In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission (the "SEC"). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect," "anticipate," "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company's beliefs concerning future levels of sales and redemptions of the Company's products, investment spreads and yields, or the earnings and profitability of the Company's activities.
NET INCOME totaled $7.7 million in 1999, compared with $16.5 million in 1998 and $8.9 million in 1997. On July 1, 1999, the Company acquired the New York individual life and individual and group annuity business of MBL Life Assurance Corporation ("MBL Life"). Since the acquisition of MBL Life was accounted for under the purchase method of accounting, the results of operations include those of MBL Life only from its date of acquisition. On October 31, 1997, John Alden Life Insurance Company of New York ("JANY") was merged with and into the Company. JANY was acquired by SunAmerica Life Insurance Company, the Company's parent, on March 31, 1997 in a transaction accounted for under the purchase method of accounting. Therefore, the results of operations include those of JANY only from the date of acquisition. The income statement for 1998 and 1999 include the results of JANY's operations for the full period, and the income statement for 1997 includes JANY's operating results only for the period of April 1, 1997 through September 30, 1997. Consequently, the operating results for 1999, 1998 and 1997 are not comparable. On a pro forma basis, using the historical financial information of the acquired businesses and assuming that both the MBL Life acquisition and the JANY merger, collectively
referred to as the "Acquisitions", had been consummated on October 1, 1996, the beginning of the prior-year periods discussed herein, net income would have been $9.4 million, $19.9 million and $15.8 million for the year ended December 31, 1999 and the years ended September 30, 1998 and 1997, respectively.
Net investment spreads include the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. Average invested assets exceeded average interest bearing liabilities by $89.0 million in 1999, $47.3 million in 1998 and $21.4 million in 1997. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.28% in 1999, 2.20% in 1998 and 2.04% in 1997. On a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1996, the Spread Difference would have been 1.73% in 1999, 1.64% in 1998 and 1.46% in 1997. The pro forma results primarily reflect the effect of the lower yielding assets received in the Acquisitions.
Investment income (and the related yields on average invested assets) totaled $127.3 million (7.20%) in 1999 compared with $117.5 million (7.56%) in 1998 and $65.6 million (7.39%) in 1997. The decrease in the investment yield in 1999 as compared with 1998 and 1997 principally reflect the effects of lower yielding assets received in the MBL Life acquisition. The invested assets associated with the MBL Life acquisition included high-grade corporate, government and government/agency bonds, which are generally lower yielding than a significant portion of the invested assets that comprise the remainder of the Company's portfolio. On a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1996, the yield on related average invested assets would have been 6.72% in 1999, 6.92% in 1998 and 6.80% in 1997.
Total interest expense equaled $82.6 million in 1999, $80.7 million in 1998 and $46.4 million in 1997. The average rate paid on all interest-bearing liabilities was 4.92% in 1999, 5.36% in 1998 and 5.35% in 1997. Interest-bearing liabilities averaged $1.68 billion during 1999, $1.51 billion during 1998 and $866.0 million during 1997. On a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1996, the
NET REALIZED INVESTMENT LOSSES totaled $11.2 million in 1999 compared to net investment gains of $4.7 million in 1998 and $5.0 million in 1997. Net realized investment gains and losses include impairment writedowns of $7.7 million in 1999, $0.4 million in 1998 and $0.1 million in 1997. Therefore, net losses from sales and redemptions of investments totaled $3.5 million in 1999 while net gains from sales and redemptions of investments totaled $5.1 million in 1998 and 1997.
Impairment writedowns primarily have been applied to defaulted bonds and mortgage loans. Impairment writedowns represent 0.44%, 0.03% and 0.01% of related average invested assets in 1999, 1998 and 1997, respectively. For the twenty-one fiscal quarters beginning October 1, 1994, impairment writedowns as a percent of average invested assets have ranged up to 0.86% and have averaged 0.14%. Such writedowns are based upon estimates of the
net realizable value of the applicable assets. Actual realization will be dependent upon future events.
Sales of variable annuity products (which include premiums allocated to the fixed accounts) ("Variable Annuity Product Sales") amounted to $127.7 million, $157.5 million and $125.2 million in 1999, 1998 and 1997, respectively, and primarily reflect sales of the Company's flagship variable annuity, Polaris. The Polaris products are multimanager variable annuities that offer investors a choice of 27 variable funds and 8 guaranteed fixed-rate funds. Variable Annuity Product Sales have decreased in 1999, principally as a result of regulatory changes in the State of New York relating to non-taxable policy exchange requirements.
UNIVERSAL LIFE INSURANCE FEES result from the acquisition of universal life insurance contract reserves and the ongoing receipt of renewal premiums on such contracts, and comprise mortality charges, up-front fees earned on premiums received and administrative fees on such contracts, net of the excess mortality expense on these contracts. Universal life insurance fees amounted to $1.9 million in 1999 and represent 1.4% of average reserves for universal life insurance contracts for 1999. Since the MBL Life acquisition occurred on July 1, 1999, there were no such fees earned in 1998 and 1997.
INVESTED ASSETS totaled $1.81 billion at December 31, 1999 and $1.52 billion at December 31, 1998. The Company manages most of its invested assets internally. The Company's general investment philosophy is to hold fixed-rate assets for long-term investment. Thus, it does not have a trading portfolio. However, the Company has determined that all of its portfolio of bonds and notes (the "Bond Portfolio") is available to be sold in response to changes in market interest rates, changes in relative value of asset sectors and individual securities, changes in prepayment risk, changes in the credit quality outlook for certain securities, the Company's
THE BOND PORTFOLIO, which constituted 84% of the Company's total investment portfolio at December 31, 1999, had an amortized cost that was $64.2 million greater than its aggregate fair value at December 31, 1999, compared with an aggregate fair value that exceeded its amortized cost by $19.8 million at December 31, 1998. The net unrealized losses on the Bond Portfolio in 1999 principally reflect the recent increase in prevailing interest rates and the corresponding effect on the fair value of the Bond Portfolio at December 31, 1999.
Non-investment-grade securities generally provide higher yields and involve greater risks than investment-grade securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment-grade issuers. In addition, the trading market for these securities is usually more limited than for investment-grade securities. The Company had no material concentrations of non-investment-grade securities at December 31, 1999.
(2) Bonds and short-term promissory instruments are divided into six quality categories for NAIC rating purposes, ranging from 1 (highest) to 5 (lowest) for nondefaulted bonds plus one category, 6, for bonds in or near default. These six categories correspond with the S&P/Moody's/DCR/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. The NAIC categories include $41.8 million of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.
While the trading market for the Company's privately traded Secured Loans is more limited than for publicly traded issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. As a result of restrictive financial covenants, these Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities. However, management believes that the risk of loss upon default for these Secured Loans is mitigated by such financial covenants and the collateral values underlying the Secured Loans. The Company's Secured Loans are rated by S&P, Moody's, DCR, Fitch, the NAIC or by the Company, pursuant to comparable statutory ratings guidelines established by the NAIC.
At December 31, 1999, approximately 55% of the mortgage loans were seasoned loans underwritten to the Company's standards and purchased at or near par from other financial institutions. Such loans generally have higher average interest rates than loans that could be originated today. The balance of the mortgage loan portfolio has been originated by the Company under strict underwriting standards. Commercial mortgage loans on properties such as offices, hotels and shopping centers generally represent a higher level of risk than do mortgage loans secured by multifamily residences. This greater risk is due to several factors, including the larger size of such loans and the more immediate effects of general economic conditions on these commercial property types. However, due to the seasoned nature of the Company's mortgage loan portfolio and its strict underwriting standards utilized, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed rate investments are priced over the yield curve, and general economic conditions. Its portfolio strategy is constructed with a view to
achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 85% of the Company's fixed annuity reserves had surrender penalties or other restrictions at December 31, 1999.
SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company's existing portfolio of cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At December 31, 1999, approximately $224.6 million of the Company's Bond Portfolio had an aggregate unrealized gain of $4.3 million, while approximately $1.30 billion of the Bond Portfolio had an aggregate unrealized loss of $68.5 million. In addition, the Company's investment portfolio currently provides approximately $17.9 million of monthly cash flow from scheduled principal and interest payments. Historically, cash flows from operations and from the sale of the Company's annuity products have been more than sufficient in amount to satisfy the Company's liquidity needs.
Management is aware that prevailing market interest rates may shift significantly and has strategies in place to manage either an increase or decrease in prevailing rates. In a rising interest rate environment, the Company's average cost of funds would increase over time as it prices its
new and renewing annuities to maintain a generally competitive market rate. Management would seek to place new funds in investments that were matched in duration to, and higher yielding than, the liabilities assumed. The Company believes that liquidity to fund withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or Reverse Repos on the Company's substantial MBS segment of the Bond Portfolio, thereby avoiding the sale of fixed-rate assets in an unfavorable bond market.
The Year 2000 issue arose from computer programs written using two digits rather than four digits to define the applicable year. This possibly could have caused a failure of the information technology systems (IT systems) and other equipment containing imbedded technology (non-IT systems) in the year 2000. The Company implemented a plan to address the Year 2000 issue and to assess Year 2000 issues relating to third parties with which the Company has critical relationships. The Company's cost to make necessary repairs had no significant impact on its results of operations. The Company has not experienced any business disruption from the year 2000 issue. Its IT and non-IT systems were compliant on January 1, 2000, and there have been no problems related to any third parties compliance.