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, 1997
/ / 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, 1997: 69,705,961
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
--------------- -------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
- -----------------------------------------------------------------------
INVESTMENTS:
Fixed maturities - actively managed at fair value
(amortized cost: 1997-$9,590.2; 1996-$8,738.4). . . . . . . . . . . $ 9,848.5 $ 8,842.5
Equity securities at fair value (cost: 1997-$10.0; 1996-$0.0). . . . 10.3 -
Credit-tenant loans . . . . . . . . . . . . . . . . . . . . . . . . . 215.3 208.5
Mortgage loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . 103.9 122.7
Policy loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63.4 66.8
Short-term investments. . . . . . . . . . . . . . . . . . . . . . . . 360.3 109.6
Due from brokers. . . . . . . . . . . . . . . . . . . . . . . . . . . 63.7 0.4
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . 47.7 25.6
--------------- -------------
Total investments . . . . . . . . . . . . . . . . . . . . . . . . . 10,713.1 9,376.1
Accrued investment income . . . . . . . . . . . . . . . . . . . . . . 170.2 156.6
Funds held by reinsured and reinsurance receivables . . . . . . . . . 187.8 98.0
Cost of policies purchased. . . . . . . . . . . . . . . . . . . . . . 22.9 50.4
Cost of policies produced . . . . . . . . . . . . . . . . . . . . . . 440.0 380.2
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . 10.5 13.4
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41.8 20.8
--------------- -------------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11,586.3 $ 10,095.5
=============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------
LIABILITIES:
Insurance liabilities . . . . . . . . . . . . . . . . . . . . . . . . $ 9,497.6 $ 8,679.9
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148.2 148.0
Investment borrowings and due to brokers. . . . . . . . . . . . . . . 590.4 156.3
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . 142.4 98.4
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 138.7 98.1
--------------- -------------
Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . 10,517.3 9,180.7
SHAREHOLDERS' EQUITY:
Preferred stock (par value $.001 per share; 50,000,000 shares
authorized; issued and outstanding: 1997-0; 1996-7,254,464) . . . . - -
Common stock and additional paid-in capital (par value $.001
per share, 500,000,000 shares authorized; issued: 1997-69,774,103;
1996-62,441,423; outstanding: 1997-69,705,961; 1996-62,441,423) . . 474.8 473.1
Net unrealized appreciation of securities,
net of applicable deferred income taxes:
B 1997-$60.5; 1996-$21.1 . . . . . . . . . . . . . . . . . . . . . 112.3 39.1
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . 483.9 402.6
Cost of treasury stock (68,142 shares at cost). . . . . . . . . . . . (2.0) -
--------------- -------------
Total Shareholders' Equity. . . . . . . . . . . . . . . . . . . . 1,069.0 914.8
--------------- -------------
Total Liabilities and Shareholders' Equity. . . . . . . . . . . . $ 11,586.3 $ 10,095.5
=============== =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(DOLLARS IN MILLIONS - EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS
SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------- --------------------
1997 1996 1997 1996
--------------- -------------------- ------ -------
<S> <C> <C> <C> <C>
REVENUES:
Insurance policy and fee income . . . $ 32.2 $ 21.1 $103.4 $ 59.1
Net investment income 207.2 179.7 598.7 523.5
Net realized gains (losses) . . . . . (0.7) 2.2 3.0 (2.7)
--------------- -------------------- ------ -------
Total revenues. . . . . . . . . . 238.7 203.0 705.1 579.9
--------------- -------------------- ------ -------
BENEFITS AND EXPENSES:
Insurance policy benefits . . . . . . 26.5 26.0 80.4 81.9
Change in future policy benefits and
other liabilities . . . . . . . . . 30.8 19.5 94.0 46.1
Interest expense on annuities and
financial products. . . . . . . . . 108.6 96.7 314.4 281.2
Interest expense on notes payable . . 2.7 2.7 8.0 8.0
Interest expense on investment and
short-term borrowings . . . . . . 5.8 2.9 14.6 7.8
Amortization related to operations. . 12.5 10.0 35.4 30.0
Amortization and change in future
policy benefits related to net
realized gains (losses) . . . . . . (0.2) 0.8 1.5 0.2
Other operating costs and expenses. . 4.8 5.2 16.1 15.8
--------------- -------------------- ------ -------
Total benefits and expenses . . . 191.5 163.8 564.4 471.0
--------------- -------------------- ------ -------
Income before income taxes. . . . . . . 47.2 39.2 140.7 108.9
Income tax expense. . . . . . . . . . . 16.3 13.6 51.0 37.9
--------------- -------------------- ------ -------
Net income. . . . . . . . . . . . $ 30.9 $ 25.6 $ 89.7 $ 71.0
=============== ==================== ====== =======
EARNINGS PER COMMON SHARE
AND COMMON EQUIVALENT SHARE:
Weighted average shares . . . . . . . 70.7 63.9 70.6 63.2
Net income $ 0.44 $ 0.40 $ 1.27 $ 1.12
=============== ==================== ====== =======
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------
1997 1996
--------------------------------- --------
<S> <C> <C>
Preferred stock:
Balance, beginning of period. . . . . . . . . . . . . . . . $ - $ -
Issuance of 7,254,464 shares of Series A Preferred Stock
($.001 per share liquidation preference). . . . . . . . . - -
Conversion of 7,254,464 Series A shares to common stock . - -
--------------------------------- --------
Balance, end of period. . . . . . . . . . . . . . . . . . . $ - $ -
================================= ========
Common stock and additional paid-in capital:
Balance, beginning of period. . . . . . . . . . . . . . . . $ 473.1 $ 346.8
Issuance of shares of common stock related to restricted
stock awards and options and 401(k) matching
(1997-78,216 shares; 1996-93,223 shares). . . . . . . . . 1.7 1.5
Issuance of 7,254,464 shares of Series A Preferred Stock. . - 125.9
Issuance of 7,254,464 shares of common stock pursuant
to conversion of Series A Preferred Stock . . . . . . . . - -
--------------------------------- --------
Balance, end of period. . . . . . . . . . . . . . . . . . . $ 474.8 $ 474.2
================================= ========
Net unrealized appreciation (depreciation) of securities,
net of applicable deferred income taxes (benefits):
Balance, beginning of period. . . . . . . . . . . . . . . . $ 39.1 $ 125.2
Change in unrealized appreciation (depreciation) 73.2 (133.8)
--------------------------------- --------
Balance, end of period. . . . . . . . . . . . . . . . . . . $ 112.3 $ (8.6)
================================= ========
Retained earnings:
Balance, beginning of period. . . . . . . . . . . . . . . . $ 402.6 $ 313.6
Net income 89.7 71.0
Dividends on common stock . . . . . . . . . . . . . . . . (8.1) (7.4)
Dividends on preferred stock. . . . . . . . . . . . . . . (0.3) -
--------------------------------- --------
Balance, end of period. . . . . . . . . . . . . . . . . . . $ 483.9 $ 377.2
================================= ========
Treasury stock:
Balance, beginning of period. . . . . . . . . . . . . . . . $ - $ -
Purchase of 68,142 shares of common stock, at cost. . . . . (2.0) -
--------------------------------- --------
Balance, end of period. . . . . . . . . . . . . . . . . . . $ (2.0) $ -
================================= ========
Total shareholders' equity. . . . . . . . . . . . . . . . $ 1,069.0 $ 842.8
================================= ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------
1997 1996
--------------------------------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income. . . . . . . . . . . . . . . . . . . . $ 89.7 $ 71.0
Adjustments to reconcile net income to net cash
provided by operations:
Amortization and depreciation 38.2 33.7
Realized (gains) losses on investments, net . . (5.9) (4.6)
Income taxes. . . . . . . . . . . . . . . . . . 3.1 20.9
Increase in insurance liabilities . . . . . . . 4.0 37.2
Interest credited to insurance liabilities. . . 323.3 287.9
Fees charged to insurance liabilities . . . . . (4.8) (3.3)
Amortization (accrual) of investment income . . (19.9) (18.3)
Deferral of cost of policies produced . . . . . (110.3) (90.4)
Other . . . . . . . . . . . . . . . . . . . . . (6.4) 2.1
--------------------------------- ----------
Net cash provided by operating activities . . . . 311.0 336.2
--------------------------------- ----------
Cash flows from investing activities:
Sales of investments. . . . . . . . . . . . . . . 2,397.4 2,391.9
Maturities and redemptions of investments . . . . 404.2 346.9
Purchases of investments. . . . . . . . . . . . . (3,574.5) (3,513.7)
--------------------------------- ----------
Net cash used in investing activities . . . . . . (772.9) (774.9)
--------------------------------- ----------
Cash flows from financing activities:
Deposit to insurance liabilities. . . . . . . . . 1,495.4 1,248.5
Withdrawals from insurance liabilities. . . . . . (1,090.0) (1,107.7)
Dividends on common stock . . . . . . . . . . . . (8.1) (7.4)
Dividends on preferred stock. . . . . . . . . . . (0.3) -
Proceeds from preferred stock issuance. . . . . . - 125.9
Purchase of treasury stock. . . . . . . . . . . . (2.0) -
Investment borrowings, net. . . . . . . . . . . . 317.6 (99.5)
--------------------------------- ----------
Net cash provided by financing activities . . . . 712.6 159.8
--------------------------------- ----------
Net increase (decrease) in short-term investments 250.7 (278.9)
Short-term investments - beginning of period. . . 109.6 417.6
--------------------------------- ----------
Short-term investments - end of period. . . . . . $ 360.3 $ 138.7
================================= ==========
Supplemental cash flow disclosure:
Income taxes (refunded) paid, net . . . . . . . . $ 48.9 $ (31.2)
================================= ==========
Interest paid on notes payable and investment
borrowings. . . . . . . . . . . . . . . . . . . $ 24.7 $ 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 1996 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, 1997,
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
All of the Company's fixed maturity investments are classified as
"actively managed", and are carried at estimated fair value in accordance with
SFAS 115. 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, 1997 and December 31, 1996.
ADJUSTMENTS TO ACTIVELY MANAGED FIXED MATURITIES
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997 DECEMBER 31, 1996
-------------------- -------------------
EFFECT OF EFFECT OF
COST FAIR VALUE CARRYING COST FAIR VALUE CARRYING
BASIS ADJUSTMENTS VALUE BASIS ADJUSTMENTS VALUE
-------------------- ------------------- ---------- --------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENTS:
Actively managed fixed maturities $ 9,590.2 $ 258.3 $ 9,848.5 $8,738.4 $ 104.1 $ 8,842.5
Equity securities . . . . . . . . 10.0 0.3 10.3 - - -
Other invested assets . . . . . . 44.6 3.1 47.7 24.7 0.9 25.6
-------------------- ------------------- ---------- --------- ------------- ----------
9,644.8 261.7 9,906.5 8,763.1 105.0 8,868.1
OTHER BALANCE SHEET ITEMS:
Cost of policies purchased. . . . 67.6 (44.7) 22.9 71.5 (21.1) 50.4
Cost of policies produced . . . . 486.0 (46.0) 440.0 408.3 (28.1) 380.2
Other liabilities . . . . . . . . (140.5) 1.8 (138.7) (102.5) 4.4 (98.1)
Deferred income tax liability . . (81.9) (60.5) (142.4) (77.3) (21.1) (98.4)
------------------- -------------
Unrealized appreciation
of investments, net . . . . . . $ 112.3 $ 39.1
================== =============
</TABLE>
3. CHANGES IN COMMON STOCK AND PREFERRED STOCK
On September 1, 1997, the Company paid a common stock dividend of $.04
per share. The total amount paid in common stock dividends for the third
quarter was $2.8 million. For the first nine months of 1997, the Company paid
$8.1 million of dividends on common stock and $0.3 million of dividends on the
Series A Preferred Stock. At the Company's 1997 Annual Meeting, held on May
14, 1997, the Company's common stockholders approved the issuance of 7,254,464
shares of common stock, and all outstanding shares of Series A Preferred Stock
automatically converted to common stock on a share-for-share basis.
On October 29, 1997, the board of directors declared a common stock
dividend of $.04 per share payable on December 1, 1997, to shareholders of
record at the close of business on November 12, 1997. The total dividend
payment will be approximately $2.8 million.
During the first nine months of this year, 920 common shares were issued
pursuant to the exercise of stock options, 47,000 shares of restricted stock
were awarded to certain executive officers, and 30,296 shares of newly-issued
common stock were contributed to employee benefit plans. On September 11,
1997, the Company's board of directors approved a definitive agreement under
which American General Corporation will acquire the remaining 54% of the
common stock of the Company not currently owned by American General
Corporation. Reference is made to the Company's Report on Form 8-K/A, dated
September 11, 1997, for a more detailed description of the definitive
agreement with American General Corporation. Upon the approval of the
definitive agreement by the Company's board of directors, 166,000 restricted
shares of common stock of the Company previously issued to certain officers
under the Company's Stock and Incentive Plan vested and such officers
transferred 68,142 of such shares to the Company to satisfy tax withholding
requirements.
4. IMPENDING CHANGE IN DISCLOSURE OF EARNINGS PER SHARE DATA
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share ( SFAS
128"). SFAS 128 specifies the computation, presentation, and disclosure
requirements for earnings per share. SFAS 128 is effective for financial
statements issued for periods ending after December 15, 1997, including
interim periods. Earlier application is not permitted. However, an entity is
permitted to disclose pro forma earnings per share amounts computed using SFAS
128 in the notes to financial statements in periods prior to adoption. When
adopted, SFAS 128 requires restatement of earnings per share data for all
prior periods presented. SFAS 128 is designed to improve the earnings per
share information provided in financial statements by simplifying the existing
computational guidelines of Accounting Principles Board Opinion No. 15,
Earnings Per Share ( APB 15"). Some of the changes made by SFAS 128 to
simplify the earnings per share computations include: (a) eliminating the
presentation of primary earnings per share and replacing it with basic
earnings per share, with the principal difference being that common stock
equivalents resulting from stock options and convertible securities are not
considered in computing basic earnings per share, (b) eliminating the modified
treasury stock method in computing common stock equivalents for dilutive
earnings per share, and (c) revising the contingent share provisions and the
supplemental earnings per share date requirements. SFAS 128 requires dual
presentation of basic and diluted earnings per share on the face of the income
statement for all entities with complex capital structures regardless of
whether basic and diluted earnings per share are the same; it also requires a
reconciliation of the numerator and denominator used in computing basic and
diluted earnings per share. Following is pro forma earnings per share data
assuming SFAS 128 had been adopted in the accompanying consolidated interim
financial statements:
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1996
-------------------------------- -----
<S> <C> <C>
Basic. . $ 1.35 $1.14
Dilutive $ 1.27 $1.12
</TABLE>
The primary reason for the differences between basic and dilutive
earnings per share for the nine months ended September 30, 1997, is the
exclusion of Series A Preferred Stock during the period the stock was
outstanding.
<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
$10.6 billion of statutory assets at September 30, 1997. Unless the context
otherwise requires, references to the "Company" are references to Western
National Corporation and its consolidated subsidiaries.
A subsidiary of American General Corporation, a Texas corporation
("AGC"), currently owns approximately 46% of the Company's outstanding common
stock. References to "American General" are references to AGC and its direct
and indirect majority-controlled subsidiaries. On September 12, 1997,
American General and the Company jointly announced a definitive agreement
under which American General will acquire the remaining 54% of the common
stock of the Company for a total consideration consisting of cash and American
General common stock valued at approximately $1.2 billion, or $29.75 per
share, subject to adjustment in certain circumstances. The transaction has
been approved by the boards of directors of both American General and the
Company, and by a special committee of the Company's board of directors. The
transaction, which is subject to approval by the Company's shareholders and
requisite regulatory authorities, will be taxable to the Company's
shareholders and is expected to close in early January 1998. Reference is
made to the Company's Report on 8-K/A, dated September 11, 1997, for a more
detailed description of the definitive agreement with American General.
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 throughout 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 Western 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 Western'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, substantially mitigates the potentially adverse effects of
interest rate changes, except in the case of sudden and dramatic changes in
market rates.
As of the last day of each quarter, Western calculates the investment
spread on insurance liabilities by measuring the difference between the
average yield on invested assets and the average base liability crediting rate
on such date. Since first quarter 1994, investment spread, as so defined, has
remained between approximately 1.91% and 2.20%, and stood at approximately
2.18% at September 30, 1997. Western also presents its average spread on
insurance liabilities for each quarter, which Western believes more accurately
reflects its experience during the reported period. The investment spread
calculations exclude prepayment income and loss, income from the Company's
investment in limited partnerships and certain other equity-like investments,
and investment income from other non-scheduled sources. Average investment
spread has remained between approximately 1.96% and 2.24% since first quarter
1994, and was 2.24% for third quarter 1997. Western generally expects to
maintain a spread within the range of spreads it has achieved in recent years.
The level of the investment spread varies over time as a result of market
factors, competitive influences, liability mix, crediting rates, and
investment yields.
Operating income (which excludes realized investment gains (losses) net
of applicable adjustments to amortization, expenses and taxes) for the quarter
was $31.1 million, or $0.44 per share, up from $24.7 million, or $0.39 per
share, in the third quarter 1996. For the nine months ended September 30,
1997, operating income was $89.8 million, or $1.27 per share, compared to
$72.9 million, or $1.15 per share, in the first nine months of 1996. 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 income is the best
indicator of earnings capacity for financial services organizations such as
Western.
The following table sets forth operating and net income for the periods
indicated (in millions):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
QUARTER ENDED SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ------------------
1997 1996 1997 1996
----------------------------- -------------------------------- ------- -------
<S> <C> <C> <C> <C>
OPERATING INCOME:
Operating revenues . . . . . . . . $ 239.4 $ 200.8 $702.1 $582.6
Benefits and expenses. . . . . . . 191.7 163.0 562.9 470.8
----------------------------- -------------------------------- ------- -------
Pre-tax operating income . . . . . 47.7 37.8 139.2 111.8
Income tax expense from operations 16.6 13.1 49.4 38.9
----------------------------- -------------------------------- ------- -------
Net operating income . . . . . . . 31.1 24.7 89.8 72.9
Realized gains (losses) net of
amortization, expenses and taxes (0.2) 0.9 (0.1) (1.9)
----------------------------- -------------------------------- ------- -------
Net income . . . . . . . . . . . . $ 30.9 $ 25.6 $ 89.7 $ 71.0
============================= ================================ ======= =======
</TABLE>
Net investment income. Net investment income for the third quarter 1997
increased 15% to $207.2 million from $179.7 million in the third quarter 1996,
and year-to-date increased 14% to $598.7 million from $523.5 million for the
year-earlier period. This category of earnings, net of interest expense on
short-term investment borrowings, was $201.4 million for the third quarter
1997 compared to $176.8 million for the third quarter 1996. Year-to-date net
investment income, excluding interest expense on short-term borrowings, was
$584.1 million, compared to $515.7 million for the year-earlier period. The
year-to-date increase in net investment income is primarily attributable to a
$1.2 billion increase in average net invested assets to $9.9 billion from $8.7
billion at September 30, 1996, a slight increase in average annualized
investment yield (based on amortized cost) to 8.25% from 8.22% at September
30, 1996, and a $3.5 million increase in prepayment revenue to $7.4 million
from $3.9 million for the first nine months of 1996. Prepayment revenue for
third quarter 1997 increased to $4.9 million from $0.2 million in the
corresponding 1996 quarter. The year-to-date increase in net investment
income was partially offset by a decrease in income attributable to
partnership investments. Income from partnership investments was not material
for the first nine months of 1997 compared to $7.0 million for the
corresponding 1996 period, which was attributable to a single partnership
investment liquidated in third quarter 1996.
Net realized investment gains (losses). Net realized investment losses
were $0.7 million in the third quarter compared to gains of $2.2 million for
the corresponding year-earlier period. Year-to-date net realized investment
gains were $3.0 million, compared to losses of $2.7 million in the
corresponding 1996 period. Net of related adjustments to amortization,
reserves, related expenses, and taxes, net realized investment losses for both
the third quarter 1997 and year-to-date were $0.2 million and $0.1,
respectively, compared to gains of $0.9 million and losses of $1.9 million in
the corresponding periods. Included in the third quarter and year-to-date net
realized investment gains/losses is a $1.2 million charge related to capital
gain and loss items arising from the Internal Revenue Service ("IRS") audit
of the Company's 1993 and short-period 1994 returns. 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. Due to tax and yield
considerations, management will normally seek to manage the portfolio on a
gain/loss neutral basis.
Amortization and change in future policy benefits related to net realized
investment gains (losses). As described in Note 1 to the Consolidated
Financial Statements of the Company's 1996 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 amortization of the cost of policies
produced. As a result of the net realized investment gains/losses from the
sales of fixed maturities, amortization of the cost of policies produced was
decreased by $0.2 million in the third quarter and increased by $1.5 million
year-to-date, compared to increases of $0.8 million and $0.2 million,
respectively, in the third quarter and first nine months of 1996.
Insurance policy and fee income. Insurance policy and fee income was
$32.2 million and $21.1 million, respectively, in the third quarters of 1997
and 1996. The year-to-date level for 1997 was $103.4 million, which was a
$44.3 million increase 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 increases in
insurance policy and fee income for the third quarter and year-to-date are
primarily attributable to $27.5 million and $88.3 million, respectively, of
premium income resulting from the modified coinsurance agreement with American
General Life Insurance Company ("AGLIC "), compared to $16.7 million and $46.0
million, respectively, from this source in the corresponding 1996 periods.
Insurance policy benefits and other liabilities. Total third quarter
1997 insurance policy benefits (including changes in future policy benefits),
which relate solely to policies with mortality and morbidity features,
increased $11.8 million to $57.3 million from $45.5 million in the
year-earlier quarter. Insurance policy benefits for the first nine months of
1997 and 1996 were $174.4 million and $128.0 million, respectively. The
increases in this expense item for the third quarter and year-to-date were
primarily attributable to the establishment of $27.5 million and $88.3
million, respectively, of reserves resulting from the modified coinsurance
agreement with AGLIC, compared to $16.7 million and $46.0 million,
respectively, of such reserves for the corresponding 1996 periods. Third
quarter 1997 and 1996 reflected unfavorable mortality experience of $1.6
million and $0.7 million, respectively, on life contingent SPIA contracts.
Mortality experience was unfavorable by $1.6 million for the first nine months
of 1997, compared to a favorable mortality experience of $2.7 million for the
first nine months of 1996. Mortality experience varies from period to period
as differences between actual and expected mortality occur. Such differences
may be favorable or unfavorable.
Interest expense on annuities and financial products. Interest expense
on annuities and financial products increased by $11.9 million in the third
quarter 1997 and by $33.2 million year-to-date compared to the corresponding
year-earlier periods. This increase is primarily attributable to an increase
in reserves to $9.5 billion at September 30, 1997, from $8.3 billion at
September 30, 1996. The average rate credited on all insurance liabilities
declined to approximately 6.0% at September 30, 1997, from 6.2% a year
earlier. The decrease in average crediting rate reflects in part the reduced
percentage of total insurance liabilities accounted for by the Company's SPIA
policies, which generally have higher implicit interest rates than its other
policies, as well as a reduction in average interest rates on the Company's
deferred annuity business. 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.
Amortization related to operations. Amortization related to operations,
which excludes the effects of realized gains and losses, of the cost of
policies produced and the cost of policies purchased increased by $2.5 million
in the third quarter 1997 and by $5.4 million year-to-date compared to the
corresponding year-earlier periods. The quarter and year-to-date increases
are primarily the result of increases in the amount of in-force business.
Asset balances and scheduled amortization of costs of policies produced and
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.,
recomputed 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 changes to ongoing amortization rates. No
unlocking adjustments were made in the first nine months of 1997 or 1996.
Other operating costs and expenses. Other operating costs and expenses
were $4.8 million for the third quarter 1997, which was a $0.4 million
decrease from the year-earlier quarter. Year-to-date other operating costs
and expenses were $16.1 million, compared to $15.8 million in the year-earlier
period. The year-to-date increase was primarily the result of higher levels
of annuity sales and in-force business.
Interest expense on notes payable and investment borrowings. Interest
expense of $8.5 million for the third quarter 1997 was up from $5.6 million in
the year-earlier quarter. Third quarter 1997 interest expense consists of
$5.8 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 1997 was $22.6 million, compared to $15.8
million in the corresponding period. Year-to-date interest expense consists
of $14.6 million in interest expense on investment and short-term borrowings
and $7.8 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.
Investment borrowings were somewhat higher in the first nine months of 1997
from the corresponding 1996 period, reflecting a favorable dollar roll market.
Income taxes. Third quarter 1997 income taxes increased to $16.3 million
from $13.6 million in the year-earlier quarter, and year-to-date income tax
increased to $51.0 million from $37.9 million for the year-earlier period.
These increases resulted primarily from higher levels of net income and a
second quarter charge of $1.2 million relating to the settlement of issues
arising from the IRS audit of the Company's 1993 and short-period 1994
returns.
The components of deferred income tax included in the consolidated
balance sheet are as follows (in millions):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------- ------------------
<S> <C> <C>
Deferred income tax assets:
Company net operating loss carryforward. . $ 10.5 $ 13.4
------------------- ------------------
Deferred income tax assets . . . . . . . . . $ 10.5 $ 13.4
=================== ==================
Deferred income tax liabilities:
Western's operations . . . . . . . . . . . $ 81.9 $ 77.3
Unrealized appreciation on invested assets 60.5 21.1
------------------- ------------------
Deferred income tax liabilities. . . . . . . $ 142.4 $ 98.4
=================== ==================
</TABLE>
The deferred income tax asset of $10.5 million at September 30, 1997, 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.
The deferred income tax liability of $142.4 million at September 30,
1997, was primarily the result of the temporary differences between tax and
financial bases of the cost of policies produced, the cost of policies
purchased, invested assets and insurance liabilities. The temporary
differences between tax and financial bases related to net unrealized
appreciation of actively-managed fixed maturities, which are carried at market
value in accordance with the requirements of SFAS 115, contributed to the tax
liability at year-end 1996 and at September 30, 1997.
Net income. Third quarter 1997 net income was $30.9 million, up 21% from
$25.6 million for the prior year's third quarter. Year-to-date net income
was $89.7 million, up 26% from $71.0 million for the 1996 corresponding
period. The third quarter and year-to-date increases were a result of
increased operating earnings. Net income per share of $0.44 for the third
quarter was up 10% from $0.40 in the year-earlier quarter. Net income per
share of $1.27 for year-to-date was up 13% from $1.12 in the corresponding
1996 period. The percentage change in net income per share was less than the
percentage change in net income due to an increase in the number of common and
common equivalent shares from 63.2 million at September 30, 1996, to 70.6
million at September 30, 1997. This increase is due principally to the
issuance of 7.2 million common equivalent shares to American General in third
quarter 1996 for $126 million of net proceeds to the Company, which were
converted to common shares on May 14, 1997.
INVESTMENTS
The Company's investment strategy is to maintain a diversified portfolio
consisting largely of readily- marketable, investment grade fixed maturity
securities, to provide adequate liquidity through active asset/liability
management for expected liability cash flows and other requirements, and
maximize return through active investment management. The Company's
investment strategy places strong emphasis on active asset/liability
management as a principal tool to mitigate variations in investment spread and
disintermediation risk. At September 30, 1997, the Company had invested
assets with a total carrying value of approximately $10.7 billion. See Note 2
to the unaudited Consolidated Financial Statements.
The following table shows Western's investment performance for the nine
months ended September 30, 1997, and September 30, 1996 (in millions and
before giving effect to SFAS No. 115 adjustment).
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Net investment income (1) . . . . . . . . . . . . . $ 584.1 $ 515.7
Average net invested assets, at amortized cost (2). 9,678.4 8,564.4
Annualized yield on average net invested assets (3) 8.25% 8.22%
<FN>
_______________
(1) Net of interest expense on short-term investment borrowings.
(2) Net of short-term investment borrowings.
(3) Excludes prepayment income (loss), income from partnerships and
certain other equity-like investments, and investment income from other
non-scheduled sources.
</TABLE>
Market interest rates were lower at September 30, 1997, from the level
prevailing at the end of 1996. However, 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 or 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.
The following table sets forth the composition of the Company's fixed
maturity portfolio as of the dates indicated:
<TABLE>
<CAPTION>
FIXED MATURITIES BY TYPE SEPTEMBER 30, DECEMBER 31,
(IN MILLIONS, BASED ON CARRYING VALUE) 1997 1996
- ------------------------------------------------- ------------------------- --------------
<S> <C> <C>
U.S. Treasury securities and obligations of
U.S. government corporations and agencies . . . $ 12.8 $ 21.4
Obligations of states and political subdivisions. 217.4 222.0
Public utility securities . . . . . . . . . . . . 1,186.7 1,242.2
Other corporate securities. . . . . . . . . . . . 5,145.8 4,687.4
Asset-backed securities . . . . . . . . . . . . . 446.2 351.9
Mortgage-backed securities. . . . . . . . . . . . 2,839.6 2,317.6
------------------------- --------------
Total fixed maturities. . . . . . . . . . $ 9,848.5 $ 8,842.5
========================= ==============
</TABLE>
The following table sets forth the quality of Western's fixed maturities
(which do not include short-term investments) as of September 30, 1997,
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>
FIXED MATURITIES BY GAAP GAAP GAAP CARRYING VALUE
-------------------
QUALITY RATING AT CARRYING AMORTIZED AS % OF FIXED AS % OF AS % OF
SEPTEMBER 30, 1997 VALUE COST MATURITIES INV.ASSETS AMORT.COST
--------- ---------- -------------------- ----------- -----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
AAA $ 3,036.0 $ 2,981.7 30.8% 28.3% 101.8%
AA. . . . . . . . . . . . . . . 818.2 801.0 8.3 7.6 102.2
A . . . . . . . . . . . . . . . 2,449.7 2,382.9 24.9 22.9 102.8
BBB+. . . . . . . . . . . . . . 895.9 861.6 9.1 8.4 104.0
BBB . . . . . . . . . . . . . . 1,062.1 1,031.3 10.8 9.9 103.0
BBB-. . . . . . . . . . . . . . 831.3 801.7 8.4 7.8 103.7
--------- ---------- -------------------- ----------- -----------
Total investment grade. . . . 9,093.2 8,860.2 92.3 84.9 102.6
BB+ . . . . . . . . . . . . . . 200.3 191.6 2.1 1.9 104.5
BB. . . . . . . . . . . . . . . 98.3 93.9 1.0 0.9 104.7
BB- . . . . . . . . . . . . . . 150.3 143.3 1.5 1.4 104.9
B+ and below. . . . . . . . . . 306.4 301.2 3.1 2.8 101.7
--------- ---------- -------------------- ----------- -----------
Total below investment grade. 755.3 730.0 7.7 7.0 103.5
Total fixed maturities. . . . $ 9,848.5 $ 9,590.2 100.0% 91.9% 102.7%
========= ========== ==================== =========== ===========
</TABLE>
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 7.0% of total invested assets and 7.7% of total fixed maturity
investments at September 30, 1997. 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.
At September 30, 1997, the Company had fixed maturity investments with
an amortized cost of $0.8 million that were in substantive default (i.e., in
default due to nonpayment of interest or principal). There were no fixed
maturity investments in substantive default at September 30, 1996. The
Company had no credit impairment writedowns during the first nine months of
1997 or 1996.
At September 30, 1997, the Company's actively managed fixed maturity
portfolio had net unrealized gains of $258.3 million compared with net
unrealized gains of $104.1 million as of December 31, 1996. The net gain at
September 30, 1997 consisted of $311.3 million of unrealized gains and $53.0
million of unrealized losses. Estimated fair values for 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.
Fixed maturity investments at September 30, 1997, 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"),
mortgage-backed agency pass-through securities, and commercial mortgage-backed
securities.
At September 30, 1997, the Company held mortgage loans with a carrying
value of $103.9 million (or 1% of total invested assets) down from $122.7
million at December 31, 1996. None of the Company's mortgage loans were 90 or
more days past due at September 30, 1997. Western recorded no writedowns for
credit impairment in its mortgage portfolio during the first nine months of
1997.
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, 1997, the Company had outstanding
interest rate swap agreements with notional contract amounts totaling $260.0
million. The agreements expire at various dates through 1999. Under the
agreements outstanding at September 30, 1997, the Company will receive fixed
rates averaging 7.3% and will pay floating rates, primarily based on LIBOR,
averaging 5.8%. The swaps, which are marked to market in accordance with SFAS
115, had a market value of a positive $1.8 million at September 30, 1997.
The Company has made commitments to partnerships aggregating $105.5
million at September 30, 1997, of which $15.8 million had been funded at that
date. Income from partnership investments was not material for the first nine
months of 1997 compared to $7.0 million for the corresponding 1996 period,
which was attributable to a single partnership investment liquidated in third
quarter 1996.
For a discussion regarding the effects of changing interest rates on the
Company's investments, see the Company's 1996 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 1997 were $429.6 million,
compared to $448.7 million in the corresponding 1996 quarter. This 4%
decrease in quarter-over-quarter sales is primarily due to the current
interest rate and equity environment that tends to favor other investment
alternatives over fixed annuities. Year-to-date premiums collected were $1.5
billion, up 32% from the corresponding period in 1996. Western utilizes four
marketing distribution channels - Financial Institutions, Personal Producing
General Agents (PPGAs), Specialty, and Direct Marketing. Additionally,
Western markets a variable annuity product through its financial institution,
PPGA and direct marketing channels.
The following table sets forth premium generated by distribution channel
(in millions):
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, NINE MONTHS
----------------------------- ENDED SEPTEMBER 30,
-------------------
1997 1996 1997 1996
----------------------------- --------------------------------- --------- ---------
<S> <C> <C> <C> <C>
PREMIUMS AND DEPOSITS COLLECTED:
Financial institutions
Proprietary . . . . . . . . . . . $ 281.9 $ 294.9 $1,000.9 $ 588.0
Retail. . . . . . . . . . . . . . 67.8 86.2 275.0 361.6
----------------------------- --------------------------------- --------- ---------
Total . . . . . . . . . . . . . 349.7 381.1 1,275.9 949.6
Personal producing general agents . 41.4 40.5 122.3 110.9
Specialty sales . . . . . . . . . . 38.0 25.3 124.7 94.1
Direct marketing. . . . . . . . . . 0.8 2.1 4.4 4.4
----------------------------- --------------------------------- --------- ---------
Total direct premiums and deposits
collected . . . . . . . . . . . . 429.9 449.0 1,527.3 1,159.0
Reinsurance ceded . . . . . . . . . (0.3) (0.3) (0.8) (1.0)
----------------------------- --------------------------------- --------- ---------
Net premiums and deposits collected $ 429.6 $ 448.7 $1,526.5 $1,158.0
============================= ================================= ========= =========
</TABLE>
FINANCIAL INSTITUTIONS. Sales through financial institutions accounted
for 81% of Western's overall sales in the third quarter and 84% of overall
sales year-to-date 1997. Total financial institution sales for third quarter
1997 were $349.7 million, compared to $381.1 million for the corresponding
1996 quarter. This slight decline was due to the increased competition from
other investments and retirement funding alternatives such as bank CDs,
variable annuities, and mutual funds in a period of low interest rates.
Financial institution sales for the first nine months of 1997 were $1.3
billion, an increase of 34% from $949.6 million for the same period in 1996.
Western's third quarter 1997 sales in the financial institution market
reflected high levels of production from relatively few large bank
distribution relationships. The largest five relationships accounted for 81%
of financial institution sales in the third quarter 1997, compared to 80% for
third quarter 1996. 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 1997: First Union 49%, Home Savings 12%, First of
America 11%, Fleet 5%, and U.S. Bancorporation 4%.
Of the $349.7 million in total financial institution sales for the third
quarter 1997, 81% were proprietary sales and 19% were retail sales. The $1.3
billion of financial institution sales year-to-date consisted of 78%
proprietary sales and 22% retail sales.
Proprietary Sales. In 1995, Western initiated its first proprietary
------------------
fixed annuity distribution arrangement in the financial institution market.
Western's proprietary annuity programs have become the primary focus of its
marketing strategy. Under these programs, Western and a 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 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 to its customers and receives an investment management fee.
Western is solely responsible for policy administration and insurance
regulatory compliance, and retains the right to establish policy crediting
rates. Western believes that it is currently the only insurance company to
have implemented a proprietary fixed annuity program that also provides for
the selling financial institution to manage the resulting assets. Because
Western's proprietary program generally provides for the financial institution
to receive an investment management fee based on the resulting assets, the
financial institution has an economic interest in both the successful
distribution of Western's annuities and in the persistency of such business.
At September 30, 1997, Western had established proprietary fixed annuity
programs at ten financial institutions, the largest of which was First Union.
The Western/First Union proprietary fixed annuity program was launched in
March 1996. First Union proprietary annuity sales for the third quarter and
first nine months of 1997 were $172.5 million and $639.6 million, compared to
$212.1 million and $394.9 million for the corresponding 1996 periods. Total
proprietary annuity sales for third quarter 1997 were $281.9 million, compared
to $294.9 million in the corresponding 1996 quarter. Year-to-date proprietary
sales were $1.0 billion, up 70% from $588.0 million for the corresponding 1996
period.
Retail Sales. Third quarter 1997 retail sales, which include all
-------------
non-proprietary sales through financial institutions, were down 21% to $67.8
million, compared to $86.2 million for the third quarter 1996. Retail sales
for the first nine months of 1997 were $275.0 million, down 24% from retail
sales of $361.6 million for the year-earlier period. The decreases reflect
Western's increased focus on its proprietary marketing efforts, as well as the
conversion of certain accounts from retail to proprietary status.
PERSONAL PRODUCING GENERAL AGENTS. Third quarter sales through PPGAs
increased 2% to $41.4 million from $40.5 million in the third quarter 1996.
For the first nine months of 1997, PPGA sales were $122.3 million, compared to
$110.9 million in 1996. The increases in this channel were primarily the
result of improved sales in the Company's wholesale PPGA marketing activities,
reflecting increased emphasis on that market niche.
SPECIALTY. Third quarter specialty sales, which include SPIAs,
supplemental contracts, and life insurance, increased 50% to $38.0 million,
compared to $25.3 million for the third quarter 1996. Year-to-date specialty
sales increased 33% to $124.7 million, compared to $94.1 million for the
year-earlier period. This increase was due principally to $92.2 million of
structured settlement sales under a modified coinsurance agreement with AGLIC
compared to $59.8 million for the corresponding year-earlier period. 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, AGLIC issues the policies, and a portion of
each risk, normally 50%, is reinsured to Western.
DIRECT MARKETING. Western's conservation unit, which is part of its
direct sales operations, effected $22.2 million of internal exchanges in the
third quarter 1997, compared to $45.3 million in the third quarter 1996.
Internal exchanges for the first nine months of 1997 and 1996 totaled $59.0
million and $106.2 million, respectively. The year-to-date decrease reflects
a reduction in the amount of business exiting surrender charge protection,
which is a principal focus of this unit. Sales of Western products through
the Company's direct marketing subsidiary, Independent Advantage Financial and
Insurance Services, Inc. ("IAF"), were $0.8 million for the third quarter
1997, compared to $2.1 million for the third quarter 1996. Such sales were
$4.4 million for both the first nine months of 1997 and 1996. In the third
quarter and first nine months of 1997, IAF sold $6.4 million and $20.7
million, respectively, of annuity and life products of nonaffiliated life
insurance companies, compared to $8.8 million and $24.7 million for the
corresponding periods in 1996.
VARIABLE ANNUITIES. In the third quarter and first nine months of 1997,
premiums collected from sales of Western's variable annuity product were $6.5
million and $15.9 million, respectively, compared to $1.3 million and $4.1
million, respectively, for the corresponding 1996 periods. The quarter and
year-to-date increases in variable annuity sales reflect an increase in the
number of marketing relationships that offer this product.
PREMIUM AND DEPOSIT DATA
Western excludes internal exchanges from its deposit and withdrawal data.
Western had $38.2 million and $102.8 million of internal exchanges for the
third quarter and first nine months of 1997, respectively, compared to $75.5
million and $162.0 million in the corresponding 1996 periods.
The following table indicates sales by product line for the periods
indicated (in millions):
PREMIUM AND DEPOSIT DATA
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- -------------------
1997 1996 1997 1996
--------------- ------------------- --------- ---------
<S> <C> <C> <C> <C>
FIRST-YEAR PREMIUMS AND DEPOSITS:
Single premium deferred annuities (1). . . $ 372.7 $ 408.2 $1,343.8 $1,012.2
Flexible premium deferred annuities. . . . 1.9 2.2 5.1 8.9
Single premium immediate annuities . . . . 37.1 24.2 121.9 88.3
Variable annuities . . . . . . . . . . . . 6.5 1.3 15.9 4.1
--------------- ------------------- --------- ---------
Total first-year . . . . . . . . . . . 418.2 435.9 1,486.7 1,113.5
--------------- ------------------- --------- ---------
RENEWAL PREMIUMS AND DEPOSITS:
Flexible premium deferred annuities. . . . 10.8 12.1 37.8 42.5
Life products. . . . . . . . . . . . . . . 0.9 1.0 2.8 3.0
--------------- ------------------- --------- ---------
Total renewal. . . . . . . . . . . . . 11.7 13.1 40.6 45.5
--------------- ------------------- --------- ---------
Total premiums and deposits collected. 429.9 449.0 1,527.3 1,159.0
Reinsurance ceded. . . . . . . . . . . . . (0.3) (0.3) (0.8) (1.0)
--------------- ------------------- --------- ---------
Net Premiums and Deposits Collected. . $ 429.6 $ 448.7 $1,526.5 $1,158.0
=============== =================== ========= =========
<FN>
_______________
(1) Includes certain deferred annuity products that allow for additional deposits, but generally
have been utilized by policyholders as SPDAs.
</TABLE>
<PAGE>
The table below sets forth the change in contract values of annuities in
force, excluding annuities and supplemental contracts with life contingencies,
for the periods indicated (in millions):
<TABLE>
<CAPTION>
IMMEDIATE
ANNUITIES
DEFERRED WITHOUT LIFE
ANNUITIES CONTINGENCIES TOTAL
----------- --------------- ----------
<S> <C> <C> <C>
December 31, 1995. . $ 6,121.0 $ 414.5 $ 6,535.5
Deposits . . . . . 1,066.7 38.8 1,105.5
Distributions (1). (884.0) (61.8) (945.8)
Credited interest. 261.3 25.3 286.6
----------- --------------- ----------
September 30, 1996 . $ 6,565.0 $ 416.8 $ 6,981.8
=========== =============== ==========
December 31, 1996. . $ 6,839.4 $ 418.7 $ 7,258.1
Deposits . . . . . 1,386.0 36.7 1,422.7
Distributions (1). (950.6) (56.2) (1,006.8)
Credited interest. 302.2 25.4 327.6
----------- --------------- ----------
September 30, 1997 . $ 7,577.0 $ 424.6 $ 8,001.6
=========== =============== ==========
<FN>
_______________
(1) Includes withdrawals, deaths and annuitizations.
</TABLE>
As a percentage of average deferred annuity liabilities, the year-to-date
average annualized distribution rate for the first nine months of 1997 was
17.2%, compared to 18.1% for the first nine months of 1996. Withdrawals did
not differ significantly from anticipated levels for the third quarter and
first nine months of 1997. Because withdrawals tend to be sensitive to
changes in market interest rates, they may increase as a result of increases
in market interest rates.
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, 1997, and 1996. See also, "Sales-Specialty",
above. Additionally, Western is a party to a stand-by coinsurance agreement
with an 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. 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 pass-through securities) or other short-term borrowings.
Of Western's total insurance liabilities at September 30, 1997, 19% could
not be surrendered, 53% could be surrendered only by incurring a surrender
charge, and 28% 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 3.5 years and
the surrender charge averaged approximately 5.0% of accumulated policy value
at September 30, 1997.
Payment characteristics of insurance liabilities at September 30, 1997,
were as follows (in millions):
<TABLE>
<CAPTION>
<S> <C>
Payments under contracts containing fixed payment dates:
Due in one year or less . . . . . . . . . . . . . . . . . . . $ 190.3
Due after one year through five years . . . . . . . . . . . . 686.0
Due after five years through ten years. . . . . . . . . . . . 791.6
Due after ten years . . . . . . . . . . . . . . . . . . . . . 4,115.5
--------
Total gross payments with payment dates fixed by contract 5,783.4
Less amounts representing future interest on such contracts . . 3,967.9
--------
Insurance liabilities with payment dates fixed by contract. . . 1,815.5
Insurance liabilities with payment dates not fixed by contract. 7,682.1
--------
Total insurance liabilities . . . . . . . . . . . . . . . . $9,497.6
========
</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 19% of insurance liabilities were subject to interest
rates, ranging from 4% to 11%, fixed for the life of the contract. The
remainder of the liabilities, with limited exceptions, 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,
1997, Western had fixed maturities, short-term investments, and due from
brokers, net of investment borrowings and due to brokers, with a total market
value of $9.7 billion, or 96% of net 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's methodology,
Western's total adjusted capital at September 30, 1997, was more than two and
a half times the company action risk-based capital level.
Holding Company Liquidity and Capital
At September 30, 1997, shareholders' equity was $1.1 billion, compared to
$914.8 million at December 31, 1996. Book value at September 30, 1997, was
$15.36 per share, compared with $13.14 per share at December 31, 1996. The
increase is primarily due to net income of $89.7 million in the first nine
months of 1997. Excluding the effects of SFAS No. 115, shareholders' equity
would have been $956.7 million, or $13.75 per share, at September 30, 1997,
compared with $875.7 million, or $12.58 per share, at December 31, 1996. 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 to
the Consolidated Financial Statements of the Company's 1996 Annual Report on
Form 10-K). 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 1997 is $57.0 million, which management
believes is more than sufficient to meet the Company's anticipated debt
service obligations, dividends on common stock, and operating expenses during
the year.
On February 20, 1997, 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 $150.0 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, 1997, the Company had $69.0 million
outstanding under the Credit Agreement.
On September 1, 1997, the Company paid a common stock dividend of $.04
per share. The total amount paid in common stock dividends for the third
quarter was $2.8 million. For the first nine months of 1997, the Company paid
$8.1 million of dividends on common stock and $0.3 million of dividends on the
Series A Preferred Stock. At the Company's 1997 Annual Meeting, held on May
14, 1997, the Company's common stockholders approved the issuance of 7,254,464
shares of common stock, and all outstanding shares of Series A Preferred Stock
automatically converted to common stock on a share-for-share basis.
On October 29, 1997, the board of directors declared a common stock
dividend of $.04 per share payable on December 1, 1997, to shareholders of
record at the close of business on November 12, 1997. 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 1996 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
10.1 Agreement and Plan of Merger, dated as of September 11,
1997, among the Company, American General Corporation, and Astro Acquisition
Corp. (incorporated by reference to Exhibit 10.1 of the Report on Form 8-K/A
of the Company dated September 11, 1997).
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 11, 1997, was filed with the
Commission to report under Item 5 that American General and the Company had
entered into a definitive agreement under which American General will acquire
the remaining 54% of the common stock of the Company.
<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, 1997
<PAGE>
WESTERN NATIONAL CORPORATION AND SUBSIDIARIES EXHIBIT 11.1
COMPUTATION OF EARNINGS PER SHARE
(DOLLARS IN MILLIONS - EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
1997
-------
<S> <C>
PRIMARY:
Weighted average shares outstanding. . . 69.8
Common equivalent shares related to:
Stock options at average market price
(as determined by application of the
treasury stock method) . . . . . . . . 0.8
-----
Weighted average shares and common
stock equivalents. . . . . . . . . . . 70.6
=====
Net income . . . . . . . . . . . . . . $89.7
=====
Net income per common share. . . . . . $1.27
=====
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
1997
-------
<S> <C>
FULLY DILUTED:
Weighted average shares outstanding . . . 69.8
Common equivalent shares related to:
Stock options at end of period price
(as determined by application of the
treasury stock method). . . . . . . . . 0.8
-----
Weighted average shares and common stock
equivalents . . . . . . . . . . . . . . 70.6
=====
Net income. . . . . . . . . . . . . . . $89.7
=====
Net income per common share . . . . . . $1.27
=====
</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
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 9,849
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 10
<MORTGAGE> 104
<REAL-ESTATE> 0
<TOTAL-INVEST> 10,713
<CASH> 360
<RECOVER-REINSURE> 188
<DEFERRED-ACQUISITION> 440
<TOTAL-ASSETS> 11,586
<POLICY-LOSSES> 9,497
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 1
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 148
0
0
<COMMON> 0
<OTHER-SE> 1,069
<TOTAL-LIABILITY-AND-EQUITY> 11,586
96
<INVESTMENT-INCOME> 599
<INVESTMENT-GAINS> 1
<OTHER-INCOME> 7
<BENEFITS> 489
<UNDERWRITING-AMORTIZATION> 35
<UNDERWRITING-OTHER> 16
<INCOME-PRETAX> 141
<INCOME-TAX> 51
<INCOME-CONTINUING> 90
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 90
<EPS-PRIMARY> 1.27
<EPS-DILUTED> 1.27
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
