SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 33-5014
FIRST SUNAMERICA LIFE INSURANCE COMPANY
Incorporated in New York 06-0992729
IRS Employer
Identification No.
733 Third Avenue, 4th Floor, New York, New York 10017
Registrant's telephone number, including area code (800) 272-3007
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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes X No
---- ----
The number of shares outstanding of the registrant's common stock on
May 15, 1998 was as follows:
Common Stock (par value $10,000.00 per share) 300 shares outstanding
FIRST SUNAMERICA LIFE INSURANCE COMPANY
INDEX
Page
Number(s)
---------
Part I - Financial Information
Balance Sheet (Unaudited) -
March 31, 1998 and September 30, 1997 3 - 4
Income Statement (Unaudited) -
Three Months and Six Months Ended
March 31, 1998 and 1997 5
Statement of Cash Flows (Unaudited) -
Six Months Ended March 31, 1998 and 1997 6 - 7
Notes to Financial Statements (Unaudited) 8
Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 - 21
Part II - Other Information 22
<TABLE>
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
<CAPTION>
BALANCE SHEET
(Unaudited)
March 31, September 30,
1998 1997
--------------- ---------------
<S> <C> <C>
ASSETS
Investments:
Cash and short-term investments $ 22,194,000 $ 50,585,000
Bonds and notes available for sale,
at fair value (amortized cost:
March 1998, $1,371,785,000;
September 1997, $1,459,112,000) 1,413,960,000 1,499,253,000
Mortgage loans 150,713,000 131,117,000
Other invested assets 8,667,000 9,277,000
--------------- ---------------
Total investments 1,595,534,000 1,690,232,000
Variable annuity assets 243,364,000 171,475,000
Accrued investment income 20,114,000 22,243,000
Deferred acquisition costs 90,094,000 96,516,000
Other assets 2,070,000 4,024,000
--------------- ---------------
TOTAL ASSETS $ 1,951,176,000 $ 1,984,490,000
=============== ===============
</TABLE>
See accompanying notes
3
<TABLE>
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
<CAPTION>
BALANCE SHEET (Continued)
(Unaudited)
March 31, September 30,
1998 1997
--------------- ---------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Reserves, payables and accrued liabilities:
Reserves for fixed annuity contracts $ 1,503,217,000 $ 1,556,656,000
Payable to brokers for purchases of
securities 5,726,000 12,460,000
Income taxes currently payable 5,188,000 2,236,000
Other liabilities 12,350,000 68,601,000
--------------- ---------------
Total reserves, payables
and accrued liabilities 1,526,481,000 1,639,953,000
--------------- ---------------
Variable annuity liabilities 243,364,000 171,475,000
--------------- ---------------
Deferred income taxes 4,418,000 4,984,000
--------------- ---------------
Shareholder's equity:
Common Stock 3,000,000 3,000,000
Additional paid-in capital 144,428,000 144,428,000
Retained earnings 22,786,000 14,826,000
Net unrealized gains on debt and
equity securities available for sale 6,699,000 5,824,000
--------------- ---------------
Total shareholder's equity 176,913,000 168,078,000
--------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 1,951,176,000 $ 1,984,490,000
=============== ===============
</TABLE>
See accompanying notes
4
<TABLE>
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS (Continued)
<CAPTION>
INCOME STATEMENT
FOR THE THREE MONTHS AND SIX MONTHS ENDED MARCH 31, 1998 AND 1997
(Unaudited)
Three Months Six Months
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Investment income $29,569,000 $ 3,208,000 $59,451,000 $ 6,101,000
----------- ----------- ----------- -----------
Interest expense on:
Fixed annuity contracts (20,315,000) (2,481,000) (41,622,000) (4,738,000)
Senior indebtedness --- --- (28,000) ---
----------- ----------- ----------- -----------
Total interest expense (20,315,000) (2,481,000) (41,650,000) (4,738,000)
----------- ----------- ----------- -----------
NET INVESTMENT INCOME 9,254,000 727,000 17,801,000 1,363,000
----------- ----------- ----------- -----------
NET REALIZED INVESTMENT GAINS 395,000 66,000 2,470,000 525,000
----------- ----------- ----------- -----------
Fee income:
Variable annuity fees 821,000 369,000 1,520,000 661,000
Surrender charges 1,138,000 58,000 2,092,000 114,000
----------- ----------- ----------- -----------
TOTAL FEE INCOME 1,959,000 427,000 3,612,000 775,000
----------- ----------- ----------- -----------
GENERAL AND ADMINISTRATIVE
EXPENSES (1,086,000) (404,000) (2,030,000) (761,000)
----------- ----------- ----------- -----------
AMORTIZATION OF DEFERRED
ACQUISITION COSTS (4,194,000) (294,000) (8,220,000) (596,000)
----------- ----------- ----------- -----------
ANNUAL COMMISSIONS (27,000) (5,000) (139,000) (9,000)
----------- ----------- ----------- -----------
PRETAX INCOME 6,301,000 517,000 13,494,000 1,297,000
Income tax expense (2,614,000) (176,000) (5,533,000) (492,000)
----------- ----------- ----------- -----------
NET INCOME $ 3,687,000 $ 341,000 $ 7,961,000 $ 805,000
=========== =========== =========== ===========
</TABLE>
See accompanying notes
5
<TABLE>
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS (Continued)
<CAPTION>
STATEMENT OF CASH FLOWS
(Unaudited)
Six Months Ended March 31,
--------------------------------
1998 1997
------------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,961,000 $ 805,000
Adjustments to reconcile net income to
cash provided by operating activities:
Interest credited to fixed annuity
contracts 41,622,000 4,738,000
Net realized investment gains (2,470,000) (525,000)
Amortization of net discounts
on investments (836,000) (61,000)
Amortization of goodwill 28,000 29,000
Provision for deferred income taxes (1,038,000) 557,000
Change in:
Deferred acquisition costs 722,000 (5,003,000)
Income taxes receivable/payable 2,952,000 (65,000)
Other, net 4,957,000 (217,000)
------------- ------------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 53,898,000 258,000
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of:
Bonds and notes (354,223,000) (57,883,000)
Mortgage loans (30,354,000) ---
Other invested assets (11,000) ---
Sales of:
Bonds and notes 399,385,000 14,614,000
Other invested assets --- 139,000
Redemptions and maturities of:
Bonds and notes 38,501,000 6,639,000
Mortgage loans 9,910,000 ---
------------- ------------
NET CASH PROVIDED (USED) BY
INVESTING ACTIVITIES 63,208,000 (36,491,000)
------------- ------------
</TABLE>
See accompanying notes
6
<TABLE>
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS (Continued)
<CAPTION>
STATEMENT OF CASH FLOWS (Continued)
(Unaudited)
Six Months Ended March 31,
--------------------------------
1998 1997
------------- ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Premium receipts on fixed annuity
contracts $ 63,856,000 $ 46,148,000
Net exchanges from the fixed accounts
of variable annuity contracts (24,561,000) (8,331,000)
Withdrawal payments on fixed annuity
contracts (120,822,000) (4,779,000)
Claims and annuity payments on fixed
annuity contracts (13,870,000) (1,809,000)
Net receipts from (repayments of) other
short-term financings (15,324,000) 661,000
Cession of non-annuity product lines (34,776,000) ---
------------- ------------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES (145,497,000) 31,890,000
------------- ------------
NET DECREASE IN CASH AND
SHORT-TERM INVESTMENTS (28,391,000) (4,343,000)
CASH AND SHORT-TERM INVESTMENTS AT
BEGINNING OF PERIOD 50,585,000 6,707,000
------------- ------------
CASH AND SHORT-TERM INVESTMENTS AT
END OF PERIOD $ 22,194,000 $ 2,364,000
============= ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid on indebtedness $ 28,000 $ ---
============= ============
Income taxes paid $ 3,620,000 $ ---
============= ============
</TABLE>
See accompanying notes
7
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS (continued)
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
---------------------
First SunAmerica Life Insurance Company (the "Company") is an indirect
wholly owned subsidiary of SunAmerica Inc. (the "Parent"). In the
opinion of the Company, the accompanying unaudited financial statements
contain all adjustments (consisting of only normal recurring accruals)
necessary to present fairly the Company's financial position as of March
31, 1998 and September 30, 1997, the results of its operations for the
three months and six months ended March 31, 1998 and 1997 and its cash
flows for the six months ended March 31, 1998 and 1997. The results of
operations for the three months and six months ended March 31, 1998 are
not necessarily indicative of the results to be expected for the full
year. The accompanying unaudited financial statements should be read in
conjunction with the audited financial statements for the fiscal year
ended September 30, 1997, contained in the Company's Annual Report on
Form 10-K. The September 30, 1997 balance sheet has been restated from
that included in the Annual Report on Form 10-K to reflect the merger
with John Alden Life Insurance Company of New York (see Note 2). Certain
items have been reclassified to conform to the current period's
presentation.
2. Business Combination
--------------------
On March 31, 1997, SunAmerica Life Insurance Company, the direct parent
of the Company, completed the acquisition of all of the outstanding stock
of John Alden Life Insurance Company of New York ("JANY"). On October
31, 1997, JANY was merged with and into the Company. The income
statement for the six months ended March 31, 1998 includes the results
of JANY's operations for the full period between October 1, 1997 and
March 31, 1998. On a pro forma basis, assuming the acquisition and
merger had occurred on October 1, 1996, the beginning of the earliest
periods presented herein, revenues (investment income, net realized
investment gains and fee income) would have been $29,131,000 and net
income would have been $1,428,000 for the quarter ended March 31, 1997.
For the six months ended March 31, 1997, revenues would have been
$58,627,000 and net income would have been $3,922,000.
8
FIRST SUNAMERICA LIFE INSURANCE COMPANY
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of financial condition and results
of operations of First SunAmerica Life Insurance Company (the "Company") for
the three months and six months ended March 31, 1998 and March 31, 1997
follows. In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, the Company cautions readers
regarding certain forward-looking statements contained in this report and in
any other statements made by, or on behalf of, the Company, whether or not in
future filings with the Securities and Exchange Commission (the "SEC").
Forward-looking statements are statements not based on historical information
and which relate to future operations, strategies, financial results, or other
developments. Statements using verbs such as "expect," "anticipate," "believe"
or words of similar import generally involve forward-looking statements.
Without limiting the foregoing, forward-looking statements include statements
which represent the Company's beliefs concerning future levels of sales and
redemptions of the Company's products, investment spreads and yields, or the
earnings and profitability of the Company's activities.
Forward-looking statements are necessarily based on estimates and
assumptions that are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond the
Company's control and many of which are subject to change. These uncertainties
and contingencies could cause actual results to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. Whether or not actual results differ materially from forward-looking
statements may depend on numerous foreseeable and unforeseeable developments.
Some may be national in scope, such as general economic conditions, changes in
tax law and changes in interest rates. Some may be related to the insurance
industry generally, such as pricing competition, regulatory developments and
industry consolidation. Others may relate to the Company specifically, such
as credit, volatility and other risks associated with the Company's investment
portfolio. Investors are also directed to consider other risks and
uncertainties discussed in documents filed by the Company with the SEC. The
Company disclaims any obligation to update forward-looking information.
RESULTS OF OPERATIONS
NET INCOME totaled $3.7 million in the second quarter of 1998, compared
with $0.3 million in the second quarter of 1997. For the six months, net
income amounted to $8.0 million in 1998, compared with $0.8 million in 1997.
On October 31, 1997, John Alden Life Insurance Company of New York ("JANY") was
merged with and into the Company. JANY was acquired by SunAmerica Life
Insurance Company, the Company's parent, on March 31, 1997 in a transaction
accounted for under the purchase method of accounting. Therefore, the results
of operations include those of JANY only from the date of acquisition. The
income statements for the three months and six months ended March 31, 1998
include the results of JANY's operations for these periods, and the income
statements for the three months and six months ended March 31, 1997 do not
include JANY's operating results. Consequently, operating results for 1998 and
1997 are not comparable. On a pro forma basis, using the historical operating
results of JANY and assuming the merger had been consummated on October 1,
1996, the beginning of the earliest periods discussed herein, net income would
9
have been $1.4 million for the second quarter of 1997 and $3.9 million for the
six months of 1997.
PRETAX INCOME totaled $6.3 million in the second quarter of 1998 and $0.5
million in the second quarter of 1997. For the six months, pretax income
totaled $13.5 million in 1998, compared with $1.3 million in 1997. The
significant improvements in the current periods over the prior periods
primarily resulted from increased net investment income, fee income and net
realized investment gains, partially offset by increased amortization of
deferred acquisition costs and higher general and administrative expenses, all
of which are primarily related to the operations of JANY.
NET INVESTMENT INCOME, which is the spread between the income earned on
invested assets and the interest paid on fixed annuities and other interest-
bearing liabilities, increased to $9.3 million in the second quarter of 1998
from $0.7 million in the second quarter of 1997. These amounts equal 2.36% on
average invested assets (computed on a daily basis) of $1.57 billion in the
second quarter of 1998 and 1.65% on average invested assets of $176.3 million
in the second quarter of 1997. For the six months, net investment income
increased to $17.8 million in 1998 from $1.4 million in 1997, equalling 2.26%
on average invested assets of $1.57 billion in 1998 and 1.62% on average
invested assets of $168.4 million in 1997. On a pro forma basis, assuming the
merger had been consummated on October 1, 1996, net investment income on
related average invested assets would have been 1.80% and 1.88% for the second
quarter and the six months of 1997, respectively.
Net investment spreads include the effect of income earned on the excess
of average invested assets over average interest-bearing liabilities. This
excess amounted to $50.1 million in the second quarter of 1998, $9.0 million
in the second quarter of 1997, $40.5 million in the six months of 1998 and $9.9
million in the six months of 1997. The difference between the Company's yield
on average invested assets and the rate paid on average interest-bearing
liabilities (the "Spread Difference") was 2.19% in the second quarter of 1998,
1.35% in the second quarter of 1997, 2.12% in the six months of 1998 and 1.27%
in the six months of 1997. On a pro forma basis, assuming the merger had been
consummated on October 1, 1996, the Spread Difference would have been 1.63% and
1.70% in the second quarter and the six months of 1997, respectively.
Investment income (and the related yields on average invested assets)
totaled $29.6 million (7.55%) in the second quarter of 1998, compared with $3.2
million (7.28%) in the second quarter of 1997. For the six months, investment
income (and the related yields on average invested assets) totaled $59.5
million (7.56%) in 1998, compared with $6.1 million (7.25%) in 1997. Investment
income increased primarily as a result of higher levels of average invested
assets resulting from the merger of JANY with the Company. On a pro forma
basis, assuming the merger had been consummated on October 1, 1996, the yield
on related average invested assets would have been 7.29% and 7.33% for the
second quarter and six months of 1997, respectively.
Total interest expense equalled $20.3 million in the second quarter of
1998 and $2.5 million in the second quarter of 1997. For the six months,
interest expense aggregated $41.7 million in 1998, compared with $4.7 million
in 1997. The average rate paid on fixed annuity contracts was 5.36% in the
second quarter of 1998, compared with 5.93% in the second quarter of 1997. For
the six months, the average rate paid on fixed annuity contracts was 5.44% in
1998, compared with 5.98% in 1997. Fixed annuity contracts averaged $1.52
10
billion during the second quarter of 1998, $167.3 million during the second
quarter of 1997, $1.53 billion during the six months of 1998 and $158.5 million
during the six months of 1997. The declines in interest rates in the 1998
periods reflect the impact of the merger. The annuity contracts associated
with the merger bear, on average, significantly lower interest rates than the
Company's fixed annuity contracts on average. On a pro forma basis, assuming
the merger had been consummated on October 1, 1996, the average rate paid on
interest-bearing liabilities would have been 5.66% and 5.63% for the second
quarter and six months of 1997.
GROWTH IN AVERAGE INVESTED ASSETS since the 1997 periods primarily
reflects the merger with JANY, which contributed $1.4 billion of invested
assets. Additionally, since March 31, 1997 fixed annuity premiums have
aggregated $149.4 million. Fixed annuity premiums totaled $33.1 million in the
second quarter of 1998, $20.3 million in the second quarter of 1997, $63.9
million in the six months of 1998 and $46.1 million in the six months of
1997. These premiums include premiums for the fixed accounts of variable
annuities totaling $18.9 million, $20.1 million, $25.9 million and $45.7
million, respectively.
NET REALIZED INVESTMENT GAINS totaled $0.4 million in the second quarter
of 1998 and $0.1 million in the second quarter of 1997. For the six months,
net realized investment gains totaled $2.5 million in 1998 and $0.5 million in
1997.
The Company sold or redeemed invested assets, principally bonds and
notes, aggregating $192.6 million in the second quarter of 1998, $5.0 million
in the second quarter of 1997, $447.4 million in the six months of 1998 and
$13.0 million in the six months of 1997, respectively. Sales of investments
result from the active management of the Company's investment portfolio.
Because redemptions of investments are generally involuntary and sales of
investments are made in both rising and falling interest rate environments, net
gains and losses from sales and redemptions of investments fluctuate from
period to period, and represent 0.10%, 0.15%, 0.31% and 0.62% of average
invested assets on an annualized basis for the second quarter of 1998, the
second quarter of 1997, the six months of 1998 and the six months of 1997,
respectively. Active portfolio management involves the ongoing evaluation of
asset sectors, individual securities within the investment portfolio and the
reallocation of investments from sectors that are perceived to be relatively
overvalued to sectors that are perceived to be relatively undervalued. The
intent of the Company's active portfolio management is to maximize total
returns on the investment portfolio, taking into account credit and interest-
rate risk.
VARIABLE ANNUITY FEES are based on the market value of assets in separate
accounts supporting variable annuity contracts. Such fees totaled $0.8 million
in the second quarter of 1998 and $0.4 million in the second quarter of 1997.
For the six months, variable annuity fees totaled $1.5 million in 1998,
compared with $0.7 million in 1997. These increased fees reflect growth in
average variable annuity assets, principally due to increased market values,
the receipt of variable annuity premiums and net exchanges into the separate
accounts from the fixed accounts of variable annuity contracts, partially
offset by surrenders. Variable annuity assets averaged $215.0 million during
the second quarter of 1998 and $97.0 million during the second quarter of 1997.
For the six months, variable annuity assets averaged $198.0 million in 1998,
compared with $87.3 million in 1997. Variable annuity premiums, which exclude
premiums allocated to the fixed accounts of variable annuity products, have
11
aggregated $66.2 million since March 31, 1997. Variable annuity premiums
increased to $19.1 million in the second quarter of 1998 from $14.4 million in
the second quarter of 1997. For the six months, variable annuity premiums
increased to $35.7 million in 1998, compared with $25.8 million in 1997. Sales
of variable annuity products (which include premiums allocated to the fixed
accounts) ("Variable Annuity Product Sales") amounted to $38.0 million, $34.4
million, $61.6 million and $71.5 million in the second quarters of 1998 and
1997 and the six months of 1998 and 1997, respectively. The increase in
Variable Annuity Product Sales in the second quarter of 1998 is due, in part,
to market share gains through enhanced distribution efforts and growing
consumer demand for flexible retirement savings products that offer a variety
of equity, fixed income and guaranteed fixed account investment choices. The
Company has encountered increased competition in the variable annuity
marketplace during recent years and anticipates that the market will remain
highly competitive for the foreseeable future. Also, recent administrative
budget proposals include the proposed taxation of exchanges involving variable
annuity contracts and reallocation within variable annuity contracts and
certain other proposals relating to annuities ("Regulations").
SURRENDER CHARGES on fixed and variable annuities totaled $1.1 million
(including $0.8 million attributable to the merger) in the second quarter of
1998 and $58,000 in the second quarter of 1997. For the six months, surrender
charges on fixed and variable annuities totaled $2.1 million (including $1.5
million attributable to the merger) in 1998, compared with $114,000 in 1997.
Surrender charges generally are assessed on annuity withdrawals at declining
rates during the first seven years of an annuity contract. Withdrawal
payments, which include surrenders and lump-sum annuity benefits, totaled $69.7
million (including $61.5 million attributable to the merger) in the second
quarter of 1998, compared with $3.4 million in the second quarter of 1997.
These payments, annualized, represent 16.4% (18.8% of average fixed annuity
reserves associated with the merger) and 5.3%, respectively, of average fixed
and variable annuity reserves. For the six months, withdrawal payments totaled
$127.4 million (including $113.0 million attributable to the merger) in 1998
and $7.2 million in 1997 and, annualized, represent 15.0% (17.1% of average
fixed annuity reserves associated with the merger) and 6.1%, respectively, of
average fixed and variable annuity reserves. Withdrawals include variable
annuity withdrawals from the separate accounts totaling $4.6 million (8.5% of
average variable annuity reserves), $1.0 million (4.3% of average variable
annuity reserves), $6.6 million (6.7% of average variable annuity reserves) and
$2.4 million (5.5% of average variable annuity reserves) in the second quarters
of 1998 and 1997 and the six months of 1998 and 1997, respectively. Management
anticipates that withdrawal rates will remain relatively stable at current
period rates for the foreseeable future.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $1.1 million in the second
quarter of 1998 and $0.4 million in the second quarter of 1997. For the six
months, general and administrative expenses totaled $2.0 million in 1998,
compared with $0.8 million in 1997. General and administrative expenses int
he 1998 periods reflect the impact of the merger. General and administrative
expenses remain closely controlled through a company-wide cost containment
program and continue to represent less than 1% of average total assets.
AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $4.2 million in the
second quarter of 1998, compared with $0.3 million in the second quarter of
1997. For the six months, such amortization totaled $8.2 million in 1998,
compared with $0.6 million in 1997. The increases in amortization in the 1998
periods primarily reflect the amortization of the deferred acquisition costs
attributable to the merger, which aggregated $3.7 million and $7.2 million for
12
the second quarter and six months of 1998, respectively. Amortization has also
increased due to additional fixed and variable annuity sales and the subsequent
amortization of related deferred commissions and other direct selling costs.
ANNUAL COMMISSIONS represent renewal commissions paid quarterly in
arrears to maintain the persistency of certain of the Company's fixed and
variable annuity contracts. Annual commissions totaled $27,000 in the second
quarter of 1998, $5,000 in the second quarter of 1997, $139,000 in the six
months of 1998 and $9,000 in the six months of 1997. Theses increases are
primarily attributable to the fixed annuity contracts acquired in the merger.
Based on current sales, the Company estimates that such annual commissions will
increase in future periods.
INCOME TAX EXPENSE totaled $2.6 million in the second quarter of 1998,
compared with $176,000 in the second quarter of 1997, representing effective
tax rates of 41% and 34%, respectively. For the six months, income tax expense
totaled $5.5 million in 1998, compared with $492,000 in 1997, representing
effective tax rates of 41% and 38%, respectively.
FINANCIAL CONDITION AND LIQUIDITY
SHAREHOLDER'S EQUITY increased 5.2% to $176.9 million at March 31, 1998
from $168.1 million at September 30, 1997, primarily due to $8.0 million of net
income recorded in the six months of 1998 and a $0.8 million improvement in net
unrealized gains on debt and equity securities available for sale (credited
directly to shareholder's equity).
INVESTED ASSETS at March 31, 1998 totaled $1.60 billion, compared with
$1.69 billion at September 30, 1997. The Company manages most of its invested
assets internally. The Company's general investment philosophy is to hold
fixed-rate assets for long-term investment. Thus, it does not have a trading
portfolio. However, the Company has determined that all of its portfolio of
bonds and notes (the "Bond Portfolio") is available to be sold in response to
changes in market interest rates, changes in relative value of asset sectors
and individual securities, changes in prepayment risk, changes in the credit
quality outlook for certain securities, the Company's need for liquidity and
other similar factors.
THE BOND PORTFOLIO, which constitutes 88% of the Company's total
investment portfolio (at amortized cost), had an aggregate fair value that
exceeded its amortized cost by $42.2 million at March 31, 1998, compared with
an excess of $40.1 million at September 30, 1997.
At March 31, 1998, the Bond Portfolio (at amortized cost) included $1.35
billion of bonds rated by Standard & Poor's Corporation ("S&P"), Moody's
Investors Service ("Moody's"), Duff & Phelps Credit Rating Co. ("DCR"), Fitch
Investors Service, L.P. ("Fitch") or the National Association of Insurance
Commissioners ("NAIC") and $25.4 million of bonds rated by the Company pursuant
to statutory rating guidelines established by the NAIC. At March 31, 1998,
approximately $1.26 billion of the Bond Portfolio was investment grade,
including $507.0 million of U.S. government/agency securities and mortgage-
backed securities ("MBSs").
At March 31, 1998, the Bond Portfolio included $115.1 million (at
amortized cost with a fair value of $118.8 million) of bonds that were not
investment grade. Based on their March 31, 1998 amortized cost, these non-
13
investment-grade bonds accounted for 6.0% of the Company's total assets and
7.4% of its invested assets.
Non-investment-grade securities generally provide higher yields and
involve greater risks than investment-grade securities because their issuers
typically are more highly leveraged and more vulnerable to adverse economic
conditions than investment-grade issuers. In addition, the trading market for
these securities is usually more limited than for investment-grade securities.
The Company had no material concentrations of non-investment-grade securities
at March 31, 1998.
The table on the following page summarizes the Company's rated bonds by
rating classification as of March 31, 1998 (dollars in thousands):
14
<TABLE>
RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands)
<CAPTION>
Issues not rated by S&P/Moody's/
Issues Rated by S&P/Moody's/DCR/Fitch DCR/Fitch, by NAIC Category Total
- - ---------------------------------------------- ----------------------------------- -----------------------------------
S&P/(Moody's)/ Estimated NAIC Estimated Percent of Estimated
[DCR]/{Fitch} Amortized fair category Amortized fair Amortized invested fair
category (1) cost value (2) cost value cost assets(3) value
- - ---------------- ----------- ----------- ---------- --------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AAA to A-
(Aaa to A3)
[AAA to A-]
{AAA to A-} $ 852,984 $ 879,744 1 $ 146,969 $ 151,885 $ 999,953 64.37% $1,031,629
BBB+ to BBB-
(Baa1 to Baa3)
[BBB+ to BBB-]
{BBB+ to BBB-} 222,575 228,388 2 34,152 35,182 256,727 16.53 263,570
BB+ to BB-
(Ba1 to Ba3)
[BB+ to BB-]
{BB+ to BB-} --- --- 3 --- --- --- 0.00 ---
B+ to B-
(B1 to B3)
[B+ to B-]
{B+ to B-} 106,251 109,366 4 8,854 9,395 115,105 7.41 118,761
CCC+ to C
(Caa to C)
[CCC]
{CCC+ to C-} --- --- 5 --- --- --- 0.00 ---
CI to D
[DD]
{D} --- --- 6 --- --- --- 0.00 ---
---------- ---------- ---------- ---------- ---------- ----------
TOTAL RATED ISSUES $1,181,810 $1,217,498 $ 189,975 $ 196,462 $1,371,785 $1,413,960
========== ========== ========== ========== ========== ==========
Footnotes appear on the following page.
</TABLE>
15
Footnotes to the table of Rated Bonds by Rating Classification
--------------------------------------------------------------
(1) S&P and Fitch rate debt securities in rating categories ranging from AAA
(the highest) to D (in payment default). A plus (+) or minus (-)
indicates the debt's relative standing within the rating category. A
security rated BBB- or higher is considered investment grade. Moody's
rates debt securities in rating categories ranging from Aaa (the highest)
to C (extremely poor prospects of ever attaining any real investment
standing). The number 1, 2 or 3 (with 1 the highest and 3 the lowest)
indicates the debt's relative standing within the rating category. A
security rated Baa3 or higher is considered investment grade. DCR rates
debt securities in rating categories ranging from AAA (the highest) to DD
(in payment default). A plus (+) or minus (-) indicates the debt's
relative standing within the rating category. A security rated BBB- or
higher is considered investment grade. Issues are categorized based on
the highest of the S&P, Moody's, DCR or Fitch ratings if rated by multiple
agencies.
(2) Bonds and short-term promissory instruments are divided into six quality
categories for NAIC rating purposes, ranging from 1 (highest) to 5
(lowest) for nondefaulted bonds plus one category, 6, for bonds in or near
default. These six categories correspond with the S&P/Moody's/DCR/Fitch
rating groups listed above, with categories 1 and 2 considered investment
grade. The NAIC categories include $25.4 million (at amortized cost) of
assets that were rated by the Company pursuant to applicable NAIC rating
guidelines.
(3) At amortized cost.
16
Senior secured loans ("Secured Loans") are included in the Bond Portfolio
and their amortized cost aggregated $115.1 million at March 31, 1998. Secured
Loans are senior to subordinated debt and equity, and are secured by assets of
the issuer. At March 31, 1998, Secured Loans consisted of $102.4 million of
publicly traded securities and $12.7 million of privately traded securities.
These Secured Loans are composed of loans to 66 borrowers spanning 19
industries, with 18% of these assets (at amortized cost) concentrated in
utilities, 14% concentrated in financial institutions and 13% concentrated in
aerospace-defense. No other industry concentration constituted more than 9%
of these assets.
While the trading market for the Company's privately-traded Secured Loans
is more limited than for publicly traded issues, management believes that
participation in these transactions has enabled the Company to improve its
investment yield. As a result of restrictive financial covenants, these
Secured Loans involve greater risk of technical default than do publicly traded
investment-grade securities. However, management believes that the risk of
loss upon default for these Secured Loans is mitigated by such financial
covenants and the collateral values underlying the Secured Loans. The
Company's Secured Loans are rated by S&P, Moody's, DCR, Fitch, the NAIC or by
the Company, pursuant to comparable statutory ratings guidelines established
by the NAIC.
MORTGAGE LOANS aggregated $150.7 million at March 31, 1998 and consisted
of 122 commercial first mortgage loans with an average loan balance of
approximately $1.2 million, collateralized by properties located in 30 states.
Approximately 46% of this portfolio was retail, 18% was office, 18% was
industrial and 18% was other types. At March 31, 1998, approximately 15%, 12%
and 11% of this portfolio were secured by properties located in California,
Michigan and New York, respectively, and no more than 10% of this portfolio was
secured by properties located in any other single state. At March 31, 1998,
there was one mortgage loan with an outstanding balance of $10 million or more,
which loan represented approximately 7% of the portfolio. At March 31, 1998,
approximately 12% of the mortgage loan portfolio consisted of loans with
balloon payments due before April 1, 2001. During the second quarter and the
six months of 1998 and 1997, loans delinquent by more than 90 days, foreclosed
loans and restructured loans have not been significant in relation to the total
mortgage loan portfolio.
At March 31, 1998, approximately 80% of the mortgage loans were seasoned
loans underwritten to the Company's standards and purchased at or near par from
other financial institutions. Such loans generally have higher average
interest rates than loans that could be originated today. The balance of the
mortgage loan portfolio has been originated by the Company under strict
underwriting standards. Commercial mortgage loans on properties such as
offices, hotels and shopping centers generally represent a higher level of risk
than do mortgage loans secured by multifamily residences. This greater risk
is due to several factors, including the larger size of such loans and the more
immediate effects of general economic conditions on these commercial property
types. However, due to the seasoned nature of the Company's mortgage loan
portfolio and its strict underwriting standards, the Company believes that it
has prudently managed the risk attributable to its mortgage loan portfolio
while maintaining attractive yields.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks
of interest rate fluctuations and disintermediation. The Company believes that
its fixed-rate liabilities should be backed by a portfolio principally composed
17
of fixed-rate investments that generate predictable rates of return. The
Company does not have a specific target rate of return. Instead, its rates
of return vary over time depending on the current interest rate environment,
the slope of the yield curve, the spread at which fixed-rate investments are
priced over the yield curve, and general economic conditions. Its portfolio
strategy is constructed with a view to achieve adequate risk-adjusted returns
consistent with its investment objectives of effective asset-liability
matching, liquidity and safety. The Company's fixed-rate products incorporate
surrender charges or other restrictions in order to encourage persistency.
Approximately 91% of the Company's fixed annuity reserves had surrender
penalties or other restrictions at March 31, 1998.
As part of its asset-liability matching discipline, the Company conducts
detailed computer simulations that model its fixed-rate assets and liabilities
under commonly used stress-test interest rate scenarios. With the results of
these computer simulations, the Company can measure the potential gain or loss
in fair value of its interest-rate sensitive instruments and seek to protect
its economic value and achieve a predictable spread between what it earns on
its invested assets and what it pays on its liabilities by designing its
fixed-rate products and conducting its investment operations to closely match
the duration of the fixed-rate assets to that of its fixed-rate liabilities.
The Company's fixed-rate assets include: cash and short-term investments;
bonds and notes; and mortgage loans. At March 31, 1998, these assets had an
aggregate fair value of $1.60 billion with a duration of 4.0. At March 31,
1998, the Company's fixed-rate liabilities consist solely of fixed annuity
liabilities and had an aggregate fair value (determined by discounting future
contractual cash flows by related market rates of interest) of $1.40 billion
with a duration of 3.2. The Company's potential exposure due to a 10% increase
in prevailing interest rates from their March 31, 1998 levels is a loss of
$10.9 million in fair value of its fixed-rate assets that is not offset by a
decrease in the fair value of its fixed-rate liabilities. Because the Company
actively manages its assets and liabilities and has strategies in place to
minimize its exposure to loss as interest rate changes occur, it expects that
actual losses would be less than the estimated potential loss.
Duration is a common option-adjusted measure for the price sensitivity
of a fixed-maturity portfolio to changes in interest rates. It measures the
approximate percentage change in the market value of a portfolio if interest
rates change by 100 basis points, recognizing the changes in cash flows
resulting from embedded options such as policy surrenders, investment
prepayments and bond calls. It also incorporates the assumption that the
Company will continue to utilize its existing strategies of pricing its fixed
annuity products, allocating its available cash flow amongst its various
investment portfolio sectors and maintaining sufficient levels of liquidity.
Because the calculation of duration involves estimation and incorporates
assumptions, potential changes in portfolio value indicated by the portfolio's
duration will likely be different from the actual changes experienced under
given interest rate scenarios, and the differences may be material.
The Company also seeks to provide liquidity from time to time by using
reverse repurchase agreements ("Reverse Repos") and by investing in MBSs. It
also seeks to enhance its spread income by using Reverse Repos. Reverse Repos
involve a sale of securities and an agreement to repurchase the same
securities at a later date at an agreed upon price and are generally over-
collateralized. MBSs are generally investment-grade securities collateralized
by large pools of mortgage loans. MBSs generally pay principal and interest
monthly. The amount of principal and interest payments may fluctuate as a
18
result of prepayments of the underlying mortgage loans.
There are risks associated with some of the techniques the Company uses
to provide liquidity, enhance its spread income and match its assets and
liabilities. The primary risk associated with Reverse Repos is counterparty
risk. The Company believes, however, that the counterparties to its Reverse
Repos are financially responsible and that the counterparty risk associated
with those transactions is minimal. The primary risk associated with MBSs is
that a changing interest rate environment might cause prepayment of the
underlying obligations at speeds slower or faster than anticipated at the time
of their purchase. As part of its decision to purchase an MBS, the Company
assesses the risk of prepayment by analyzing the security's projected
performance over an array of interest-rate scenarios. Once an MBS is
purchased, the Company monitors its actual prepayment experience monthly to
reassess the relative attractiveness of the security with the intent to
maximize total return.
INVESTED ASSETS EVALUATION routinely includes a review by the Company of
its portfolio of debt securities. Management identifies monthly those
investments that require additional monitoring and carefully reviews the
carrying values of such investments at least quarterly to determine whether
specific investments should be placed on a nonaccrual basis and to determine
declines in value that may be other than temporary. In making these reviews
for bonds, management principally considers the adequacy of any collateral,
compliance with contractual covenants, the borrower's recent financial
performance, news reports and other externally generated information concerning
the creditor's affairs. In the case of publicly traded bonds, management also
considers market value quotations, if available. For mortgage loans,
management generally considers information concerning the mortgaged property
and, among other things, factors impacting the current and expected payment
status of the loan and, if available, the current fair value of the underlying
collateral.
The carrying values of bonds that are determined to have declines in
value that are other than temporary are reduced to net realizable value and no
further accruals of interest are made. The valuation allowances on mortgage
loans are based on losses expected by management to be realized on transfers
of mortgage loans to real estate, on the disposition and settlement of mortgage
loans and on mortgage loans that management believes may not be collectible in
full. Accrual of interest is suspended when principal and interest payments
on mortgage loans are past due more than 90 days.
DEFAULTED INVESTMENTS, comprising all investments that are in default as
to the payment of principal or interest, totaled $1.1 million at March 31, 1998
(at amortized cost, with a fair value of $1.1 million), and constituted 0.1%
of total invested assets. At September 30, 1997, defaulted investments totaled
$2.3 million and constituted 0.1% of total invested assets.
SOURCES OF LIQUIDITY are readily available to the Company in the form of
the Company's existing portfolio of cash and short-term investments, Reverse
Repo capacity on invested assets and, if required, proceeds from invested
asset sales. At March 31, 1998, approximately $1.28 billion of the Company's
Bond Portfolio had an aggregate unrealized gain of $43.4 million, while
approximately $94.2 million of the Bond Portfolio had an aggregate unrealized
loss of $1.2 million. In addition, the Company's investment portfolio
currently provides approximately $15.1 million of monthly cash flow from
scheduled principal and interest payments. Historically, cash flows from
19
operations and from the sale of the Company's annuity products have been more
than sufficient in amount to satisfy the Company's liquidity needs. However
in the current period, withdrawal rates on the acquired JANY business have
necessitated the liquidation of certain invested assets in order to fund the
withdrawals. The Company expects that withdrawal rates will require the
continued modest liquidation of invested assets for the foreseeable future.
Management is aware that prevailing market interest rates may shift
significantly and has strategies in place to manage either an increase or
decrease in prevailing rates. In a rising interest rate environment, the
Company's average cost of funds would increase over time as it prices its new
and renewing annuities to maintain a generally competitive market rate.
Management would seek to place new funds in investments that were matched in
duration to, and higher yielding than, the liabilities assumed. The Company
believes that liquidity to fund withdrawals would be available through incoming
cash flow, the sale of short-term or floating-rate instruments or Reverse Repos
on the Company's substantial MBS segment of the Bond Portfolio, thereby
avoiding the sale of fixed-rate assets in an unfavorable bond market.
In a declining rate environment, the Company's cost of funds would
decrease over time, reflecting lower interest crediting rates on its fixed
annuities. Should increased liquidity be required for withdrawals, the Company
believes that a significant portion of its investments could be sold without
adverse consequences in light of the general strengthening that would be
expected in the bond market.
The Company relies significantly on computer systems and applications in
its daily operations. Many of these systems and applications are not presently
year 2000 compliant. The Company's business, financial condition and results
of operations could be materially and adversely affected by the failure of the
Company's systems and applications (and those operated by third parties
interfacing with the Company's systems and applications) to properly operate
or manage dates beyond the year 1999. The Company's parent has a coordinated
plan to repair or replace these noncompliant systems and to obtain similar
assurances from third parties interfacing with the Company's systems and
applications and expects to significantly complete its plan by the end of
calendar year 1998. The cost of these changes will be substantially borne by
the Company's affiliates and will not have a material impact on the Company's
results of operations.
REGULATION
The Company is subject to regulation and supervision by the States of New
York, New Mexico and Nebraska, the states in which the Company is authorized
to transact business. State insurance laws establish supervisory agencies with
broad administrative and supervisory powers. Principal among these powers are
granting and revoking licenses to transact business, regulating marketing and
other trade practices, operating guaranty associations, licensing agents,
approving policy forms, regulating certain premium rates, regulating insurance
holding company systems, establishing reserve requirements, prescribing the
form and content of required financial statements and reports, performing
financial, market conduct and other examinations, determining the
reasonableness and adequacy of statutory capital and surplus, defining
acceptable accounting principles, regulating the type, valuation and amount of
investments permitted, and limiting the amount of dividends that can be paid
and the size of transactions that can be consummated without first obtaining
regulatory approval.
During the last decade, the insurance regulatory framework has been
placed under increased scrutiny by various states, the federal government and
20
the NAIC. Various states have considered or enacted legislation that changes,
and in many cases increases, the states' authority to regulate insurance
companies. Legislation has been introduced from time to time in Congress that
could result in the federal government assuming some role in the regulation of
insurance companies or allowing combinations between insurance companies,
banks and other entities. In recent years, the NAIC has approved and
recommended to the states for adoption and implementation several regulatory
initiatives designed to reduce the risk of insurance company insolvencies and
market conduct violations. These initiatives include investment reserve
requirements, risk-based capital standards, codification of insurance
accounting principles, new investment standards and restrictions on an
insurance company's ability to pay dividends to its stockholders. The NAIC is
also currently developing model laws and regulations relating to product
design, actuarial standards, certain separate account products and
illustrations for annuity products. Current proposals are still being debated
and the Company is monitoring developments in this area and the effects any
changes would have on the Company.
From time to time, Federal initiatives are proposed that could affect the
Company's businesses. Such initiatives include employee benefit plan
regulations and tax law changes affecting the taxation of insurance companies
and the tax treatment of insurance products. Recent administration budget
proposals include the proposed taxation of exchanges involving variable annuity
contracts and reallocations within variable annuity contracts and certain other
proposals relating to annuities. The Company believes these proposals have a
small likelihood of being enacted, because they would discourage retirement
savings and there is strong popular and industry opposition to them. Other
proposals made in recent years to limit the tax deferral of annuities have not
been enacted. The Company believes that certain of the proposals, if
implemented, would have an adverse effect on the Company's ability to sell
variable annuities, and, consequently, on its results of operations. However,
the Company would not expect this to materially impact earnings in the near
term because the Company believes that adoption of the administration
proposals, however unlikely, would reduce annuity surrenders on the existing
block of variable annuity contracts and the ongoing earnings potential arising
from that block would offset the near-term economic impact of the potential
decrease in sales.
21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
Not applicable.
Item 2. Changes in Securities
---------------------
Not applicable.
Item 3. Defaults Upon Senior Securities
-------------------------------
Not applicable.
Item 4. Submissions of Matters to a Vote of Security Holders
----------------------------------------------------
Not applicable.
Item 5. Other Information
-----------------
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
EXHIBITS
Exhibit
No. Description
- - ------- -----------
27 Financial Data Schedule
No Current Report on Form 8-K was filed during the three months ended March 31,
1998.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Signature Title Date
- - --------- ----- ----
/s/ SCOTT L. ROBINSON Senior Vice President, May 15,
1998
- - ------------------------ Treasurer and Director -------
- - -----
Scott L. Robinson (Principal Financial
Officer)
/s/ N. SCOTT GILLIS Senior Vice President and May 15,
1998
- - ------------------------ Controller (Principal -------
- - -----
N. Scott Gillis Accounting Officer)
23
FIRST SUNAMERICA LIFE INSURANCE COMPANY
LIST OF EXHIBITS FILED
Exhibit
No. Description
- - ------- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND INCOME STATEMENT OF FIRST SUNAMERICA LIFE INSURANCE COMPANY'S FORM 10-Q
FOR THE SIX MONTHS ENDED MARCH 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 1,413,960,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 31,000
<MORTGAGE> 150,713,000
<REAL-ESTATE> 1,765,000
<TOTAL-INVEST> 1,595,534,000
<CASH> 22,194,000
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 90,094,000
<TOTAL-ASSETS> 1,951,176,000
<POLICY-LOSSES> 1,503,217,000
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
<COMMON> 3,000,000
0
0
<OTHER-SE> 173,913,000
<TOTAL-LIABILITY-AND-EQUITY> 1,951,176,000
0
<INVESTMENT-INCOME> 59,423,000
<INVESTMENT-GAINS> 2,470,000
<OTHER-INCOME> 3,612,000
<BENEFITS> 41,622,000
<UNDERWRITING-AMORTIZATION> 8,220,000
<UNDERWRITING-OTHER> 139,000
<INCOME-PRETAX> 13,494,000
<INCOME-TAX> 5,533,000
<INCOME-CONTINUING> 7,961,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,961,000
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
