SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ................. to ....................
Commission File Number 1-12540
WESTERN NATIONAL CORPORATION
(Exact name of registrant as specified in its articles of incorporation)
DELAWARE 75-2502064
(State of incorporation) (I.R.S. Employer Identification No.)
5555 SAN FELIPE ROAD, SUITE 900, HOUSTON, TEXAS 77056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 888-7800
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
Shares of common stock outstanding as of September 30, 1996: 62,441,223
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN MILLIONS)
<TABLE>
<CAPTION>
<S> <C> <C>
September 30, December 31,
1996 1995
--------------- --------------
(unaudited) (audited)
ASSETS
- --------------------------------------------------------
Investments:
Fixed maturities - actively managed at fair value
(amortized cost: 1996-$8,487.5; 1995-$7,654.5) $ 8,456.6 $ 7,996.7
Fixed maturities - held to maturity at amortized cost
(fair value: 1996- $1.9; 1995 - $2.1) 1.1 1.1
Equity securities at fair value
(cost: 1996-$19.5; 1995-$0.8) 19.5 0.8
Mortgage loans 125.2 86.5
Credit-tenant loans 203.4 249.7
Policy loans 67.7 68.3
Other invested assets 13.9 24.5
Due from brokers 27.0 -
Short-term investments 138.7 417.6
--------------- --------------
Total invested assets 9,053.1 8,845.2
Accrued investment income 149.1 131.7
Reinsurance receivable 1.7 1.8
Cost of policies purchased 76.0 35.8
Cost of policies produced 395.0 228.7
Deferred income taxes 13.3 8.9
Other assets 23.0 61.4
--------------- --------------
TOTAL ASSETS $ 9,711.2 $ 9,313.5
=============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
- --------------------------------------------------------
Liabilities:
Insurance liabilities $ 8,341.9 $ 7,915.8
Notes payable 148.0 147.8
Investment borrowings and due to brokers 220.4 257.3
Deferred income taxes 73.0 118.4
Other liabilities 85.1 88.6
--------------- --------------
TOTAL LIABILITIES 8,868.4 8,527.9
Shareholders' Equity:
Preferred Stock (par value $.001 per share;
50,000,000 shares authorized; issued and
outstanding: 1996 - 7,254,464; 1995 - 0) 125.9 -
Common stock and additional paid-in capital
(par value $.001 per share; 500,000,000
shares authorized; issued and outstanding:
1996 - 62,441,223; 1995 - 62,348,000) 348.3 346.8
Net unrealized appreciation (depreciation)
of securities, net of applicable deferred
income taxes: 1996-$(4.8); 1995-$67.5 (8.6) 125.2
Retained earnings 377.2 313.6
--------------- --------------
TOTAL SHAREHOLDERS' EQUITY 842.8 785.6
--------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 9,711.2 $ 9,313.5
=============== ==============
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN MILLIONS - EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Quarter Ended Nine Months Ended
-------------- -------------------
September 30, September 30,
-------------- -------------------
1996 1995 1996 1995
-------------- ------------------- ------- -------
REVENUES:
Net investment income $ 175.5 $ 170.2 $516.5 $493.3
Equity in earnings of partnership 4.2 1.9 7.0 2.5
Insurance policy and fee income 4.4 7.7 13.1 21.7
Net realized investment gains
(losses) 2.2 (26.1) (2.7) (90.9)
-------------- ------------------- ------- -------
TOTAL REVENUES 186.3 153.7 533.9 426.6
BENEFITS AND EXPENSES:
Insurance policy benefits 26.0 26.4 81.9 83.2
Change in future policy benefits and
other liabilities 2.8 6.8 0.1 6.2
Interest expense on annuities and
financial products 96.7 91.5 281.2 270.7
Interest expense on notes payable 2.7 2.7 8.0 8.0
Interest expense on investment and
short-term borrowings 2.9 4.9 7.8 6.4
Amortization related to operations 10.0 6.8 30.0 22.2
Amortization and change in future
policy benefits related to
realized gains (losses) 0.8 (5.5) 0.2 (30.4)
Other operating costs and expenses 5.2 5.7 15.8 16.7
-------------- ------------------- ------- -------
TOTAL BENEFITS AND EXPENSES 147.1 139.3 425.0 383.0
Income before income taxes 39.2 14.4 108.9 43.6
Income tax expense 13.6 4.9 37.9 15.1
-------------- ------------------- ------- -------
NET INCOME $ 25.6 $ 9.5 $ 71.0 $ 28.5
============== =================== ======= =======
EARNINGS PER COMMON SHARE
AND COMMON EQUIVALENT SHARE:
Weighted average shares 63.9 62.4 63.2 62.4
Net income $ 0.40 $ 0.15 $ 1.12 $ 0.46
============== =================== ======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
<S> <C> <C>
Nine Months Ended September 30,
---------------------------------
1996 1995
--------------------------------- --------
Preferred stock:
Balance, beginning of period $ - $ -
Proceeds from stock issue
(7,254,464 shares) 125.9 -
--------------------------------- --------
Balance, end of period $ 125.9 $
================================= ========
Common stock and additional paid-in capital:
Balance, beginning of period $ 346.8 $ 346.3
Issuance of shares of common stock related
to restricted stock awards, options and
benefit plans (1996 - 93,223 shares;
1995- 45,000 shares) 1.5 0.5
--------------------------------- --------
Balance, end of period $ 348.3 $ 346.8
================================= ========
Net unrealized appreciation (depreciation)
of securities:
Balance, beginning of period $ 125.2 $(322.1)
Change in unrealized appreciation
(depreciation) (133.8) 370.0
--------------------------------- --------
Balance, end of period $ (8.6) $ 47.9
================================= ========
Retained earnings:
Balance, beginning of period $ 313.6 $ 316.3
Net income 71.0 28.5
Dividends on common stock (7.4) (7.6)
--------------------------------- --------
Balance, end of period $ 377.2 $ 337.2
================================= ========
Total shareholders' equity $ 842.8 $ 731.9
================================= ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
<S> <C> <C>
Nine Months Ended September 30,
---------------------------------
1996 1995
--------------------------------- ----------
Cash flows from operating activities:
Net income $ 71.0 $ 28.5
Adjustments to reconcile net income to
net cash provided by operations:
Amortization and depreciation 33.7 (13.1)
Realized (gains) losses on investments,
net (4.6) 85.6
Income taxes (123.5) 30.5
Increase in insurance liabilities 0.9 36.9
Interest credited to insurance
liabilities 287.9 270.7
Fees charged to insurance liabilities (3.3) (3.4)
Accrual and amortization of investment
income (18.3) (8.2)
Deferral of cost of policies produced (90.4) (39.1)
Other 182.8 (11.0)
--------------------------------- ----------
Net cash provided by operating activities 336.2 377.4
--------------------------------- ----------
Cash flows from investing activities:
Sales of investments 2,391.8 2,510.4
Maturities and redemptions of investments 346.9 234.3
Purchases of investments (3,598.8) (2,906.7)
--------------------------------- ----------
Net cash provided by (used in) investing
activities (860.1) (162.0)
--------------------------------- ----------
Cash flows from financing activities:
Proceeds from preferred stock issuance 125.9 -
Deposit to insurance liabilities 1,248.5 519.2
Withdrawals from insurance liabilities (1,107.7) (765.4)
Dividends on common stock (7.4) (7.6)
Due to brokers 85.2 15.6
Investment borrowings, net (99.5) 101.5
--------------------------------- ----------
Net cash provided by (used in) financing
activities 245.0 (136.7)
--------------------------------- ----------
Net increase (decrease) in short-term
investments (278.9) 78.7
Short-term investments - beginning of
period 417.6 28.0
--------------------------------- ----------
Short-term investments - end of period $ 138.7 $ 106.7
================================= ==========
Supplemental cash flow disclosure:
Income taxes (refunded) paid, net $ (31.2) $ 15.5
================================= ==========
Interest paid on notes payable and
investment borrowings $ 16.6 $ 16.6
================================= ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following notes should be read in conjunction with the notes to
consolidated financial statements contained in the 1995 Annual Report on Form
10-K of Western National Corporation (the "Company").
1. SIGNIFICANT ACCOUNTING POLICIES
The unaudited consolidated financial statements as of September 30, 1996,
and for the three-month and nine-month periods ended September 30, 1996 and
1995, reflect all adjustments, consisting only of normal recurring items that
are necessary in the opinion of management to present fairly the Company's
financial position, results of operations and cash flows on a basis consistent
with that of the prior audited consolidated financial statements.
Intercompany amounts and transactions were eliminated.
2. ADJUSTMENT TO ACTIVELY MANAGED FIXED MATURITIES
The Company classifies fixed maturity investments into two categories in
accordance with SFAS No. 115. The categories are "actively managed", which
are carried at estimated fair value, and "held to maturity", which are carried
at amortized cost. The adjustment to carry actively managed fixed maturity
investments at fair value resulted in the following cumulative adjustments to
balance sheet accounts as of September 30, 1996 and December 31, 1995.
ADJUSTMENTS TO ACTIVELY MANAGED FIXED MATURITIES
(IN MILLIONS)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
SEPTEMBER 30, 1996 DECEMBER 31, 1995
-------------------- -------------------
EFFECT OF EFFECT OF
COST FAIR VALUE CARRYING COST FAIR VALUE CARRYING
BASIS ADJUSTMENTS VALUE BASIS ADJUSTMENTS VALUE
---------- -------------------- ---------- ------------------- ------------- ----------
INVESTMENTS:
Actively managed fixed
maturities $ 8,487.5 $ (30.9) $ 8,456.6 $ 7,654.5 $ 342.2 $ 7,996.7
Equity securities 19.5 - 19.5 0.8 - 0.8
Other invested assets 13.0 0.9 13.9 13.5 11.0 24.5
---------- -------------------- ---------- ------------------- ------------- ----------
$ 8,520.0 $ (30.0) $ 8,490.0 $ 7,668.8 $ 353.2 $ 8,022.0
OTHER BALANCE SHEET ITEMS:
Cost of policies purchased $ 72.5 $ 3.5 $ 76.0 $ 75.8 $ (40.0) $ 35.8
Cost of policies produced 386.0 9.0 395.0 325.1 (96.4) 228.7
Insurance liabilities (8,341.9) - (8,341.9) (7,879.5) (36.3) (7,915.8)
Other liabilities (89.2) 4.1 (85.1) (100.8) 12.2 (88.6)
Deferred income taxes (77.8) 4.8 (73.0) (50.9) (67.5) (118.4)
-------------------- -------------
Unrealized appreciation
(depreciation) of
investments, net $ (8.6) $ 125.2
==================== =============
</TABLE>
3. CHANGES IN COMMON STOCK AND PREFERRED STOCK
On September 3, 1996, the Company paid a common stock dividend of $.04
per share. The total amount paid in common stock dividends for the third
quarter and the first nine months of 1996 was $2.5 million and $7.4 million,
respectively.
<PAGE>
On September 17, 1996, the Company issued 7,254,464 shares of a
newly-created class of Series A Participating Convertible Preferred Shares
(the "Series A Preferred Stock") to American General Corporation for net cash
proceeds of approximately $126 million. The Series A Preferred Stock shares
pro rata on a share-for-share basis with the Company's existing common stock
in dividends and in liquidation, subject to a $.001 per share liquidation
preference. No dividend may be paid on shares of the Company's common stock
unless a corresponding dividend is paid on the Series A Preferred Stock.
Except as otherwise required by Delaware law, the Series A Preferred Stock has
no voting power. The Series A Preferred Stock is not redeemable. The Series
A Preferred Stock automatically converts with no further action on the part of
the Company or its holder into common stock on a share-for-share basis, upon
approval of the Company's common stockholders of the issuance of the common
stock. The Company has agreed to submit to its shareholders a proposal
providing for such conversion at its 1997 annual meeting of shareholders. The
Certificate of Designation also contains anti-dilution provisions relating to
conversion. Reference is made to the Company's Report on Form 8-K/A, dated
September 17, 1996, for a more detailed description of the Series A Preferred
Stock. As a result of this issuance, American General now owns 24,947,500
shares of common stock and 7,254,464 shares of Series A Preferred Stock, which
are treated as common stock equivalents. American General's combined
ownership of common and Series A Preferred shares represents a 46.2% equity
interest in the Company.
On October 22, 1996, the board of directors declared a cash dividend of
$.04 per outstanding share of common stock and Series A Preferred Stock. The
dividend is payable December 3, 1996, to shareholders of record at the close
of business on November 12, 1996. The total dividend payment will be
approximately $2.8 million. During the first nine months of 1996, 2,150
common shares were issued pursuant to the exercise of stock options, 74,000
shares of restricted stock were awarded to certain executive officers, and
17,073 shares of newly-issued common stock were contributed to employee
benefit plans.
4. CHANGES IN CALCULATION AND PRESENTATION OF INVESTMENT SPREAD
In the first quarter 1996, Western revised the manner in which it reports
investment spread on insurance liabilities. Western began excluding
first-year bonus interest on certain deferred annuities, which is generally
paid in lieu of commissions, from its average crediting rate calculations.
The revised method defines investment spread on insurance liabilities as the
difference between the average yield on invested assets and the average base
liability crediting rate. Bonus interest is capitalized along with other
acquisition expenses and amortized over the lifetime of the block of business.
Western believes that the exclusion of the capitalized bonus interest is more
consistent with the presentation of interest expenses and acquisition expenses
in its Statement of Operations. This change to Western's investment spread
calculations had no effect on the unaudited Consolidated Financial Statements.
Prior periods have been adjusted to reflect this change. The following
table sets forth investment spread on insurance liabilities as revised and as
originally reported as of the last day of each of the quarters indicated:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Q3/96 Q2/96 Q1/96 Q4/95 Q3/95
_____ _____ _____ _____ _____
Revised 2.08% 2.07% 1.99% 1.91% 1.98%
As originally reported N/A N/A N/A 1.85% 1.89%
</TABLE>
Prior to the second quarter 1996, Western only presented investment
spread on insurance liabilities as of the last day of each quarter. In second
quarter 1996, Western also began presenting an average investment spread on
insurance liabilities for each quarter. Western believes that the average
investment spread on insurance liabilities more accurately reflects Western's
experience during the reported period.
The following table sets forth Western's average investment spread for
each of the quarters indicated:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Q3/96 Q2/96 Q1/96 Q4/95 Q3/95
_____ _____ _____ _____ _____
Average investment spread 2.15% 2.09% 1.96% 2.08% 2.12%
</TABLE>
Average investment spread and average investment yield numbers presented
in this Report on Form 10-Q exclude prepayment income (loss), income from the
Company's investment in Conseco Capital Partners II, L.P., and income from
other non-scheduled sources.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BACKGROUND
Western National Corporation (the "Company") is a Delaware corporation
organized in October 1993 to serve as the holding company for Western National
Life Insurance Company ("Western"), a Texas life insurance company founded in
1944. Western is a leading provider of retirement annuity products, with $9.2
billion of statutory assets at September 30, 1996. Unless the context
otherwise requires, references to the "Company" are references to Western
National Corporation and its consolidated subsidiaries.
American General Corporation, a Texas corporation ("AGC"), and its
subsidiaries own approximately a 46.2% equity interest in the Company. See
Note 3 to the unaudited Consolidated Financial Statements. References to
"American General" are references to AGC and its direct and indirect
majority-controlled subsidiaries.
RESULTS OF OPERATIONS
General
The Company's operating earnings are primarily a function of its
investment spread, the amount of its invested assets, and its operating
expenses. Accordingly, management's principal emphasis is on generating
profits through adequate pricing of its insurance products and maintaining
appropriate investment spreads over the life of the policies sold. Investment
spread is the excess of net investment income over interest credited to
insurance liabilities, and is a function of the level of, and yield on,
invested assets and the interest crediting rates on insurance liabilities. The
Company's investment spread over recent periods has been maintained through a
combination of active investment management and the ability to change rates
credited on a majority of its insurance liabilities. Management adjusts
crediting rates based upon pricing objectives, current investment performance,
market interest rates, and competitive factors. Although the Company has the
right to adjust interest crediting rates on most products, such adjustments to
crediting rates may not be sufficient to maintain targeted investment spreads
in all economic and market-rate environments. Furthermore, competitive and
other factors may limit the Company's ability to adjust crediting rates. A
narrowing of spreads may adversely affect operating results. Western believes
that its policy structure, which generally provides for resetting of policy
crediting rates at least annually and imposes withdrawal penalties during the
first five to ten years a policy is in force, mitigates substantially the
potentially adverse effects of interest rate changes, except in the case of
sudden and dramatic changes in market rates.
The spread between investment yield and the average base crediting rate
on insurance liabilities was approximately 2.08% at September 30, 1996,
compared to 2.07% at June 30, 1996, and 1.98% at September 30, 1995.
Western's average investment spread on insurance liabilities was 2.15% for the
third quarter 1996, compared to 2.09% for the second quarter 1996, and 2.12%
for the third quarter 1995. Capitalized bonus interest is excluded from
Western's investment spread on insurance liabilities calculations. See Note 4
to the unaudited Consolidated Financial Statements. Western generally expects
to maintain a spread within the range of spreads it has achieved in recent
quarters. The amount of the investment spread on insurance liabilities varies
over time as a result of market factors, competitive influences, and
investment yields.
Operating earnings (excluding realized investment gains (losses) net of
applicable adjustments to amortization, expenses and taxes) for the quarter
were $24.7 million, or $.39 per share, up from $22.8 million, or $.37 per
share, in the third quarter 1995. For the nine months ended September 30,
1996, operating income was $72.9 million, or $1.15 per share, compared to
$67.5 million, or $1.08 per share, in the first nine months of 1995. Because
the decision to realize investment gains or losses lies to a great degree in
management's discretion, and may reflect tax or other considerations unrelated
to core earning power, management believes that operating earnings are the
best indication of earnings capacity for financial services organizations such
as Western.
<PAGE>
The following table sets forth operating and net income for the periods
indicated (in millions):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
QUARTER ENDED NINE MONTHS ENDED
-------------- -------------------
SEPTEMBER 30, SEPTEMBER 30,
-------------- -------------------
1996 1995 1996 1995
-------------- ------------------- ------- -------
Operating Income:
- -----------------------------------
Operating revenues $ 184.1 $ 179.8 $536.6 $517.5
Benefits and expenses 146.3 144.8 424.8 413.4
-------------- ------------------- ------- -------
Pre-tax operating income 37.8 35.0 111.8 104.1
Income tax expense from operations 13.1 12.2 38.9 36.6
-------------- ------------------- ------- -------
Net operating income 24.7 22.8 72.9 67.5
Realized investment gains (losses)
net of amortization, expenses
and taxes 0.9 (13.3) (1.9) (39.0)
-------------- ------------------- ------- -------
Net income $ 25.6 $ 9.5 $ 71.0 $ 28.5
============== =================== ======= =======
</TABLE>
Net investment income. Net investment income, including the Company's
equity in earnings of a partnership, for the third quarter 1996 increased 4%
to $179.7 million from $172.1 million in the third quarter 1995, and
year-to-date increased 6% to $523.5 million from $495.8 million for the
year-earlier period. This category of earnings, net of interest expense on
short-term investment borrowings, was $176.8 million for the third quarter
1996 compared to $167.2 million for the third quarter 1995. Year-to-date net
investment income, excluding interest expense on short-term investment
borrowings, was $515.7 million, compared to $489.4 million for the
year-earlier period. The increases in net investment income for the quarter
and the nine-month period are partially attributable to an increase in the
amount of invested assets, lower portfolio management expenses, and an
increase in income resulting from prepayment revenues, which is included in
this category of earnings. Prepayment revenues resulted in $3.7 million of
income year-to-date, compared to prepayment losses of $1.1 million in the
year-earlier period. Income resulting from prepayment revenues for third
quarter 1996 was slightly higher than it was for third quarter 1995. The
amount of prepayment revenues received by Western varies significantly from
period to period based on both the composition of the portfolio and the level
of and direction of changes in market interest rates. Generally, prepayment
revenues will increase as market interest rates decline and decrease as market
interest rates rise.
Western's equity share of net income in the Conseco Capital Partners II,
L.P. investment ("CCPII") for the third quarter and for the first nine months
of 1996 was $4.2 million and $7.0 million, respectively. Income resulting
from CCPII was $1.9 million for the third quarter 1995, and $2.5 million for
the nine months ending September 30, 1995. CCPII was dissolved during the
third quarter 1996. The Company plans to invest in certain equity and
equity-like investments that are intended to replace the investment income
previously generated by CCPII. However, the Company anticipates that total
equity and equity-like investments will not exceed more than approximately 1%
of total invested assets. The Company would note that equity investments are
likely to result in a higher degree of volatility in reported earnings than is
typically the case with fixed income investments, and present a greater risk
of loss, as they reflect claims on an issuers capital structure junior to that
of most fixed-income investments.
Net investment income also increased from earlier quarters because
Western was more fully invested during the third quarter 1996. Western has
begun to pre-invest in anticipation of future net cash flows, as such net cash
flows from operations have increased. The percentage of cash flow that is
pre-invested by Western is based on market conditions and varies from time to
time. During the third quarter, the average daily amount outstanding
reflecting such advance investments was approximately $93.0 million. The
Company earns a positive spread on such advance investments so long as
short-term rates are lower than the rates earned in such investments. The
amount of cash flow that is pre-invested is not anticipated to exceed
approximately 2% of invested assets.
<PAGE>
The average portfolio yield (calculated based on amortized cost) was
approximately 8.26% in the third quarter 1996, compared to 8.36% in the third
quarter 1995. See Note 4 to the unaudited Consolidated Financial Statements.
The average amount of net investable assets (calculated based on amortized
cost) for the third quarter 1996 increased from the year-earlier period by
approximately $580 million to approximately $8.8 billion.
Net realized investment gains (losses). Net of related adjustments to
amortization, reserves, related expenses, and taxes, the Company had net
realized investment gains of $0.9 million in the third quarter 1996 and net
realized investment losses of $1.9 million year-to-date, compared to losses of
$13.3 million and $39.0 million in the corresponding periods of 1995. The
amount of investment gains or losses fluctuates depending on general market
conditions and interest rates as well as the level of activity in the
portfolio. Western follows an active strategy in the management of its
portfolio, in which decisions to buy, sell, or hold securities are dictated
principally by relative value analysis, or other portfolio management
considerations, rather than the gain or loss to be realized on any given
trade. Western will generally report realized investment gains in periods
during which the market value of the portfolio exceeds amortized cost and
realized investment losses in periods in which market value is less than
amortized cost. Although Western's overall portfolio value exceeded amortized
cost during most of 1995, management elected to incur substantial realized
losses in 1995 in order to enhance portfolio yield and to utilize certain
capital loss tax carrybacks that would otherwise have expired at the end of
1995.
Amortization and changes in future policy benefits related to realized
investment gains (losses). As described in Note 1 to the Consolidated
Financial Statements of the Company's 1995 Annual Report on Form 10-K, the
realization of investment gains and losses affects the timing of amortization
of the cost of policies purchased and the cost of policies produced. As a
result of the net realized investment gains and losses from sales of fixed
maturities, amortization of the cost of policies produced was increased by
$0.8 million in the third quarter 1996 and by $0.2 million year-to-date,
compared to decreases of $5.5 million and $30.4 million in the third quarter
and first nine months of 1995, respectively.
Insurance policy and fee income. Insurance policy and fee income was
$4.4 million and $7.7 million in the third quarters of 1996 and 1995,
respectively. The year-to-date level for 1996 was $13.1 million, which was an
$8.6 million decrease from the year-earlier period. This income relates
primarily to premiums from products with mortality and morbidity features,
such as traditional life insurance and certain single premium immediate
annuities (SPIAs). It also includes surrender charge income, primarily from
deferred annuities, and fee income from direct sales operations. The decrease
in this area of income is primarily attributable to a decrease in the number
of policies written by Western with mortality and morbidity features,
reflecting the Company's decision to pursue the structured settlement SPIA
market through its joint venture with American General Life Insurance Company,
rather than directly. See Sales-Specialty, below.
Insurance policy benefits and other liabilities. Total third quarter
insurance policy benefits (including changes in future policy benefits), which
relate solely to policies with mortality and morbidity features, decreased by
$4.4 million from the year-earlier quarter. Insurance policy benefits for the
first nine months of 1996 decreased by $7.4 million from the year-earlier
period. These decreases are primarily attributable to the implementation of
the structured settlement SPIA joint venture with American General Life
Insurance Company. Third quarter 1996 also reflected unfavorable mortality
experience of $0.5 million on life contingent SPIA contracts, compared to an
unfavorable mortality experience of $1.3 million for the corresponding 1995
quarter. The first nine months of 1996 and 1995 reflected favorable mortality
experience of $2.7 million and $1.9 million, respectively, on life contingent
SPIA contracts. Mortality experience varies from period to period due to
variances between actual mortality and expected mortality within the periods.
Such variances may be favorable or unfavorable.
Interest expense on annuities and financial products. Interest expense
on annuities and financial products increased by $5.2 million in the third
quarter 1996 and by $10.5 million year-to-date compared to the corresponding
year-earlier periods. The increase in interest expense is primarily
attributable to an increase in reserves to $8.3 billion at September 30, 1996,
from $7.8 billion at September 30, 1995. The average rate credited on all
insurance liabilities decreased to approximately 6.2% at September 30, 1996,
from 6.3% a year earlier. Average crediting rates on annuities may increase
if market interest rates rise, or as lower cost policies lapse, are repriced,
or are replaced with policies having higher crediting rates. Conversely, if
market interest rates generally decrease, the average crediting rate will
generally tend to decrease as well.
<PAGE>
Amortization related to operations. Scheduled amortization, which
excludes the effects of realized gains and losses, of the cost of policies
produced and the cost of policies purchased increased by $3.2 million in the
third quarter 1996 and by $7.8 million year-to-date compared to the
corresponding year-earlier periods. The increases in scheduled amortization
are the result of increases in the amount of in-force business and changes in
assumptions made in the fourth quarter 1995 concerning crediting rates on
policyholder balances and expected lapses of certain out-of-surrender-charge
blocks of business. Asset balances and scheduled amortization of the cost of
policies produced and the cost of policies purchased are reviewed annually for
products governed by SFAS 97 and may be reviewed more frequently if
circumstances dictate. This accounting standard requires that the asset
balances and future amortization be unlocked; i.e., re-computed based on
actual past experience and updated expectations of future experience. This
unlocking may result in both one-time adjustments related to prior
amortization as well as adjustments related to ongoing amortization rates. No
unlocking adjustments were made in the first nine months of 1996, compared to
an unlocking adjustment of $1.6 million in the corresponding 1995 period.
Other operating costs and expenses. Other operating costs and expenses
were $5.2 million for the third quarter 1996, which was a $0.5 million
decrease from the year-earlier quarter. Year-to-date other operating costs
and expenses were $15.8 million, compared to $16.7 million in the
year-earlier period. Other operating costs and expenses for the third quarter
1996 and year-to-date included a guaranty fund expense of $0.5 million and
$1.0 million, respectively, compared to a guaranty fund expense of $0.7
million and $3.2 million for the third quarter and for the first nine months
of 1995, respectively. Excluding guaranty fund expenses, this category of
expenses decreased by $0.3 million in the third quarter 1996 compared to the
corresponding 1995 quarter, and increased by $1.3 million year-to-date
compared to the corresponding period.
Western may be required under the solvency or guaranty laws of most
states in which it does business to pay assessments (up to certain prescribed
limits) to fund policyholder losses or liabilities of insurance companies that
become insolvent. At September 30, 1996, Western had a reserve for guaranty
fund assessments of $28.8 million, which it believes is adequate for all known
insolvencies.
Interest expense on investment and short-term borrowings and notes
payable. Interest expense of $5.6 million for the third quarter 1996 was down
from $7.6 million in the year-earlier quarter. Third quarter 1996 interest
expense consists of $2.9 million in interest expense on investment and
short-term borrowings and $2.7 million in interest expense relating to the
Senior Notes. Interest expense for the first nine months of 1996 was $15.8
million, compared to $14.4 million in the corresponding period. Year-to-date
interest expense consists of $7.8 million in interest expense on investment
and short-term borrowings and $8.0 million in interest expense relating to the
Senior Notes. The amount of investment interest expense will vary
substantially from time to time based on the level of market interest rates
and the volume of investment borrowings.
Income taxes. Third quarter income taxes increased to $13.6 million from
$4.9 million in the year-earlier quarter, and year-to-date income tax
increased to $37.9 million from $15.1 million for the year-earlier period.
These increases resulted primarily from higher levels of net income due to the
termination at the end of 1995 of the Company's realized loss/tax recovery
program. See "Net realized investment gains (losses)", above.
The components of income tax included in the consolidated balance sheet
are as follows (in millions):
<TABLE>
<CAPTION>
<S> <C> <C>
SEPTEMBER 30, DECEMBER 31,
--------------- -------------
1996 1995
--------------- -------------
Deferred income tax liabilities:
Western's operations $ 77.8 $ 50.9
Unrealized appreciation (depreciation) (4.8) 67.5
--------------- -------------
Deferred income tax liabilities $ 73.0 $ 118.4
=============== =============
Deferred income tax assets:
Company net operating loss carryforward $ 13.3 $ 8.9
--------------- -------------
Deferred income tax assets $ 13.3 $ 8.9
=============== =============
</TABLE>
<PAGE>
The deferred income tax liability of $73.0 million at September 30, 1996,
was primarily the result of the temporary differences between tax and
financial bases of the cost of policies produced, the cost of policies
purchased, insurance liabilities, guaranty fund liabilities, and certain types
of investments. The temporary differences between tax and financial bases
related to net unrealized depreciation of actively-managed fixed maturities,
which are carried at market value in accordance with the requirements of SFAS
115, reduced the tax liability by $4.8 million.
The deferred income tax asset of $13.3 million at September 30, 1996, was
attributable to net operating losses incurred by the Company that could not be
utilized by Western since each files separate federal income tax returns.
Management believes that it is more likely than not that the deferred tax
asset of $13.3 million will be realized against future years' taxable income
generated at the holding company level during the carryforward period.
Net income. Third quarter 1996 net income was $25.6 million, or $.40 per
share, up from $9.5 million, or $.15 per share, for the prior year's third
quarter. Year-to-date net income was $71.0 million, or $1.12 per share, up
from $28.5 million, or $.46 per share, for the year-earlier period. The
increases in net income for the third quarter 1996 and year-to-date were
primarily the result of the termination at the end of 1995 of the Company's
realized loss/tax recovery program and increases in operating revenues.
INVESTMENTS
At September 30, 1996, Western had invested assets of approximately $9.1
billion after giving effect to a mark-to-market adjustment under SFAS No. 115
of $30.0 million. See Note 2 to the unaudited Consolidated Financial
Statements. Western's invested assets consist principally of actively managed
fixed-income securities, as well as small volumes of credit-tenant loans on
commercial property, short-term investments, and other investments.
The following table shows Western's investment performance for the nine
months ended September 30, 1996, and September 30, 1995 (in millions and
before giving effect to SFAS No. 115 adjustment).
<TABLE>
<CAPTION>
<S> <C> <C>
1996 1995
--------- ---------
Weighted average book value of invested assets(1) $8,750.8 $8,170.5
Net investment income(2)(3) 515.7 489.4
Yield on average invested assets 8.3% 8.4%
<FN>
_______________
(1) Net of short-term investment borrowings and amounts due to brokers.
(2) Net of interest expense on short-term investment borrowings.
(3) Includes equity in earnings of partnership.
</TABLE>
Although market interest rates increased generally in the first nine
months of 1996 from the levels prevailing in late 1995, changes in market
rates affect the portfolio yield only slowly due to the relatively small
volume of new investments in any one period in relation to the size of the
overall portfolio. In addition, because the portfolio includes a mix of
securities with yields both above and below the average portfolio yield (as
well as both above and below current market interest rates), changes in
portfolio yield will not necessarily parallel changes in market interest
rates, except over longer periods of time. Securities that are sold or
otherwise redeemed, or that are partially prepaid, may be yielding rates above
or below the portfolio yield or current market interest rates. As part of
Western's realized loss/tax recovery program in 1995, a majority of the
portfolio sales transactions were concentrated in lower yielding issues;
therefore, average portfolio yield remained relatively unchanged in 1995
despite the general decrease in market interest rates during that year.
<PAGE>
The following table sets forth the composition of the Company's fixed
maturity portfolio as of the dates indicated:
<TABLE>
<CAPTION>
<S> <C> <C>
FIXED MATURITIES BY TYPE SEPTEMBER 30, DECEMBER 31,
(IN MILLIONS, BASED ON CARRYING VALUE) 1996 1995
- ------------------------------------------------- ------------------------- --------------
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 21.2 $ 60.0
Obligations of states and political subdivisions 223.0 173.9
Public utility securities 1,259.4 1,376.0
Other corporate securities 4,637.6 4,033.0
Mortgage-backed securities 2,316.5 2,354.9
------------------------- --------------
Total $ 8,457.7 $ 7,997.8
========================= ==============
</TABLE>
The following table sets forth the quality of Western's fixed maturities
(which do not include short-term investments) as of September 30, 1996,
classified in accordance with the highest rating by a nationally recognized
statistical rating organization or, as to fixed maturities not commercially
rated, based on ratings assigned by the National Association of Insurance
Commissioners ("NAIC"):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
FIXED MATURITIES BY GAAP GAAP FAIR VALUE
-----------
QUALITY RATING AT CARRYING AMORTIZED FAIR AS % OF AS % OF AS % OF
SEPTEMBER 30, 1996 VALUE COST VALUE FIXED INVESTED AMORT.
--------- ---------- --------
MATURITIES ASSETS COST
----------- ----------- --------
(IN MILLIONS)
AAA $ 2,544.7 $ 2,563.0 $2,544.7 30.1% 27.8% 99.3%
AA 777.4 794.1 777.4 9.2 8.5 97.9
A 2,402.7 2,401.4 2,402.7 28.4 26.3 100.1
BBB+ 747.0 741.4 747.0 8.8 8.2 100.8
BBB 956.1 957.1 956.1 11.3 10.5 99.9
BBB- 541.8 545.5 541.8 6.4 5.9 99.3
--------- ---------- -------- ----------- ----------- --------
Total
investment
grade 7,969.7 8,002.5 7,969.7 94.2 87.2 99.6
BB+ 115.3 116.8 115.3 1.4 1.3 98.7
BB 80.1 78.8 80.1 0.9 0.9 101.7
BB- 160.8 159.8 160.8 1.9 1.7 100.7
B+ and below 131.8 130.7 132.6 1.6 1.4 101.5
--------- ---------- -------- ----------- ----------- --------
Total below
investment
grade 488.0 486.1 488.8 5.8 5.3 100.6
Total fixed
maturities $ 8,457.7 $ 8,488.6 $8,458.5 100.0% 92.5% 99.7%
========= ========== ======== =========== =========== ========
</TABLE>
_______________
The NAIC assigns securities quality ratings and uniform prices called "NAIC
Designations", which are used by insurers when preparing their annual
statements. The NAIC assigns ratings to publicly-traded as well as
privately-placed securities. The NAIC Designations range from Class 1 to Class
6, with Class 1 being the highest quality. For purposes of the table above,
and only for fixed maturities not commercially rated, any NAIC Class 1
securities would be included in the "A" rating category; Class 2, "BBB-";
Class 3, "BB-"; and Classes 4, 5 and 6, "B+ and below".
Investments in fixed maturity securities that are rated below investment
grade as determined by nationally recognized statistical rating organizations
(or, if not rated by such firms, with ratings below Class 2 assigned by the
NAIC) were 5.3% of total invested assets and 5.8% of total fixed maturity
investments at September 30, 1996. Western intends to maintain approximately
the present percentage of its portfolio invested in fixed maturity securities
that are rated below investment grade, although such percentages may vary by
several percentage points from time to time.
<PAGE>
Investments in below investment grade corporate debt securities generally
have greater risks than other corporate debt investments. Risk of loss upon
default by the borrower is greater with such securities because they generally
are unsecured and often are subordinated to other creditors of the issuers.
Furthermore, the issuers usually have higher levels of indebtedness and are
more sensitive to adverse economic conditions, such as recession or increasing
interest rates, than are investment grade issuers. Western is sensitive to
its risk exposure and carefully monitors its below investment grade
securities.
None of Western's fixed maturity investments were in substantive default
(i.e., in default due to nonpayment of interest or principal) as of September
30, 1996, compared to $6.8 million in substantive default as of September 30,
1995. Western recorded no writedowns of fixed maturity investments during the
first nine months of 1996 or 1995.
At September 30, 1996, Western's actively managed fixed maturity
portfolio had net unrealized losses of $30.9 million. The net loss, which
consisted of $131.6 million of unrealized gains and $162.5 million of
unrealized losses, compares with net unrealized gains of $342.2 million at
December 31, 1995. Estimated fair values for actively-managed fixed maturity
investments are primarily based on estimates from nationally recognized
pricing services and broker-dealer market makers. The amounts of unrealized
gains and losses fluctuate due to both credit factors and changes in market
interest rates. The market value of fixed income securities generally
decreased during the first nine months of 1996, as a result of a rise in
market interest rates.
Fixed maturity investments at September 30, 1996, consisted primarily of
debt securities of the U.S. government, public utilities and other
corporations, and mortgage-backed securities. Investments in mortgage-backed
securities include collateralized mortgage obligations ("CMOs") and
mortgage-backed pass-through securities.
At September 30, 1996, Western held mortgage loans with a carrying value
of $125.2 million (or 1.4% of total invested assets), up from $82.6 million at
September 30, 1995. This increase reflects Western's reclassification during
the second quarter 1996 of $43.5 million of investments from the credit-tenant
loan category to the mortgage loan category. These reclassified investments
represent credit-tenant loans on which the commercial credit rating of the
tenant, Kmart Corp., was downgraded to below investment grade status by
several national statistical rating services.
None of Western's mortgage loans were 90 or more days past due at
September 30, 1996. Western recorded no writedowns for credit impairment in
the mortgage portfolio during the first nine months of 1996.
The Company occasionally uses derivative financial instruments,
consisting primarily of interest rate swaps, to alter interest rate exposure
arising from mismatches between assets and liabilities. Under the terms of the
interest rate swaps, the Company agrees with other parties to exchange, at
specified intervals, the differences between fixed-rate and floating-rate
interest amounts calculated by reference to an agreed notional amount. The
Company pays the floating rate and receives the fixed rate under the
contracts, with the net amount paid or received being charged or credited to
net investment income. At September 30, 1996, the Company had outstanding
interest rate swap agreements with notional contract amounts totaling $330.0
million. The agreements expire at various dates through 1999. Under the
agreements the Company principally received fixed rates averaging 7.3% and
paid floating rates, primarily based on LIBOR, averaging 5.7% during the first
nine months of 1996. The swaps, which are marked to market in accordance with
SFAS 115, resulted in a $4.1 million decrease in other liabilities at
September 30, 1996.
For a discussion regarding the effects of changing interest rates on the
Company's investments, see the Company's 1995 Annual Report on Form 10-K,
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Effects of Changing Interest Rates on Investments".
SALES
Total premiums collected in the third quarter 1996 were $448.7 million,
up 111% from the corresponding 1995 quarter, and year-to-date premiums
collected were $1.2 billion, up 131% from the corresponding 1995 period.
Western utilizes four marketing distribution channels -Financial Institutions,
Personal Producing General Agents (PPGAs), Direct Marketing, and Specialty.
Additionally, Western markets a variable annuity product through its financial
institution, PPGA and direct marketing channels.
<PAGE>
The following table sets forth premium generated by distribution channel
(in millions):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Quarter Ended Nine Months Ended
------------- ------------------
September 30, September 30,
------------- ------------------
1996 1995 1996 1995
------ ------ ------- -------
PREMIUMS AND DEPOSITS COLLECTED:
Financial institutions
Proprietary $ 294.9 $ 13.8 $ 588.0 $ 13.8
Retail 86.2 133.5 361.6 320.5
------------------- ------- --------- -------
Total 381.1 147.3 949.6 334.3
Personal producing general agents 40.5 44.9 110.9 120.9
Specialty sales 25.3 19.7 94.1 44.1
Direct marketing 2.1 0.6 4.4 2.9
------------------- ------- --------- -------
Total premiums and deposits
collected 449.0 212.5 1,159.0 502.2
Reinsurance ceded (0.3) (0.1) (1.0) (0.7)
------------------- ------- --------- -------
Net Premiums and Deposits
Collected (1) $ 448.7 $212.4 $1,158.0 $501.5
=================== ======= ========= =======
SALES PRODUCTION DATA:
Western National Life $ 448.7 $212.4 $1,158.0 $501.5
Independent Advantage Financial and
Insurance Services, Inc. (2) 8.8 10.9 24.7 34.6
------------------- ------- --------- -------
Total Sales Production $ 457.5 $223.3 $1,182.7 $536.1
=================== ======= ========= =======
<FN>
(1) Effective January 1, 1996, the Company revised the way it reports Premiums and Deposits
Collected. Previously, internal exchanges were included in Premiums and Deposits Collected.
Beginning January 1, 1996, internal exchanges are not included in Premiums and Deposits Collected,
and prior periods have been adjusted to reflect this method of reporting. An internal exchange is
the rollover of an existing policyholder's deposit to a revised contract with a new surrender charge
period, on which there is generally reduced or no commission expense. Western had $75.5 million and
$15.7 million of internal exchanges in the third quarters of 1996 and 1995, respectively, and $162.0
million and $33.6 million of internal exchanges for the first nine months of 1996 and 1995,
respectively.
(2) Represents fixed and variable annuity and life insurance sales of nonaffiliated life
insurance company products by Independent Advantage Financial and Insurance Services, Inc., a direct
marketing subsidiary of the Company.
</TABLE>
FINANCIAL INSTITUTIONS. Sales through financial institutions accounted
for more than three-fourths of Western's overall sales in both the third
quarter and year-to-date 1996 results. Third quarter sales in this area were
up 159% to $381.1 million, compared to $147.3 million for the third quarter
1995. Financial institution sales for the first nine months of 1996 were
$949.6 million, compared to $334.3 million for the year-earlier period.
Financial institution sales are expected to continue to constitute a very
large percentage of Western's total sales in future periods, especially in
light of Western's proprietary annuity relationships. Such relationships are
more fully described below.
Western's third quarter 1996 sales in the financial institution market
reflected high levels of production from relatively few large bank
distribution relationships. The largest five relationships accounted for 80%
of financial institution sales in the third quarter 1996, compared to 38% of
sales for full-year 1995. This increased concentration may make Western's
sales levels more vulnerable to the loss of any single major relationship.
Each of the largest five relationships accounted for the following percentage
of sales in the third quarter 1996: First Union 56%, Home Savings 9%, Shawmut
7%, First of America 5%, and Firstar Bank 3%. First Union began marketing
Western non-proprietary fixed annuity products in mid-1995. In March 1996,
Western and First Union launched a proprietary fixed annuity program. The
Western/First Union proprietary annuity program resulted in sales of $212.1
million for the third quarter 1996. Western's management believes that its
relationship with First Union has the potential for substantial continued
production in future periods.
<PAGE>
Of the $381.1 million in total financial institution sales for the third
quarter 1996, 77% were proprietary sales and 23% were retail sales. The
$949.6 million of financial institution sales year-to-date consisted of 62%
proprietary sales and 38% retail sales.
Proprietary Sales. In 1995, Western initiated its first proprietary
fixed annuity distribution arrangement in the financial institution market.
In these proprietary arrangements, Western and the distributing financial
institution jointly develop a product to be offered solely through that
institution, and jointly establish product specifications and target spreads.
This process requires a mutual agreement regarding policy benefits, sales
compensation and profitability. In most cases, the distributing financial
institution, subject to investment guidelines established and monitored by
Western, manages Western's general account assets resulting from annuity sales
of its proprietary product and receives an investment management fee. Western
is solely responsible for policy administration and insurance regulatory
compliance, and Western retains the right to establish interest crediting
rates. Western believes that it was the first insurance company to develop a
proprietary fixed annuity program that provides for the selling financial
institution to also manage the resulting assets, and expects this program to
provide it with a competitive advantage in the financial institution
marketplace.
At year-end 1995, Western had established, or had agreements to
establish, proprietary fixed annuity programs at several financial
institutions, the largest of which was First Union. The first proprietary
program commenced sales in the third quarter 1995, and a second proprietary
program commenced in the fourth quarter 1995. The remaining proprietary
programs entered into in 1995 were all at varying stages of production as of
September 30, 1996. During the first nine months of 1996, Western announced
and launched two new proprietary programs. Proprietary annuity sales for the
third quarter and the first nine months of 1996 were $294.9 million and $588.0
million, respectively, compared with $13.8 million for the third quarter and
first nine months of 1995.
Retail Sales. Third quarter 1996 retail sales, which include all
non-proprietary sales through financial institutions, were down 35% to $86.2
million, compared to $133.5 million for the third quarter 1995. Retail sales
for the first nine months of 1996 were $361.6 million, up 13% from retail
sales of $320.5 million for the year-earlier period. The decrease in this
distribution channel for the third quarter 1996 reflects Western's increased
focus on its proprietary annuity programs.
PERSONAL PRODUCING GENERAL AGENTS. Third quarter sales through PPGAs
decreased to $40.5 million from $44.9 million in the third quarter 1995. For
the first nine months of 1996, PPGA sales were $110.9 million, compared to
$120.9 million in 1995. The decreases in this channel were primarily the
result of increased competition from equity-oriented products in this market,
reflecting the continued strength of the domestic equity markets.
DIRECT MARKETING. Western's conservation unit, which is part of its
direct sales operations, effected $75.5 million of internal exchanges in the
third quarter 1996, compared to $15.7 million in the third quarter 1995.
Internal exchanges for the first nine months of 1996 and 1995 totaled $162.0
million and $33.6 million, respectively. Sales of Western products through
the Company's direct marketing channel were $2.1 million for the third quarter
1996, compared to $0.6 million for the third quarter 1995. Such sales were
$4.4 million and $2.9 million for the first nine months of 1996 and 1995,
respectively. In the third quarter and first nine months of 1996, the
Company's direct marketing subsidiary sold $8.8 million and $24.7 million,
respectively, of annuity and life products of nonaffiliated life insurance
companies, compared to $10.9 million and $34.6 million for the corresponding
periods in 1995.
SPECIALTY. Third quarter specialty sales, which include SPIAs,
supplemental contracts, and life insurance, increased 28% to $25.3 million,
compared to $19.7 million for the third quarter 1995. Year-to-date specialty
sales increased 113% to $94.1 million, compared to $44.1 million for the
year-earlier period. The increase is primarily due to $59.8 million in
structured settlement sales resulting from a modified coinsurance agreement
entered into with American General Life Insurance Company in late 1995. The
agreement provides for the parties to jointly market SPIA policies in the
structured settlement market and for such policies to be administered by
Western. Under the agreement, American General Life Insurance Company issues
the policies, and 50% of each risk is reinsured to Western (which portion is
reported by Western as specialty sales).
<PAGE>
VARIABLE ANNUITIES. In the third quarter and first nine months of 1996,
premiums collected from sales of Western's variable annuity product were $1.3
million and $4.1 million, respectively. Western did not have a variable
annuity product in the corresponding 1995 periods. Western is currently
concentrating on developing distribution channels for this product, and the
level of future sales will be dependent on the outcome of these efforts.
PREMIUM AND DEPOSIT DATA
Effective January 1, 1996, the Company began excluding internal exchanges
from its deposit and withdrawal data. Data reported for prior periods has
been adjusted to reflect this change. Western had $75.5 million and $162.0
million of internal exchanges for the third quarter and first nine months of
1996, respectively, compared to $15.7 million and $33.6 million in the
corresponding 1995 periods.
The following table indicates sales by product line for the periods
indicated:
PREMIUM AND DEPOSIT DATA
(IN MILLIONS)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Quarter Ended Nine Months Ended
------------- -------------------
September 30, September 30,
------------- -------------------
1996 1995 1996 1995
------------- ------- ------- ---------
FIRST-YEAR PREMIUMS AND DEPOSITS
Single premium deferred
annuities $ 408.2 $171.3 $1,012.6 $387.0
Flexible premium deferred
annuities 2.2 7.6 8.6 21.3
Single premium immediate
annuities 24.2 18.7 90.7 41.1
------------------- ------- --------- -------
Total first-year 434.6 197.6 1,111.9 449.4
------------------- ------- --------- -------
RENEWAL PREMIUMS AND DEPOSITS
Flexible premium deferred
annuities 12.1 14.0 42.5 49.7
Life and other 2.3 1.0 7.1 3.2
------------------- ------- --------- -------
Total renewal 14.4 15.0 49.6 52.9
------------------- ------- --------- -------
NET PREMIUMS AND DEPOSITS
COLLECTED
Total premiums and deposits
collected 449.0 212.6 1,161.5 502.3
Reinsurance ceded (0.3) (0.1) (1.1) (0.7)
------------------- ------- --------- -------
NET PREMIUMS AND DEPOSITS
COLLECTED $ 448.7 $212.5 $1,160.4 $501.6
=================== ======= ========= =======
</TABLE>
The table below sets forth the change in contract values of annuities in
force (net of reinsurance), excluding annuities and supplemental contracts
with life contingencies, for the periods indicated (in millions):
<TABLE>
<CAPTION>
<S> <C> <C> <C>
IMMEDIATE
ANNUITIES
DEFERRED WITHOUT LIFE
ANNUITIES CONTINGENCIES TOTAL
--------- --------------- -------
December 31, 1994 $ 5,984.2 $ 407.7 $6,391.9
Deposits 458.3 27.6 485.9
Distributions (675.5) (50.8) (726.3)
Credited interest 247.2 25.0 272.2
--------- -------------- --------
September 30, 1995 $ 6,014.2 $ 409.5 $6,423.7
December 31, 1995 $ 6,121.0 $ 412.7 $6,533.7
Deposits 1,066.7 22.6 1,089.3
Distributions (884.0) (60.9) (944.9)
Credited interest 261.3 25.0 286.3
--------- -------------- --------
September 30, 1996 $ 6,565.0 $ 399.4 $6,964.4
========= ============== ========
</TABLE>
<PAGE>
Distributions (withdrawals, deaths and annuitizations) in the first nine
months of 1996 increased from the previous year's period primarily due to an
increase in the amount of annuity deposits surrenderable without penalty. As
a percentage of average deferred annuity liabilities, the year-to-date average
annualized distribution rate for the first nine months of 1996 was 18.1%,
compared to 14.7% for the first nine months of 1995. Year-to-date withdrawals
were somewhat higher than anticipated. Withdrawals tend to be sensitive to
changes in market interest rates and alternative investment opportunities, and
they will fluctuate from period to period.
The Company believes that the increased withdrawal activity in 1996
reflects the fact that substantial blocks of annuities issued in 1991 have
exited surrender charge protection in 1996. Because Western's sales levels in
late 1991 and continuing through 1992 and 1993 declined substantially from
those prevailing in 1990 and the first half of 1991, the Company anticipates
that withdrawal rates will moderate somewhat over the next several quarters,
provided interest rates do not increase substantially. Total third quarter
1996 withdrawals were $249 million, compared with $296 million in second
quarter 1996 and $232 million in first quarter 1996.
REINSURANCE
In conformity with industry practice, Western reinsures a portion of the
business it sells. Under such reinsurance arrangements, the original insurer
remains liable under the reinsured policies in the event the reinsurer is
unable to fulfill its obligations. Premiums ceded were not material in the
quarters ended September 30, 1996, and 1995.
Western is a party to a modified coinsurance agreement with American
General Life Insurance Company. Under the agreement, American General Life
Insurance Company issues the policies, and 50% of each risk is reinsured to
Western. See -Sales -Speciality, above. Additionally, Western is a party to
a stand-by coinsurance agreement with an unaffiliated insurer under which the
insurer has agreed to provide coinsurance for selected Western policies upon
the occurrence of certain contingencies.
FINANCIAL CONDITION
Liquidity for Insurance Operations
Western's business generally provides adequate cash flow from premium
collections and investment income to meet its obligations. To date in 1996,
net cash flow from operations, premium collections plus investment income less
benefits and expenses, was $440 million, including $241 million in the third
quarter. The liabilities related to insurance policies are primarily long
term and generally are paid from operating cash flows. Most assets are
invested in bonds and other securities, most of which are readily marketable.
Although there is no present need or intent to dispose of such investments to
meet liquidity needs, Western could liquidate portions of these investments if
the need arose. To increase its return on investments and improve liquidity,
Western may from time to time enter into reverse repurchase agreements, dollar
roll transactions (which are specialized forms of collateralized lending
involving mortgage-backed securities) or other short-term borrowings.
Of Western's total insurance liabilities at September 30, 1996, 19% could
not be surrendered, 47% could be surrendered only by incurring a surrender
charge, and 34% could be surrendered without penalty. The extent of increases
and decreases in the percentage of interest-sensitive reserves subject to
withdrawal without penalty will depend on the level of new sales, as well as
on the level of policyholder withdrawals. In general, policy liabilities not
subject to a surrender charge are more likely to be withdrawn by policyholders
than are those that remain subject to such charges. Of those liabilities
subject to surrender charge, the average remaining surrender charge period was
approximately 3.1 years and the surrender charge averaged approximately 4.5%
of accumulated policy value at September 30, 1996.
<PAGE>
Payment characteristics of insurance liabilities at September 30, 1996,
were as follows (in millions):
<TABLE>
<CAPTION>
<S> <C>
Payments under contracts containing fixed payment dates:
Due in one year or less $ 164.5
Due after one year through five years 652.1
Due after five years through ten years 738.0
Due after ten years 3,550.5
--------
Total gross payments with payment dates fixed by contract 5,105.1
Less amounts representing future interest on such contracts 3,474.0
--------
Insurance liabilities with payment dates fixed by contract 1,631.1
Insurance liabilities with payment dates not fixed by contract 6,710.8
--------
Total insurance liabilities $8,341.9
========
</TABLE>
Of the above insurance liabilities under contracts containing fixed
payment dates, approximately 30% related to payments that will be made on such
date only if the contract holder is living. Expected mortality is considered
in determining the amount of this liability. The remainder of the insurance
liabilities with fixed payment dates were payable regardless of the contract
holder's survival.
Approximately 20% of insurance liabilities were subject to interest
rates, ranging from 3% to 11%, fixed for the life of the contract.
Approximately 98% of the deferred annuity liabilities were subject to interest
rates that may be reset, subject to minimum guaranteed rates, at least
annually.
Western believes that it has adequate short-term investments and readily
marketable securities to cover the payments under contracts containing fixed
payment dates, plus any likely cash needs for surrenders. At September 30,
1996, Western had fixed maturities and short-term investments, net of
investment borrowings and amounts due to brokers, with a total market value of
more than $8.4 billion, or 93% of invested assets. Western believes that most
of these investments could be readily sold or used to facilitate borrowings
under dollar roll and reverse repurchase agreements.
The Texas Department of Insurance, the NAIC and several other states
evaluate the sufficiency of an insurer's capital by computing a risk-adjusted
capital level which takes into consideration risks associated with the assets
and insurance products of the insurer. Using the NAIC computations, Western's
total adjusted capital was more than twice the company action risk-based
capital level as calculated at September 30, 1996, under the guidelines.
Holding Company Liquidity and Capital
At September 30, 1996, shareholders' equity, as adjusted for SFAS No.
115, was $842.8 million, or $12.09 per share, compared to $785.6 million, or
$12.61 per share as of December 31, 1995. Shareholders' equity at September
30, 1996, reflects the issuance on September 17, 1996, of 7,254,464 shares of
Series A Participating Convertible Preferred Stock (the "Series A Preferred
Stock") to American General, which resulted in net proceeds to the Company of
approximately $126 million. Reference is made to the Company's Report on Form
8-K/A, dated September 17, 1996, for a more detailed discussion of the Series
A Preferred Stock and the related transactions with American General. The net
proceeds were contributed to the capital of Western to support the significant
increases in Western's premiums and insurance liabilities thus far in 1996 and
future anticipated asset growth at Western. The Company anticipates that
Western's growth potential due to this infusion of capital will eventually
offset the dilutive effects on earnings per share caused by the issuance.
Without taking into account Western's growth potential due to the capital
infusion, but assuming the proceeds are invested at Western's current
portfolio rate, the issuance of the Series A Preferred Stock would result in a
decrease in earnings per share of approximately $0.06 annually. Because the
additional shares were issued so late in third quarter 1996, the dilutive
effect on third quarter earnings per share was negligible.
Shareholders' equity is also affected by net adjustments made in the
market value of the Company's investment portfolio as required under SFAS No.
115. See Note 2 to the Consolidated Financial Statements of the Company's
1995 Annual Report on Form 10-K. Excluding the effects of SFAS No. 115,
shareholders' equity would have been $851.4 million, or $12.22 per share, at
September 30, 1996, compared with $660.4 million, or $10.60 per share, at
<PAGE>
December 31, 1995. In general, SFAS No. 115 requires that actively managed
portfolios of marketable securities be marked to current market value, with
the resulting unrealized gain or loss reported as an adjustment to
shareholders' equity (see Note 2). Because no corresponding adjustment is
made to liabilities, management of the Company is of the view that SFAS No.
115 distorts the true economic effects of changes in interest rates on the
financial condition of financial services companies, and that resulting equity
and book value determinations are not meaningful indicators of financial
strength. Because SFAS No. 115 causes the Company's reported book value to
vary substantially with changes in market interest rates, the Company expects
its shareholders' equity to vary widely over time, increasing during periods
of declining interest rates and decreasing during periods of rising interest
rates.
Because Western is governed for insurance regulatory purposes by
statutory accounting principles that do not give effect to the adjustments
required by SFAS No. 115, the application of SFAS No. 115 does not affect
Western's statutory operations or regulatory capital position.
As a result of the Company's holding company structure, the parent
company's ability to make required debt service payments and meet other cash
needs depends upon dividends and fees received from its wholly-owned
subsidiaries. Dividend payments by insurance companies, such as Western, are
subject to statutory limitations and in certain cases to the approval of the
insurance regulatory authorities. The maximum dividend payment that Western
may make without prior approval in 1996 is $42.4 million, which management
believes is more than sufficient to meet the Company's anticipated debt
service obligations, dividends on common and preferred stock, and operating
expenses during the year. Western has not paid a dividend to the Company in
1996.
On September 8, 1995, the Company entered into a five-year credit
agreement (the "Credit Agreement") with First Union National Bank of North
Carolina and certain other financial institutions (collectively referred to as
the "Lenders"). Under the Credit Agreement, the Lenders have agreed to extend
credit to the Company on a revolving basis, upon the Company's request, in an
aggregate principal amount up to $100.0 million. The Credit Agreement
contains certain provisions that require the Company and its material
subsidiaries to maintain specified levels of financial solvency during the
term of the agreement. At September 30, 1996, the Company had $45.1 million
outstanding under the Credit Agreement.
On September 3, 1996, the Company paid a common stock dividend of $.04
per share. The total amount paid was $2.5 million. On October 22, 1996, the
board of directors declared a cash dividend of $.04 per outstanding share of
common stock and Series A Preferred Stock. The dividend is payable on
December 3, 1996, to shareholders of record at the close of business on
November 12, 1996. The total dividend payment will be approximately $2.8
million.
OTHER INFORMATION
With respect to statements herein that may be construed as predictive of
future performance, readers should be aware that performance may differ from
that currently anticipated. Such differences may be either positive or
negative and may be significant. Differences may arise from, among other
things, changes in the economic, legal, and competitive environment in which
the Company operates. Reference is made to the Company's 1995 Annual Report
on Form 10-K for additional information on factors affecting the Company's
business.
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits
4.1 Certificate of Designation, Preferences and Rights and
Limitations of the Series A Participating Convertible
Preferred Stock of the Company (incorporated by reference
to Exhibit 4.1 of the Report on Form 8-K/A of the Company
dated September 17, 1996).
10.1 Stock Purchase Agreement, dated as of September 13, 1996,
between American General Corporation and the Company
(incorporated by reference to Exhibit 10.1 of the
Report on Form 8-K/A of the Company dated September 17, 1996).
10.2 Shareholder's Agreement, dated as of December 2, 1994, between
American General Corporation and the Company (incorporated by
reference to Exhibit 10.2 of the Report on Form 8-K/A of the
Company dated September 17, 1996).
10.3 Amendment No. 1 to Shareholder's Agreement, dated as of
September 13, 1996, between American General Corporation and
the Company (incorporated by reference to Exhibit 10.3 of the
Report on Form 8-K/A of the Company dated September 17, 1996).
11.1 Computation of Earnings Per Share.
27.1 Financial Data Schedule.
b) Reports on Form 8-K
A report on Form 8-K/A, dated September 17, 1996, was filed with the
Commission to report under Item 5 the issuance of 7,254,464 shares of Series A
Participating Convertible Preferred Stock to American General Corporation and
the agreements relating to the transaction.
<PAGE>
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 THEREUNTO DULY AUTHORIZED.
WESTERN NATIONAL CORPORATION
By: /s/ Arthur R. McGimsey
===========================
Arthur R. McGimsey
Executive Vice President and
Chief Financial Officer
Dated: November 13, 1996
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES EXHIBIT 11.1
COMPUTATION OF EARNINGS PER SHARE
(IN MILLIONS - EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
<S> <C>
NINE MONTHS ENDED
SEPTEMBER 30, 1996
------------------
PRIMARY:
Weighted average shares outstanding 62.4
Common equivalent shares related to:
Series A Preferred Stock 0.4
Stock options at average market price
(as determined by application of the
treasury stock method) 0.4
-----
Weighted average shares and common
stock equivalents 63.2
=====
Net income $71.0
======
Net income per common share $1.12
======
NINE MONTHS ENDED
SEPTEMBER 30, 1996
------------------
FULLY DILUTED:
Weighted average shares outstanding 62.4
Common equivalent shares related to:
Series A Preferred Stock 0.4
Stock options at end of period price
(as determined by application of the
treasury stock method) 0.4
-----
Weighted average shares and common stock
equivalents 63.2
=====
Net income $71.0
======
Net income per common share $1.12
======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY'S FORM 10-Q FOR THE
YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<CIK> 0000913202
<NAME> WESTERN NATIONAL CORPORATION
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 8,457
<DEBT-CARRYING-VALUE> 1
<DEBT-MARKET-VALUE> 2
<EQUITIES> 20
<MORTGAGE> 125
<REAL-ESTATE> 0
<TOTAL-INVEST> 9,053
<CASH> 139
<RECOVER-REINSURE> 2
<DEFERRED-ACQUISITION> 395
<TOTAL-ASSETS> 9,711
<POLICY-LOSSES> 8,340
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 2
<POLICY-HOLDER-FUNDS> 108
<NOTES-PAYABLE> 148
0
126
<COMMON> 3
<OTHER-SE> 714
<TOTAL-LIABILITY-AND-EQUITY> 9,711
13
<INVESTMENT-INCOME> 524
<INVESTMENT-GAINS> (3)
<OTHER-INCOME> 1
<BENEFITS> 363
<UNDERWRITING-AMORTIZATION> 30
<UNDERWRITING-OTHER> 16
<INCOME-PRETAX> 109
<INCOME-TAX> 38
<INCOME-CONTINUING> 71
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 71
<EPS-PRIMARY> 1.12
<EPS-DILUTED> 1.12
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
