Management's discussion and analysis of financial condition and results of operations of First SunAmerica Life Insurance Company (the "Company") for the three years in the period ended September 30, 1997 follows. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission (the "SEC"). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect," "anticipate," "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward- looking statements include statements which represent the Company's beliefs concerning future levels of sales and redemptions of the Company's products, investment spreads and yields, or the earnings and profitability of the Company's activities.
on average invested assets (computed on a daily basis) of $176.9 million in 1997, 2.08% on average invested assets of $134.5 million in 1996 and 2.70% on average invested assets of $103.2 million in 1995.
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 $8.0 million in 1997, $13.8 million in 1996 and $17.6 million in 1995. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 1.25% in 1997, 1.47% in 1996 and 1.69% in 1995.
Investment income (and the related yields on average invested assets) totaled $12.8 million (7.22%) in 1997, compared with $10.0 million (7.40%) in 1996 and $7.8 million (7.59%) in 1995. Investment income increased primarily as a result of higher levels of average invested assets, partially offset by a decline in portfolio yields. The higher yield in 1995 reflected the effects of both higher short-term interest rates and extension fee income earned on certain bonds. Decreasing investment yields since 1995 were primarily due to a generally declining interest rate environment.
GROWTH IN AVERAGE INVESTED ASSETS since 1995 primarily reflects the sales of the Company's fixed-rate products, consisting of fixed annuity premiums (including those for the fixed accounts of variable annuity products). Fixed annuity premiums totaled $70.8 million in 1997, compared with $45.4 million in 1996 and $51.7 million in 1995. These premiums include premiums for the fixed accounts of variable annuities totaling $68.9 million, $41.2 million and $2.9 million, respectively, which have increased primarily because of increased sales of the Company's Polaris product and greater inflows into the one-year fixed account of that product. The Company has observed that many purchasers of its variable annuity contracts allocate new premiums to the one-year fixed account and concurrently elect the option to dollar cost average into one or more variable funds. Accordingly, the Company anticipates that it will see a large portion of these premiums transferred into the variable funds.
NET REALIZED INVESTMENT GAINS/LOSSES totaled $0.4 million of gains in 1997, compared to $0.5 million of losses in 1996 and $1.3 million of losses in 1995. Net realized investment losses include impairment writedowns of $0.1 million in both 1997 and 1996. Therefore, net gains from sales of investments totaled $0.5 million in 1997 and net losses from sales of investments totaled $0.4 million in 1996. There were no impairment writedowns in 1995.
The Company sold invested assets, principally bonds and notes, aggregating $48.7 million, $80.0 million and $57.7 million in 1997, 1996 and 1995, respectively. Sales of investments result from the active management of the Company's investment portfolio. Because sales of investments are made in both rising and falling interest rate environments, net gains and losses from sales of investments fluctuate from period to period, and represent 0.25%, 0.27% and 1.31% of average invested assets for 1997, 1996 and 1995, respectively. Active portfolio management involves the ongoing evaluation of
AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $1.2 million in 1997, compared with $0.5 million in 1996 and $0.3 million in 1995. The increases in amortization during the three-year period were primarily due to additional fixed and variable annuity sales and the subsequent amortization of related deferred commissions and other direct selling costs.
INCOME TAX EXPENSE totaled $0.9 million in 1997, compared with $0.4 million in 1996 and $0.2 million in 1995, representing effective tax rates of 45% in 1997, 38% in 1996 and 26% in 1995. The differing tax rates for the three year period reflect changes in state income tax expense.
INVESTED ASSETS at year end totaled $190.2 million in 1997, compared with $153.2 million at year-end 1996. This 24.1% increase primarily resulted from sales of fixed annuities.
Footnotes to the table of Rated Bonds by Rating Classification --------------------------------------------------------------
(2) Bonds and short-term promissory instruments are divided into six quality categories for NAIC rating purposes, ranging from 1 (highest) to 5 (lowest) for nondefaulted bonds plus one category, 6, for bonds in or near default. These six categories correspond with the S&P/Moody's/DCR/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. The NAIC categories include $4.9 million (at amortized cost) of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed rate investments are priced over the yield curve, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 93% of the Company's fixed annuity reserves had surrender penalties or other restrictions at September 30, 1997.
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. 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. 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.
DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of principal or interest, were $0.2 million at September 30, 1996 and constituted 0.1% of total invested assets. There were no defaulted investments at September 30, 1997.
and renewing annuities to maintain a generally competitive market rate. Management would seek to place new funds in investments that were matched in duration to, and higher yielding than, the liabilities assumed. The Company believes that liquidity to fund withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or Reverse Repos on the Company's substantial MBS segment of the Bond Portfolio, thereby avoiding the sale of fixed-rate assets in an unfavorable bond market.