The Company's executive offices and the principal offices of its life insurance subsidiaries are in leased premises at 1 SunAmerica Center, Los Angeles, California. The Company's life insurance subsidiaries also lease office space in Woodland Hills, California; Houston, Texas; and New York, New York. The Company's broker-dealers lease space in Phoenix, Arizona; San Diego, California; Atlanta, Georgia; New York, New York and Houston, Texas. The Company's asset management subsidiary leases offices in New York, New York. The retirement trust services subsidiary occupies leased premises in Englewood, Colorado. The Company's premium finance subsidiary is headquartered in Sherman Oaks, California.
NET INCOME totaled $516.3 million ($2.61 per basic share and $2.34 per diluted share) in 1998, compared with $379.1 million ($2.01 per basic share and $1.81 per diluted share) in 1997 and $274.4 million ($1.44 per basic share and $1.32 per diluted share) in 1996. On March 31, 1997, the Company acquired certain annuity contracts from John Alden Life Insurance Company and all of the outstanding common stock of John Alden Life Insurance Company of New York (collectively, the "John Alden Acquisition"). During fiscal 1996, the Company acquired CalAmerica Life Insurance Company ("CalAmerica") on December 29, 1995; Ford Life Insurance Company ("Ford Life") on February 29, 1996; and certain annuity contracts from The Central National Life Insurance Company of Omaha (the "Central National Annuity Contracts") on April 1, 1996 (collectively, the "1996 Acquisitions"). The John Alden Acquisition and the 1996 Acquisitions (collectively, the "Acquisitions") were accounted for under the purchase method of accounting, and, therefore, results of operations include those of the Acquisitions only from their respective dates of acquisition. Consequently, operating results for fiscal years 1998, 1997 and 1996 are not comparable. On a pro forma basis, using the historical operating results of the acquired businesses and assuming the Acquisitions had been consummated on October 1, 1995, the beginning of the earliest period discussed herein, net income would have been $397.4 million ($2.11 per basic share and $1.90 per diluted share) in 1997 and $323.2 million ($1.73 per basic share and $1.56 per diluted share) in 1996.
Net investment spreads include the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. This excess amounted to $1.88 billion in 1998, $1.15 billion in 1997 and $1.06 billion in 1996. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.93% in 1998, 2.95% in 1997 and 3.01% in 1996. On a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1995, the Spread Difference would have been 2.91% in 1997 and 2.82% in 1996.
Partnership income increased to $371.1 million (a yield of 23.42% on related average assets of $1.58 billion) in 1998, compared with $241.5 million (a yield of 21.00% on related average assets of $1.15 billion) in 1997 and $178.6 million (a yield of 19.04% on related average assets of $937.8 million) in 1996. Partnership income includes income recognized by using the cost method of accounting, which amounted to $211.2 million in 1998, $114.7 million in 1997 and $82.1 million in 1996. Such income is based primarily upon cash distributions received from limited partnerships, the operations of which the Company does not influence. Consequently, such income is not predictable and there can be no assurance that the Company will realize comparable levels of such income in the future.
GROWTH IN AVERAGE INVESTED ASSETS since 1996 primarily reflects the impact of the Acquisitions and growth of the Company's GIC reserves. The Company acquired $722.5 million of invested assets of CalAmerica on December 29, 1995, $3.10 billion of invested assets of Ford Life on February 29, 1996, $908.8 million of invested assets associated with the Central National Annuity Contracts on April 1, 1996 and $5.00 billion of invested assets associated with the John Alden Acquisition on March 31, 1997. The Company intends to continue to pursue a strategy of enhancing its internal growth with complementary acquisitions. On July 15, 1998, the Company entered into a definitive agreement to acquire MBL Life Assurance Corporation's individual life and individual and group annuity business (which has approximately $2 billion of individual life reserves and $3 billion of fixed annuity reserves) for a purchase price of approximately $130 million in cash. The acquisition is subject to customary conditions and required regulatory approvals, and is expected to be completed by the end of December 1998.
GIC premiums increased to $4.01 billion in 1998 from $2.08 billion in 1997 and $1.02 billion in 1996. These amounts represent 72%, 50% and 28% of the GIC reserve balance at the beginning of the respective periods. The increases in GIC premiums reflect an expansion of the GIC client base due, in part, to a broadening of the Company's products and distribution channels, including its AAA-rated company, SunAmerica National Life Insurance Company, and its AAA/Aaa-rated credit-enhanced GIC products, and an expansion of its international client base. The size of the Company's GIC reserves increased over the three-year period to $8.38 billion at September 30, 1998 from $3.61 billion at September 30, 1995.
The GICs issued by the Company generally guarantee the payment of principal and interest at a fixed rate for a fixed term of three to twelve years with an average of approximately 7 years. In the case of GICs sold to pension plans, certain withdrawals may be made at book value in the event of circumstances specified in the plan document, such as employee retirement, death, disability, hardship withdrawal or employee termination. The Company generally imposes surrender penalties in the event of other withdrawals prior to maturity. GICs purchased for their long-term portfolios by banks, asset management firms, certain trusts and state and local governmental entities either prohibit withdrawals or permit scheduled book value withdrawals subject to the terms of the underlying indenture or agreement. GICs purchased by asset management firms for their short-term portfolios either prohibit withdrawals or permit withdrawals with notice ranging from 90 to 270 days. In pricing GICs, the Company analyzes cash flow information and prices accordingly so that it is compensated for possible withdrawals prior to maturity.
The Company sold or redeemed invested assets, principally bonds and notes, aggregating $22.90 billion in 1998, $19.13 billion in 1997 and $11.21 billion in 1996, respectively. Sales of
VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $204.5 million in 1998, $141.2 million in 1997 and $104.7 million in 1996. These increased fees reflect growth in average variable annuity assets, due to increased market values, the receipt of variable annuity premiums and net exchanges into the separate accounts from the fixed accounts of variable annuity contracts, partially offset by surrenders. Variable annuity fees represent 1.9%, 1.8% and 1.8% of average variable annuity assets for 1998, 1997 and 1996, respectively. Variable annuity assets averaged $10.93 billion during 1998, $7.66 billion during 1997 and $5.75 billion during 1996. Variable annuity premiums, which exclude premiums allocated to the fixed accounts of variable annuity products, have aggregated $1.88 billion in 1998, $1.31 billion in 1997 and $929.2 million in 1996. These amounts represent 20%, 20% and 18% of variable annuity reserves at the beginning of the respective periods.
Sales of variable annuity products (which include premiums allocated to the fixed accounts) ("Variable Annuity Product Sales") amounted to $3.47 billion, $2.47 billion and $1.71 billion in 1998, 1997 and 1996, respectively, and primarily reflect sales of the Company's flagship variable annuity, Polaris. Polaris is a multi-manager variable annuity that offers investors a choice of 26 variable funds and 7 guaranteed fixed-rate funds. Increases in Variable Annuity Product Sales are due, in part, to market share gains through enhanced distribution efforts and growing consumer demand for flexible retirement savings products that offer a variety of equity, fixed income and guaranteed fixed account investment choices. In recent weeks, subsequent to the Company's fiscal year end, sales of variable annuities have slowed as investors paused to reevaluate their investment decisions in light of volatile markets. The Company believes that fluctuating market conditions increase the value of financial planning services and make the flexibility and security of variable annuities even more attractive.
NET RETAINED COMMISSIONS are primarily derived from commissions on the sales of non-proprietary investment products by the Company's broker-dealer subsidiaries, after deducting the substantial portion of such commissions that is passed on to registered representatives. Net retained commissions totaled $114.5 million in 1998, $64.9 million in 1997 and $49.8 million in 1996. Broker- dealer sales (mainly sales of general securities, mutual funds and annuities) totaled $29.31 billion in 1998, $17.52 billion in 1997 and $12.78 billion in 1996. The increases in sales and net retained commissions reflect a greater number of registered representatives, higher average production per
SURRENDER CHARGES on fixed and variable annuities totaled $54.4 million (including $37.4 million attributable to the Acquisitions) in 1998, $35.2 million (including $24.5 million attributable to the Acquisitions) in 1997 and $22.1 million (including $11.1 million attributable to the Acquisitions) in 1996. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first seven years of an annuity contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $3.12 billion (including $1.85 billion attributable to the Acquisitions) in 1998, compared with $2.28 billion (including $1.00 billion attributable to the Acquisitions) in 1997 and $1.42 billion (including $245.8 million attributable to the Acquisitions) in 1996. These payments represent 13.2% (23.7% of average fixed annuity reserves associated with the Acquisitions), 12.0% (15.0% of average fixed annuity reserves associated with the Acquisitions) and 11.1% (9.3% of average fixed annuity reserves associated with the 1996 Acquisitions), respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity withdrawals from the separate accounts totaling $964.9 million (8.8% of average variable annuity reserves), $827.3 million (10.8% of average variable annuity reserves) and $637.0 million (11.1% of average variable annuity reserves) in 1998, 1997 and 1996, respectively. Consistent with the assumptions used in connection with the Acquisitions, management anticipates that the level of withdrawal payments will continue to reflect higher relative withdrawal rates in the near future because of higher surrenders on the acquired annuity businesses.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $310.3 million in 1998, compared with $265.7 million in 1997 and $210.7 million in 1996. General and administrative expenses reflect the impact of the Acquisitions, as well as the acquisitions of Sentra-Spelman, Financial Service Corporation and The Financial Group, Inc. As a result, the number of employees has increased to approximately 2,500 at September 30, 1998 from approximately 2,000 at September 30, 1997 and approximately 1,600 at September 30, 1996. As a result, compensation (net of deferrals) has increased to $174.8 million in 1998 from $145.3 million in 1997 and $123.5 million in 1996. 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.
SHAREHOLDERS' EQUITY increased 15.8% to $2.99 billion at September 30, 1998 from $2.58 billion at September 30, 1997, primarily due to $516.3 million of net income recorded in 1998, which was partially offset by $100.5 million of dividends paid to shareholders.
On August 20, 1998, the Company entered into an agreement to merge with American International Group, Inc. ("AIG"). The merger will be treated as a pooling of interests for accounting purposes, and will be a tax-free reorganization. Each share of the Company's Common Stock (including Nontransferable Class B) will be exchanged for 0.855 shares of AIG's common stock. The transaction was approved by both the Company's and AIG's shareholders at special meetings on November 18, 1998. The merger is expected to be completed in late 1998 or early 1999.
INVESTED ASSETS at September 30, 1998 totaled $26.07 billion, compared with $24.41 billion at September 30, 1997. 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 constitutes 72% of the Company's total investment portfolio, had an aggregate fair value that exceeded its amortized cost by $399.2 million at September 30, 1998, compared with an excess of $398.8 million at September 30, 1997.
At September 30, 1998, the Bond Portfolio (excluding $292.0 million of redeemable preferred stocks) included $17.21 billion of bonds rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service ("Moody's"), Duff & Phelps Credit Rating Co. ("DCR"), Fitch Investors Service, L.P. ("Fitch") or the National Association of Insurance Commissioners ("NAIC"), and $1.30 billion of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At September 30, 1998, approximately $16.73 billion of the Bond Portfolio was investment grade, including $6.71 billion of U.S. government/agency securities and mortgage-backed securities ("MBSs").
At September 30, 1998, the Bond Portfolio included $1.78 billion of bonds that were not investment grade. These non-investment-grade bonds accounted for 4.5% of the Company's total assets and 6.8% of its invested assets. In addition to its direct investment in non-investment-grade bonds, the Company has entered into Total Return Agreements with an aggregate notional principal amount of $533.0 million at September 30, 1998 (see "Asset-Liability Matching").
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, two-tiered interest rate structures or other restrictions in order to encourage persistency. Approximately 86% of the Company's fixed annuity and GIC reserves had surrender penalties or other restrictions at September 30, 1998.
As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what
it pays on its liabilities by designing its fixed-rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company's fixed-rate assets include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; and investments in limited partnerships that invest primarily in fixed-rate securities and are accounted for by using the cost method. At September 30, 1998, these assets had an aggregate fair value of $24.36 billion with a duration of 3.7. The Company's fixed-rate liabilities include: fixed annuities; GICs; trust deposits; long-term notes and debentures; and preferred securities of subsidiary grantor trusts. At September 30, 1998, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $23.10 billion with a duration of 3.4. The Company's potential exposure due to a 10% increase in prevailing interest rates from their September 30, 1998 levels is a loss of $50.8 million in fair value of its fixed-rate assets that is not offset by a decrease in the fair value of its fixed-rate liabilities. Because the Company actively manages its assets and liabilities and has strategies in place to minimize its exposure to loss as interest rate changes occur, it expects that actual losses would be less than the estimated potential loss.
As a component of its asset and liability management strategy, the Company utilizes interest rate swap agreements ("Swap Agreements") to match assets more closely to liabilities. Swap Agreements are agreements to exchange with a counterparty interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company typically utilizes Swap Agreements to create a hedge that effectively converts floating-rate assets and liabilities into fixed-rate instruments. At September 30, 1998, the Company had 38 outstanding Swap Agreements with an aggregate notional principal amount of $1.87 billion. These agreements mature in various years through 2010 and have an average remaining maturity of 43 months.
The Company also seeks to provide liquidity from time to time by using reverse repurchase agreements ("Reverse Repos") and by investing in MBSs. It also seeks to enhance its spread income by using Reverse Repos and Total Return Agreements. Reverse Repos involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed upon price and are generally over-collateralized. Total Return Agreements effectively exchange a fixed rate of interest on the notional amount for the coupon income plus or minus the increase or decrease in the fair value of specified non-investment-grade bonds. MBSs are generally investment-grade securities collateralized by large pools of mortgage loans. MBSs generally pay principal and interest monthly. The amount of principal and interest payments may fluctuate as a result of prepayments of the underlying mortgage loans.
The carrying values of investments that are determined to have declines in value that are other than temporary are reduced to net realizable value and, in the case of bonds, no further accruals of interest are made. The provisions for impairment on mortgage loans are based on losses expected by management to be realized on transfers of mortgage loans to real estate, on the disposition and settlement of mortgage loans and on mortgage loans that management believes may not be collectible in full. Accrual of interest is suspended when principal and interest payments on mortgage loans are past due more than 90 days.
DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of principal or interest, totaled $55.0 million at September 30, 1998, including $19.7 million of bonds and notes and $35.3 million of mortgage loans. At September 30, 1998, defaulted investments constituted 0.2% of total invested assets. At September 30, 1997, defaulted investments totaled $38.0 million, including $15.1 million of bonds and notes and $22.9 million of mortgage loans, and constituted 0.2% 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 September 30, 1998, approximately $15.74 billion of the Company's Bond Portfolio had an aggregate unrealized gain of $717.0 million, while approximately $3.06 billion of the Bond Portfolio had an aggregate unrealized loss of $317.8 million. In addition, the Company's investment portfolio currently provides approximately $209.4 million of monthly cash flow from scheduled principal and interest payments. Further, $3.23 billion remains available to the Company to issue securities under a shelf registration statement filed in July 1997. Historically, cash flows from operations and from the sale of the Company's annuity and GIC 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 and GICs 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.
On a parent company stand-alone basis, SunAmerica Inc. (the "Parent"), at September 30, 1998, had invested assets with a fair value of $2.53 billion and outstanding senior indebtedness of $1.22 billion, comprising all of the Company's outstanding senior indebtedness. Additionally, as of September 30, 1998, the Parent had three GICs purchased by local government entities, which aggregated $213.7 million.
During November 1996 and October 1995, respectively, the Parent purchased the common securities of SunAmerica Capital Trust III and SunAmerica Capital Trust II (collectively, the "Grantor Trusts") and issued an aggregate of $511.9 million of junior subordinated debentures (the "Debentures") to the Grantor Trusts in connection with the public issuance of the preferred securities of the Grantor Trusts (see Note 10 of Notes to Consolidated Financial Statements).
The Parent's annual debt service (principal and interest payments) with respect to its senior indebtedness, GIC obligations and Debentures totals $292.0 million for fiscal 1999, $563.5 million for fiscal 2000, $139.0 million for fiscal 2001, $297.4 million for fiscal 2002, $112.3 million for fiscal 2003 and $4.14 billion, in the aggregate, thereafter. On December 6, 1998, the Company is contractually scheduled to receive $431.3 million upon delivery of 10.1 million shares of the Company's Common Stock in accordance with the terms of the Company's PERCS Units.
The Company has transferred to third-party investors certain of its interests in various partnerships that make tax-advantaged affordable housing investments. As part of these transactions, the
In the ordinary course of business, the Company has agreed to make capital contributions, if required, aggregating approximately $670.2 million, to 121 limited partnerships over the next 5 years in exchange for ownership interests in such partnerships.