The results of operations of the Company for 1999 are affected by the acquisition of business from MBL Life on July 1, 1999 (See Note 5 of the accompanying financial statements).
Management's discussion and analysis of financial condition and results of operations of First SunAmerica Life Insurance Company (the "Company") for the three years ended December 31, 2000, December 31, 1999 and September 30, 1998 follows. Effective December 31, 1998, the Company changed its fiscal year end from September 30 to December 31. Accordingly, the three-month period ended December 31, 1998 was a transition period. Certain prior period amounts have been restated to conform to the current period's presentation.
NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest-bearing liabilities, totaled $42.1 million in 2000, down from $42.8 million in 1999 and up from $35.2 million in 1998. These amounts equal 2.49% on average invested assets (computed on a daily basis) of $1.69 billion in 2000, 2.42% on average invested assets of $1.77 billion in 1999 and 2.27% on average invested assets of $1.55 billion in 1998. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1997, net investment income on related average invested assets would have been 2.05% in 1999 and 1.64% in 1998. The improvement in the 1999 net investment yield over the 1998 pro forma amount reflects the redeployment of assets received in the Acquisition into higher yielding investment categories.
Net investment spreads include the effect of income earned or interest paid on the difference between average invested assets and average interest-bearing liabilities. Average invested assets exceeded average interest-bearing liabilities by $79.6 million in 2000, compared with $89.0 million in 1999 and $47.3 million in 1998. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.27% in 2000, 2.18% in 1999 and 2.10% in 1998. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1997, the Spread Difference would have been 1.87% in 1999 and 1.57% in 1998 reflecting primarily the effect of the lower-yielding assets received in the Acquisition.
Expenses incurred to manage the investment portfolio amounted to $2.0 million in 2000, $1.9 million in 1999 and $1.6 million in 1998. These expenses are included as a reduction to investment income in the income statement. Investment expenses increased from prior periods because the size of the portfolio increased as a result of the Acquisition.
DECLINE IN AVERAGE INVESTED ASSETS largely results from the surrenders and rollovers to variable products of the fixed annuity liabilities related to the Acquisition. Changes in average invested assets also reflect sales of fixed annuities and the fixed account options of the Company's variable annuity products ("Fixed Annuity Premiums"), and renewal premiums on its universal life product ("UL Premiums") acquired in the Acquisition, partially offset by net exchanges from fixed accounts into the separate accounts of variable annuity contracts. Fixed Annuity Premiums and UL Premiums totaled $63.9 million in 2000, $89.2 million in 1999 and $130.9 million in 1998 and are largely premiums for the fixed accounts of variable annuities. Such premiums have decreased, in part, as a result of regulatory changes in the state of New York relating to non-taxable policy exchange requirements. On an annualized basis, these premiums represent 5%, 6% and 8%, respectively, of the related reserve balances at the beginning of the respective periods.
NET REALIZED INVESTMENT LOSSES totaled $20.8 million in 2000, and $11.2 million in 1999 compared with net realized investment gains of $4.7 million in 1998 and include impairment writedowns of $20.8 million in 2000, $7.7 million in 1999, and $0.4 million in 1998, respectively. Thus, net realized losses from sales and redemptions of investments totaled $0.03 million of losses in 2000, $3.5 million of losses in 1999 and $5.1 million of gains in 1998.
The Company sold or redeemed invested assets, principally bonds and notes, aggregating $389.1 million in 2000, $478.7 million in 1999 and $985.1 million in 1998. Sales of investments result from the active management of the Company's investment portfolio, including assets received as part of the Acquisition. Because redemptions of investments are generally involuntary and sales of investments are made in both rising and falling interest rate environments, net gains and losses from sales and redemptions of investments fluctuate from period to period, and represent 0.00%, 0.20% and 0.33% of average invested assets in 2000, 1999 and 1998, respectively. Active portfolio management involves the ongoing evaluation of asset sectors, individual securities within the investment portfolio and the reallocation of investments from sectors that are perceived to be relatively overvalued to sectors that are perceived to be relatively undervalued. The intent of the Company's active portfolio management is to maximize total returns on the investment portfolio, taking into account credit, option, liquidity and interest-rate risk.
Impairment writedowns include $20.8 million, $7.7 million and $0.4 million of provisions applied to bonds in 2000, 1999 and 1998, respectively. Impairment writedowns represent 1.23%, 0.44% and 0.03% of average invested assets for 2000, 1999 and 1998, respectively. For the five years ended December 31, 2000, impairment writedowns as a percentage of average invested assets have ranged from 0.03% to 1.23% and have averaged 0.44%. Such writedowns are based upon estimates of the net realizable value of the applicable assets. Actual realization will be dependent upon future events.
These amounts represent 9%, 19% and 47% of variable annuity reserves at the beginning of the respective periods. Transfers from the fixed accounts of the Company's variable annuity products to the separate accounts (see "Growth in Average Invested Assets") are not classified in variable annuity premiums. Accordingly, changes in variable annuity premiums are not necessarily indicative of the ultimate allocation by customers among fixed and variable account options of the Company's variable annuity products.
Sales of variable annuity products (which include premiums allocated to the fixed accounts) ("Variable Annuity Product Sales") amounted to $72.0 million, $127.7 million and $157.5 million in 2000, 1999 and 1998, respectively. Variable Annuity Product Sales primarily reflect sales of the Company's flagship variable annuity line, Polaris. Polaris is a multimanager variable annuity that offers investors a choice of 31 variable funds and a number of guaranteed fixed-rate funds. Variable Annuity Product Sales have decreased in both 1999 and 2000, principally as a result of regulatory changes in the State of New York relating to non-taxable policy exchange requirements.
UNIVERSAL LIFE INSURANCE FEES, NET result from the universal life insurance contract reserves acquired in the Acquisition and the ongoing receipt of renewal premiums on such contracts, and consist of mortality charges, up-front fees earned on premiums received and administrative fees, net of excess mortality expense on these contracts. The Company does not actively market universal life insurance contracts. Universal life insurance fees amounted to $2.2 million and $1.1 million in 2000 and 1999, respectively. Such fees represent 0.84% and 0.83% of average reserves for universal life insurance contracts in the respective periods.
SURRENDER CHARGES on fixed and variable annuity contracts and universal life contracts totaled $3.8 million in 2000 (including $2.4 million attributable to JANY merger),$3.3 million in 1999 (including $2.5 million attributable to JANY merger) and $4.4 million in 1998 (including $3.9 million attributable to JANY merger). Surrender charges generally are assessed on withdrawals at declining rates during the first seven years of a contract. Withdrawal payments, which exclude claims and periodic annuity benefits, totaled $409.2 million in 2000 (including $58.1 million attributable to the Acquisition), compared with $392.4 million in 1999 (including $297.7 million attributable to the Acquisition) and $234.4 million in 1998. These payments, when expressed as a percentage of average fixed and variable annuity and universal life reserves, represent 19.1% (2.7% attributable to the Acquisition), 19.0% (14.5% attributable to the Acquisition) and 14.0% for 2000, 1999 and 1998, respectively. The increase in withdrawal rates in 2000 as compared to 1999 and 1998 is due primarily to increased surrenders on certain closed blocks of fixed annuity business. Withdrawals include variable annuity payments from the separate accounts totaling $36.6 million (6.2% of average variable annuity reserves), $28.6 million (6.9% of average variable annuity reserves) and $12.8 million (5.5% of average variable annuity reserves) in 2000, 1999 and 1998, respectively. Management anticipates that withdrawal rates will remain relatively stable for the foreseeable future.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $4.8 million in 2000, $5.3 million in 1999 and $1.7 million in 1998. General and administrative expenses remain closely controlled through a company-wide cost containment program and continue to represent less than 1% of average total assets.
AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $19.4 million in 2000, compared with $22.7 million in 1999 and $17.1 million in 1998. The decline in amortization during 2000 represents a reduction in amortization attributable to a closed block of fixed annuties acquired in prior years. The higher amortization during 1999 was due to additional variable annuity product sales and the subsequent amortization of related deferred commissions and other direct selling costs.
ANNUAL COMMISSIONS represent renewal commissions paid quarterly in arrears to maintain the persistency of certain of the Company's variable annuity contracts. Substantially all of the Company's currently available variable annuity products allow for an annual commission payment option in return for a lower immediate commission. Annual commissions totaled $0.6 million in 2000, compared with $0.5 million in 1999 and $0.3 million in 1998.
INCOME TAX EXPENSE totaled $4.3 million in 2000, $6.6 million in 1999 and $12.1 million in 1998, representing effective tax rates of 37%, 46% and 42%, respectively. The lower rate in 2000 was principally due to the impact of state income taxes. See Note 11 of the accompanying financial statements.
SHAREHOLDER'S EQUITY increased to $187.6 million at December 31, 2000 from $161.2 million at December 31, 1999, due principally to $7.3 million of net income recorded in 2000 and a $19.1 million decrease in accumulated other comprehensive loss.
INVESTED ASSETS at December 31, 2000 totaled $1.49 billion, compared with $1.81 billion at December 31, 1999. 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, notes and redeemable preferred stocks (the "Bond Portfolio") is available to be sold in response to changes in market interest rates, changes in relative value of asset sectors and individual securities, changes in prepayment risk, changes in the credit quality outlook for certain securities, the Company's need for liquidity and other similar factors.
THE BOND PORTFOLIO, which constituted 83% of the Company's total investment portfolio at December 31, 2000, had an amortized cost that was $31.9 million greater than its aggregate fair value at December 31, 2000 and $64.2 million greater than its aggregate fair value at December 31, 1999. The decrease in net unrealized losses on the Bond Portfolio during 2000 principally reflects the decline in prevailing interest rates and the corresponding effect on the fair value of the Bond Portfolio at December 31, 2000.
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 issuer concentrations of non-investment-grade securities at December 31, 2000.
The table on the following page summarizes the Company's rated bonds by rating classification as of December 31, 2000.
Senior secured loans ("Secured Loans") are included in the Bond Portfolio and aggregated $53.9 million at December 31, 2000. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. At December 31, 2000, Secured Loans consisted of $18.7 million of publicly traded securities and $35.2 million of privately traded securities. These Secured Loans are composed of loans to borrowers spanning 8 industries, with 26% of these assets concentrated in utilities, 10% concentrated in technology, 10% concentrated in telecommunication and 10% concentrated in energy. No other industry concentration constituted more than 7% of these assets.
MORTGAGE LOANS aggregated $167.4 million at December 31, 2000 and consisted of 117 commercial first mortgage loans with an average loan balance of approximately $1.4 million, collateralized by properties located in 32 states. Approximately 31% of this portfolio was office, 28% was retail, 17% was industrial, 11% was multifamily residential and 13% was other types. At December 31, 2000, approximately 28% of this portfolio was secured by properties located in California, approximately 13% by properties located in Michigan, approximately 10% by properties located in New York and no more than 5% of this portfolio was secured by properties located in any other single state. At December 31, 2000, one mortgage loan had an outstanding balance of $10.0 million or more, which represented approximately 6% of this portfolio. At December 31, 2000, approximately 25% of the mortgage loan portfolio consisted of loans with balloon payments due before January 1, 2004. During 2000 and 1999, loans delinquent by more than 90 days, foreclosed loans and restructured loans have not been significant in relation to the total mortgage loan portfolio.
At December 31, 2000, approximately 52% of the mortgage loans were seasoned loans underwritten to the Company's standards and purchased at or near par from other financial institutions. Such loans generally have higher average interest rates than loans that could be originated today. The balance of the mortgage loan portfolio has been originated by the Company under strict underwriting standards. Commercial mortgage loans on properties such as offices, hotels and shopping centers generally represent a higher level of risk than do mortgage loans secured by multifamily residences. This greater risk is due to several factors, including the larger size of such loans and the more immediate effects of general economic conditions on these commercial property types. However, due to the seasoned nature of the Company's mortgage loan portfolio and its strict underwriting standards, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields.
DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of principal or interest, totaled $7.2 million of bonds at December 31, 2000, and constituted less than 0.5% of total invested assets. At December 31, 1999, defaulted investments totaled $1.8 million (including $0.9 million of mortgage loans and $0.9 million of bonds) and constituted less than 0.1% of total invested assets.
SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company's existing portfolio of cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At December 31, 2000, approximately $604.4 million of the Company's Bond Portfolio had an aggregate unrealized loss of $46.5 million, while approximately $633.1 million of the Bond Portfolio had an aggregate unrealized gain of $14.6 million. In addition, the Company's investment portfolio currently provides approximately $15.4 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.
RECENTLY ISSUED ACCOUNTING STANDARDS are discussed in Note 3 of the accompanying financial statements.