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
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
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 REGISTRANTS COMMON STOCK ON
NOVEMBER 15, 1999 WAS AS FOLLOWS:
Common Stock (par value $10,000.00 per share) 300 shares outstanding
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
INDEX
Page
Number(s)
---------
<S> <C>
Part I - Financial Information
Balance Sheet (Unaudited) -
September 30, 1999 and December 31, 1998. . . . . . . . . . 3
Statement of Income and Comprehensive Income (Unaudited) -
Three Months and Nine Months Ended September 30, 1999
and 1998. . . . . . . . . . . . . . . . . . . . . . . . . . 4
Statement of Cash Flows (Unaudited) -
Nine Months Ended September 30, 1999 and 1998 . . . . . . . 5-6
Notes to Financial Statements (Unaudited) . . . . . . . . . 7-10
Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . 11-24
Quantitative and Qualitative Disclosures About Market
Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Part II - Other Information . . . . . . . . . . . . . . . . . . . 26
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
BALANCE SHEET
(Unaudited)
September 30, December 31,
1999 1998
--------------- --------------
<S> <C> <C>
ASSETS
Investments:
Cash and short-term investments. . . . . . $ 59,352,000 $ 18,466,000
Bonds and notes available for sale,
at fair value (amortized cost:
September 1999, $1,701,131,000,
December 1998, $1,293,637,000) . . . . . 1,657,112,000 1,313,390,000
Mortgage loans . . . . . . . . . . . . . . 213,779,000 176,737,000
Other invested assets. . . . . . . . . . . 42,783,000 6,539,000
--------------- --------------
Total investments. . . . . . . . . . . . . 1,973,026,000 1,515,132,000
Variable annuity assets held in separate
accounts . . . . . . . . . . . . . . . . . 438,993,000 344,619,000
Accrued investment income. . . . . . . . . . 23,922,000 18,169,000
Deferred acquisition costs . . . . . . . . . 134,607,000 96,918,000
Deferred income taxes 17,408,000 ---
Receivable from brokers for sales of
securities . . . . . . . . . . . . . . . . 1,919,000 30,597,000
Other assets . . . . . . . . . . . . . . . . 3,111,000 2,247,000
--------------- --------------
TOTAL ASSETS . . . . . . . . . . . . . . . . $2,592,986,000 $2,007,682,000
=============== ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Reserves, payables and accrued liabilities:
Reserves for fixed annuity contracts . . . $1,655,560,000 $1,432,558,000
Reserves for universal life insurance
contracts 281,567,000 ---
Income taxes currently payable . . . . . . 13,611,000 10,144,000
Payable to brokers for purchases
of securities. . . . . . . . . . . . . . 1,985,000 19,806,000
Other liabilities. . . . . . . . . . . . . 28,919,000 12,088,000
--------------- --------------
Total reserves, payables
and accrued liabilities. . . . . . . . . 1,981,642,000 1,474,596,000
--------------- --------------
Variable annuity liabilities related
to separate accounts . . . . . . . . . . . 438,993,000 344,619,000
--------------- --------------
Deferred income taxes --- 3,792,000
--------------- --------------
Shareholder's equity:
Common Stock . . . . . . . . . . . . . . . 3,000,000 3,000,000
Additional paid-in capital . . . . . . . . 144,428,000 144,428,000
Retained earnings. . . . . . . . . . . . . 41,767,000 34,737,000
Accumulated other comprehensive
income (loss). . . . . . . . . . . . . . (16,844,000) 2,510,000
--------------- --------------
Total shareholder's equity . . . . . . . . 172,351,000 184,675,000
--------------- --------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY . $2,592,986,000 $2,007,682,000
=============== ==============
</TABLE>
See accompanying notes
3
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
For the three months and nine months ended September 30, 1999 and 1998
(Unaudited)
Three Months Nine Months
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Investment income . . . . . . . . . . $ 37,117,000 $ 28,833,000 $ 91,523,000 $ 87,614,000
------------- ------------- ------------- -------------
Interest expense on:
Fixed annuity contracts . . . . . . (21,091,000) (19,127,000) (55,989,000) (59,317,000)
Universal life insurance contracts (3,482,000) --- (3,482,000) ---
Senior indebtedness --- (71,000) --- (81,000)
------------- ------------- ------------- -------------
Total interest expense. . . . . . . (24,573,000) (19,198,000) (59,471,000) (59,398,000)
------------- ------------- ------------- -------------
NET INVESTMENT INCOME . . . . . . . . 12,544,000 9,635,000 32,052,000 28,216,000
------------- ------------- ------------- -------------
NET REALIZED INVESTMENT
GAINS (LOSSES). . . . . . . . . . . (4,874,000) 160,000 (5,451,000) 2,615,000
------------- ------------- ------------- -------------
Fee income:
Variable annuity fees . . . . . . . 1,657,000 1,085,000 4,548,000 2,908,000
Universal life insurance fees 1,966,000 --- 1,966,000 ---
Surrender charges . . . . . . . . . 895,000 913,000 2,343,000 3,396,000
------------- ------------- ------------- -------------
TOTAL FEE INCOME. . . . . . . . . . . 4,518,000 1,998,000 8,857,000 6,304,000
------------- ------------- ------------- -------------
GENERAL AND ADMINISTRATIVE
EXPENSES. . . . . . . . . . . . . . (4,166,000) (1,156,000) (6,419,000) (2,357,000)
------------- ------------- ------------- -------------
AMORTIZATION OF DEFERRED
ACQUISITION COSTS . . . . . . . . . (6,000,000) (4,540,000) (16,800,000) (13,094,000)
------------- ------------- ------------- -------------
ANNUAL COMMISSIONS. . . . . . . . . . (155,000) (78,000) (323,000) (236,000)
------------- ------------- ------------- -------------
PRETAX INCOME . . . . . . . . . . . . 1,867,000 6,019,000 11,916,000 21,448,000
Income tax expense. . . . . . . . . . (731,000) (2,788,000) (4,886,000) (9,187,000)
------------- ------------- ------------- -------------
NET INCOME. . . . . . . . . . . . . . 1,136,000 3,231,000 7,030,000 12,261,000
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF TAX:
Net unrealized gains (losses)
on debt and equity securities
available for sale identified
in the current period . . . . . . (13,874,000) 949,000 (20,051,000) 1,563,000
------------- ------------- ------------- -------------
Less reclassification
adjustment for net
realized losses (gains)
included in net income. . . . . . 685,000 39,000 697,000 (368,000)
------------- ------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) . (13,189,000) 988,000 (19,354,000) 1,195,000
------------- ------------- ------------- -------------
COMPREHENSIVE INCOME (LOSS) . . . . . $(12,053,000) $ 4,219,000 $(12,324,000) $ 13,456,000
============= ============= ============= =============
</TABLE>
See accompanying notes
4
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS
For the nine months ended September 30, 1999 and 1998
(Unaudited)
1999 1998
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . $ 7,030,000 $ 12,261,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Interest credited to:
Fixed annuity contracts. . . . . . . . 55,989,000 59,317,000
Universal life insurance contracts 3,482,000 ---
Net realized investment losses (gains) 5,451,000 (2,615,000)
Accretion of net discounts on
investments. . . . . . . . . . . . . (2,847,000) (1,442,000)
Amortization of goodwill . . . . . . . . 44,000 44,000
Provision for deferred income taxes. . . (10,779,000) (1,150,000)
Change in:
Accrued investment income. . . . . . . . . (5,753,000) 1,355,000
Deferred acquisition costs . . . . . . . . 6,311,000 6,113,000
Income taxes currently payable . . . . . . 3,467,000 5,782,000
Other liabilities. . . . . . . . . . . . . 16,831,000 (6,097,000)
Other, net . . . . . . . . . . . . . . . . . 3,392,000 8,288,000
-------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES. . 82,618,000 81,856,000
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of:
Bonds and notes. . . . . . . . . . . . . . (471,548,000) (587,837,000)
Mortgage loans . . . . . . . . . . . . . . (65,921,000) (82,256,000)
Other investments, excluding short-term
investments --- 225,000
Sales of:
Bonds and notes. . . . . . . . . . . . . . 280,011,000 634,365,000
Other investments, excluding short-term
investments. . . . . . . . . . . . . . . 914,000 494,000
Redemptions and maturities of:
Bonds and notes. . . . . . . . . . . . . . 57,817,000 57,301,000
Mortgage loans . . . . . . . . . . . . . . 28,726,000 23,243,000
Other investments, excluding short-term
investments 408,000 ---
Short-term investments received from
Anchor National Life Insurance Company
in assumption reinsurance transaction
with MBL Life Assurance Corporation 368,665,000 ---
-------------- --------------
NET CASH PROVIDED BY INVESTING ACTIVITIES. . 199,072,000 45,535,000
-------------- --------------
</TABLE>
See accompanying notes
5
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS (Continued)
For the nine months ended September 30, 1999 and 1998
(Unaudited)
1999 1998
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Premium receipts on:
Fixed annuity contracts . . . . . . . $ 49,794,000 $ 100,061,000
Universal life insurance contracts 2,572,000 ---
Net exchanges from the fixed accounts
of variable annuity contracts . . . (29,736,000) (36,220,000)
Withdrawal payments on:
Fixed annuity contracts . . . . . . . (234,431,000) (165,960,000)
Universal life insurance contracts (4,101,000) ---
Claims and annuity payments on fixed
annuity contracts . . . . . . . . . (24,902,000) (29,967,000)
Net repayments of other short-term
financings --- (10,686,000)
-------------- --------------
NET CASH USED BY FINANCING ACTIVITIES . (240,804,000) (142,772,000)
-------------- --------------
NET DECREASE IN CASH AND SHORT-TERM
INVESTMENTS . . . . . . . . . . . . . 40,886,000 (15,381,000)
CASH AND SHORT-TERM INVESTMENTS AT
BEGINNING OF PERIOD . . . . . . . . . 18,466,000 71,060,000
-------------- --------------
CASH AND SHORT-TERM INVESTMENTS AT
END OF PERIOD . . . . . . . . . . . . $ 59,352,000 $ 55,679,000
============== ==============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid on indebtedness $ --- $ 81,000
============== ==============
Net income taxes paid . . . . . . . . . $ 13,122,000 $ 5,438,000
============== ==============
</TABLE>
See accompanying notes
6
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
-----------------------
At December 31, 1998, First SunAmerica Life Insurance Company (the
"Company") was an indirect wholly owned subsidiary of SunAmerica Inc. On January
1, 1999, SunAmerica Inc. merged with and into American International Group, Inc.
("AIG") in a tax-free reorganization that has been treated as a pooling of
interests for accounting purposes. Thus, SunAmerica Inc. ceased to exist on that
date. However, on the date of merger, substantially all of the net assets of
SunAmerica Inc. were contributed to a newly formed subsidiary of AIG named
SunAmerica Inc. ("SunAmerica").
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 September 30, 1999 and
December 31, 1998, the results of its operations for the three months and nine
months ended September 30, 1999 and 1998 and its cash flows for the nine months
ended September 30, 1999 and 1998. The results of operations for the three
months and nine months ended September 30, 1999 are not necessarily indicative
of the results to be expected for the full year.
The Company has changed its fiscal year end from September 30 to December 31.
The accompanying unaudited financial statements should be read in conjunction
with the audited financial statements for the fiscal year ended September 30,
1998, contained in the Company's Annual Report on Form 10-K, and the unaudited
financial statements as of and for the three months ended December 31, 1998,
contained in the Company's Transition Report on Form 10-Q. Certain items have
been reclassified to conform to the current period's presentation.
2. Reinsurance
-----------
On December 31, 1998, Anchor National Life Insurance Company ("ANLIC"), an
affiliate of the Company, acquired the individual life business and the
individual and group annuity business of MBL Life Assurance Corporation ("MBL
Life"), via a 100% coinsurance transaction, for a cash purchase price of
$128,420,000. As part of this transaction, ANLIC acquired assets having an
aggregate fair value of $5,718,227,000, composed primarily of invested assets
totaling $5,715,010,000. Liabilities assumed by ANLIC in this acquisition
totaled $5,831,266,000, including $3,460,503,000 of fixed annuity reserves,
$2,317,365,000 of universal life reserves and $24,011,000 of guaranteed
investment contract reserves.
Included in the block of business acquired by ANLIC from MBL Life was
$282,947,000 of individual life business and $404,318,000 of group annuity
business whose contract owners are residents of New York State ("the New York
Business"). On July 1, 1999, the New York Business was acquired by the Company
via an assumption reinsurance agreement. The remainder of the business acquired
by ANLIC was converted to assumption reinsurance, which superseded the
coinsurance arrangement. As part of this transfer, invested assets equal to
$675,303,000 and other net assets of $11,962,000 were also transferred to the
Company.
7
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
2. Reinsurance (continued)
-----------
Approximately $10,000,000 of the $128,420,000 purchase price was allocated to
the Company based on the estimated future gross profits of the New York
Business, and together with $2,000,000 of acquisition expenses, is included in
Deferred Acquisition Costs in the accompanying balance sheet.
This business was assumed from MBL Life subject to existing reinsurance
ceded agreements in which the maximum retention on any single life was
$2,000,000. In order to limit even further the exposure to loss on any single
life and to recover an additional portion of the benefits paid over such limits,
the Company entered into a monthly renewable term reinsurance treaty, effective
July 1, 1999, under which it retains no more than $100,000 of risk on any one
insured life. With respect to the assumption agreement, the Company could
become liable for all obligations of the reinsured policies if the reinsurers
were to become unable to meet the obligations assumed under the respective
reinsurance agreements.
3. Adoption of New Accounting Standard
---------------------------------------
Effective October 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130")
which requires the reporting of comprehensive income in addition to net income
from operations. Comprehensive income is a more inclusive financial reporting
methodology that includes disclosure of certain financial information that
historically has not been recognized in the calculation of net income. The
adoption of SFAS 130 did not have an impact on the Company's results of
operations, financial condition or liquidity. Comprehensive income amounts for
the prior year are presented to conform to the current year's presentation.
8
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. Adoption of New Accounting Standard (continued)
---------------------------------------
The before tax, after tax, and tax benefit (expense) amounts for each component
of the increase (decrease) in unrealized gains on bonds and notes available for
sale for both the current and prior periods are summarized below:
<TABLE>
<CAPTION>
Tax Benefit
Before Tax (Expense) Net of Tax
------------- ----------- -------------
THREE MONTHS ENDED SEPTEMBER 30,
1999:
<S> <C> <C> <C>
Net unrealized losses on debt
and equity securities available
for sale identified in the
current period . . . . . . . . . $(22,863,000) $ 8,002,000 $(14,861,000)
Increase in deferred acquisition
cost adjustment identified in
the current period . . . . . . 1,519,000 (532,000) 987,000
------------- ------------ -------------
Subtotal . . . . . . . . . . . . (21,344,000) 7,470,000 (13,874,000)
------------- ------------ -------------
Reclassification adjustment for:
Net realized losses included
in net income. . . . . . . . 4,872,000 (1,705,000) 3,167,000
Related change in deferred
acquisition costs. . . . . . . (3,819,000) 1,337,000 (2,482,000)
------------- ------------ -------------
Total reclassification
adjustment . . . . . . . . . 1,053,000 (368,000) 685,000
------------- ------------ -------------
Total other comprehensive loss . $(20,291,000) $ 7,102,000 $(13,189,000)
============= ============ =============
THREE MONTHS ENDED SEPTEMBER 30,
1998:
Net unrealized gains on debt and
equity securities available
for sale identified in the
current period . . . . . . . . . $ 3,481,000 $(1,218,000) $ 2,263,000
Decrease in deferred acquisition
cost adjustment identified in
the current period . . . . . . (2,022,000) 708,000 (1,314,000)
------------- ------------ -------------
Subtotal . . . . . . . . . . . . 1,459,000 (510,000) 949,000
------------- ------------ -------------
Reclassification adjustment for:
Net realized gains included
in net income. . . . . . . . 240,000 (84,000) 156,000
Related change in deferred
acquisition costs. . . . . . . (179,000) 62,000 (117,000)
------------- ------------ -------------
Total reclassification
adjustment . . . . . . . . . 61,000 (22,000) 39,000
------------- ------------ -------------
Total other comprehensive income $ 1,520,000 $ (532,000) $ 988,000
============= ============ =============
</TABLE>
9
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. Adoption of New Accounting Standard (continued)
---------------------------------------
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<CAPTION>
Tax Benefit
Before Tax (Expense) Net of Tax
------------- ----------- -------------
NINE MONTHS ENDED SEPTEMBER 30,
1999:
<S> <C> <C> <C>
Net unrealized losses on debt
and equity securities available
for sale identified in the
current period . . . . . . . . . $(69,255,000) $ 24,239,000 $(45,016,000)
Increase in deferred acquisition
cost adjustment identified in
the current period . . . . . . 38,408,000 (13,443,000) 24,965,000
------------- ------------- -------------
Subtotal . . . . . . . . . . . . (30,847,000) 10,796,000 (20,051,000)
------------- ------------- -------------
Reclassification adjustment for:
Net realized losses included
in net income. . . . . . . . 5,479,000 (1,918,000) 3,561,000
Related change in deferred
acquisition costs. . . . . . (4,408,000) 1,544,000 (2,864,000)
------------- ------------- -------------
Total reclassification
adjustment . . . . . . . . . 1,071,000 (374,000) 697,000
------------- ------------- -------------
Total other comprehensive loss . $(29,776,000) $ 10,422,000 $(19,354,000)
============= ============= =============
NINE MONTHS ENDED SEPTEMBER 30,
1998:
Net unrealized gains on debt
and equity securities available
for sale identified in the
current period . . . . . . . . . $ 4,132,000 $ (1,446,000) $ 2,686,000
Decrease in deferred acquisition
cost adjustment identified in
the current period . . . . . . (1,727,000) 604,000 (1,123,000)
------------- ------------- -------------
Subtotal . . . . . . . . . . . . 2,405,000 (842,000) 1,563,000
------------- ------------- -------------
Reclassification adjustment for:
Net realized gains included
in net income. . . . . . . . (2,395,000) 838,000 (1,557,000)
Related change in deferred
acquisition costs. . . . . . 1,828,000 (639,000) 1,189,000
------------- ------------- -------------
Total reclassification
adjustment . . . . . . . . . (567,000) 199,000 (368,000)
------------- ------------- -------------
Total other comprehensive income $ 1,838,000 $ (643,000) $ 1,195,000
============= ============= =============
</TABLE>
10
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FIRST SUNAMERICA LIFE INSURANCE COMPANY
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 nine months ended September 30, 1999 and September 30, 1998
follows. The Company has changed its fiscal year end to December 31.
Accordingly, the quarter ended December 31, 1998 was a transition period.
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 or 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 $1.1 million in the third quarter of 1999, compared with
$3.2 million in the third quarter of 1998. For the nine months, net income
amounted to $7.0 million in 1999, compared with $12.3 million in 1998. On July
1, 1999, the Company acquired the New York individual life and individual and
group annuity business of MBL Life Assurance Corporation (the "Acquisition").
The Acquisition was accounted for under the purchase method of accounting, and,
therefore results of operations include those of the Acquisition only from its
date of acquisition. Consequently, the operating results for 1999 and 1998 are
not comparable. On a pro forma basis, using the historical financial
information of the acquired business and assuming that the Acquisition had been
consummated on July 1, 1998, the beginning of the prior-year periods discussed
herein, net income would have been $4.3 million and $13.4 million for the third
quarter and the nine months of 1998, respectively.
PRETAX INCOME totaled $1.9 million in the third quarter of 1999 and $6.0
million in the third quarter of 1998. For the nine months, pretax
11
<PAGE>
income totaled $11.9 million in 1999, compared with $21.4 million in 1998. The
decreases in 1999 resulted primarily from a decrease in net realized investment
gains, increased general and administrative expenses, and increased amortization
of deferred acquisition costs, which were partially offset by increased variable
annuity and universal life insurance fees.
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 $12.5 million in the third quarter of
1999 from $9.6 million in the third quarter of 1998. These amounts equal 2.36%
on average invested assets (computed on a daily basis) of $2.13 billion in the
third quarter of 1999 and 2.52% on average invested assets of $1.53 billion in
the third quarter of 1998. For the nine months, net investment income increased
to $32.1 million in 1999 from $28.2 million in 1998, equaling 2.51% of average
invested assets of $1.70 billion in 1999 and 2.44% of average invested assets of
$1.54 billion in 1998. On a pro forma basis, assuming the Acquisition had been
consummated on July 1, 1998, net investment income on related average invested
assets would have been 1.83% and 2.06% in the third quarter and nine months of
1998, respectively. The improvement of 1999 net investment yields over these pro
forma amounts reflects the redeployment of lower yielding assets received in the
Acquisition into higher yielding investment categories.
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 $116.1 million in the third quarter of 1999, $56.0 million in the
third quarter of 1998, $90.3 million in the nine months of 1999 and $52.8
million in the nine months of 1998. The difference between the Company's yield
on average invested assets and the rate paid on average interest-bearing
liabilities (the "Spread Difference") was 2.09% in the third quarter of 1999,
2.33% in the third quarter of 1998 and 2.25% in the nine months of 1999 and
1998. On a pro forma basis, assuming the Acquisition had been consummated on
July 1, 1998, the spread difference would have been 1.93% and 2.20% in the third
quarter and nine months of 1998, respectively, reflecting primarily the effect
of the lower yielding assets received in the Acquisition. The invested assets
associated with the Acquisition included high-grade corporate, government and
government/agency bonds, which are generally lower yielding than a significant
portion of the invested assets that comprise the remainder of the Company's
portfolio.
Investment income (and the related yields on average invested assets)
totaled $37.1 million (6.98%) in the third quarter of 1999, $28.8 million
(7.55%) in the third quarter of 1998, $91.5 million (7.16%) in the nine months
of 1999 and $87.6 million (7.56%) in the nine months of 1998. The decreases in
the investment yields in 1999 as compared with 1998 principally reflect the
effects of lower yielding assets received in the Acquisition. On a pro forma
basis, assuming the Acquisition had been consummated on July 1, 1998, the yield
on related average invested assets would have been 7.37% and 7.49% in the third
quarter and nine months of 1998, respectively.
Total interest expense equaled $24.6 million in the third quarter of 1999,
compared with $19.2 million in the third quarter of 1998. For the nine months,
total interest expense aggregated $59.5 million in 1999 and $59.4 million in
1998. The average rate paid on all interest-bearing liabilities was 4.89% in
the third quarter of 1999, 5.22% in the third quarter of 1998, 4.91% in the nine
months of 1999 and 5.31% in the nine months of 1998. Interest-bearing
liabilities averaged $2.01 billion in the third quarter of 1999, $1.47 billion
in the third quarter of 1998, $1.61 billion in the nine months of 1999 and $1.49
billion in the nine months of 1998. Total interest expense in 1999 and related
average rates paid reflect the effects of the acquisition. On a pro forma
basis, assuming the Acquisition had been consummated on July 1, 1998, the
average rate paid on
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<PAGE>
all interest-bearing liabilities would have been 5.53% and 5.43% and
interest-bearing liabilities would have averaged $2.16 billion and $1.72 billion
in the third quarter and nine months of 1998, respectively. The decreases in
the overall rates paid in 1999 result primarily from a generally lower interest
rate environment.
GROWTH IN AVERAGE INVESTED ASSETS largely resulted from the impact of the
Acquisition. Changes in average invested assets also reflect sales of fixed
annuities and the fixed account options of the Company's variable annuity
products ("Fixed Annuity Premiums"), and renewal premiums on its universal life
product ("UL Premiums") acquired in the Acquisition, partially offset by net
exchanges from fixed accounts into the separate accounts of variable annuity
contracts. Fixed Annuity Premiums and UL Premiums totaled $35.4 million in the
third quarter of 1999, $31.2 million in the third quarter of 1998, $69.9 million
in the nine months of 1999, and $100.1 million in the nine months of 1998 and
are largely premiums for the fixed accounts of variable annuities. Such
premiums have decreased in the nine months principally as a result of regulatory
changes in the state of New York relating to non-taxable policy exchange
requirements offset by greater inflows into the one-year and six-month fixed
accounts of these products, which are used for dollar-cost averaging into the
variable accounts. Accordingly, the Company anticipates that it will see a large
portion of these premiums transferred into the variable funds. On an annualized
basis, these premiums represent 7%, 7%, 8% and 9%, respectively, of the related
reserve balances at the beginning of the respective periods. These decreases in
1999 premiums when expressed as a percentage of related reserve balances result
from the impact of the Acquisition. When premium and reserve balances resulting
from the Acquisition are excluded, the resulting premiums represent 10% and 12%
of beginning fixed annuity reserve balances in the third quarter and nine months
of 1999, respectively.
NET REALIZED INVESTMENT LOSSES totaled $4.9 million in the third quarter of
1999, compared with net realized investment gains of $0.2 million in the third
quarter of 1998. For the nine months, net realized investment losses amounted
to $5.5 million in 1999, compared with net realized investment gains of $2.6
million in 1998. Net realized investment losses in the third quarter of 1999
include impairment writedowns of $3.2 million and in the nine months of 1999
include impairment writedowns of $7.0 million. There were no impairment
writedowns in the third quarter of 1998 and $0.4 million in the nine months of
1998. Thus, net losses from sales and redemptions of investments totaled $1.7
million in the third quarter of 1999, compared to net gains from sales and
redemptions of investments of $0.2 million in the third quarter of 1998. Net
gains from sales of investments totaled $1.3 million in the nine months of 1999,
compared to $3.0 million in the nine months of 1998.
The Company sold or redeemed invested assets, principally bonds and notes,
aggregating $104.7 million in the third quarter of 1999, $257.6 million in the
third quarter of 1998, $337.7 million in the nine months of 1999 and $524.6
million in the nine months of 1998. Sales of investments result from the active
management of the Company's investment portfolio, including assets received as
of part of the Acquisition. 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 0.32%, 0.05%, 0.12%
and 0.26% of average invested assets in the third quarter of 1999, the third
quarter of 1998, the nine months of 1999 and the nine months of 1998,
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
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<PAGE>
intent of the Company's active portfolio management is to maximize total returns
on the investment portfolio, taking into account credit, option, liquidity and
interest-rate risk.
Impairment writedowns primarily have been applied to defaulted bonds and
mortgage loans. On an annualized basis, impairment writedowns represent 0.59%
and 0.55% of related average invested assets for the quarter and nine months
ended September 30, 1999 and 1998, respectively. For the twenty fiscal quarters
beginning October 1, 1994, impairment writedowns as a percent of average
invested assets have ranged up to 0.86% and have averaged 0.16%. Such
writedowns are based upon estimates of the net realizable value of the
applicable assets. Actual realization will be dependent upon future events.
VARIABLE ANNUITY FEES are based on the market value of assets in separate
accounts supporting variable annuity contracts. Such fees totaled $1.7 million
in the third quarter of 1999 and $1.1 million in the third quarter of 1998. For
the nine months, variable annuity fees totaled $4.5 million in 1999, compared
with $2.9 million in 1998. The increased fees in 1999 reflect growth in average
variable annuity assets, principally due to the receipt of variable annuity
premiums, increased market values and net exchanges into the separate accounts
from the fixed accounts of variable annuity contracts, partially offset by
surrenders. On an annualized basis, variable annuity fees represent 1.5% of
average variable annuity assets in all periods presented. Variable annuity
assets averaged $427.6 million, $279.5 million, $393.3 million and $251.8
million, during the third quarter of 1999, the third quarter of 1998, the nine
months of 1999 and the nine months of 1998, respectively. Variable annuity
premiums, which exclude premiums allocated to the fixed accounts of variable
annuity products, aggregated $23.1 million in the third quarter of 1999, $21.2
million in the third quarter of 1998, $52.5 million in the nine months of 1999
and $63.6 million in the nine months of 1998. On an annualized basis, these
amounts represent 22%, 30%, 20% and 43% of variable annuity reserves at the
beginning of the respective periods. Transfers from the fixed accounts of the
Company's variable annuity products to the separate accounts (see "Growth in
Average Invested Assets") are not classified in variable annuity premiums (in
accordance with generally accepted accounting principles). Accordingly, changes
in variable annuity premiums are not necessarily indicative of the ultimate
allocation by customers among fixed and variable account options of the
Company's variable annuity products.
Sales of variable annuity products (which include premiums allocated to the
fixed accounts) ("Variable Annuity Product Sales") amounted to $34.4 million,
$24.7 million, 64.5 million and 70.3 million in the third quarters of 1999 and
1998 and in the nine months of 1999 and 1998, respectively. Variable annuity
product sales primarily reflect sales of the Company's flagship variable annuity
line, Polaris. The Polaris products are multimanager variable annuities that
offer investors a choice of 26 variable funds and 6 guaranteed fixed-rate funds.
Variable Annuity Product Sales have decreased in 1999, principally as a result
of regulatory changes in the State of New York relating to non-taxable policy
exchange requirements.
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, from time to time, Federal
initiatives are proposed that could affect the taxation of variable annuities
and annuities generally (See "Regulation").
UNIVERSAL LIFE INSURANCE FEES result from the acquisition of universal life
insurance contract reserves and the ongoing receipt of renewal premiums on such
contracts, and comprise mortality charges, up-front fees earned on premiums
received and administrative fees on such contracts. Universal life
14
<PAGE>
insurance fees amounted to $2.0 million in the third quarter and nine months of
1999. Such fees annualized represent 2.79% and 2.76% of average reserves for
universal life insurance contracts for the third quarter and nine months of
1999, respectively. Since the Acquisition occurred on July 1, 1999, there were
no such fees earned in 1998.
SURRENDER CHARGES on fixed and variable annuity and universal life
contracts totaled $0.9 million in the third quarter of 1999 (including $0.04
million attributable to the Acquisition) and $0.9 million in the third quarter
1998. For the nine months, such surrender charges totaled $2.3 million in 1999
(including $0.04 million attributable to the Acquisition) and $3.4 million in
1998. Surrender charges generally are assessed on withdrawals at declining
rates during the first seven years of a contract. Withdrawal payments totaled
$169.4 million in the third quarter of 1999 (including $87.7 million
attributable to the Acquisition) compared to $48.5 million in the third quarter
of 1998. For the nine months, withdrawal payments totaled $258.6 million in
1999 (including $87.7 million attributable to the Acquisition) and $182.0
million in 1998. Annualized, these payments, when expressed as a percentage of
averaged fixed and variable annuity and universal life reserves, represent 28.2%
(58.3% attributable to the Acquisition), 11.4%, 17.5% (19.4% attributable to the
Acquisition) and 13.9% for the third quarters of 1999 and 1998 and nine months
of 1999 and 1998, respectively. Excluding the effects of the Acquisition,
withdrawal payments represent 18.1% and 16.6% in the third quarter and nine
months of 1999, respectively, of related average fixed and variable annuity
reserves. Withdrawals include variable annuity payments from the separate
accounts totaling $7.6 million (7.1% of average variable annuity reserves), $3.1
million (4.4% of average variable annuity reserves), $20.0 million (6.8% of
average variable annuity reserves), and $10.8 million (5.7% of average variable
annuity reserves) in the third quarters of 1997 and 1998 and the nine months of
1999 and 1998, respectively. Consistent with the assumptions used in connection
with the Acquisition, management anticipates that the level of withdrawal
payments will reflect higher relative withdrawal rates in the near future
because of higher surrenders on the acquired business.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $4.2 million in the third
quarter of 1999 and $1.2 million in the third quarter of 1998. For the nine
months, general and administrative expenses totaled $6.4 million in 1999 and
$2.4 million in 1998. The increases in 1999 over 1998 principally reflect $1.5
million of reinsurance premiums paid and other increased costs related to the
business acquired in the Acquisition, and expenses related to servicing the
Company's growing block of variable annuity policies. In addition, expenses in
1998 include a credit of approximately $1.2 million relating to expense
allowances on ceded reinsurance. 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 $6.0 million (including
$0.3 million attributable to the Acquisition), in the third quarter of 1999,
compared with $4.5 million in the third quarter of 1998. For the nine months,
such amortization totaled $16.8 million (including $0.3 million attributable to
the Acquisition), in 1999 and $13.1 million in 1998. The increases in
amortization during 1999 were also due to additional Variable Annuity Product
Sales and the subsequent amortization of related deferred commissions and other
direct selling costs.
ANNUAL COMMISSIONS represent renewal commissions, including those paid
quarterly in arrears to maintain the persistency of certain of the Company's
fixed and variable annuity contracts. Annual commissions totaled $0.2 million
in the third quarter of 1999 and $0.1 million in the third quarter
15
<PAGE>
of 1998. For the nine months, annual commissions totaled $0.3 million in 1999
and $0.2 million in 1998.
INCOME TAX EXPENSE totaled $0.7 million in the third quarter of 1999,
compared with $2.8 million in the third quarter of 1998 and $4.9 million in the
nine months of 1999, compared with $9.2 million in the nine months of 1998,
representing effective annualized tax rates of 39%, 46%, 41% and 43%,
respectively.
FINANCIAL CONDITION AND LIQUIDITY
SHAREHOLDER'S EQUITY decreased to $172.4 million at September 30, 1999 from
$184.7 million at December 31, 1998, primarily due to a $19.4 million decrease
in accumulated other comprehensive income offset by $7.0 million of net income
recorded in 1999.
INVESTED ASSETS totaled $1.97 billion at September 30, 1999 and $1.52
billion at December 31, 1998. 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 constituted 84% of the Company's total investment
portfolio at September 30, 1999, had an amortized cost that was $44.0 million
greater than its aggregate fair value at September 30, 1999, compared with an
aggregate fair value that exceeded its amortized cost by $19.8 million at
December 31, 1998.
At September 30, 1999, the Bond Portfolio included $1.58 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 $76.6 million of bonds rated by the Company pursuant to statutory ratings
guidelines established by the NAIC. At September 30, 1999, approximately $1.52
billion of the Bond Portfolio was investment grade, including $616.1 million of
U.S. government/agency securities and mortgage-backed securities ("MBSs").
At September 30, 1999, the Bond Portfolio included $134.8 million of bonds
that were not investment grade. These non-investment-grade bonds accounted for
5.2% of the Company's total assets and 6.8% 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
September 30, 1999.
The table on the following page summarizes the Company's rated bonds by
rating classification as of September 30, 1999.
16
<PAGE>
<TABLE>
<CAPTION>
RATED BONDS BY RATING CLASSIFICATION
(dollars in thousands)
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 Estimated Percent of
[DCR] {Fitch} Amortized fair category Amortized fair Amortized fair invested
category (1) cost value (2) cost value cost value assets
- ------------------- ---------- ---------- --------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AAA+ to A-
(Aaa to A3)
[AAA to A-]
{AAA to A-} . . . $1,171,303 $1,148,832 1 $ 80,718 $ 79,207 $1,252,021 $1,228,039 62.24%
BBB+ to BBB-
(Baal to Baa3)
[BBB+ to BBB-]
{BBB+ to BBB-}. . 242,737 236,484 2 58,024 57,762 300,761 294,246 14.91
BB+ to BB-
(Ba1 to Ba3)
[BB+ to BB-]
{BB+ to BB-}. . . 8,048 7,580 3 2,390 2,155 10,438 9,735 0.49
B+ to B-
(B1 to B3)
[B+ to B-]
{B+ to B-}. . . . 124,942 114,462 4 1,993 1,960 126,935 116,422 5.90
CCC+ to C
(Caa to C)
[CCC]
{CCC+ to C-}. . . 10,133 7,915 5 643 555 10,776 8,470 0.43
CI to D
[DD]
{D} 200 200 6 --- --- 200 200 0.01
---------- ---------- ---------- ---------- ---------- ----------
TOTAL RATED ISSUES. $1,557,363 $1,515,473 $ 143,768 $ 141,639 $1,701,131 $1,657,112
========== ========== ========== ========== ========== ==========
<FN>
Footnotes appear on the following page.
</TABLE>
17
<PAGE>
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 and 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 $76.6 million of assets that were rated by the Company pursuant to
applicable NAIC rating guidelines.
18
<PAGE>
Senior secured loans ("Secured Loans") are included in the Bond Portfolio
and aggregated $137.5 million at September 30, 1999. Secured Loans are senior
to subordinated debt and equity, and are secured by assets of the issuer. At
September 30, 1999, Secured Loans consisted of $35.8 million of publicly traded
securities and $101.7 million of privately traded securities. These Secured
Loans are composed of loans to 55 borrowers spanning 15 industries, with 20% of
these assets concentrated in utilities and 10% concentrated in airlines. No
other industry concentration constituted more than 7% 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 $213.8 million at September 30, 1999 and
consisted of 156 commercial first mortgage loans with an average loan balance of
approximately $1.4 million, collateralized by properties located in 33 states.
Approximately 41% of this portfolio was office, 25% was retail, 12% was
industrial, 11% was multifamily residential and 11% was other types. At
September 30, 1999, approximately 33% of this portfolio was secured by
properties located in California, approximately 11% by properties located in New
York and Michigan and no more than 5% of this portfolio was secured by
properties located in any other single state. At September 30, 1999, one
mortgage loan had an outstanding balance of $10 million or more, which
represented approximately 5% of this portfolio, and approximately 35% of the
mortgage loan portfolio consisted of loans with balloon payments due before
October 1, 2002. During 1999 and 1998, 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 September 30, 1999, approximately 56% 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 utilized, 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
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
19
<PAGE>
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 64% of the Company's fixed annuity and
universal life reserves had surrender penalties or other restrictions at
September 30, 1999.
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 September 30, 1999, these assets had an aggregate fair
value of $1.93 billion with a duration of 3.8. The Company's fixed rate
liabilities are its fixed annuity and universal life insurance contracts. At
September 30, 1999, these liabilities had an aggregate fair value (determined by
discounting future contractual cash flows by related market rates of interest)
of $1.78 billion with a duration of 3.4. The Company's potential exposure due
to a relative 10% increase in prevailing interest rates from their September 30,
1999 levels is a loss of $7.6 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 market value 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 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 the Company's Reverse
20
<PAGE>
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. It is the
Company's policy that these agreements are entered into with counterparties who
have a debt rating of A/A2 or better from both S&P and Moody's. The Company
continually monitors its credit exposure with respect to those agreements. 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 is routinely conducted by the Company.
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 investments that are determined to have declines in
value that are other than temporary are reduced to net realizable value and, in
the case of bonds, no further accruals of interest are made. The provisions for
impairment 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 $4.1 million at September 30, 1999
and constituted 0.2% of total invested assets. At December 31, 1998 defaulted
investments totaled $2.4 million and constituted 0.2% 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 September 30, 1999, approximately $431.6 million of the Company's
Bond Portfolio had an aggregate unrealized gain of $7.6 million, while
approximately $1.23 billion of the Bond Portfolio had an aggregate unrealized
loss of $51.6 million. In addition, the Company's investment portfolio
currently provides approximately $19.6 million of monthly cash flow from
scheduled principal and interest payments. Historically, cash flows from
operations and from the sales of the Company's annuity products have been more
than sufficient in amount to satisfy the Company's liquidity needs. The Company
anticipates that liquidity needs will be higher for the next quarter due to the
Acquisition and short-term investments will be sold as needed to satisfy these
requirements.
21
<PAGE>
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.
YEAR 2000
SunAmerica initiated its strategy to deal with the year 2000 challenge in
1997. At that time, many of the computer systems and applications upon which
the Company relied in its daily operations were not year 2000 compliant. This
means that because they historically used only two digits to identify the year
in a date, they were unable to distinguish dates in the "2000s" from dates in
the "1900s". SunAmerica has incurred approximately $22.5 million of programming
costs to make necessary repairs of certain specific non-compliant systems. In
addition, SunAmerica has made expenditures of approximately $19.0 million to
replace certain other specific non-compliant systems, which expenditures have
been capitalized as software costs and will be amortized over future periods.
To date, the Company has not been allocated any portion of these costs and
expenditures. SunAmerica does not expect to incur, and the Company does not
expect to be allocated, significant additional other costs because the repair or
replacement of substantially all systems was completed as of September 30, 1999.
Further, testing of both the repaired and replaced systems was substantially
completed as of September 30, 1999. Nevertheless, the Company will continue to
test all of its computer systems and applications throughout 1999 to ensure
continued compliance.
In addition, SunAmerica has distributed a year 2000 questionnaire to those
third parties with which it has significant interaction. These include
suppliers, distributors, facilitators, fund managers, lessors and financial
institutions. The questionnaire is designed to enable SunAmerica to evaluate
these third parties' year 2000 compliance plans and state of readiness and to
determine the extent to which the Company's systems and applications may be
affected by the failure of others to remedy their own year 2000 issues. To
date, however, SunAmerica has received only inconclusive feedback from such
parties and has not independently confirmed any information received from them.
Therefore, there can be no assurance that such parties will complete their year
2000 conversions in a timely fashion or will not suffer a year 2000 business
disruption that may adversely affect the Company's financial condition and
results of operations.
Although SunAmerica's efforts to remedy year 2000 issues are expected to be
completed prior to any potential disruption to the Company's business,
SunAmerica is developing several contingency plans to implement in the event
that the transition to the year 2000 becomes difficult.
22
<PAGE>
The discussion above contains forward-looking statements. Such statements
are based on the SunAmerica's current estimates, assumptions and opinions, and
are subject to various uncertainties that could cause the actual results to
differ materially from it's expectations. Such uncertainties include, among
others, costs to be incurred, SunAmerica's success in identifying systems and
applications that are not year 2000 compliant, the nature and amount of
programming required to upgrade or replace each of the affected systems and
applications, the availability of qualified personnel, consultants and other
resources, and the success of the year 2000 conversion efforts of significant
third parties.
REGULATION
The Company is subject to regulation and supervision by insurance
regulatory agencies of the States of New York, New Mexico and Nebraska, states
in which the Company is authorized to transact business. 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 and valuation
requirements, including risk based capital measurements, 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. In general, such regulation is for the protection of policyholders
rather than security holders.
Insurance companies, including the Company, are subject to laws and
regulations designed to reduce the risk of insolvencies and market conduct
violations including investment reserve requirements and risk-based capital
("RBC") standards. The NAIC and many states are also in the process of
developing and adopting a codification of insurance accounting principles and
new investment standards. The NAIC is also developing model laws or regulations
relating to, among other things, product design, product reserving standards and
illustrations for annuity products. The Company is monitoring developments in
this area and the effects any changes would have on the Company.
The RBC standards consist of formulas which establish capital requirements
relating to insurance, business, asset and interest rate risks. The standards
are intended to help identify companies which are under-capitalized and require
specific regulatory actions in the event an insurer's RBC is deficient. The
Company has more than enough statutory capital to meet the NAIC's RBC
requirements as of the most recent calendar year end. The State of New York, in
which the Company is domiciled, has adopted these RBC standards and the Company
is in compliance with such laws. Further, for statutory reporting purposes, the
annuity reserves of the Company are calculated in accordance with statutory
requirements and are adequate under current cash-flow testing models.
Federal legislation has been recently enacted allowing combinations between
insurance companies, banks and other entities. It is not yet known what effect
this legislation will have on insurance companies. In addition, 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 and other investment products. Proposals made in recent years to
limit the tax deferral of annuities or otherwise modify the tax rules related to
the treatment of annuities have not been enacted. While certain of the
proposals, if implemented, could have an adverse effect on the Company's sales
of affected products, and, consequently, on its results of operations, the
Company believes these proposals have a small likelihood of being enacted,
because they would discourage retirement savings and there is strong public and
industry opposition to them.
24
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The quantitative and qualitative disclosures about market risk are
contained in the Asset-Liability Matching section of Management's Discussion and
Analysis of Financial Condition and Results of Operations on pages 19 and 20
herein.
25
<PAGE>
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
- ----- -----------
2(a) Purchase and Sale Agreement, dated as of July 15, 1998, by and among
the Company, SunAmerica Inc. ("SAI"), Anchor National Life Insurance Company and
MBL Life Assurance Corporation, is incorporated herein by reference to Exhibit
2(e) to SAI's 1998 Annual Report on Form 10-K, filed December 21, 1998.
3(a) Agreement and Plan of Merger and Amended and Restated Certificate of
Incorporation are incorporated herein by reference to Exhibit 3(a) of the
Company's 1997 Annual Report on Form 10-K, filed December 23, 1997.
3(b) Bylaws, as amended January 1, 1996, are incorporated herein by
reference to Exhibit 3(b) of the Company's quarterly report on Form 10-Q for the
quarter ended March 31, 1996, dated May 14, 1996.
27 Financial Data Schedule
REPORTS ON FORM 8-K
No Current Reports on Form 8-K were filed by the Company during the third
quarter ended September 30, 1999.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST SUNAMERICA LIFE INSURANCE COMPANY
-------------------------------------------
Registrant
Date: November 15, 1999 /s/ SCOTT L. ROBINSON
- -------------------------- ------------------------
Scott L. Robinson
Senior Vice President and Director
(Principal Financial Officer)
Date: November 15, 1999 /s/ N. SCOTT GILLIS
- -------------------------- ----------------------
N. Scott Gillis
Senior Vice President and Controller
(Principal Accounting Officer)
27
<PAGE>
FIRST SUNAMERICA LIFE INSURANCE COMPANY
LIST OF EXHIBITS FILED
Exhibit
No. Description
- ----- -----------
27 Financial Data Schedule.
28
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
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