AAG, GALIC and Loyal rent office space in Cincinnati, Ohio totaling nearly 200,000 square feet under leases expiring primarily in 2006 through 2008. Several of the Company's non-insurance subsidiaries lease marketing and administrative offices in locations throughout the United States.
General Accident rents office space in Puerto Rico totaling approximately 70,000 square feet under leases expiring primarily in 2000 through 2002.
The following financial data has 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 acquisitions of American Memorial and Loyal in November 1995 and General Accident in December 1997 (in millions, except per share amounts).
Income from continuing operations $ 71.4 $ 61.1 $ 58.7 $ 40.9 $ 53.0 Loss from discontinued operations - - (3.2) (2.6) (9.6) Extraordinary items (1.5) (6.0) (0.2) (1.7) (3.4) Change in accounting principle - - - (0.5) - Net income $ 69.9 $ 55.1 $ 55.3 $ 36.1 $ 40.0
Basic earnings per common share: Continuing operations $1.63 $1.39 $1.45 $1.05 $1.41 Discontinued operations - - (0.08) (0.07) (0.27) Extraordinary items (0.03) (0.14) - (0.05) (0.10) Change in accounting principle - - - (0.01) - Net income $1.60 $1.25 $1.37 $0.92 $1.04
Diluted earnings per common share: Continuing operations $1.61 $1.39 $1.45 $1.05 $1.41 Discontinued operations - - (0.08) (0.07) (0.27) Extraordinary items (0.03) (0.14) - (0.05) (0.10) Change in accounting principle - - - (0.01) - Net income $1.58 $1.25 $1.37 $0.92 $1.04
Balance Sheet Data at year end: Total assets $7,710.3 $7,024.1 $6,611.0 $5,089.9 $4,913.8 Notes payable 135.8 114.9 167.7 183.3 225.9
Mandatorily redeemable preferred securities of subsidiary trusts 225.0 75.0 - - - Net unrealized gains (losses) included in stockholders' equity 133.2 61.8 89.3 (29.0) 56.9 Total stockholders' equity 583.9 486.5 429.3 204.4 250.3
Including cash and investments on hand and the unused availability under a bank line of credit, AAG and AAG Holding had more than $140 million of liquidity at March 1, 1998. The March 1998 acquisition of Arkansas National Life Insurance Company was completed using cash on hand at GALIC. Based upon the current level of operations and anticipated growth, AAG believes that it will have sufficient resources to meet its liquidity requirements.
Investments Insurance laws restrict the types and amounts of investments which are permissible for life insurers. These restrictions are designed to ensure the safety and liquidity of insurers' investment portfolios. The NAIC has developed a model investment law which management believes will not have a material impact on AAG's operations.
AAG invests primarily in fixed income investments which, including loans and short-term investments, comprised 98% of its investment portfolio at December 31, 1997. AAG generally invests in securities with intermediate- term maturities with an objective of optimizing interest yields while maintaining an appropriate relationship of maturities between AAG's assets and expected liabilities.
At December 31, 1997, AAG's mortgage-backed securities ("MBSs") portfolio represented less than one-third of fixed maturity investments. AAG invests primarily in MBSs which have a lower risk of prepayment. In addition, the majority of MBSs held by AAG were purchased at a discount. Management believes that the structure and discounted nature of the MBSs will reduce the effect of prepayments on earnings over the anticipated life of the MBS portfolio.
Nearly 90% of AAG's MBSs are rated "AAA" with substantially all being investment grade quality. 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.
Year 2000 Issue The Company has determined that it will need to modify or replace significant portions of its software so that its computer systems will function properly with respect to dates in the year 2000 and beyond. The Company also has initiated discussions with its business associates and financial institutions to assess the extent to which its operations are vulnerable should those organizations fail to properly remediate their computer systems.
The Company's comprehensive Year 2000 initiative is being managed by a team of internal staff and outside consultants. The team's activities are designed to ensure that there is no adverse effect on the Company's core business operations. These efforts are scheduled to be completed in early 1999. The cost of the Year 2000 initiatives is not expected to be material to the Company's results of operations or financial position.
Estimated Year 2000 costs and completion dates are based on management's best estimate. However, there can be no assurance that these estimates will be achieved. Factors such as the availability of trained personnel could affect the successful completion of the project. Should software modifications and new software installation not be completed on a timely basis, the resulting disruptions could have a material adverse impact on operations.
General The operations of American Memorial Life Insurance Company and Loyal American Life Insurance Company are included in AAG's financial statements from the date of their acquisition in November 1995. Accordingly, the 1997 and 1996 income statement components are not comparable to 1995.
Management believes the concept of net operating earnings (or "core" earnings) is helpful in comparing the operating performance of AAG with that of similar companies. Net operating earnings per share for 1997 and 1996 were up 14% and 17%, respectively, over the comparable prior years. However, net operating earnings should not be considered a substitute for net income as an indication of AAG's overall performance. The following table (in millions, except per share amounts) compares the Company's net operating earnings over the past three years.
Expenses per income statement (530.0) (498.8) (348.9) Less provision for relocation expenses 4.0 - - Operating expenses (526.0) (498.8) (348.9)
Operating earnings before tax 102.2 79.5 74.9 Income tax expense 32.1 17.8 26.5 Net operating earnings $ 70.1 $ 61.7 $ 48.4
The Company's principal products are Single Premium Deferred Annuities ("SPDAs") and Flexible Premium Deferred Annuities ("FPDAs"). The following table summarizes AAG's premiums (in millions).
* Includes $14 million of premiums which were directed toward the fixed rate option of the variable product.
The table does not include premiums of subsidiaries until their first full year following acquisition. American Memorial's 1995 pre-need annuity receipts were $28 million and its pre-need life insurance premiums were $52 million; Loyal's 1995 life premiums were $21 million and its accident and health premiums were $20 million.
Life, Accident and Health Premiums and Benefits Life, accident and health premiums and benefits increased in 1997 due primarily to an increase in pre- need life insurance sales through the largest owner of funeral homes in the world. This customer accounted for approximately one-half of American Memorial's life and annuity sales in 1997. The increase in life, accident and health premiums and expenses in 1996 reflects the acquisition of American Memorial and Loyal.
Other Income Other income increased in 1997 due primarily to increased revenues from certain non-insurance subsidiaries and additional annuity fees. Other income increased in 1996 reflecting (i) policy fees, primarily at American Memorial and Loyal and (ii) higher revenues at AAG's agency subsidiaries.
Amortization of Insurance Acquisition Costs Amortization of insurance acquisition costs includes certain commissions on sales of life insurance products and reflects the effect of the November 1995 acquisition of American Memorial and Loyal. The costs in 1997 and 1996 also reflect $8.1 million and $8.7 million, respectively, of amortization of the present value of future profits.
Other Expenses In 1996, other expenses increased 68%, reflecting: (i) a full year of operating expenses of American Memorial and Loyal; (ii) pretax charges of $15.7 million related to pension and other liabilities of the Company's former manufacturing operations and (iii) operating expenses of AAG's agency subsidiaries. Other expenses decreased 10% in 1997, reflecting primarily the absence of the $15.7 million pretax charge mentioned above.
Income Taxes AAG's effective tax rate decreased in 1997 and 1996 from 1995 due to a reduction of the valuation allowance associated with certain deferred tax assets.
Preferred Stock: Balance at beginning of year $ 49.0 $ 17.0 $ - Preferred Stock issued - 32.0 17.0 Preferred Stock retired (49.0) - - Balance at end of year $ - $ 49.0 $ 17.0
Year ended December 31, 1997 1996 1995 Cash Flows from Operating Activities: Net income $ 69.9 $ 55.1 $ 55.3 Adjustments: Discontinued operations - - 3.2 Extraordinary losses on retirement of debt 1.5 6.0 0.2 Increase in life, accident and health reserves 36.3 28.4 17.5 Benefits to annuity policyholders 278.8 271.8 254.7 Amortization of insurance acquisition costs 36.3 34.1 12.7 Equity in net (earnings) loss of affiliate(0.8) 2.2 (0.1) Realized gains on investing activities (5.2) (1.2) (15.7) Increase in insurance acquisition costs (72.6) (68.5) (34.9) Increase in accrued investment income (4.8) (7.4) (3.0) Increase in other assets (32.6) (10.4) (12.4) Increase (decrease) in other liabilities 19.8 (6.3) 17.9 Other, net (15.5) 1.7 (3.5) 311.1 305.5 291.9 Cash Flows from Investing Activities: Purchases of and additional investments in: Fixed maturity investments (1,449.9) (1,010.1)(1,107.5) Equity securities (12.5) - - Real estate, mortgage loans and other assets (16.1) (26.7) (22.6) Purchase of subsidiaries, net of cash acquired (48.7) - (55.2) Maturities and redemptions of fixed maturity investments 408.2 255.2 147.1 Sales of: Fixed maturity investments 747.6 261.0 768.5 Equity securities 5.8 1.3 2.0 Real estate, mortgage loans and other assets 20.9 27.8 8.2 Decrease (increase) in policy loans (1.3) 5.4 (6.1) (346.0) (486.1) (265.6) Cash Flows from Financing Activities: Fixed annuity receipts 493.7 573.8 457.5 Annuity surrenders, benefits and withdrawals (607.2) (517.9) (412.8) Additions to notes payable 114.0 92.7 33.5 Reductions of notes payable (94.9) (153.2) (49.1) Issuance of trust preferred securities 149.3 72.4 - Issuance of Common Stock - - 37.3 Retirement of Common Stock (1.1) - - Issuance of Preferred Stock - 32.0 17.0 Retirement of Preferred Stock (47.0) - - Cash dividends paid (5.3) (4.5) (3.0) 1.5 95.3 80.4 Net increase (decrease) in cash and short-term investments (33.4) (85.3) 106.7
Cash and short-term investments at beginning of year 84.1 169.4 62.7 Cash and short-term investments at end of year $ 50.7 $ 84.1 $ 169.4
AAG's acquisitions of General Accident Life Assurance Company of Puerto Rico, Inc. in December 1997 and Laurentian Capital Corporation ("LCC") in November 1995 have been recorded as purchases; their results of operations have been included in AAG's Consolidated Financial Statements since their acquisition.
Investment in Affiliate AAG's investments in equity securities of companies that are 20% to 50% owned by AFG and its subsidiaries are carried at cost, adjusted for a proportionate share of their undistributed earnings or losses. Changes in AAG's equity in its affiliate caused by issuances of the affiliate's stock are recognized in earnings when such issuances are not part of a broader reorganization.
To the extent that unrealized gains (losses) from securities classified as "available for sale" would result in adjustments to DPAC, unearned revenues and policyholder liabilities had those gains (losses) actually been realized, such balance sheet amounts are adjusted, net of deferred taxes.
Life, Accident and Health Reserves Liabilities for future policy benefits under traditional ordinary life, accident and health policies are computed using the net level premium method. Computations are based on anticipated investment yields (primarily 7%), mortality, morbidity and surrenders and include provisions for unfavorable deviations. Reserves are modified as necessary to reflect actual experience and developing trends.
Earnings Per Share In 1997, AAG implemented SFAS No. 128, "Earnings Per Share." This standard requires the presentation of basic and diluted earnings per share for entities with potentially dilutive securities. Basic earnings per share are calculated using the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share include the effect of the assumed exercise of diluted common stock options. Implementation of SFAS No. 128 did not affect AAG's reported earnings per share amounts for prior years.
Available for Sale Amortized Market Gross Unrealized Cost Value Gains Losses U. S. Government and government agencies and authorities $ 303.1 $ 312.8 $ 9.8 ($0.1) States, municipalities and political subdivisions 26.8 27.6 0.8 - Foreign government 20.1 21.0 0.9 - Public utilities 135.6 141.7 6.1 - Mortgage-backed securities 1,250.6 1,302.5 51.9 - All other corporate 2,185.8 2,293.8 108.0 - $3,922.0 $4,099.4 $177.5 ($0.1)
Held to Available 1996 Maturity Maturity for Sale Total Total One year or less 1% 2% 3% 3% After one year through five years 12 9 21 18 After five years through ten years 10 21 31 36 After ten years 2 12 14 10 25 44 69 67 Mortgage-backed securities 10 21 31 33 35% 65% 100% 100%
The distribution of maturities based on market value is generally the same. Mortgage-backed securities had an estimated average life of approximately six and one-half years at December 31, 1997.
At December 31, 1997 and 1996, AAG had no unrealized losses on its marketable equity securities. Realized gains and changes in unrealized appreciation on fixed maturity and equity security investments are summarized as follows (in millions):
At December 31, 1997, there were 2.5 million shares of AAG Common Stock reserved for issuance under AAG's Stock Option Plan. Under the Stock Option Plan, the exercise price of each option equals the market price of AAG Common Stock at the date of grant. Options become exercisable at the rate of 20% per year commencing one year after grant. All options expire ten years after the date of grant.
1997 1996 1995 Income (loss) before income taxes: Continuing operations $104.2 $78.5 $90.7 Discontinued operations - - (4.9) Extraordinary items (2.3) (9.2) (0.3) Income before income taxes $101.9 $69.3 $85.5
1997 1996 1995 Federal: Current $32.0 $14.2 $31.9 Deferred - - (1.7) Total $32.0 $14.2 $30.2
Future minimum lease payments, net of sublease revenues, under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 1997 are payable as follows: 1998 - $3.5 million; 1999 - $4.5 million; 2000 - $4.1 million; 2001 - $4.0 million; 2002 - $3.8 million; 2003 and beyond - $16.7 million.
0. STATUTORY INFORMATION; RESTRICTIONS ON TRANSFERS OF FUNDS AND ASSETS OF SUBSIDIARIES
Pretax income from operations $ 91.7 $ 87.1 $ 85.8 Net income from operations 72.7 68.1 60.5 Net income 73.6 66.2 71.4
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. Based on net income at December 31, 1997, GALIC may pay $73.6 million in dividends in 1998 without prior approval.
Liabilities Annuity benefits accumulated $5,528.1 $5,319.1 $5,365.6 $5,180.0 Notes payable 135.8 136.6 114.9 119.0
Year ended December 31, 1997 1996 1995 Revenues: Net investment income and other income $ 34.2 $ 10.6 $ 1.7 Equity in undistributed earnings of subsidiaries (92.9) 47.6 64.7 Capital distributions from subsidiaries 181.1 61.2 54.2 122.4 119.4 120.6 Costs and Expenses: Interest and other financing expenses 0.2 15.2 19.0 Provision for relocation expenses 4.0 - - Other expenses 14.0 25.7 10.9 18.2 40.9 29.9 Income from continuing operations before income taxes 104.2 78.5 90.7 Provision for income taxes 32.8 17.4 32.0 Income from continuing operations 71.4 61.1 58.7
(b) Includes unrealized gains of $133.2 million and $61.8 million in 1997 and 1996, respectively.
Operating Activities: Net income $ 69.9 $55.1 $55.3 Adjustments: Discontinued operations - - 3.2 Extraordinary items 1.5 6.0 0.2 Equity in net earnings of subsidiaries (58.8) (70.8) (77.0) Realized gains on investing activities (0.1) - - Depreciation and amortization 2.2 1.6 0.9 Decrease (increase) in other assets (1.9) (8.5) 0.1 Increase (decrease) in balances with affiliates 9.5 (26.5) 13.5 Increase (decrease) in other liabilities (11.2) 0.1 2.5 Capital distributions from subsidiaries 181.2 61.2 54.2 Contributions to subsidiaries (3.1) (12.7) (33.0) Other, net (0.7) 1.3 - 188.5 6.8 19.9
Investing Activities: Purchase of investments (104.8) - - Decrease (increase) in intercompany notes 0.7 (46.9) - Purchase of subsidiaries (51.7) - (63.6) Maturities and redemptions of fixed maturity investments 0.5 - - Sales of investments 22.0 - - Sales of real estate and other assets - 0.2 - Sale of AILIC to GALIC - - 6.5 (133.3) (46.7) (57.1)
Net Increase (Decrease) in Cash and Short-term Investments 1.7 0.5 (0.5)
Consolidated Income Statement: Years Ended December 31, 1997, 1996 and 1995
Consolidated Statement of Changes in Stockholders' Equity: Years Ended December 31, 1997, 1996 and 1995
Diluted earnings (loss) per common share: Continuing operations $1.61 $1.39 $1.45 Discontinued operations - - (0.08) Extraordinary items (0.03) (0.14) - Net income $1.58 $1.25 $1.37
Retained Earnings Since January 1, 1993: Balance at beginning of year $186.5 $131.4 $ 76.1 Net income 69.9 55.1 55.3 Common dividends declared (4.3) - - Balance at end of year $252.1 $186.5 $131.4
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.
Insurance Acquisition Costs Unamortized insurance acquisition costs consist primarily of deferred policy acquisition costs and the present value of future profits on business in force of acquired insurance companies. Certain commission costs are expensed as paid and are included in amortization of life insurance acquisition costs.
Held to Available Maturity for Sale Total Purchases ($116.3) ($893.8) ($1,010.1) Maturities and paydowns 106.6 148.6 255.2 Sales 9.3 251.7 261.0 Gross gains 1.1 8.3 9.4 Gross losses (0.3) (8.3) (8.6)
Issuer Amount Outboard Marine Corporation (1 issue) $62.5 Provident Financial Group (common and preferred stock) 59.1
Investment in affiliate reflects AAG's 4% ownership (2.7 million shares; carrying value of $16.8 million at December 31, 1997) of the common stock of Chiquita Brands International which is accounted for under the equity method. AFG and its other subsidiaries own an additional 35% interest in the common stock of Chiquita. Chiquita is a leading international marketer, producer and distributor of bananas and other quality fresh and processed food products. The market value of AAG's investment in Chiquita was approximately $44 million and $34 million at December 31, 1997 and 1996, respectively, and $36 million at March 1, 1998.
The interest accrual rates used range primarily from 7.25% to 7.50%. During each of the next five years, the PVFP is expected to decrease at a rate of approximately 10% of the balance at the beginning of each respective year.
1997 1996 Direct obligations of AAG $ 1.3 $ 1.3 Obligations of AAG Holding (guaranteed by AAG): Secured Bank Credit Line due 1999 75.0 44.7 Unsecured Bank Credit Line due 1998 32.0 - 9-1/2% Senior Notes due 2001 - 40.8 11-1/8% Senior Subordinated Notes due 2003 24.1 24.1 Other subsidiary debt 3.4 4.0 Total $135.8 $114.9
At March 1, 1998, scheduled principal payments on debt for the remainder of 1998 and the subsequent four years, adjusted to reflect the above transactions, were as follows (in millions):
At December 31, 1997 and 1996, the weighted average interest rate on amounts borrowed under AAG Holding's bank credit lines was 6.80% and 6.68%, respectively. At March 1, 1998, the weighted average interest rate on its new credit line was 6.15%.
Cash interest payments were $9.4 million in 1997, $17.4 million in 1996 and $17.2 million in 1995.
AAG and AAG Holding effectively provide an unconditional guarantee of the Trusts' obligations.
Effect of: Reduction of valuation allowance(3.5) (10.0) - Other, net (0.2) (0.1) 0.3 Total provision 32.0 14.2 30.2
Amounts applicable to: Discontinued operations - - 1.7 Extraordinary items 0.8 3.2 0.1 Provision for income tax as shown on the Consolidated Income Statement $ 32.8 $17.4 $32.0
December 31, 1997 1996 Deferred tax assets: Net operating loss carryforwards $39.8 $45.5 Accrued expenses 4.6 13.8 Investment securities, including affiliate 32.7 31.9 Valuation allowance for deferred tax assets (33.0) (36.5)
At December 31, 1997, AAG had net operating loss carryforwards for federal income tax purposes of approximately $114 million which are scheduled to expire from 2002 through 2005.
Capital and surplus $317.0 $285.0 $272.8 Asset valuation reserve 64.7 91.4 90.2 Interest maintenance reserve 23.9 24.7 32.2
Summary Financial Information of AAG Holding AAG has guaranteed all of the outstanding debt of AAG Holding. Summarized consolidated financial information for AAG Holding is as follows (in millions):
Investments $6,634 $6,272 Unamortized insurance acquisition costs 225 195 Assets held in separate accounts 300 247 Other assets 284 278
1997 1996 Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value Assets Fixed maturity investments $6,375.8 $6,440.0 $5,821.3 $5,850.2 Equity securities 83.0 83.0 51.0 51.0 Investment in affiliate 16.8 43.6 16.5 34.1
Realized gains (losses) $ 0.3 $ 0.6 $ 0.5($ 0.2) $ 1.2 Total revenues 139.0 150.9 145.9 141.5 577.3
Average common shares outstanding Basic and diluted 43.1 43.1 43.1 43.1 43.1
* In the third quarter of 1997, AAG recorded a $4 million ($2.6 million after tax) charge relating to the relocation of Loyal from Mobile, Alabama to Cincinnati, Ohio. Excluding this charge, third quarter 1997 basic and diluted earnings per share would have been $0.06 higher.
Financing Activities: Additions to notes payable - 87.7 33.5 Reductions of notes payable (0.1) (74.8) (48.1) Issuance of Common Stock - - 37.3 Retirement of Common Stock (1.1) - - Issuance of Preferred Stock - 32.0 17.0 Retirement of Preferred Stock (47.0) - - Cash dividends paid (5.3) (4.5) (3.0) (53.5) 40.4 36.7
Cash and short-term investments at end of period $ 3.6 $ 1.9 $ 1.4
CARL H. LINDNER Chairman of the Board March 27, 1998 of Directors
WILLIAM J. MANEY Senior Vice President, March 27, 1998 Treasurer and Chief Financial Officer (Principal Accounting Officer)