The Company's executive offices consist of approximately 33,000 square feet of leased space located at 699 Walnut Street, Des Moines, Iowa. AmerUs Life and Delta share executive offices consisting of approximately 103,000 square feet located at 611 Fifth Avenue, Des Moines, Iowa. AmerUs Life also leases approximately 56,000 square feet of additional office space in Des Moines. The Company, AmerUs Life and Delta lease their executive offices from AmerUs Properties, Inc., an affiliate. AmVestors occupies approximately 60,000 square feet in a building owned by AmVestors with approximately 105,000 square feet, the remainder of which is leased to third parties.
The following table sets forth certain financial and operating data of the Company. The selected consolidated financial data below for each of the five years ending December 31, 1997 are derived from the Consolidated Financial Statements of the Company, which financial statements have been audited by KPMG Peat Marwick LLP, independent auditors. During 1997, the Company acquired Delta and AmVestors in transactions that were accounted for using the purchase method of accounting. As a result, the Consolidated Income Statement Data includes the results of Delta and AmVestors from their respective acquisition dates and the Consolidated Balance Sheet Data includes year-end data for Delta and AmVestors.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Consolidated Financial and Operating Data and Consolidated Financial Statements and related notes.
The following table reflects net income adjusted to eliminate certain items (net of applicable income taxes) which management believes are not necessarily indicative of overall operating trends, including net realized gains or losses on investments. Different items are likely to occur in each period presented and others may have different opinions as to which items may warrant adjustment. The adjusted operating income shown below does not constitute net income computed in accordance with GAAP.
The Company acquired all of the outstanding stock of Delta in October, 1997, for approximately $165 million in cash. The transaction was accounted for as a purchase and accordingly, the Company's results of operations include Delta from the date of purchase. The Company acquired all of the outstanding stock of AmVestors on December 19, 1997, in a stock exchange valued at approximately $350 million. This transaction was also accounted for as a purchase and the Company's results of operations include AmVestors from the date of purchase. (See note 14 to the note to Consolidated Financial Statements for the discussion of the Company's acquisitions.)
Since the operating results from the Closed Block are reported on one line of the income statement, "Contribution from the Closed Block," individual income statement components are not fully comparable with those prior to the establishment of the Closed Block. Management believes that the presentation of the results of operations on a combined basis as if the Closed Block had not been formed facilitates comparability with the results of operation for 1996 prior to the formation of the Closed Block and for 1995. Accordingly, the combined presentation set forth below includes certain revenues and expenses associated with the policies included in the Closed Block. Such presentation does not, however, affect the Company's reported net income.
A summary of the Company's combined revenues, including revenues associated with the Closed Block, follows:
In 1997, individual life and annuity premiums and product charges increased by $11.2 million to $315.0 million, or 3.7%, from $303.8 million in 1996 and compared to $294.8 million in 1995. Included in the 1997 increase was $1.2 million of premium and product charges earned in the fourth quarter primarily from the Delta acquisition. Insurance premiums increased by $7.5 million, to $254.3 million in 1997 compared to $246.8 million in 1996, and $244.1 million in 1995. Traditional life insurance premiums increased by $7.9 million in 1997, compared to a $9.3 million increase experienced in 1996. The increase in traditional life insurance premiums in 1997 and 1996 has primarily been the result of continued growth in renewal premiums and also the increased sales of term life insurance products in 1997. Changes in the level of immediate annuity deposits and supplementary contract premiums have primarily been the result of fluctuations in immediate annuity and supplementary contract sales. Other premiums have decreased significantly over the past two years primarily due to the Company's exit from several group life and long-term disability reinsurance pools in 1995 and the sale of the Company's remaining group life operation in 1996.
Universal life product charges have increased slightly in each of the past two years primarily due to increased cost of insurance charges as a result of the normal aging of the block of business. Annuity product charges for 1997 included $0.7 million earned in the fourth quarter by recently acquired companies.
Net investment income increased by $53.3 million to $338.2 million in 1997 compared to $284.9 million in 1996, and $285.2 million in 1995. Included in the 1997 increase in net investment income was $30.2 million of net investment income from recently acquired companies during the fourth quarter. The remaining $23.1 million increase in 1997 was attributable to an increase in average invested assets and effective yields on average invested assets. Average invested assets (excluding market value adjustments and acquisitions) in 1997 increased $111.5 million from 1996, and the effective yield on average invested assets (excluding market value adjustments and acquisitions) increased to 7.89% in 1997 from 7.55% in 1996. Contributing to the higher yields in 1997 was investment income of $10.1 million from equity in earnings of certain investment partnerships. Average invested assets (excluding market value adjustments) increased by $171.8 million in 1996, largely as a result of the investment of $175.0 million in proceeds from bank borrowings late during the year. The effective yield on average invested assets (excluding market value adjustments) decreased to 7.55% in 1996 from 7.88% in 1995, primarily as a result of lower bond yields and the timing of the investment of the proceeds from the bank borrowing.
Realized gains on investments were $14.5 million in 1997 compared to gains of $66.4 million and $51.4 million in 1996 and 1995, respectively. Included in the amounts for 1996 were approximately $51.1 million of gains from the sale of common stock as a result of the liquidation of the Company's equity portfolio which commenced in 1995. The increase in gains in 1996 resulted primarily from increased sales of common stock in the investment portfolio. The sale of common stock in 1996 and 1995 was a direct result of the Company's decision to reduce the level of equity securities as a percentage of its investment portfolio on a long-term basis. Proceeds from these sales were invested primarily in fixed maturity securities.
A summary of the Company's combined policyowner benefits, including policyowner benefits associated with the Closed Block, follows:
Annuity benefits, including the fourth quarter results of recent acquisitions, were $117.6 million, an increase of $17.0 million compared to 1996. The annuity benefits of recent acquisitions amounted to $23.2 million which were partially offset by a $6.2 million decrease in AmerUs Life's annuity benefits to $94.4 million compared to $100.6 million in 1996. The decrease in AmerUs Life's annuity benefits during 1997 was due to reduced interest credited to policyowner account balances. The weighted average crediting rate for AmerUs Life's individual deferred annuity liabilities decreased eleven basis points to 5.25% in 1997 compared to 5.36% in 1996 and AmerUs Life's average deferred annuity liabilities decreased $119.1 million from 1996 to 1997, also contributing to the lower interest credited amounts in 1997 for AmerUs Life. Most annuity sales after May, 1996 have been recorded by the Ameritas Joint Venture, resulting in a decrease in the average deferred annuity liabilities at AmerUs Life. Annuity benefits decreased by $13.1 million in 1996 to $100.6 million compared to $113.7 million in 1995, primarily due to reduced interest credited to policyowner account balances. The weighted average crediting rate for AmerUs Life's individual deferred annuity liabilities decreased 80 basis points to 5.36% in 1996 compared to 6.16% in 1995 and AmerUs Life's average deferred annuity liabilities decreased by $71.0 million from 1995 to 1996, also contributing to the lower interest credited amounts in 1996.
A summary of the Company's combined expenses, including expenses associated with the Closed Block, follows:
The Company's commission expense, net of deferrals, increased by $0.4 million to $8.3 million in 1997 compared to $7.9 million in 1996, and $10.4 million in 1995. The increase in 1997 was primarily the result of the fourth quarter commission expense, net of deferrals of the Company's recent acquisitions. The reduction in 1996 was primarily due to a decrease in gross commission expense as a result of lower life insurance sales in 1996 and the transfer of new annuity sales to the Ameritas Joint Venture in May 1996. Other underwriting, acquisition and insurance expenses, net of deferrals, were $50.0 million in 1997, compared to $49.9 million in 1996 and $40.5 million in 1995. Included in the 1997 expenses were $4.1 million of fourth quarter expenses, net of deferrals, attributable to the recently acquired companies.
Dividends to policyowners increased by $5.7 million to $61.2 million in 1997 compared to $55.5 million in 1996 and $49.4 million in 1995. The increase in dividends over each of the past two years was primarily the result of the growth and aging of in force business. Traditional life reserves grew 7.7% from the end of 1995 to the end of 1996 and an additional 8.1% to the end of 1997, to $1.31 billion. The weighted average dividend interest rate credited to these policies was 7.19% in 1997 compared to 7.17% and 7.14% in 1996 and 1995, respectively.
Income before income tax expense and equity in earnings of unconsolidated subsidiary decreased by $38.6 million to $78.4 million in 1997 compared to $117.0 million in 1996, and $110.5 million in 1995. While acquisitions added $3.3 million of income before income tax expense during the fourth quarter, the overall decrease in 1997 income resulted primarily from the decrease in realized gains on investments in 1997. The increase in 1996 resulted primarily from the increase in realized gains on investments.
Income tax expense decreased by $21.8 million in 1997 to $22.0 million compared to $43.8 million in 1996, and $41.2 million in 1995. The decrease in 1997 was primarily due to the lower pre-tax income as a result of the lower realized gains on investments, a $4.5 million provision for the equity add-on tax included in the first half of 1996, and increased tax credits of $3.9 million in 1997. The increase in income taxes in 1996 was primarily the result of the higher pre-tax income due primarily to the increased realized gains on investments and the $4.5 million provision for the equity add-on tax in the first half of 1996, partially offset by $2.7 million of low-income housing tax credits. The equity add-on tax is applicable only to mutual life insurance companies and the Company believes such tax is not applicable to the Company after June 30, 1996 due to the conversion of AmerUs Life into a stock company.
Net income decreased by $16.1 million in 1997 to $58.1 million compared to $74.2 million and $69.3 million in 1996 and 1995, respectively. Net income for 1997 included $1.8 million from acquisitions during the fourth quarter. The overall lower net income for 1997 was primarily due to lower realized gains on investments. The increase in net income from 1995 to 1996 was primarily due to higher realized gains on investments.
The Company's cash flows from operations consist of dividends from subsidiaries, if declared and paid, interest income on loans and advances to its subsidiaries (including a surplus note issued to the Company by AmerUs Life), investment income on assets held by the Company and fees which the Company charges its subsidiaries and certain other of its affiliates for management services, offset by the expenses incurred for debt service, salaries and other expenses.
The Company intends to rely primarily on dividends and interest income from its life insurance subsidiaries in order to make dividend payments to its shareholders. The payment of dividends by its life insurance subsidiaries is regulated under various state laws. Under Iowa law, AmerUs Life and Delta Life may pay dividends only from the earned surplus arising from their respective businesses and must receive the prior approval of the Iowa Commissioner to pay any dividend that would exceed certain statutory limitations. The current statutory limitation is the greater of (i) 10% of the respective company's policyowners' surplus as of the preceding year end or (ii) the net gain from operations for the previous calendar year. Iowa law gives the Iowa Commissioner broad discretion to disapprove requests for dividends in excess of these limits. Based on this limitation and 1997 results, AmerUs Life and Delta Life would be able to pay approximately $58 million and $8 million, respectively, in dividends in 1998 without obtaining the Iowa Commissioner's approval. The payment of dividends by American and FBL is regulated under Kansas law, which has statutory limitations similar to those in place in Iowa. Based on these limitations and 1997 results, AmVestors' subsidiaries could pay approximately $15 million in dividends in 1998. On February 26, 1998, AmerUs Life paid the Company $5 million in dividends. Based upon the cumulative limitations and 1997 results, the Company's subsidiaries could pay an estimated $75 million in additional dividends in 1998 without obtaining regulatory approval.
The cash flows of the Company's life insurance subsidiaries consist primarily of premium income, deposits to policyowner account balances, income from investments, sales, maturities and calls of investments and repayments of investment principal. Cash outflows are primarily related to withdrawals of policyowner account balances, investment purchases, payment of policy acquisition costs, payment of policyowner benefits, income taxes and current operating expenses. Life insurance companies generally produce a positive cash flow from operations, as measured by the amount by which cash flows are adequate to meet benefit obligations to policyowners and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business.
The Company and its subsidiaries generated cash flows from operating activities of $224.4 million, $147.6 million and $189.1 million for the years ended December 31, 1997, 1996 and 1995, respectively. Excess operating cash flows were primarily used to increase the Company's fixed maturity investment portfolio.
Matching the investment portfolio maturities to the cash flow demands of the type of insurance being provided is an important consideration for each type of life insurance product and annuity. The Company continuously monitors benefits and surrenders to provide projections of future cash requirements. As part of this monitoring process, the Company performs cash flow testing of its assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing its investment strategy, the Company establishes a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage-backed securities, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations. There can be no assurance that future experience regarding benefits and surrenders will be similar to historic experience since withdrawal and surrender levels are influenced by such factors as the interest rate environment and the claims-paying and financial strength ratings of the Company's life insurance subsidiaries.
The Company's life insurance subsidiaries may also obtain liquidity through sales of investments or borrowings collateralized by their investment portfolios. The Company's investment portfolio as of December 31, 1997 had a carrying value of $8.9 billion, including Closed Block investments. As of December 31, 1997, fixed maturity securities were $7.9 billion, or 88.9% of invested assets, with public and private fixed maturity securities constituting $7.5 billion, or 95.4%, and $0.4 million, or 4.6%, of total fixed maturity securities, respectively.
The objective of the Company's investment in mortgage backed securities ("MBS") is to provide incremental return, while maintaining reasonable liquidity and cash flow stability. Each MBS is evaluated to determine its interest rate sensitivity and average life variability. In general, the Company seeks investments which provide improved cash flow stability through either implicit or explicit prepayment protection. Investments with implicit prepayment protection can take the form of pass-throughs or collateralized mortgage obligations ("CMOs") backed by seasoned pools of loans which have already had ample opportunity to refinance but have failed to do so. Explicit prepayment protection can take the form of prepayment lockouts, yield maintenance provisions or prepayment penalties, which are common features of multifamily MBS, commercial MBS and FHA-insured project loans. At December 31, 1997 the Company's MBS investment portfolio composition was approximately 54% fixed rate pass-throughs backed by seasoned loan pools, 5% floating rate pass-throughs and 41% CMOs with some form of explicit prepayment protection. The Company has established specific investment guidelines for the management of MBS. As a general policy, the Company does not invest in interest-only and principal-only or other similar leveraged derivative mortgage instruments.
The following table summarizes the composition of the fixed maturity securities by category as of December 31, 1997 and 1996:
Commercial mortgage loans consist primarily of fixed-rate mortgage loans. As of December 31, 1997, the Company held 435 individual commercial mortgage loans with an average balance of $1.1 million.
As of December 31, 1997, only five loans aggregating $2.0 million, or .9%, of the Company's loan portfolio (as measured by principal balance) were classified as delinquent or in foreclosure. As of the same date, only $4.4 million, or 0.9%, of the Company's loan portfolio (as measured by principal balance) was classified as restructured. During 1997, the Company had no foreclosures.
In recent years the Company has significantly reduced its equity real estate portfolio. As of December 31, 1997, the carrying value of investment real estate, including the Closed Block, was $8.7 million.
As of December 31, 1997, the Company held equity securities of $61.5 million. The largest holding of equity securities, Federal Home Loan Bank, had a carrying value of $62.2 million as of December 31, 1997.
Interest rate changes may have temporary effects on the sale and profitability of the annuities and life insurance products offered by the Company. For example, if interest rates rise, competing investments (such as annuities or life insurance products offered by the Company's competitors, certificates of deposit, mutual funds, and similar instruments) may become more attractive to potential purchasers of the Company's products until the Company increases the interest rate credited to owners of its annuities and life insurance products. In contrast, as interest rates fall, the Company attempts to adjust its credited rates to compensate for the corresponding decline in reinvestment rates. The Company monitors interest rates and sells annuities and life insurance policies that permit flexibility to make interest rate changes as part of its management of interest spreads. However, the profitability of the Company's products is based upon persistency, mortality and expenses, as well as interest rate spreads.
Inforce reserves and the assets allocated to each segment are modeled on a regular basis to analyze projected cash flows under a variety of economic scenarios. The result of this modeling is used to modify asset allocation, investment portfolio duration and convexity and renewal crediting strategies. The Company invests in CMOs as part of its basic portfolio strategy, but uses other types of derivatives only as a hedge against the effects of interest rate fluctuations or to synthetically alter the investment characteristics of specific assets. For a further discussion and disclosure of the nature and extent of the Company's use of derivatives, see Note 13 to the Consolidated Financial Statements.
Until February 3, 1997, the Company and its subsidiaries, with the exception of American Vanguard Life Insurance Company, filed as part of a consolidated United States federal income tax return with AMHC and its subsidiaries. For the short tax year beginning February 4, 1997, the Company and its subsidiaries will not file as part of a consolidated United States federal income tax return with AMHC. Further, the Company and its subsidiaries (including AmerUs Life, Delta and AmVestors) would not be eligible to file a consolidated life/non-life United States federal income tax return until January 1, 2003, subject to the other requirements of federal income tax law relating to consolidation.
In June 1997, the FASB issued Statement 130, "Reporting Comprehensive Income." SFAS 130 establishes standards for reporting and display of comprehensive income and its components: revenues, expenses, gains, and losses. All items that are required to be recognized under accounting standards as components of comprehensive income, consisting of changes in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources, are to be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 is effective for financial statements beginning after December 15, 1997. The provisions of SFAS 130 are of a reporting nature and are not expected to have an impact on the financial position or results of operations of the Company.
In June 1997, the FASB issued Statement 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 establishes standards for the way that public businesses report information about operating segments in financial statements. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. SFAS 131 is effective for financial statements for periods beginning after December 15, 1997. The provisions of SFAS 131 are of a reporting nature and are not expected to have an impact on the financial position or results of operations of the Company as the life insurance and annuity operation is the Company's only business segment.
In February 1998, the FASB issued Statement 132, "Employer's Disclosure about Pensions and Other Postretirement Benefits". SFAS 132 standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on the benefit obligations and fair values of plan assets and on changes in the benefit obligations and fair values of plan assets and eliminates certain disclosures. SFAS 132 is effective for financial statements for periods beginning after December 15, 1997. The provisions of SFAS 132 are of a reporting nature and are not expected to have an impact on the financial position or results of operations of the Company.
In December 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." This statement provides guidance on when an insurance or other enterprise should recognize a liability for guaranty fund and other assessments and on how to measure such liability. SOP 97-3 is effective for fiscal years beginning after December 15, 1998; however, its adoption will not have a material impact on the financial position or results of operations as the Company currently estimates assessment liabilities when a determination of an insolvency has occurred.
As the year 2000 approaches, an important business issue has emerged regarding how existing application software programs and operating systems can accommodate the date value "2000." Many existing application software products were designed to only accommodate a two digit date position which represents the year (e.g., the number "95" is stored on the system and represents the year 1995). As a result, the year 1999 (i.e., "99") is the maximum date value many systems will be able to accurately process. The Company formed a year 2000 working group to address potential problems posed by this development to assure that the Company is prepared for the year 2000. The Company has already made significant progress in accomplishing the necessary modifications and conversions to deal with year 2000 issues and anticipates that the majority of the required efforts will be completed by the end of 1998. Management does not anticipate that the Company will incur significant operating expenses or be required to invest heavily in computer system improvements to address year 2000 issues. Total estimated costs are in a range of $4 to $6 million with approximately $3 million to be incurred in 1998. However, if modifications and conversions to deal with year 2000 issues are not completed on a timely basis or are not fully effective, such issues may have a material adverse effect on the operations of the Company. All cost associated with year 2000 modifications and conversions will be expensed as incurred.