ITEM 1
Business ________
Introduction ____________
American Annuity Group, Inc. ("American Annuity", "AAG", or "the Company") is a holding company whose only significant asset is the capital stock of Great American Life Insurance Company ("GALIC"). American Annuity is the successor to STI Group, Inc., formerly known as Sprague Technologies, Inc. ("STI"). STI was formed in May 1987 by The Penn Central Corporation ("Penn Central") for the purpose of divesting its electronics components businesses. STI subsequently sold substantially all of its assets and retired its debt, netting approximately $100 million in cash and cash equivalents.
In September 1992, STI reached an agreement with Great American Insurance Company ("GAI") to purchase 100% of the capital stock of GALIC for $468 million. The acquisition was consummated on December 31, 1992. The purchase of GALIC was financed with (a) $230 million of borrowings, (b) $156 million of new equity raised from the sale of common and preferred stock to GAI, and (c) cash available at the Company. American Financial Corporation ("AFC"), the parent of GAI, beneficially owned approximately 80% of American Annuity's Common Stock at March 1, 1994.
GALIC _____
For definitions of many of the insurance terms used throughout this section, please see the glossary beginning on page 11.
GALIC is an insurance company which was incorporated in New Jersey in 1959 and redomiciled as an Ohio corporation in 1982. GALIC was acquired by AFC in 1973 through AFC's acquisition of GAI. GALIC entered the tax-deferred annuity business in 1976; prior to that time it wrote primarily whole-life, term-life, and accident and health insurance policies. GALIC is currently rated "A" (Excellent) by A.M. Best.
Annuities are long-term retirement savings plans that benefit from interest accruing on a tax-deferred basis. The issuer of the annuity collects contributions, credits interest or investment income and pays out a benefit upon surrender or annuitization.
Annuity contracts can be either variable rate or fixed rate. With a variable rate annuity, the rate at which interest is credited to the contract is tied to an underlying securities portfolio or other performance index. With a fixed rate annuity, an interest crediting rate is set by the issuer, periodically reviewed by the issuer, and changed from time to time as determined to be appropriate.
GALIC is engaged in the sale of fixed rate annuities primarily to employees of qualified not-for-profit organizations under Section 403(b) of the Internal Revenue Code. These employees are eligible to save for retirement through contributions made on a before-tax basis to purchase 403(b) annuities. Contributions are made at the discretion of the participants through payroll deductions. Federal income taxes are not payable on contributions or earnings until amounts are withdrawn.
GALIC markets its annuities principally to employees of educational institutions in the kindergarten through high school ("K-12") segment. Management believes that the K-12 segment is attractive because of the growth potential and persistency rate it has demonstrated. In 1993, written
premiums from the K-12 segment represented approximately 90% of GALIC's total tax-qualified premiums, with sales of annuities to other not-for- profit groups accounting for the balance.
The following table (in millions) presents information concerning GALIC in accordance with generally accepted accounting principles ("GAAP"), unless otherwise noted.
Sales of annuities are affected by many factors, including: (i) competitive rates and products; (ii) the general level of interest rates; (iii) the favorable tax treatment of annuities; (iv) commissions paid to agents; (v) services offered; (vi) ratings from independent insurance rating agencies; and (vii) general economic conditions.
Annuity receipts in 1993 increased primarily due to the introduction of new single premium products in the second half of 1992. Receipts in 1992 were lower than anticipated due to (i) a reduction in receipts relating to a new product introduced in 1990 which encouraged rollovers of other retirement funds and (ii) unfavorable economic and market conditions, including the impact of the negative publicity associated with a number of highly publicized insolvencies in the life insurance industry.
GALIC's Corporate Strategy
GALIC's primary business objective is to maximize its long-term profitability through the sale of 403(b) annuities. GALIC seeks to achieve this objective through a strategy of: (i) offering annuity products that are tailored to meet its policyholders' financial needs and designed to encourage a high level of persistency; (ii) providing competitive commission structures and high-quality service in order to foster long-term relationships with its independent agents; (iii) maintaining a conservative investment portfolio in order to demonstrate financial stability to its policyholders; (iv) maintaining competitive crediting rates on annuity policies to encourage new, as well as renewal, business while achieving the desired spread between investment earnings and interest credited; (v) developing complementary distribution channels; and (vi) maintaining high ratings from independent insurance rating agencies.
Annuity Products
GALIC's principal products are Flexible Premium Deferred Annuities ("FPDAs") and Single Premium Deferred Annuities ("SPDAs"). In 1993, FPDAs accounted for approximately two-thirds of GALIC's total annuity receipts, with SPDAs accounting for the remainder. GALIC's annuity products are designed to discourage early terminations and withdrawals through the use of various surrender charges. Over the past five years, the annual persistency rate of GALIC's annuity products has averaged approximately 92%. The following table summarizes GALIC's written premiums and policyholder benefit reserves on a statutory basis by product line (dollars in millions).
Policyholder
1993 Premiums Written Benefit Reserves at _____________________ First % of December 31, 1993 ___________________ YearRenewal Total Amount % ____________ _____ ______ ___ Flexible Premium: 403(b) Single-tier $ 14 $ 14 7.0% $ 70 1.6% 403(b) Two-tier 31 202 58.0 2,739 63.5 Other Single-tier 2 1 0.7 39 0.9 Other Two-tier 2 6 2.0 187 4.4 ____ ____ _____ ______ _____ Total 49 223 67.7 3,035 70.4 ____ ____ _____ ______ _____
Single Premium: Single-tier 13 - 3.2 27 0.6 Two-tier 115 - 28.6 1,012 23.5 ____ ____ _____ ______ _____ Total 128 - 31.8 1,039 24.1 ____ ____ _____ ______ _____
Annuities in Pay Out - - - 217 5.0 Life, Accident & Health - 2 0.5 23 0.5 ____ ____ _____ ______ _____ Total $177 $225 100.0% $4,314 100.0% ____ ____ _____ ______ _____
GALIC's FPDAs are characterized by premium payments that are flexible in amount and timing as determined by the policyholder. GALIC's SPDAs require a one-time lump-sum premium payment. Since January 1, 1988, approximately three-fourths of GALIC's SPDA receipts have resulted from rollovers of tax- deferred funds previously maintained by policyholders with other insurers.
All of GALIC's annuity products are fixed rate annuities which provide minimum interest rate guarantees of 3% to 4% per annum. At December 31, 1993, approximately 95% of GALIC's policyholder liabilities consisted of annuities which offered a minimum interest rate guarantee of 4%. All of GALIC's annuity
policies permit GALIC to change the crediting rate at any time (subject to the minimum guaranteed interest rate). In determining the frequency and extent of changes in the crediting rate, GALIC takes into account the profitability of its annuity business and the relative competitive position of its products. The average rate being credited on funds held by GALIC was approximately 5.3%, 6.2%, and 7.2% at December 31, 1993, 1992, and 1991, respectively.
GALIC seeks to maintain a desired spread between the yield on its investment portfolio and the rate it credits to its policies. GALIC accomplishes this by (i) offering flexible crediting rates, (ii) designing annuity products that encourage persistency and (iii) maintaining an appropriate matching of assets and liabilities. Tax qualified annuity policyholders maintain access to their funds without incurring penalties through a provision in the contract which allows policy loans in accordance with the Internal Revenue Code.
The persistency rates of GALIC's products are helped by the two-tier design contained in most of GALIC's products. Two-tier annuities have a permanent surrender charge for funds withdrawn in a lump sum in excess of the amount permitted to be withdrawn pursuant to the contract. Two account values are maintained for two-tier annuities -- the annuitization (or upper-tier) value and the surrender (or lower-tier) value. The annuitization value is paid only if the policyholder chooses to annuitize (withdraw funds in a series of periodic payments for at least the minimum number of years specified in the contract). If a lump sum payment is desired, the surrender value is paid. After the initial surrender charges have been reduced to zero, single-tier annuities have only one value which is available whether the policy is surrendered or annuitized.
With some two-tier annuities, the annuitization value and the surrender value are the same at inception of the policy, but since each value accumulates interest at a different rate, over time, the annuitization value will grow to an amount which is greater than the surrender value. Other two-tier annuities credit the same interest rate to both the surrender and the annuitization value but withhold a portion of the first-year premiums when calculating the surrender value; no such amounts are withheld in calculating the annuitization value.
GALIC's two-tier annuities are particularly attractive to policyholders who intend to utilize funds accumulated to provide retirement income since the annuitization value is accumulated at a competitive long-term interest rate. Management believes that over time, as the policyholder population ages, the percentage of policyholders annuitizing will increase.
In addition to its use of two-tier structures, GALIC imposes certain surrender charges and front-end fees during the first five to ten years of a new policy to discourage customers from withdrawing funds in the early years of a policy. As a result of these features, GALIC's annuity products have achieved high persistency. As the following table illustrates, GALIC's annual persistency rates for its major products have averaged approximately 92% over the past five years.
Persistency Rates ___________________________________________ Product Group 1993 1992 1991 1990 1989 _____________ ____ ____ ____ ____ ____ Flexible Premium 92.0% 90.6% 89.3% 91.2% 94.4% Single Premium 93.3 93.8 92.8 92.6 92.0
Annuity surrender payments represented 6.9%, 7.8% and 9.4% of average statutory reserves in 1993, 1992 and 1991, respectively.
At December 31, 1993, GALIC had approximately 230,000 annuity policies in force, nearly all of which were individual contracts. GALIC's policyholders are employees of over 8,300 institutions nationwide. Of the $4.3 billion in total statutory reserves held by GALIC as of December 31, 1993, approximately 95% were attributable to policies in the accumulation phase.
Marketing and Distribution
GALIC markets its annuity products through approximately 55 managing general agents ("MGAs") who, in turn, direct more than 1,000 actively producing independent agents. GALIC has developed its business since 1980 on the basis of its relationships with MGAs and independent agents primarily through a consistent marketing approach and responsive service.
GALIC seeks to attract and retain MGAs who are experienced and highly motivated and who consistently place a high volume of the types of annuities offered by GALIC. Toward this end, GALIC has established a "President's Advisory Council" consisting of 10 of the top producers each year, all of whom must market primarily GALIC products. The President's Advisory Council serves as a major influence on new product design and marketing strategy.
To extend the distribution of GALIC annuities to a broader customer base, the Company began to develop a Personal Producing General Agent ("PPGA") distribution system. Over 85 PPGAs are contracted to sell GALIC annuities to both qualified and non-qualified customers. These new appointments will give the Company the opportunity to expand the premium writings in those territories not served by an MGA.
GALIC's strategy is to offer its agents competitive commission rates and to provide prompt processing of agent requests, with the objective of attracting and retaining agents on the basis of service, as well as compensation. Commissions paid on first year premiums are significantly higher than those paid on renewal premiums. Commissions are generally lower for sales of annuities to older policyholders, reflecting the lower profit potential available from policyholders who maintain their funds with GALIC for a shorter period.
GALIC is licensed to sell its products in all states (except Kansas and New York) and in the District of Columbia. The geographical distribution of GALIC's annuity premiums written in 1993 compared to 1989 was as follows (dollars in millions):
Investments
GALIC's annuity products are structured to generate a stable flow of investable funds. GALIC earns a spread by investing these funds at an investment earnings rate in excess of the crediting rate payable to its policyholders.
The Ohio Insurance Code contains rules governing the types and amounts of investments which are permissible for an Ohio life insurer, including GALIC. These rules are designed to ensure the safety and liquidity of the insurer's investment portfolio by placing restrictions on the quality, quantity and diversification of permitted investments.
Investments comprise approximately 96% of American Annuity's assets and are the principal source of its income. Fixed income securities (including policy loans, mortgage loans and short-term investments) comprise over 98% of AAG's investment portfolio.
Risks inherent in connection with fixed income securities include loss upon default and market price volatility. Factors which can affect the market price of these securities include: (i) creditworthiness of issuers; (ii) changes in market interest rates; (iii) the number of market makers and investors; and (iv) defaults by major issuers of securities.
In recent years, GALIC has reduced its holdings in non-investment grade fixed maturity securities and equity securities of affiliates. This shift in investment strategy has placed an emphasis on high quality fixed income securities which management believes should produce a more consistent and predictable level of investment income.
The National Association of Insurance Commissioners ("NAIC") assigns quality ratings to publicly traded as well as privately placed securities. These ratings range from Class 1 (highest quality) to Class 6 (lowest quality). The following table shows GALIC's fixed maturity portfolio by NAIC designation (and comparable Standard & Poor's Corporation rating) at December 31:
GALIC's primary investment objective in selecting securities for its fixed maturity portfolio is to optimize interest yields while maintaining an appropriate relationship of maturities between GALIC's assets and expected liabilities. GALIC invests in bonds that have primarily intermediate-term maturities. This practice provides GALIC with additional flexibility to respond to fluctuations in the marketplace.
The table below sets forth the maturities of GALIC's fixed maturity investments based on their carrying value. At December 31, 1993, the average maturity of GALIC's fixed maturity investments was approximately 6 years (including CMOs, which had an estimated average life of approximately 4 years).
The following table shows the performance of GALIC's investment portfolio, excluding equity investments in affiliates (dollars in millions):
GALIC's investment portfolio is managed by American Money Management ("AMM"), a subsidiary of AFC. As part of the acquisition by STI, GALIC and AMM executed an investment services agreement which established the investment management fee paid to AMM at a maximum of one-tenth of one percent of GALIC's invested assets. Independent Ratings
GALIC is currently rated "A" (Excellent) by A.M. Best and "A+" (High claims paying ability) by Duff & Phelps. Publications of A.M. Best indicate that an "A" rating is assigned to those companies which in A.M. Best's opinion have achieved excellent overall performance when compared to the standards established by A.M. Best as norms of the life insurance industry and which generally have demonstrated a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company's financial and operating performance, independent rating agencies review the company's profitability, leverage and liquidity, as well as the company's book of business, the quality and estimated market value of its assets, the adequacy of its policy reserves and the experience and competency of its management. Their ratings are based upon factors of concern to policyholders and agents and are not directed toward the protection of investors.
Management believes that the ratings assigned to GALIC by independent insurance rating agencies are important because potential policyholders often use a company's rating as an initial screening device in considering annuity products. Management also believes that the majority of purchasers of 403(b) annuities would not be willing to purchase annuities from an issuer that had an A.M. Best rating below certain levels. In addition, certain school districts, hospitals and banks do not allow insurers with an A.M. Best rating below certain levels to sell annuity products through their
institutions.
Policy Liabilities and Reserves
GALIC establishes and carries reserves to meet future obligations under its annuity policies. GALIC's $4.3 billion liability for accumulated policyholders' funds at December 31, 1993, is calculated based upon assumptions of future interest rate spreads expected to be realized and expected mortality, maturity and surrender rates to be experienced on the annuity policies in force. Annuity premiums are generally recorded under GAAP as increases to the liability for accumulated policyholders' funds rather than as revenues. Accumulated interest also increases this liability. Benefit payments are recorded as decreases to this liability instead of as expenses.
Competition
GALIC operates in a highly competitive environment. More than 100 insurance companies offer tax-deferred annuities. GALIC competes with other insurers and financial institutions based on many factors, including ratings, financial strength, reputation, service to policyholders, product design (including interest rates credited), commissions and service to agents. Since GALIC markets and distributes policies through independent agents, it must also compete for agents. Management believes that consistently targeting the same market and emphasizing service to agents and policyholders give GALIC a competitive advantage.
No single insurer dominates the marketplace. Competitors include (i) individual insurers and insurance groups, (ii) mutual funds and (iii) other financial institutions of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all of their profits inure to their policyholders, and many of which possess financial resources substantially in excess of those available to GALIC. In a broader sense, GALIC competes for retirement savings with a variety of financial institutions offering a full range of financial services.
Regulation
GALIC is subject to comprehensive regulation under the insurance laws of the States of Ohio and California and the other states in which it operates. These laws, in general, require approval of the particular insurance regulators prior to certain actions such as the payment of dividends in excess of statutory limitations, continuing service arrangements with affiliates and certain other transactions. Regulation and supervision are administered by a state insurance commissioner who has broad statutory powers with respect to granting and revoking licenses, approving forms of insurance contracts and determining types and amounts of business which may be conducted in light of the financial strength and size of the particular company. State insurance departments conduct periodic financial examinations of insurance companies. GALIC's state of domicile, Ohio, requires that examinations be conducted at least every three years and its most recent examination was for the three-year period ended December 31, 1990. State insurance laws also regulate the character of each insurance company's investments, reinsurance and security deposits.
GALIC may be required, under the solvency or guaranty laws of most states in which it does business, to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The incurrence and amount of such assessments have increased in recent years. In connection with the GALIC purchase, GALIC's costs for state guarantee
funds are set at $1 million per year for a five-year period with respect to insurance companies in receivership, rehabilitation, liquidation or similar situations at December 31, 1992. For any year in which GALIC pays more than $1 million to the various states, GAI will reimburse GALIC for the excess assessments. For any year in which GALIC pays less than $1 million, AAG will pay GAI the difference between $1 million and the assessed amounts. GALIC paid $2.2 million in assessments in 1993 and, accordingly, has recorded a receivable from GAI at December 31, 1993 of $1.2 million.
The Ohio Department of Insurance is GALIC's principal regulatory agency. GALIC is deemed to be "commercially domiciled" in California based on past premium volume written in the state and, as a result, is subject to certain provisions of the California Insurance Holding Company laws, particularly those governing the payment of stockholder dividends, changes in control and intercompany transactions. An insurer's status as "commercially domiciled" is determined annually under a statutory formula. GALIC's status may change in California in the future if its premium volume there decreases to below 20% of its overall premium volume over the most recent three years.
The NAIC is an organization comprised of the chief insurance regulator for each of the 50 states and the District of Columbia. One of its major roles is to develop model laws and regulations affecting insurance company operations and encourage uniform regulation through the adoption of such models in all states. As part of the overall insurance regulatory process, the NAIC forms numerous task forces to review, analyze and recommend changes to a variety of areas affecting both the operating and financial aspects of insurance companies. Recently, increased scrutiny has been placed upon the insurance regulatory framework, and a number of state legislatures have considered or enacted legislative proposals that alter, and in many cases increase, state authority to regulate insurance companies and their holding company systems. In light of recent legislative developments, the NAIC and state insurance regulators have also become involved in a process of re- examining existing laws and regulations and their application to insurance companies. Legislation has also been introduced in Congress which could result in the federal government's assuming some role in the insurance industry, although none has been enacted to date.
In 1990, the NAIC began an accreditation program to ensure that states have adequate procedures in place for effective insurance regulation, especially with respect to financial solvency. The accreditation program requires that a state meet specific minimum standards in over 15 regulatory areas to be considered for accreditation. The accreditation program is an ongoing process and once accredited, a state must enact any new or modified standards approved by the NAIC within two years following adoption. As of December 31, 1993, 32 states, including Ohio and California, were accredited.
In December 1992, the NAIC adopted a model law enacting risk-based capital formulas which became effective in 1993. The model law sets thresholds for regulatory action, and currently GALIC's capital significantly exceeds risk- based capital requirements. If the NAIC elects to impose more stringent risk-based capital rules in the future, GALIC's ability to pay dividends could be adversely affected.
The current NAIC model for extraordinary dividends requires prior regulatory approval of any dividend that exceeds the "lesser of" 10% of statutory surplus or 100% of the prior year's net gain from operations. Prior to 1986, the model standard was the "greater of" such amounts. The NAIC has approved eight alternative provisions which may be considered "substantially similar" to the model. The NAIC model or one of the alternatives must be adopted by a state in order to be accredited by the NAIC.
In October 1993, Ohio revised its dividend law to adopt one of the eight alternatives. The standard in Ohio requires 30 days prior notice of any dividend which, together with all such amounts paid in the preceding twelve months, exceeds the "greater of" 10% of statutory surplus or 100% of the prior year's net income, but not exceeding earned surplus as of the prior year-end. The maximum dividend permitted by law is not indicative of an insurer's actual ability to pay dividends, which may be constrained by business and regulatory considerations. These considerations include the impact of dividends on surplus, which could affect (i) an insurer's ratings, (ii) its competitive position and (iii) the amount of premiums that can be written. Furthermore, the Ohio Insurance Department has broad discretion to limit the payment of dividends by insurance companies domiciled in Ohio.
California amended its dividend law effective January 1, 1994, adopting one of the alternative provisions approved by the NAIC. Under the new California law, approval is required for dividends which exceed the "greater of" 10% of statutory surplus or 100% of "net gain from operations", but not exceeding earned surplus, in any twelve month period.
The NAIC has been considering the adoption of a model investment law for several years. The current projection for adoption of a model law is the end of 1994, at the earliest. A draft is not scheduled to be released until the second quarter of 1994. In addition, it is not yet determined whether the model law would be added to the NAIC accreditation standards so that consideration of the model for adoption in states would be required for the achievement or continuation of any state's accreditation. It is not possible to predict the impact of these activities on GALIC.
In 1991, the NAIC adopted additional disclosure requirements relating to the marketing and sale of two-tier annuities. Certain states have adopted regulations or interpreted existing regulations to restrict the sale of two- tier annuity products or impose limitations on the terms of such products that make their sale less attractive to GALIC. To date, these additional disclosure requirements and restrictions have not had a material impact on GALIC's business. The NAIC is also considering the adoption of actuarial guidelines with respect to two-tier annuity products. In connection with the sale of GALIC, GAI is obligated to neutralize the financial effects of implementing any such guidelines on GALIC's statutory earnings and capital, except for the initial, one-time impact on GALIC's statutory earnings. GAI's obligations will apply only to GALIC's annuity business at the date of adoption and only if the guidelines are (i) adopted prior to January 1, 1996, or (ii) on the NAIC agenda for adoption as of December 31, 1995, and actually adopted on or prior to December 31, 1996. Management cannot predict whether or when the guidelines will be adopted nor can it predict the form of the guidelines and, therefore, cannot predict the final impact on GALIC.
There can be no assurance that existing insurance-related laws and regulations will not become more restrictive in the future and thereby have a material adverse effect on the operations of GALIC and on the ability of GALIC to pay dividends.
Discontinued Manufacturing Operations _____________________________________
Prior to 1993, the Company sold most of its manufacturing operations. These actions were taken in light of an ongoing strategic review process that led management and the Board of Directors to conclude that such operations either lacked a strong competitive position in the relevant product markets or did not have strong growth prospects or provide sufficiently high returns on investment.
In 1991, the Company sold its interest in a manufacturing operation for $18 million in cash. In 1992, the Company sold substantially all of its remaining operations for $130 million in cash, notes and property.
In 1993, AAG recorded a $14.8 million pretax provision related to discontinued operations. Approximately $9.7 million of the provision represented employee related obligations resulting primarily from a decrease in the discount rate used to calculate pension obligations; approximately $3.3 million related to adjustments for certain property and inventory associated with the Company's former manufacturing properties.
At December 31, 1993, the Company owned an electronic components manufacturer with assets of approximately $8.6 million and 1993 revenues of approximately $11.9 million.
Employees _________
As of December 31, 1993, AAG employed approximately 15 persons and GALIC employed approximately 425 persons. None of the employees are represented by a labor union. AAG believes that its employee relations are excellent.
In 1993, AAG and GALIC moved their offices to Cincinnati from Stamford, Connecticut and Los Angeles, California, respectively.
Most of the manufacturing facilities are currently being leased to companies using them for manufacturing operations. The Company is attempting to sell or extend leases on these facilities. In addition, the Company has agreed to contribute a facility in North Adams, Massachusetts which has been vacant for several years to a not-for-profit entity which intends to develop the property into a multi-discipline art center.
Environmental Matters
Federal and state laws and regulations, including the federal Comprehensive Environmental Response, Compensation, and Liability Act and similar state laws, impose liability on the Company (as the successor to Sprague) for the investigation and cleanup of hazardous substances disposed of or spilled by its discontinued manufacturing operations, at facilities still owned by the Company and facilities transferred in connection with the sales of certain operations, as well as at disposal sites operated by third parties. In addition, the Company has indemnified the purchasers of its former operations for the cost of such activities. At several sites, the Company is conducting cleanup activities of soil and ground water contamination in accordance with consent agreements between the Company and state environmental agencies. The Company has also conducted or is aware of investigations at a number of other locations of its former operations that have disclosed environmental contamination that could cause the Company to incur additional costs of investigation and remediation. The Company has also been identified by state and federal regulators as a potentially responsible party at a number of other disposal sites.
Based on the costs incurred by the Company over the past several years and discussions with its independent environmental consultants, management believes that reserves recorded for such clean-up activities are sufficient in all material respects to satisfy the known liabilities. However, the regulatory standards for clean-up are continually evolving toward more stringent requirements. In addition, many of the environmental investigations at the Company's former operating locations and third-party sites are still preliminary, and where clean-up plans have been proposed, they have not yet received full approval from the relevant regulatory agencies. Further, the presence of the Company generated wastes at third-party disposal sites exposes the Company to joint and several liability for the potential additional costs of cleaning up wastes generated by others. Accordingly, there can be no assurance that the costs of environmental clean-up for the Company may not be significantly higher in future years, possibly necessitating additional charges.
Except as set forth below, the Company considers any administrative or judicial proceedings involving the Company which are related to environmental matters to be ordinary routine litigation incidental to its business.
The Maine Department of Environmental Protection has issued a proposed Administrative Consent Agreement and Enforcement Order calling for a $328,000 fine based on alleged 1991 violations of certain reporting regulations. The Company is working with the Department of Environmental Protection to resolve this matter and is negotiating the amount of the fine.
ITEM 3
ITEM 3
Legal Proceedings _________________
American Annuity (as the successor to STI), its directors and AFC are defendants in seven class and derivative actions which were filed in the Court of Chancery of the State of Delaware. These actions were filed following the public announcement on June 26, 1992 that STI was considering a proposal from GAI relating to the purchase of GALIC. The actions are captioned: (a) William Steiner v. STI Group, Inc., et al., Civil Action No. ___________________________________________ 12614 filed June 29, 1992; (b) Frank Seinfeld v. STI Group, Inc., et al., __________________________________________ Civil Action No. 12616 filed June 29, 1992; (c) Frederick Rand v. STI Group, ____________________________ Inc., et al., Civil Action No. 12622 filed June 30, 1992; (d) Eli Ballan, et _____________ ______________ al., v. Carl H. Lindner, et al., Civil Action No. 12619 filed June 30, 1992; ________________________________ (e) Seymour Arkin v. Carl H. Lindner, et al., Civil Action No. 12620 filed _________________________________________ June 20, 1992; (f) Jeffrey Rubenstein v. Carl H. Lindner, et al., Civil ______________________________________________ Action No. 12532 filed July 7, 1992; and (g) Harry Lewis v. Carl H. Lindner, _______________________________ et al., Civil Action No. 12633 filed July 7, 1992. On September 24, 1992, _______ all of the foregoing actions were consolidated under the caption In re STI _________ Group, Inc. Shareholders Litigation, Consolidated Civil Action No. 12619. ___________________________________ The consolidated action asserts both class and derivative claims against American Annuity, its directors and AFC.
The consolidated action alleges that the acquisition of GALIC by the Company was a self-dealing transaction designed to benefit AFC, was a waste of the Company's assets and constituted a breach of fiduciary duties by AFC and the Company's directors. Following the filing of the suits, the Company and AFC engaged in active settlement discussions with the plaintiffs. These discussions resulted in an agreement to settle the consolidated action on the basis of the earlier increase in the per share consideration paid by AFC for shares of the Company's common stock in connection with the acquisition and the decrease in the price paid by the Company for GALIC. The plaintiffs' counsel have applied to the Court of Chancery for an award of fees and expenses in the amount of $550,000. The Company has not opposed this application. The Court is scheduled to consider approval of the settlement and an award of attorneys' fees in April 1994.
AAG and GALIC are subject to litigation and arbitration in the normal course of its business. GALIC is not a party to any material pending litigation or arbitration.
PART II
ITEM 5
ITEM 5
Market for Registrant's Common Equity and Related Stockholder Matters _______________________________
AAG's Common Stock is listed and traded principally on the New York Stock Exchange ("NYSE") under the symbol AAG. On March 1, 1994, there were approximately 10,000 holders of record of Common Stock. The following table sets forth the range of high and low sales prices for the Common Stock on the NYSE Composite Tape.
_________________ _________________ High Low High Low ____ ___ ____ ___ First Quarter $11.38 $5.63 $8.00 $6.13 Second Quarter 11.38 8.75 6.75 5.63 Third Quarter 11.00 7.88 6.75 5.63 Fourth Quarter 10.38 8.25 6.75 5.88
The Company paid annual dividends of $.05 per share in 1993, 1992 and 1991. AAG has not determined a dividend paying policy for the future; the amount of dividends available to be paid at December 31, 1993 is limited to $2.5 million by certain indenture covenants.
In December 1993, AAG announced an offer to purchase stock from holders of ten or fewer shares of its Common Stock. In February 1994, AAG repurchased 4,107 shares at $11 per share from approximately 1,100 shareholders.
ITEM 6
ITEM 6
Selected Financial Data _______________________
The following financial data have been summarized from, and should be read in conjunction with, the Company's consolidated financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations". The data reflects the purchase of GALIC as of December 31, 1992 (in millions, except per share amounts).
Operations Statement Data: 1993 1992 1991 1990 1989 __________________________ ____ ____ ____ ____ ____ Net investment income $353.3 $ 3.6 $ 1.9 $ 0.4 $ 1.2 Total revenues 387.2 3.6 1.9 0.4 1.2 Earnings (loss) from continuing operations 53.0 (9.0) (4.7) (6.0) (6.9) Loss from discontinued operations (9.6) (16.8) (47.8) (43.3) (89.9) Extraordinary item (3.4) - - - - Change in accounting principle - (3.1) - - - ______ _____ _____ _____ _____ Net earnings (loss) $ 40.0 ($28.9) ($52.5) ($49.3) ($96.8) ______ _____ _____ _____ _____
Earnings (loss) per common share: Continuing operations $1.41 ($0.50)($0.26) ($0.33) ($0.37) Discontinued operations (.27) (.94) (2.66) (2.37) (4.94) Extraordinary item (.10) - - - - Change in accounting principle - (.17) - - - _____ _____ _____ _____ _____ Net earnings (loss) $1.04 ($1.61) ($2.92) ($2.70) ($5.31) _____ _____ _____ _____ _____
Balance Sheet Data: ___________________ Total assets $4,913.8 $4,480.4 $170.1 $294.8 $382.6 Long-term debt 225.9 230.9 27.9 30.6 65.7 Total stockholders' equity 250.3 186.6 108.5 171.8 216.7
ITEM 7
ITEM 7
Management's Discussion and Analysis of Financial Condition and Results of Operations ________________________________________________
General
Following is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of AAG's financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page.
AAG is organized as a holding company with nearly all of its operations being conducted by Great American Life Insurance Company ("GALIC"), which was acquired by AAG on December 31, 1992. The parent corporation, however, has continuing expenditures for administrative expenses, corporate services, liabilities in connection with discontinued operations and, most importantly, for the payment of interest on borrowings and dividends on preferred stock. Since its business is financial in nature, AAG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.
Liquidity and Capital Resources
Ratios The ratio of AAG's long-term debt to equity was .90 at December 31, ______ 1993, compared to 1.24 at December 31, 1992. AAG's ratio of earnings to fixed charges was 4.7 in 1993; the ratio of earnings to fixed charges and preferred dividends was 3.8 for the same period.
Sources and Uses of Funds In connection with the GALIC acquisition, AAG _________________________ sold common and preferred stock to GALIC's parent, Great American Insurance Company, for $156 million in cash. The proceeds of those stock sales together with $230 million in new borrowings and most of the accumulated cash funds of the Company were used to purchase GALIC. The total cost to acquire GALIC was approximately $486 million, including transaction costs and fees of $17.4 million.
The borrowings used to fund the GALIC acquisition were repaid during 1993 from the sales of $125 million of 11-1/8% Senior Subordinated Notes due 2003 and $100 million of 9-1/2% Senior Notes due 2001. As a result of the refinancings, AAG has no scheduled principal maturities until the year 2001. Annual interest and dividend payments on AAG's debt and preferred stock are approximately $26.6 million.
AAG's ability to make interest and principal payments on its debt, and pay dividends on its preferred stock and other holding company costs is dependent on cash payments from GALIC. In 1993, AAG received $53.6 million in tax allocation payments (including $19 million for 1992) and $18.2 million in capital distributions from GALIC. In the second quarter of 1993, AAG made a capital contribution of $13.0 million to GALIC.
Capital distributions by GALIC are subject to various laws and regulations which limit the amount of dividends that can be paid without regulatory approval. (See Note L to the financial statements.) The maximum amount of dividends payable by GALIC in 1994 without approval is approximately $44.0 million.
In January 1994, AAG entered into a four-year $20 million revolving line of credit agreement with a bank. AAG has not made any cash draws under this agreement. Based upon the current level of GALIC's operations and anticipated growth, AAG believes that it will have sufficient resources from GALIC's dividends and tax allocation payments to meet its liquidity requirements.
Investments The National Association of Insurance Commissioners ("NAIC") ___________ assigns quality ratings to publicly traded as well as privately placed securities. At December 31, 1993, 95% of GALIC's fixed maturity portfolio was comprised of investment grade bonds (NAIC rating of "1" or "2") compared to 91% at December 31, 1992. Management believes that the high credit quality of GALIC's investment portfolio should generate a stable and predictable investment return.
GALIC invests primarily in fixed income investments which approximated 98% of its investment portfolio at December 31, 1993. GALIC generally invests in securities with intermediate term maturities with an objective of optimizing interest yields while maintaining an appropriate relationship of maturities between GALIC's assets and expected liabilities. GALIC's fixed maturity portfolio is classified into two categories: "held to maturity" and "available for sale". (See Note A to the financial statements.) At December 31, 1993, GALIC had approximately $206 million in net unrealized gains on its fixed maturity portfolio compared to $117 million at December 31, 1992.
At December 31, 1993, none of the Company's fixed maturity investments were non-performing. In addition, GALIC has little exposure to mortgage loans and real estate. As of December 31, 1993, these investments represented only 1.6% of total assets. The majority of mortgage loans and real estate was purchased in the latter half of 1993.
At December 31, 1993, collateralized mortgage obligations ("CMOs") represented approximately 35% of fixed maturity investments compared to 42% at December 31, 1992. As of December 31, 1993, interest only (I/O), principal only (P/O) and other "high risk" CMOs represented approximately 0.2% of total CMOs. GALIC invests primarily in CMOs which are structured to minimize prepayment risk. In addition, the majority of CMOs held by GALIC were purchased at a discount to par value. Management believes that the structure and discounted nature of the CMOs will minimize the effect of prepayments on earnings over the anticipated life of the CMO portfolio.
Substantially all of GALIC's CMOs are AAA-rated by Standard & Poor's Corporation and are collateralized by GNMA, FNMA and FHLMC single-family residential pass-through certificates. The market in which these securities trade is highly liquid. Aside from interest rate risk, AAG does not believe a material risk (relative to earnings or liquidity) is inherent in holding such investments.
The Ohio Insurance Code contains rules restricting the types and amounts of investments which are permissible for an Ohio life insurer, including GALIC. These rules are designed to ensure the safety and liquidity of the insurer's investment portfolio. The NAIC is considering the formulation of a model investment law which, if adopted, would have to be considered by Ohio for adoption. The formulation is in the preliminary stages and management believes its impact on GALIC's operations will not be material.
Results of Operations
Net Earnings and General Net earnings were $40.0 million or $1.04 per ________________________ common share in 1993. GALIC was acquired by AAG on December 31, 1992; accordingly, its results are not included in the Company's statement of operations prior to 1993. All of GALIC's products are fixed rate annuities which permit GALIC to change the crediting rate at any time (subject to minimum interest rate guarantees of 3% to 4% per annum). As a result, management has been able to react to changes in interest rates and maintain a desired interest rate "spread" with little or no effect on persistency.
The following table provides a comparison of certain amounts for GALIC (in millions):
Total annuity receipts increased primarily due to the introduction of new single premium products in the second half of 1992.
Net Investment Income GALIC's net investment income increased 7% over the _____________________ comparable 1992 period. An increase in average fixed maturity investments more than offset a decrease in interest rates available in the marketplace. Investment income is reflected in the Statement of Operations net of investment expenses of $4.9 million in 1993.
Realized Gains Individual securities are sold from time to time as market ______________ opportunities appear to present optimal situations under AAG's investment strategies.
Equity in Net Loss of Affiliate Equity in net loss of affiliate represents _______________________________ AAG's proportionate share of Chiquita's losses in 1993. Chiquita reported a net loss for 1993 of $51 million compared to a net loss of $284 million for 1992. The improvement in 1993 was attributed primarily to a multi-year investment spending program and the ongoing impact of its restructuring and cost reduction efforts.
Interest on Annuity Policyholders' Funds GALIC's interest on annuity ________________________________________ policyholders' funds decreased 5% from its comparable 1992 period. The average crediting rate on funds held by GALIC has decreased from 7.2% at December 31, 1991, to 6.2% at December 31, 1992 and to 5.3% at December 31, 1993. The rate at which GALIC credits interest on annuity policyholders' funds is subject to change based on management's judgment of market conditions.
Provision for Relocation Expenses In 1993, GALIC relocated its corporate _________________________________ offices from Los Angeles to Cincinnati; the estimated cost of this move ($8.0 million) was included in 1993 continuing operations.
Also in 1993, AAG relocated its corporate offices from Stamford to Cincinnati; the estimated cost of this relocation and related shutdown and severance costs ($5.0 million) was provided for in discontinued operations in 1992.
Discontinued Operations The Company has sold virtually all of its former _______________________ manufacturing businesses. A small Belgium based subsidiary continues to be held for sale along with certain properties, most of which are currently leased to companies using them for manufacturing operations.
The Company has certain obligations related to its former business activities. Among these obligations is the funding of pension plans, environmental remediation costs, lease payments for two former plant sites, certain retiree medical benefits, and certain obligations associated with the sales of the Company's manufacturing operations. In 1992, the Company recorded pretax charges related to discontinued operations totalling $24.5 million. In the fourth quarter of 1993, AAG recorded pretax charges for discontinued operations totalling $14.8 million. These charges included employee related obligations of approximately $9.7 million resulting primarily from a decrease (from 9.5% to 7.125%) in the discount rate used to calculate pension obligations. The remaining charges reflected write-downs and other estimated expenses associated with the Company's former manufacturing properties. (See Note H to the financial statements.)
While it is difficult to estimate future environmental remediation costs accurately, management believes the aggregate cost of remediation at all sites for which it has responsibility will range from $10 million to $15 million. The reserve for environmental remediation work was $10.6 million at December 31, 1993. Changes in regulatory standards and further investigation of these sites could affect estimated costs in the future. Management believes, based on the costs incurred by the Company over the past several years and discussions with its independent environmental consultants, that reserves recorded for such clean-up activities are sufficient to satisfy the known liabilities and that the outcome of the contingencies will not, individually or in the aggregate, have a material adverse effect on the financial condition or results of operations of AAG.
Extraordinary Item In August 1993, AAG prepaid its Bank Term Loan and wrote __________________ off $5.2 million ($3.4 million net of tax) of related unamortized debt issuance costs.
Accounting Change Effective January 1, 1992, AAG implemented Statement of _________________ Financial Accounting Standards ("SFAS") No. 106, "Accounting for Postretirement Benefits Other Than Pensions", and recorded a provision of $3.1 million for the projected future costs of providing postretirement benefits to retirees in its discontinued manufacturing operations.
New Accounting Standard to be Implemented The FASB has issued SFAS No. 112, _________________________________________ "Employers' Accounting for Postemployment Benefits", which became effective in 1994. The FASB has also issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which is scheduled to become effective in 1995. Implementation of these standards is not expected to have a material effect on AAG.
ITEM 8
ITEM 8
Financial Statements and Supplementary Data ___________________________________________
PAGE ____
Reports of Independent Auditors
Consolidated Balance Sheet: December 31, 1993 and 1992
Consolidated Statement of Operations: Years Ended December 31, 1993, 1992 and 1991
Consolidated Statement of Changes in Stockholders' Equity: Years Ended December 31, 1993, 1992 and 1991
Consolidated Statement of Cash Flows: Years Ended December 31, 1993, 1992 and 1991
Notes to Consolidated Financial Statements
"Selected Quarterly Financial Data" has been included in Note M to the Consolidated Financial Statements.
PART III
The information required by the following Items will be included in American Annuity's definitive Proxy Statement for the 1994 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission within 120 days of the Company's fiscal year end and is herein incorporated by reference:
ITEM 10
ITEM 10 Directors and Executive Officers of the Registrant __________________________________________________
ITEM 11
ITEM 11 Executive Compensation ______________________
ITEM 12
ITEM 12 Security Ownership of Certain Beneficial Owners and ___________________________________________________ Management __________
ITEM 13
ITEM 13 Certain Relationships and Related Transactions ______________________________________________
REPORTS OF INDEPENDENT AUDITORS
American Annuity Group, Inc.:
We have audited the accompanying consolidated balance sheets of American Annuity Group, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. The consolidated financial statements of American Annuity Group, Inc. for the year ended December 31, 1991, were audited by other auditors whose report thereon dated March 24, 1992, expressed an unqualified opinion on those statements prior to adjustment for reclassification of discontinued operations.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Annuity Group, Inc. and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
In 1992, the Company discontinued its manufacturing operations. As a result, these operations were reclassified and reported as discontinued operations. We also audited the adjustments that were applied to reclassify the discontinued operations in the 1991 consolidated financial statements. In our opinion such reclassifications were appropriate and properly applied.
As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting in 1993 for certain investments in debt and equity securities and in 1992 for income taxes and postretirement benefits other than pensions.
Ernst & Young
Cincinnati, Ohio March 11, 1994
American Annuity Group, Inc.:
We have audited the consolidated balance sheet of American Annuity Group, Inc., formerly Sprague Technologies, Inc., and subsidiaries (not presented separately herein) as of December 31, 1991, and the related consolidated statements of operations, common stockholders' equity and cash flows for the year then ended (before adjustments and reclassifications to conform with the presentation for 1992). Our audit also included the 1991 financial statement schedule listed in the Index at Item 14(a) for the year ended December 31, 1993. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and the financial statement schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements (before adjustments and reclassifications to conform with the presentation for 1992) present fairly, in all material respects, the financial position of American Annuity Group, Inc. and subsidiaries as of December 31, 1991, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule for 1991, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Deloitte & Touche
Stamford, Connecticut March 24, 1992
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Dollars in millions)
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS (In millions, except per share amounts)
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (In millions)
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (In millions)
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The accompanying consolidated financial statements include the accounts of American Annuity Group, Inc. and its subsidiaries ("American Annuity", "AAG" or "the Company"). Intercompany transactions and balances are eliminated in consolidation. Certain reclassifications have been made to prior periods to conform to the current year's presentation.
American Financial Corporation and subsidiaries ("AFC") owned 28,081,467 shares (80%) of AAG's Common Stock at December 31, 1993.
The acquisition of Great American Life Insurance Company ("GALIC"), a subsidiary of AFC, on December 31, 1992, was recorded as a transfer of net assets between companies under common control. As a result, the net assets of GALIC were recorded by AAG at AFC's historical basis and the excess consideration paid over AFC's historical basis was treated as a reduction of common stockholders' equity. The results of GALIC's operations have been included in AAG's consolidated financial statements since its acquisition.
Investments When available, fair values for investments are based on prices quoted in the most active market for each security. If quoted prices are not available, fair value is estimated based on present values, fair values of comparable securities, or similar methods.
AAG implemented Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", beginning December 31, 1993. This standard requires that (i) debt securities be classified as "held to maturity" and reported at amortized cost if AAG has the positive intent and ability to hold them to maturity, (ii) debt and equity securities be classified as "trading" and reported at fair value, with unrealized gains and losses included in earnings, if they are bought and held principally for selling in the near term and (iii) debt and equity securities not classified as held to maturity or trading be classified as "available for sale" and reported at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity. Only in certain limited circumstances, such as significant issuer credit deterioration or if required by insurance or other regulators, may a company change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future.
Prior to the implementation of SFAS No. 115, AAG carried a portion of its fixed maturity securities at fair value with unrealized gains and losses carried as a separate component of stockholders' equity with the remainder of such securities carried at amortized cost. In connection with implementing SFAS No. 115, AAG reviewed its investment portfolio resulting in a reclassification at December 31, 1993 of approximately $704 million of its fixed maturity portfolio (including approximately $485 million in CMOs) from "held to maturity" to "available for sale" which, in turn, resulted in (i) an increase of $36 million in the carrying value of fixed maturity investments and (ii) an increase of $23 million in stockholders' equity. The reclassification reflects management's intention to reduce the proportion of CMOs owned and more actively manage the duration of its fixed maturity portfolio. The implementation of SFAS No. 115 had no effect on net income.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Short-term investments are carried at cost; mortgage loans on real estate are generally carried at amortized cost; policy loans are stated at the aggregate unpaid balance. Carrying amounts of these investments approximate their fair value.
Gains or losses on sales of securities are recognized at the time of disposition with the amount of gain or loss determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings and the carrying value of that investment is reduced. Premiums and discounts on CMOs are amortized over their expected average lives using the interest method.
Investment in Affiliates AAG's investments in equity securities of companies that are 20% to 50% owned by AFC and its subsidiaries are carried at cost, adjusted for a proportionate share of their undistributed earnings or losses.
Deferred Policy Acquisition Costs ("DPAC") DPAC (principally new commissions, advertising, underwriting, policy issuance and sales expenses that vary with and are primarily related to the production of new business) is deferred and amortized, with interest, in relation to the present value of expected gross profits on the policies. These gross profits consist principally of net investment income and future surrender charges, less interest on policyholders' funds and future policy administration expenses. DPAC is reported net of unearned revenue relating to certain policy charges that represent compensation for future services. These unearned revenues are recognized as income using the same assumptions and factors used to amortize DPAC.
Beginning with the implementation of SFAS No. 115 in 1993, to the extent that unrealized gains from securities classified as "available for sale" would result in adjustments to DPAC, unearned revenues and policyholder liabilities had those gains actually been realized, such balance sheet amounts are adjusted, net of deferred taxes.
Annuity Policyholders' Funds Accumulated Annuity premium deposits and benefit payments are generally recorded as increases or decreases in "annuity policyholders' funds accumulated" rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for surrender charges are credited to other income.
The fair value of the liability for annuities in the payout phase is assumed to be the present value of the anticipated cash flows, discounted at current interest rates. Fair value of annuities in the accumulation phase is assumed to be the policyholders' cash surrender amount. The aggregate fair value of all annuity liabilities, net of DPAC, at December 31, 1993, approximates the amounts recorded in the financial statements.
Income Taxes As of December 31, 1992, AAG and its 80%-owned U.S. subsidiaries were consolidated with AFC for federal income tax purposes. For periods prior to December 31, 1992, AAG filed consolidated tax returns which included all of its 80%-owned U.S. subsidiaries.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
AAG and GALIC have separate tax allocation agreements with AFC which designate how tax payments are shared by members of the tax group. In general, both companies compute taxes on a separate return basis. GALIC is obligated to make payments to (or receive benefits from) AFC based on taxable income without regard to temporary differences. In accordance with terms of AAG's indentures, AAG receives GALIC's tax allocation payments for the benefit of AAG's deductions arising from current operations. If GALIC's taxable income (computed on a statutory accounting basis) exceeds a current period net operating loss of AAG, the taxes payable by GALIC associated with the excess are payable to AFC. If the AFC tax group utilizes any of AAG's net operating losses or deductions that originated prior to 1993, AFC will pay to AAG an amount equal to the benefit received.
Effective January 1, 1992, the Company implemented SFAS No. 109, "Accounting for Income Taxes". As permitted under the Statement, AAG's prior year financial statements have not been restated and no adjustment was necessary for the cumulative effect of the change. Under SFAS No. 109, the liability method used in accounting for income taxes is less restrictive than the liability method under SFAS No. 96, previously used by the Company. The provisions of SFAS No. 109 allow AAG to recognize deferred tax assets if it is more likely than not that a benefit will be realized.
Under SFAS No. 109, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. Current and deferred tax assets and liabilities are aggregated with other amounts receivable from or payable to affiliates.
Debt Issuance Costs Debt expenses are amortized over the terms of the respective borrowings on the interest method.
Statement of Cash Flows For cash flow purposes, "investing activities" are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. "Financing activities" include annuity receipts, surrenders and withdrawals and obtaining resources from owners and providing them with a return on their investments. All other activities are considered "operating". Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.
Benefit Plans AAG participates in AFC's Employee Stock Ownership Retirement Plan ("ESORP") covering all employees who are qualified as to age and length of service. The ESORP is a trusteed, noncontributory plan which invests in securities of AFC for the benefit of the employees of AFC and its subsidiaries. Contributions are discretionary by the directors of AAG and are charged against earnings in the year for which they are declared. Qualified employees having vested rights in the plan are entitled to benefit payments at age 60.
AAG and certain of its subsidiaries provide health care and life insurance benefits to eligible retirees. Effective January 1, 1992, AAG implemented SFAS No. 106, "Accounting for Postretirement Benefits Other Than Pensions". Prior to 1992, the cost of these benefits had generally been recognized as claims were incurred.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
B. ACQUISITION OF GALIC
On December 31, 1992, AAG acquired GALIC from Great American Insurance Company ("GAI"), a wholly owned subsidiary of AFC, for $468 million. In connection with the acquisition, GAI purchased from AAG 17,076,923 shares of AAG's Common Stock at $6.50 per share, and 450,000 shares of its Series A Preferred Stock at $100 per share. Concurrent with the acquisition, GAI purchased 5,140,973 shares of AAG's Common Stock pursuant to a cash tender offer.
C. INVESTMENTS
Fixed maturity investments at December 31, consisted of the following (in millions):
Distribution based on market value is generally the same. Collateralized mortgage obligations had an expected average life of approximately 4 years at December 31, 1993.
The carrying values of investments were determined after deducting cumulative provisions for impairment aggregating $14.4 million and $20.0 million at December 31, 1993 and 1992, respectively.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Gross gains of $45.3 million and gross losses of $11.0 million were realized on sales of fixed maturity investments during 1993.
The carrying value of investments in any entity in excess of 10% of stockholders' equity at December 31, 1993, other than investments in affiliates and investments issued or guaranteed by the U.S. Government or government agencies, were as follows (in millions):
At December 31, 1993, gross unrealized gains on marketable equity securities were $13.1 million and gross unrealized losses were zero. Realized gains and changes in unrealized appreciation on fixed maturity and equity security investments are summarized as follows (in millions):
GALIC's investment portfolio is managed by a subsidiary of AFC. Investment expenses included investment management charges of $4.4 million, which represented approximately one-tenth of one percent of GALIC's invested assets during 1993.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
D. INVESTMENT IN AFFILIATES
Investment in affiliates at December 31, 1993, reflects AAG's 5% ownership (2.7 million shares) of the common stock of Chiquita Brands International ("Chiquita") which is accounted for under the equity method. At that same date, AFC and its other subsidiaries owned an additional 41% interest in the common stock of Chiquita. Chiquita is a leading international marketer, processor and producer of quality food products. The carrying value of AAG's investment in Chiquita at December 31, 1993 was $25.2 million. The market value of AAG's investment in Chiquita was approximately $30.7 million at December 31, 1993 and $46.1 million at March 1, 1994.
In addition to AAG's investment in Chiquita, investment in affiliates at December 31, 1992, included a $9.0 million investment in the preferred stock of Spelling Entertainment Group Inc. The Spelling preferred stock was redeemed in November 1993.
Included in AAG's retained earnings (deficit) at December 31, 1993, was approximately $2.6 million applicable to equity in undistributed net losses of Chiquita.
E. DEFERRED POLICY ACQUISITION COSTS
The DPAC balances at December 31, 1993 and 1992 are shown net of unearned revenues of $146.2 million and $152.8 million, respectively.
F. LONG-TERM DEBT
Long-term debt consisted of the following at December 31, (in millions):
In connection with the GALIC acquisition, AAG borrowed $180 million under a Bank Term Loan Agreement and $50 million under a Bridge Loan. In 1993, AAG sold $225 million principal amount of Notes to the public and used the proceeds to repay the Bank and Bridge Loans.
As a result, AAG has no scheduled principal maturities until the year 2001. AAG recorded an extraordinary loss of $5.2 million ($3.4 million net of tax) representing unamortized bank debt issue costs which were written off upon retirement of the bank debt. The fair value of AAG's outstanding debt exceeds the carrying value (net of unamortized debt issuance costs) by approximately $19 million at December 31, 1993.
Interest payments were $11.7 million in 1993, $2.0 million in 1992 and $4.9 million in 1991.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
G. STOCKHOLDERS' EQUITY
The Company is authorized to issue 25,000,000 shares of Preferred Stock, par value $1.00 per share. On December 31, 1992, AAG issued 17,076,923 shares of Common Stock and 450,000 shares of Series A Cumulative Preferred Stock, $100 redemption value, in connection with the acquisition of GALIC. Holders of the Series A Preferred Stock are entitled to receive dividends at the rate of $7.00 per share per annum. The preferred shares issued were recorded at $29.4 million (imputed dividend rate of 12% through 2007) with the excess paid of $15.6 million credited to capital surplus and accreting over 15 years. If the preferred shares are outstanding after January 1, 2008, substantial limitations on the ability of AAG and its subsidiaries to borrow funds, issue stock or pay common stock dividends will become effective. In 1993, 1992 and 1991, AAG paid annual dividends of $.05 per common share. At December 31, 1993, AAG's cash dividends were limited to $2.5 million under indenture covenants.
Under the Company's 1987 Stock Option Plan ("Option Plan"), stock options were granted to officers and other key employees of the Company to purchase shares of Common Stock. The Company also had a Spin-Off Stock Option Plan ("Spin-Off Plan") under which a one-time grant of options was made to directors, officers and employees of the Company who had held options or shares of STI's former parent on the STI distribution date.
As a result of the sales of subsidiaries and pursuant to the terms of the plans, all options became fully vested and exercisable in January 1992. In February 1992, 1.5 million options were exercised; a total of 93,550 shares under the Option Plan and 377,804 shares under the Spin-Off Plan expired.
Also in February 1992, under the Company's Redemption Program, AAG purchased from employees (i) 499,025 shares of Common Stock at a price of $6.725 per share and (ii) 867,000 shares of Common Stock at a price of $6.8125 per share. A charge to income of $2.8 million was recorded in 1991 to reflect the exercise of stock options and the repurchase of Common Stock pursuant to the Redemption Program.
H. DISCONTINUED OPERATIONS
The results of discontinued operations included in the Statement of Operations were as follows (in millions):
Year ended December 31, _______________________ 1993 1992 1991 ____ ____ ____
Net sales $ - $ 80.7 $294.1 Cost of sales - (80.7)(258.8) Interest and debt expense - (1.2) (3.7) Selling, general and administrative costs - - (37.3) Loss on sales of businesses and restructuring provisions (14.8) (24.5) (55.1) Gain on sale of investment in affiliate - - 8.5 _____ _____ _____ Loss from discontinued operations before tax (14.8) (25.7) (52.3) Income tax benefit (5.2) (8.9) (4.5) _____ ______ _____
Loss from discontinued operations ($ 9.6) ($16.8)($47.8) _____ _____ _____
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
All of the Company's former manufacturing businesses are reported as discontinued operations. At December 31, 1993, the Company's last manufacturing unit, Electromag NV, was being held for sale and was carried at estimated net realizable value.
The loss from discontinued operations in 1993 included charges for employee related obligations of approximately $9.7 million resulting primarily from a decrease (from 9.5% to 7.125%) in the discount rate used to calculate pension obligations. The remaining charges reflected additional write-downs and other estimated expenses associated with the Company's former manufacturing properties.
During 1992, the Company recorded charges related to discontinued operations as follows: employee related obligations -- $6.8 million; environmental liabilities -- $5.0 million; corporate office shutdown and severance costs - - $5.0 million; property valuation adjustments -- $3.6 million; potential merchandise returns -- $2.0 million and other -- $2.1 million.
In 1992, AAG sold its capacitor and thick film network businesses for approximately $130 million in cash, notes and property. The Company recorded provisions of $42.6 million related to the anticipated sales of these operations during 1991.
In 1991, the Company sold its 45.3% interest in a manufacturing operation for a cash payment of $18.0 million, recognizing a pretax gain of $8.5 million on the sale.
The Company has a noncontributory defined benefit pension plan covering former U.S. employees of its discontinued manufacturing operations. The former employees in this plan generally receive pension benefits that are based upon formulas that reflect all past service with the Company and the employee's compensation during employment. Contributions are made on an actuarial basis in amounts necessary to satisfy requirements of ERISA. At December 31, 1993, the actuarial value of the benefit obligations, which are being discounted at 7.125%, exceeded the plan assets by $15.1 million, which has been included in accrued expenses in the financial statements.
Effective January 1, 1992, AAG implemented SFAS No. 106 and recorded a provision of $3.1 million for the projected future costs of providing postretirement medical benefits to retirees in its discontinued manufacturing operations.
I. INCOME TAXES
Provision (benefit) for income taxes consisted of (in millions):
1993 1992 1991 ____ ____ ____ Federal: Current $27.4 $ - $2.6 Deferred (7.4) (8.9) (5.0) Foreign: Current - - 0.3 Deferred - - (2.6) State - 0.5 0.4 _____ ____ ____ Total $20.0 ($8.4) ($4.3) _____ ____ ____
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
At December 31, 1993, AAG had net operating loss carryforwards for federal income tax purposes of approximately $161 million which are scheduled to expire as follows: $18.6 million in 1994, $24.1 million in 1995 through 2001 and $118.3 in 2002 through 2005. An income tax refund of $1.1 million was received in 1991. Cash disbursements for income taxes were not material.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. LEASES
Leases relate principally to certain administrative facilities and discontinued operations. Future minimum lease payments, net of sublease revenues, under operating leases having initial or remaining noncancellable lease terms in excess of one year at December 31, 1993 are payable as follows: 1994 -- $700,000; 1995 -- $1.0 million; 1996 -- $1.1 million; 1997 -- $1.1 million; 1998 -- $800,000; 1999 and beyond -- $2.8 million.
Rental expense for operating leases was $900,000 in 1993, $1.5 million in 1992 and $6.7 million in 1991.
K. CONTINGENCIES
The Company is presently conducting investigations or clean-up activities in accordance with consent agreements with state environmental agencies. Based on the costs incurred over the past several years and discussions with independent environmental consultants, the Company believes the aggregate cost of environmental remediation work at all sites for which it has responsibility will range from $10 million to $15 million. The reserve for environmental remediation work was $10.6 million at December 31, 1993. Management does not believe that these clean-up activities will have a material effect upon the Company's financial position, results of operations or cash flows.
"Marketable securities, restricted in use" consists primarily of amounts held in escrow with respect to certain clean-up activities due to sales of various discontinued operations.
In 1991, the Company identified possible deficiencies in procedures for reporting quality assurance information to the Defense Electronics Supply Center ("DESC") with respect to the manufacturing of capacitors utilized by, among others, the United States Government. The Company has certain indemnification obligations for losses, if any, which result from these matters. Management believes an adequate accrual has been recorded at December 31, 1993, and that any future impact on AAG's operations will not be material.
L. STATUTORY INFORMATION; RESTRICTIONS ON TRANSFERS OF FUNDS AND ASSETS OF SUBSIDIARIES
GALIC is required to file financial statements with state insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). For the year ended December 31, 1993, GALIC's statutory net earnings were $44.0 million. Certain statutory balance sheet amounts at December 31, were as follows (in millions):
1993 1992 ____ ____ Policyholders' surplus $251.3 $216.2 Asset valuation reserve 70.3 70.9 Interest maintenance reserve 35.7 17.2
The amount of dividends which can be paid by GALIC without prior approval of regulatory authorities is subject to restrictions relating to capital and surplus and statutory net income. GALIC may pay approximately $44.0 million in dividends in 1994, based on statutory net income, without prior approval.
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. Financial Statements are Included in Part II, Item 8.
2. Financial Statement Schedules:
Selected Quarterly Financial Data is included in Note M to the Consolidated Financial Statements.
Schedules filed herewith:
For 1993, 1992 and 1991 Page _______________________ ____
II - Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees other than Related Parties S-2
III - Condensed Financial Information of Registrant S-3
All other schedules for which provisions are made in the applicable regulation of the Securities and Exchange Commission have been omitted as they are not applicable, not required, or the information required thereby is set forth in the Financial Statements or the notes thereto.
3. Exhibits - See Exhibit Index on Page E-1.
(b) Reports on Form 8-K's: None
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES THREE YEARS ENDED DECEMBER 31, 1993 (In Thousands)
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In millions)
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In millions)
Condensed Statement of Cash Flows _________________________________ Year ended December 31
_____
Operating Activities: Net earnings $40.0 Adjustments: Discontinued operations 9.6 Extraordinary item 3.4 Equity in net earnings of affiliates (77.6) Increase in receivables from affiliates (2.8) Amortization of debt expense 1.2 Decrease in other assets 0.4 Increase in payables to affiliates 42.8 Decrease in other liabilities (10.7) Dividends from GALIC 18.2 Other, net (0.1) _____ 24.4 _____
Investing Activities: Additional investment in GALIC (13.0) _____
Financing Activities: Additional long-term borrowings 225.0 Reductions of long-term debt (230.0) Cash dividends paid (4.1) _____ (9.1) _____
Net Increase in Cash and Short-term Investments 2.3
Cash and short-term investments at beginning of period 8.1 _____
Cash and short-term investments at end of period $10.4 _____
AMERICAN ANNUITY GROUP, INC.
INDEX TO EXHIBITS
Number Exhibit Description ______ ___________________
3.1 Certificate of Incorporation of Registrant
3.2 By-laws of Registrant
4.1 Indenture dated as of February 2, 1993, between the Registrant and Star Bank, National Association, as Trustee, relating to the Registrant's 11-1/8% Senior Subordinated Notes due 2003, incorporated herein by reference to Exhibit 4.2 to the Registrant's Current Report on Form 8-K, dated February 5, 1993.
4.2 Indenture dated as of August 18, 1993, between the Registrant and NationsBank, National Association, as Trustee, relating to the Registrant's 9-1/2% Senior Notes due 2001, incorporated herein by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-2 dated August 11, 1993.
10.1 Agreement of Allocation of Payment of Federal Income Taxes ("American Annuity Tax Allocation Agreement"), dated December 31, 1992, between American Financial Corporation and the Registrant incorporated herein by reference to Exhibit 10.12 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
10.2 Assignment of Tax Allocation Payments dated December 31, 1992, between American Financial Corporation and the Registrant incorporated herein by reference to Exhibit 10.15 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
10.3 Agreement for the Allocation of Federal Income Taxes dated May 13, 1974, between American Financial Corporation and Great American Life Insurance Company, as supplemented on January 1, 1987 incorporated herein by reference to Exhibit 10.16 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
10.4 Investment Services Agreement, dated December 31, 1992, between Great American Life Insurance Company and American Money Management Corporation incorporated herein by reference to Exhibit 10.17 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
10.5 Common Stock Registration Agreement, dated December 31, 1992, between the Registrant and American Financial Corporation and its wholly owned subsidiary Great American Insurance Company incorporated herein by reference to Exhibit 10.22 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
10.6 Preferred Stock Registration Agreement, dated December 31, 1992, between the Registrant and American Financial Corporation and its wholly owned subsidiary Great American Insurance Company incorporated herein by reference to Exhibit 10.23 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
AMERICAN ANNUITY GROUP, INC.
INDEX TO EXHIBITS - Continued
Number Exhibit Description ______ ___________________
10.7 Common Stock Registration Agreement, dated December 31, 1992 between Chiquita Brands International, Inc. and Great American Life Insurance Company incorporated herein by reference to Exhibit 10.24 to the Registrant's Registration Statement on Form S-2 dated January 7, 1993.
10.8 American Annuity Group's 1993 Stock Appreciation Rights Plan.
Signatures __________
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, American Annuity Group, Inc. has duly caused this Report to be signed on its behalf by the undersigned, duly authorized.
American Annuity Group, Inc.
Signed: March 25, 1994 BY:s/CARL H. LINDNER _______________________________
Carl H. Lindner Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Capacity Date _________ ________ ____
s/CARL H. LINDNER Chairman of the Board March 25, 1994 _______________________ Carl H. Lindner of Directors
s/S. CRAIG LINDNER Director March 25, 1994 ________________________ S. Craig Lindner
s/ROBERT A. ADAMS Director March 25, 1994 _______________________ Robert A. Adams
s/A. LEON FERGENSON Director March 25, 1994 _______________________ A. Leon Fergenson
s/RONALD F. WALKER Director March 25, 1994 _______________________ Ronald F. Walker
s/WILLIAM J. MANEY Senior Vice President, March 25, 1994 _______________________ William J. Maney Treasurer and Chief Financial Officer