability of GAFRI's statement of operations is affected by
the acquisitions of subsidiaries discussed in Footnote C to its financial
statements.
Net earnings from operations (before realized gains (losses), equity in
earnings of affiliate, the provision for litigation costs and an accounting
change) for the second quarter and first six months of 2000 were $19.5
million and $38.0 million, respectively, compared to $19.9 million and $38.5
million for the same periods in 1999. On a diluted basis, net earnings from
operations (as defined above) were $0.46 per share and $0.89 per share in
each of the respective periods.
Retirement Products The following table summarizes GAFRI's premiums for
its retirement annuities (in millions).
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
Annuity Premiums:
Single premium fixed rate annuities $ 65 $ 58 $131 $110
Flexible premium fixed rate annuities 44 42 85 83
Single premium variable annuities 72 38 145 73
Flexible premium variable annuities 19 12 36 24
$200 $150 $397 $290
16
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Sales of annuity products linked to the performance of the stock market
(equity-indexed and variable annuities) were more than $38 million higher in
the second quarter of 2000 compared to the same period in 1999 and
approximately $90 million higher in the first six months of 2000 compared to
the same period in 1999.
Life, Accident and Health Premiums The following table summarizes GAFRI's
life, accident and health premiums and benefits as shown in the Consolidated
Statement of Operations (in millions).
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
Premiums
Life insurance $19 $16 $38 $33
Accident and health insurance 31 8 62 16
$50 $24 100 $49
Benefits
Life insurance $15 $12 $30 $27
Accident and health insurance 22 4 44 8
$37 $16 $74 $35
Net Investment Income Net investment income increased 3% in the second
quarter and first six months of 2000 compared to the same period in 1999
resulting primarily from higher invested assets due to the acquisition of
United Teacher Associates Insurance Company in the fourth quarter of 1999.
Other Income The increase in other income reflects an increase in fees
earned on GAFRI's growing variable annuity and life business, increased
surrender fees, revenues from companies acquired in the second half of 1999
and higher revenues from GAFRI's brokerage subsidiary.
Realized Gains Individual securities are sold from time to time as market
opportunities appear to present optimal situations under GAFRI's investment
strategies.
Equity in Net Earnings of Affiliate Equity in net earnings of affiliate
represents GAFRI's proportionate share of the results of Chiquita Brands
International. Chiquita reported net income for the second quarter and
first six months of 2000 of $12.8 million and $47.4 million, respectively,
compared to $7.3 million and $56.0 million in 1999.
Annuity Benefits Annuity benefits reflect amounts accrued on annuity
policyholders' funds accumulated. The majority of GAFRI's fixed rate
annuity products permit GAFRI 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), GAFRI
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), GAFRI 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.
17
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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.
Insurance Acquisition Expenses Insurance acquisition expenses include
amortization of deferred policy acquisition costs ("DPAC") as well as
commissions on sales of life insurance products. Insurance acquisition
expenses also include amortization of the present value of future profits of
businesses acquired amounting to $6.4 million in the first six months of
2000, up from $2.9 million in the first six months of 1999 due to the
October 1999 acquisition of United Teacher Associates Insurance Company.
Interest and Other Debt Expenses The increase in interest and other debt
expenses in the second quarter and first six months of 2000 compared to the
same periods in 1999 is due primarily to amounts borrowed to fund
acquisitions as well as higher interest rates on GAFRI's bank credit line.
Provision for Litigation Costs In the second quarter of 2000, the Company
recorded a charge of $32.5 million for liabilities related to various
litigation in which the Company or one of its subsidiaries is a defendant.
The charge represents amounts that the Company has already agreed to pay and
estimates of the ultimate liability in certain cases not yet finalized. The
most significant case included in this charge was a class action in which
GALIC was a defendant. In June 2000, GALIC executed a Memorandum of
Understanding to settle this case. See "Legal Proceedings" in Part II of
this report.
Other Expenses The increase in other expenses reflects primarily the
acquisition of companies in the second half of 1999.
Income Taxes The provision (credit) for income taxes reflects the effect of
reductions in the valuation allowance associated with certain deferred tax
assets.
Cumulative Effect of Accounting Change In the first quarter of 1999, GAFRI
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, GAFRI expensed previously capitalized
start-up costs of $4.7 million (net of tax) in the first quarter of 1999.
18
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 1
Legal Proceedings
In June 2000, GALIC entered into a Memorandum of Understanding to settle a
purported class action lawsuit in which it was a defendant (Woodward v.
Great American Life Insurance Company, Hamilton County Court of Common
Pleas, Case No. A9900587, filed February 2, 1999). In the settlement, GALIC
agreed to (i) create a fund against which certain former policyholders can
submit claims for reimbursement of a portion of surrender charges incurred,
(ii) record lump-sum credits to certain annuities, and (iii) allow certain
annuity holders to transfer their annuity value to other products issued by
GALIC or its subsidiaries. The complaint filed in the lawsuit had sought
unspecified money 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 included a provision for $25 million in
the charge for litigation costs taken in the quarter ended June 30, 2000 for
the expected cost of this settlement. The settlement is subject to
confirmatory discovery and court approval.
ITEM 3
Qualitative and Quantitative Disclosure About Market Risk
As of June 30, 2000, there were no material changes to the other information
provided in GAFRI's Form 10-K for 1999 under the caption "Exposure to Market
Risk" in Management's Discussion and Analysis of Financial Condition and
Results of Operations.
ITEM 4
Submissions of Matters to a Vote of Security Holders
The Registrant's Annual Stockholders' Meeting was held May 16, 2000.
Proxies were solicited pursuant to Regulation 14A under the Securities
Exchange Act of 1934. All of the nominees for director proposed by the
Registrant were elected to the Board of Directors.
In addition to the election of directors, stockholders (representing
approximately 90% of the voting shares) also voted to approve an amendment
to the Registrant's Certificate of Incorporation to change the Company's
name to Great American Financial Resources, Inc. (Proposal 2.)
The votes cast for, against, and the number withheld or abstentions as to
each matter voted on at the 2000 Annual Meeting is set forth below:
For Against Withheld/Abstain
Election of Directors:
Carl H. Lindner 37,958,410 NA 17,073
S. Craig Lindner 37,958,836 NA 16,647
Robert A. Adams 37,950,508 NA 24,975
Ronald G. Joseph 37,960,264 NA 15,219
John T. Lawrence 37,961,058 NA 14,425
William R. Martin 37,960,666 NA 14,817
Ronald W. Tysoe 37,954,185 NA 21,298
Proposal 2 37,953,724 16,946 4,813
________________
NA - Not Applicable
19
GREAT AMERICAN FINANCIAL RESOURCES, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of June 30, 2000. For
submission in electronic filing only.
(b) Report on Form 8-K - None
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.
GREAT AMERICAN FINANCIAL RESOURCES, Inc.
August 11, 2000 BY:/s/William J. Maney
William J. Maney
Executive Vice President, Treasurer
and Chief Financial Officer
20
