RESULTS OF OPERATIONS Years Ended December 31, 1994, 1993 and 1992 NET INVESTMENT INCOME increased $3.5 million, or 3%, to $142.0 million from $138.5 million in 1993. This increase resulted from an increase in average invested assets from $1,770.9 million in 1993 to $1,862.3 million in 1994, offset in part by a reduction in the average yield on invested assets from 7.8% for the year ended December 31, 1993, to 7.6% for the year ended December 31, 1994. Net investment income decreased $2.7 million, or 2%, to $138.5 million in 1993 from $141.2 million in 1992. This decrease resulted from the reduction in the average yield on invested assets from 8.4% for the year ended December 31, 1992, to 7.8% for the year ended December 31, 1993, offset in part by an increase in average invested assets from $1,689.6 million in 1992 to $1,770.9 million for 1993. Average yields have been impacted by declining interest rates throughout 1992 and 1993 and the reinvestment at lower yields of proceeds from securities disposed of to realize investment gains. The 1994 yields were down as a result of an investment in investment partnerships. These partnerships form a fund of funds totalling $23.1 million on December 31, 1994 which is structured in an attempt to consistently provide returns in excess of the Standard & Poor's (S&P) 500 over time without regard to the general direction of financial markets. This fund generated a loss of $1.9 million in 1994 compared with income of $1.2 million in 1993. Since the date of original investment this investment has experienced a loss of 2.2%, compared to a cash flow equivalent loss of 9.4% had the same amounts been invested at the same time in 10 year treasury bonds, or a .6% gain had the funds been invested in the Standard & Poor's 500. NET INVESTMENT GAINS decreased $16.2 million, or 95%, to $.8 million for the year ended December 31, 1994, from $17.0 million for the year ended December 31, 1993. This follows a $3.5 million decrease in 1993 from $20.5 million for the year ended December 31, 1992. Gains and losses may be realized upon securities which are disposed of for various reasons. The gains realized in 1994 are the result of general portfolio management while those taken in 1993 were to reduce the effects of the statutory losses resulting from surrenders following the reduction of interest crediting rates on certain annuity policies below the "bailout" rate. The gains realized during 1992 were primarily to utilize the tax benefit of capital loss carryforwards. The decision to realize gains or losses lies to a great degree in managements discretion. Unrealized gains (losses) in the company's bond portfolio were ($105.6) million, $81.4 million and $41.5 million as of December 31, 1994, 1993 and 1992, respectively. INCOME FROM DISPOSAL OF PRIVATE PLACEMENT SECURITIES was $5.8 million in 1992. During 1988, 1989, and 1990, American purchased private placement securities believed to have a quality rating equivalent to "BBB" by Standard & Poor's. In 1992 the company engaged an independent firm to review the private placement securities portfolio. That review determined those securities would have been rated "BB" - "B" if they had been rated by S&P when issued and that the total market value of the securities at the time of the report was approximately $5.8 million less than the par value of these securities. On September 21, 1992, an affiliate of the placement agent agreed to purchase the bonds at their par value, which approximated the company's cost. Several of these bonds had been written down in an amount totalling $2.1 million during 1990, 1991 and 1992 when declines in value were considered to be other than temporary. The effect on 1992 operations of this transaction was a net investment loss of $4.3 million representing the difference between the market value at the time of sale and the GAAP book carrying value of the securities, and $5.8 million of income from disposal of private placement securities representing the amount received in excess of market value. There were no similar transactions in 1994 or 1993. BENEFITS, CLAIMS AND INTEREST CREDITED TO POLICYHOLDERS decreased $1.5 million, to $112.3 million in 1994 from $113.8 million in 1993. This decrease results primarily from a reduction in the average interest rate credited on the company's annuity liabilities, from 6.2% as of December 31, 1993 to 5.8% as of December 31, 1994. This decrease was partially offset by an increase in annuity liabilities to $1,971.6 million on December 31, 1994. In 1993, this amount decreased $14.2 million, or 11%, to $113.8 million from $128.0 million in 1992. This decrease resulted primarily from a reduction in the average interest rate credited on annuity liabilities, from 7.1% as of December 31, 1992 to 6.2% as of December 31, 1993. This decrease was
partially offset by an increase in annuity liabilities to $1,826.9 million on December 31, 1993, from $1,806.2 million on December 31, 1992. AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS decreased $.4 million, to $9.0 million in 1994, from $9.4 million in 1993. Amortization of deferred policy acquisition costs (DAC) associated with gross interest margins increased $4.1 million, to $8.8 million in 1994, from $4.7 million in 1993. Amortization associated with investment gains decreased $4.6 million, to $.2 million in 1994, from $4.8 million in 1993. The 1993 amortization amounts reflect the lowering of interest crediting rates and the resulting increase in the estimates of future expected gross profits and the realization of $17.0 million of investments gains. This follows a decrease of $7.0 million, or 43%, in 1993 from $16.4 million in 1992, primarily due to decreased investment gains, the inclusion of income from disposal of private p lacement securities in the 1992 period and the increase in the estimates of future expected gross profits previously discussed. Acquisition costs incurred in 1994 and deferred into future policy periods were $25.8 million, compared with $18.2 million in 1993 and $14.1 million in 1992. GENERAL INSURANCE EXPENSES decreased $1.2 million, or 14%, to $7.6 million in 1994 from $8.8 million in 1993. This decrease is primarily attributable to the deferral of additional expenses related to the acquisition of annuity contracts in 1994. This follows an increase in general insurance expenses of $.1 million in 1993 from $8.7 million in 1992. PREMIUM AND OTHER TAXES, LICENSES AND FEES decreased $1.1 million, or 46%, to $1.3 million in 1994 from $2.4 million in 1993 following a decrease of $.1 million, or 4%, in 1993 from $2.5 million in 1992. The above amounts include charges (credits) of approximately ($.4) million, $1.6 million and $1. 8 million for the years 1994, 1993 and 1992, respectively, for nonrecoverable guaranty fund assessments resulting from a significant number of insolvencies that occurred in recent years. INTEREST EXPENSE decreased $1.0 million in 1994 following the repayment of all debt in November, 1993, with proceeds from the company's common stock offering. This follows a decrease of $1.4 million to $1.0 million in 1993 from $2.4 million in 1992. This decrease reflects the repayment of debt in 1993. INCOME TAX EXPENSE decreased $2.9 million to $5.6 million in 1994 from $8.5 million in 1993. During 1993, income tax expense increased $8.4 million to $8.5 million from $.1 million in 1992. A large portion of the tax on net investment gains realized in 1992 was offset by tax benefits from capital loss carryforwards from 1989 and 1990. These capital loss carryforwards were fully utilized during 1992 resulting in the taxation of the net investment gains realized in 1993 and 1994. LIQUIDITY AND CAPITAL RESOURCES The company is an insurance holding company whose principal asset is the common stock of American. The company's primary cash requirements are to pay operating expenses. As a holding company, the company relies on funds received from American to meet its cash requirements at the holding company level. The company receives funds from American in the form of commissions paid to American Sales, fees paid to AIG, rent, administrative, printing and data processing charges and dividends. The insurance laws of Kansas generally limit the ability of American to pay cash dividends in excess of certain amounts without prior regulatory approval and also require that certain agreements relating to the payment of fees and charges to the company by American be filed with the Kansas Insurance Commissioner.
has continued into 1995. Management believes that surrenders are lower during periods of declining interest rates. BOND PORTFOLIO RESTRUCTURING. During 1990, the quoted market values of many non-investment grade bonds substantially decreased. In response to this decrease, the company substantially increased the allowance for credit losses during the third quarter of that year, and completed a significant restructuring of its bond portfolio during 1991. During 1994, 1993 and 1992, the company disposed of bonds with book values of $337.7, $374.6 and $673.8 million for net gains (losses) of $(.8) $18.6 and $19.7 million, respectively. In 1993, the company reduced credited interest rates below the "bailout" rates on certain annuity policies and the related surrenders experienced during the "bailout" period resulted in losses on a statutory basis. The company sold securities at gains to restore the statutory surplus lost. The following chart sets forth the reasons that bonds were disposed of, the book value of bonds disposed of and the gains (losses) on dispositions for the years ended December 31, 1994, 1993, and 1992:
In managing the relationship between its assets and liabilities, the company utilizes models which determine the cash flows necessary to meet the expected cash needs on the underlying liabilities under various interest rate scenarios. The company also utilizes these models to determine the dollar value of securities that would need to be sold under each interest rate scenario so as to determine what portion of its investment portfolio needs to be carried on its balance sheet as "available-for-sale." In addition, certain
conditions specific to an individual security (such as deterioration in credit quality) may result in a security being carried as "available-for-sale." For a discussion of the impact of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" see Note 1 of Notes to Consolidated Financial Statements. The carrying value, estimated market value, unrealized gains, and unrealized losses in non-investment grade bonds owned as of December 31, 1993, and December 31, 1992, were $84.1 million and $78.4 million, respectively, $86.3 million and $74.5 million, respectively, $2.8 million and $.6 million, respectively, and $.6 million and $4.5 million, respectively. The carrying value and estimated market value of securities which are not actively traded in a liquid market as of December 31, 1993 and December 31, 1992, were $.1 million and $.1 million, respectively. The market values of corporate debt securities rated below investment grade and comparable unrated securities tend to be more sensitive to issuer-specific developments and changes in economic conditions than higher rated securities. Issuers of these securities are often highly leveraged, so that their ability to service their debt obligations during an economic downturn or during sustained periods of rising interest rates may be impaired. In addition, such issuers may not have other methods of financing available to them, and may be unable to repay debt at maturity by refinancing. The risk of loss due to default in payment of interest or principal by such issuers is significantly greater than with inves tment grade issuers for the previously mentioned reasons and because such securities frequently are subordinated to the prior payment of senior indebtedness. As of December 31, 1993, the carrying value of the company's five largest investment in securities rated non-investment grade by both Standard & Poor's Corporation ("S&P") and Moody's Investors Service, Inc. ("Moody's") aggregated $24.3 million, with an approximate market value of $25.2 million, none of which individually exceed $6.0 million. For a list of all investments exceeding 10% of stockholders' equity including those classified as non-investment grade by the company, seeNote 2 of Notes to Consolidated Financial Statements. The company's allowance for credit losses was $2.2 million, $2.5 million and $2.5 million on December 31, 1994, 1993 and 1992, respectively. As of December 31, 1994, December 31, 1993 and December 31, 1992, the book value of non-investment grade bonds were $136.9 million, $84.1 million and $78.4 million, respectively. The amount of non-investment grade bonds held affects the amount of credit risk in the company's portfolio more significantly than do the amounts of investment grade bonds.
AMVESTORS FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (continued) Increase (Decrease) in Cash and Cash Equivalents
AMVESTORS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1994, 1993 and 1992 1. Summary of Significant Accounting Policies: _________________________________________________ A. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of AmVestors and its wholly-owned subsidiaries American Investors Life Insurance Company, Inc. (American), American Investors Sales Group, Inc. (American Sales), AmVestors Investment Group, Inc. (AIG) and Omni-Tech Medical, Inc. (Omni-Tech), (collectively the company). All significant intercompany accounts and transactions have been eliminated. B. INVESTMENTS: Debt securities held-to-maturity are carried at amortized cost, except that those securities with an other than temporary impairment in value are carried at estimated net realizable value. Beginning in 1994, debt securities available-for-sale are carried at estimated market value, with any unrealized gains or losses recorded in stockholders' equity. In 1993, debt securities classified as available-for-sale were carried at the lower of aggregate cost or estimated market value, with any unrealized loss recorded in stockholders' equity. Investments are reviewed on each balance sheet date to determine if they are impaired. In determining whether an investment is impaired, the company considers whether the decline in market value at the balance sheet date is an other than temporary decline; if so, then the investment's carrying value is reduced to a new cost basis which represents estimated net realizable value. The decline in value is reported as a realized loss, and a recovery from the new cost basis is recognized as a realized gain only at sale. The estimates of net realizable value are based on information obtained from published financial information provided by issuers, independent sources such as broker dealers or the company's independent investment advisors. Such amounts represent an estimate of the consideration to be received in the future when the defaulted company's debt is settled through the sale of their assets or the restructuring of their debt. These estimates do not represent the discounted present value of these future considerations. An allowance for credit losses has been recorded to reduce total investments by charging investment losses. The recorded allowance reflects management's estimate of losses existing in the investment assets, which may occur in the future due to conditions unknown to management at this time. Management periodically reviews the adequacy of the allowance for credit losses. As credit losses are realized, they are charged against the allowance. Investments in common stock and non-redeemable preferred stock are carried at market. The cost of securities sold is determined on the identified certificate basis. Other long-term investments include policy loans and mortgage loans on real estate which are carried at cost less principal payments since date of acquisition, and certain partnership investments which are carried at an amount equal to the company's share of the partnerships' estimated market value with any unrealized gains or losses recorded in net investment income. C. FAIR VALUE OF FINANCIAL INSTRUMENTS: Estimated fair value amounts have been determined by the company using available market information and appropriate valuation methodologies. Due to the fact that considerable judgment is required to interpret market data to develop the estimates of fair value, the estimates presented are not necessarily indicative of the amounts that could be realized in a current market exchange.
DEBT SECURITIES - Fair values are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. EQUITY SECURITIES - Fair value equals the carrying value as these securities are carried at quoted market value. OTHER LONG-TERM INVESTMENTS - For certain homogeneous categories of mortgage loans, fair value is estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. Fair value of policy loans and other long-term investments is estimated to approximate the assets' carrying value. SHORT-TERM INVESTMENTS AND CASH AND CASH EQUIVALENTS - The carrying amounts reported in the balance sheet approximate the assets' fair value. AMOUNTS RECEIVABLE ON SECURITIES SETTLEMENTS IN PROCESS - The carrying amount reported in the balance sheet approximates the fair value of this asset. ACCOUNTS RECEIVABLE AND ACCRUED INVESTMENT INCOME - The carrying amounts reported in the balance sheet approximate fair value. FUTURE POLICY BENEFITS FOR INVESTMENT CONTRACTS - The fair values for deferred annuities were estimated to be the amount payable on demand at the reporting date as those investment contracts have no defined maturity and are similar to a deposit liability. The amount payable at the reporting date was c alculated as the account balance less any applicable surrender charges. OTHER POLICY LIABILITIES - The carrying amount reported in the balance sheet approximates the fair value of these liabilities. AMOUNTS DUE ON SECURITIES SETTLEMENTS IN PROCESS - The carrying amount reported in the balance sheet approximates the fair value of this liability.
Certain limited partnership investments are included in income from other long-term investments. These funds (commonly referred to as hedge funds) are managed by outside investment advisors. The investment guidelines of these partnerships provide for a broad range of investment alternatives, including stocks, bonds, futures, options, commodities, and various other financial instruments. These investments were purchased with the strategy that yield in excess of the S&P 500 Index may be obtained. The partnerships are carried at an amount equal to the company's share of the partnerships' estimated market value with related unrealized gains and losses recorded in net investment income. In accordance with the permitted guidelines, the investments purchased by these partnerships may experience greater than normal volatility which could materially effect the company's earnings for any given period. The maturity of the company's debt and equity securities portfolio as of December 31, 1994 was as follows:
The company defines high-yield securities as those corporate debt obligations rated below investment grade by Standard & Poor's and Moody's or, if unrated, those that meet the objective criteria developed by the company's independent investment advisory firm. Management believes that the return on high-yield securities adequately compensates the company for additional credit and liquidity risks that characterize such investments. In some cases, the ultimate collection of principal and timely receipt of interest is dependent upon the issuer attaining improved operating results, selling assets or obtaining financing. The book value, estimated market value and unrealized market gains and losses by type of mortgage-backed security as of December 31, 1994, and December 31, 1993 were as follows:
2. Investments (cont.): _______________________ The above table includes bonds of one issuer which the company had classified as held-to-maturity. These bonds have a book value of $8,507,732 and the sale resulted in a realized loss of $205,526. The decision to sell these bonds was based upon a significant deterioration in the issuer's creditworthiness. In addition to the above sales, the company transferred bonds of two issuers from held-to-maturity to available-for-sale as a result of an increase in the risk weights used for regulatory risk-based capital purposes. The book value of these bonds was $16,960,874. Bonds of another issuer with a book value of $1,721,460 were also transferred from held-to-maturity to available-for-sale based upon a significant deterioration in the issuer's creditworthiness. Net unrealized gains (losses) on debt securities held-to-maturity, debt securities available-for-sale, equity securities available-for-sale and other long-term investments changed as follows:
At December 31, 1994 and 1993, investments with statutory carrying values of $1,866,074,033 and $1,736,404,701 respectively, were on deposit with various insurance departments. These amounts exceeded the minimum required deposits by $66,325,834 and $57,640,783 as of December 31, 1994 and 1993, respectively. 3. Related Party Transactions: ______________________________ On January 22, 1991, the company made a $504,000, 30 year, first mortgage loan on the personal residence of a Director. At the time the loan was made, it represented a loan to value of 80%. This loan originally provided for interest at the rate equal to the cost of funds of the Eleventh District of the Federal Reserve, plus two percent and had a final payment due February 1, 2021. On December 10, 1992 the terms of the loan were renegotiated to provide for interest to be fixed at a rate of 7.5% and a final payment due January 10, 2008. The outstanding principal balances on this loan were $11,815 and $205,059 as of December 31, 1994 and 1993, respectively.
5. Reinsurance: ________________ The company reinsures portions of insurance it writes. The maximum amount of risk retained by the company on any one life is $150,000. A summary of reinsurance data follows (000's Omitted):
The company had amounts receivable under reinsurance agreements of $149,656,094 and $151,392,088 as of December 31, 1994, and December 31, 1993, respectively. Of the amounts, $147,949,099 and $149,468,739 were associated with a single reinsurer. In 1989, the company entered into a coinsurance agreement which ceded 90% of the risk on the company's block of single premium whole life policies written prior to 1989 to Employers Reassurance Corporation (ERC). The agreement provides that ERC assumes 90% of all risks associated with each policy in the block.
The following table identifies the components of the amounts receivable from ERC:
6. Credit Agreement: ____________________ On December 29, 1994, the company entered into a credit agreement with The First National Bank of Chicago (First Chicago) and Boatmen's First National Bank of Kansas City (Boatmen's), as Lenders. Under the terms of this agreement, the Lenders have committed to lend up to $25,000,000 in the form of a 5-year reducing revolving credit facility. The company has agreed to pay a commitment fee of .25% per annum on the unused portion of the commitment. Borrowings under this agreement may be used for general corporate purposes. Interest on the borrowings under this agreement is determined at the option of the company to be: (i) a fluctuating rate of interest equal to the higher of the corporate base rate announced by First Chicago from time to time, and a fluctuating rate equal to the weighted average of rates on overnight Federal Funds transactions with members of the Federal Reserve System as published by the Federal Reserve Bank of New York plus .50% per annum, or (ii) a Eurodollar rate plus a margin ranging from 1.00% to 1.25%. In addition to general covenants which are customary for facilities such as this, the company has agreed to maintain minimum consolidated net worth, a minimum cash flow coverage ratio, minimum risk based capital for American, minimum capital, surplus and asset valuation reserve of American and to maintain a maximum debt to equity(including indebtedness) ratio. Additional covenants include: (i) limitations on acquisitions; (ii) maintenance of current lines of business; (iii) limitations on additional indebtedness; (iv) limitations on investments; (v) limitations on dividends and stock repurchases, and (vi) limitations on mergers, consolidations and sales of assets, typical of such facilities. At December 31, 1994, there had been no borrowings under this agreement. 7. Retirement Plans: ____________________ The company sponsors an Employee Stock Ownership Plan (ESOP) for all full-time employees with one year of service. Qualifying participants may contribute an amount not to exceed ten percent of covered compensation. The company made no contributions to the plan during the three years ended December 31, 1994. The company sponsors a Leveraged Employee Stock Ownership Plan (LESOP) for all full-time employees with one year of service. The LESOP has acquired 370,244 shares of the company's stock through the proceeds of a note payable to American. The note bears interest at 7.0% and is payable in annual installments through December 30, 2002. The note had unpaid principal balances of $3,336,038 and $3,639,922 as of December 31, 1994 and 1993, respectively. Each year, the company makes contributions to the LESOP which are to be used to make loan interest and principal payments. On December 31 of each year, a portion of the common stock is allocated to participating employees. Of the 368,079 shares of the company's common stock now owned by the LESOP, 99,704 shares have been allocated to the
9. Stockholders' Rights Plan: ______________________________ On June 30, 1994, the company's Board of Directors voted to repeal the 1988 Stockholders' Rights Plan and set the close of business on July 22, 1994 as the record date for the payment of the one cent per share redemption price. Stockholders of record were paid on August 8, 1994, in full redemption of the rights under the plan. The total amount to redeem the Rights was $101,432. 10. Income From Disposal of Private Placement Securities _____________________________________________________ Income from disposal of private placement securities was $5.8 million in 1992. During 1988, 1989, and 1990, American purchase private placement securities believed to have a quality rating equivalent to "BBB" by S&P. In 1992, the company engaged an independent firm to review the private placement portfolio. That review determined those securities would have been rated "BB"-"B" if they had been rated by S&P when issued and that the total market value of the securities at the time of the report was approximately $5.8 million less than the par value of these securities. On September 21, 1992, an affiliate of the placement agent agreed to purchase the bonds at their par value, which approximated the company's cost. Several of these bonds had been written down in an amount totalling $2.1 million during 1990, 1991 and 1992 when declines in value were considered to be other than temporary. The effect on 1992 operations of this transaction was a net investment loss of $4.3 million representing the difference between the market value at the time of the sale and the GAAP book carrying value of the securities, and $5.8 million of income from the disposal of private placement securities, representing the amount received in excess of market value. There were no similar transactions in 1994 or 1993.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 13. Commitments and Contingencies: ________________________________ The company's insurance subsidiary is subject to state guaranty association assessments in all states in which it is admitted. Generally these associations guarantee specified amounts payable to residents of the state under policies issued by insolvent insurers. Most state laws permit assessments or some portion thereof to be credited against future premium taxes. Charges (credits) relating to guaranty fund assessments impacted 1994, 1993 and 1992 income before taxes by approximately $(368,000), $1,594,000 and $1,834,000, respectively. The company expects that further charges to income may be required in the future and will record such amounts when they become known. 14. Quarterly results (Unaudited): ________________________________ The company's quarterly results are set forth in the following table: