GAFRI owns facilities related to its former manufacturing operations totaling approximately 150,000 square feet in North Adams, Massachusetts and 60,000 square feet in Longwood, Florida. Space in these facilities is currently being leased to companies using it for manufacturing and other operations.
Please refer to "Forward-Looking Statements" following the index in front of this Form 10-K.
During 1999, GAFRI and its subsidiaries used bank borrowings and cash on hand to make acquisitions totaling approximately $130 million and to repurchase
GAFRI invests primarily in fixed income investments which, including loans and short-term investments, comprised 98% of its investment portfolio at December 31, 2001. GAFRI generally invests in securities having intermediate-term maturities with an objective of optimizing interest yields while maintaining an appropriate relationship of maturities between GAFRI's assets and expected liabilities.
The NAIC assigns quality ratings to publicly traded as well as privately placed securities. At December 31, 2001, 93% of GAFRI's fixed maturity portfolio was comprised of investment grade bonds (NAIC rating of "1" or "2"). Management believes that the high credit quality of GAFRI's investment portfolio should generate a stable and predictable investment return.
At December 31, 2001, GAFRI's mortgage-backed securities ("MBSs") portfolio represented approximately one-third of its fixed maturity investments. MBSs are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of MBSs may receive prepayments on their securities which cannot be reinvested at an interest rate comparable to the rate on the prepaid MBSs. The majority of MBSs held by GAFRI were purchased at a discount. Management believes that the discounted nature of the MBSs will reduce the effect of prepayments on earnings over the anticipated life of the MBS portfolio.
At December 31, 2001, GAFRI had a net unrealized gain on its fixed maturity investments of $129.0 million (before income taxes) consisting of $204.3 million in gross unrealized gains and $75.3 million in gross unrealized losses. At that same date, GAFRI also had a net unrealized gain on equity securities of $21.2 million consisting of $23.4 million in gross unrealized gains and $2.2 million in gross unrealized losses. Individual portfolio securities are sold creating gains or losses as market opportunities exist.
Litigation In March 2000, a jury in Dallas, Texas, returned a verdict against GALIC with total damages of $11.2 million in a lawsuit brought by two former agents of GALIC. The Company believes that the verdict was contrary to both the facts and the law and expects to prevail on appeal. A decision on the Company's appeal is expected in 2002. The ultimate outcome of this case will not have a material adverse impact on the financial condition of the Company.
Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. GAFRI's exposures to market risk relate primarily to its fixed maturity investment portfolio and annuity contracts which are exposed to interest rate risk and, to a lesser extent, equity price risk. In addition, a portion of GAFRI's long-term debt is also exposed to interest rate risk.
Management believes the concept of net operating earnings (or "core" earnings) is helpful in comparing the operating performance of GAFRI with that of similar companies. However, core earnings should not be considered a substitute for net income as an indication of GAFRI's overall performance. The following table (in millions, except per share amounts) compares the Company's core earnings over the past three years.
Realized gains (losses) on investments included the following provisions for other than temporary impairment: $77.0 million, $14.3 million and $8.6 million for the years ended 2001, 2000 and 1999, respectively. (See MD&A- "Investments")
Results for 2000 include a pretax gain of $27.2 million resulting from the sale of GAFRI's investment in a company engaged in the production of ethanol. GAFRI's investment was repurchased by the ethanol company which, following the repurchase, became wholly-owned by GAFRI's Chairman.
The increase in other income in 2000 primarily reflects increases in revenues from real estate operations, fees earned on GAFRI's growing variable annuity and life business, increased surrender fees, revenue from companies acquired in the second half of 1999 and higher revenues from GAFRI's brokerage subsidiaries.
Insurance acquisition expenses include amortization of deferred policy acquisition costs ("DPAC") as well as commissions on sales of life insurance products. Insurance acquisition expenses also include amortization of the present value of future profits of businesses acquired amounting to $9.2 million in 2001, $10.7 million in 2000 and $7.7 million in 1999.
The decrease in trust preferred distribution requirement in 2001 reflects the Company's September 2001 redemption of its ROPES.
The decrease in interest and other debt expenses in 2001 compared to 2000 is due primarily to lower average bank borrowings as well as significantly lower interest rates on these borrowings. The increase in interest and other debt expenses in 2000 compared to 1999 is due primarily to higher average amounts outstanding as well as higher interest rates on GAFRI's bank credit line.
In 1999, GAFRI recorded a charge for expenses related to realignment within the Company's operating units. The charge was primarily the result of the Company's decision to replace a number of its current computer operating systems with a single system. The charge also included various expenses associated with the elimination in 1999 of redundant positions.
reflects reductions of the valuation allowance associated with certain deferred tax assets. (See Note K.)
Equity in losses of affiliate in 2000 and 1999 represents GAFRI's proportionate share of the results of Chiquita Brands International, as well as the writedown in 2000 of GAFRI's investment in Chiquita to market value of approximately $1 per share. Chiquita reported net losses attributable to common shareholders of $112 million and $75.5 million in 2000 and 1999, respectively.
In 2001, the cumulative effect of accounting change represents the implementation of a new accounting standard (EITF 99-20) which resulted in a writedown of $8.4 million ($5.5 million or $0.13 per share after tax) of the cost basis of certain collateralized debt obligations in the second quarter.
In 1999, GAFRI implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." The SOP requires that costs of start-up activities be expensed as incurred and that unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, GAFRI expensed previously capitalized start-up costs of $4.7 million (net of tax) in the first quarter of 1999.
We have audited the accompanying consolidated balance sheet of Great American Financial Resources, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Great American Financial Resources, Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The accompanying Consolidated Financial Statements include the accounts of GAFRI and its subsidiaries. Certain reclassifications have been made to prior years to conform to the current year's presentation. Acquisitions and sales of subsidiaries have resulted in certain differences in the financial statements and have affected comparability between years. All significant intercompany balances and transactions have been eliminated. All acquisitions have been treated as purchases. The results of operations of companies since their formation or acquisition are included in the Consolidated Financial Statements.
All fixed maturity securities are considered "available for sale" and reported at fair value with unrealized gains and losses reported as a separate component of stockholders' equity. Short-term investments are carried at cost; mortgage loans on real estate are generally carried at amortized cost; policy loans are stated at the aggregate unpaid balance. Premiums and discounts on mortgage-backed securities are amortized over a period based on estimated future principal prepayments and adjusted to reflect actual prepayments.
Emerging Issues Task Force Issue No. 99-20 ("EITF 99-20") established a new standard for recognition of impairment of certain asset-backed investments. Impairment losses on these investments must be recognized when (i) the fair value of the security is less than its cost basis and (ii) there has been an adverse change in the expected cash flows. The new standard became effective on April 1, 2001. Impairment losses at initial application of this rule were recognized as the cumulative effect of an accounting change. Subsequent impairments are recognized as a component of net realized gains and losses.
To the extent that realized gains and losses result in adjustments to the amortization of DPAC related to annuities, such adjustments are reflected as components of realized gains. DPAC related to annuities is also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in unrealized gains (losses) on marketable securities.
Included in insurance acquisition costs are amounts representing the present value of future profits on business in force of the acquired insurance companies, which represent the portion of the costs to acquire such companies that is allocated to the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition.
Liabilities for future policy benefits under traditional life, accident and health policies are computed using the net level premium method. Computations are based on anticipated investment yields, mortality, morbidity and surrenders and include provisions for unfavorable deviations. Reserves established for accident and health claims are modified as necessary to reflect actual experience and developing trends.
GAFRI and Great American Life Insurance Company ("GALIC") have separate tax allocation agreements with American Financial Corporation ("AFC"), a subsidiary of AFG, which designate how tax payments are shared by members of the tax group. In general, both companies compute taxes on a separate return basis. GALIC is obligated to make payments to (or receive benefits from) AFC based on taxable income without regard to temporary differences. If GALIC's taxable income (computed on a statutory accounting basis) exceeds a current period net operating loss of GAFRI, the taxes payable or receivable by GALIC associated with the excess are payable to or receivable from AFC. If the AFC tax group utilizes any of GAFRI's net operating losses or deductions that originated prior to GAFRI's entering AFC's consolidated tax group, AFC will pay to GAFRI an amount equal to the benefit received. The tax allocation
agreements with AFC have not impacted the recognition of income tax expense and income tax payable in GAFRI's financial statements.
GAFRI sponsors an Employee Stock Ownership Retirement Plan ("ESORP") and a 401(k) plan covering all employees of GAFRI and its subsidiaries who are qualified as to age and length of service. The ESORP, which invests primarily in securities of GAFRI, is a trusteed, noncontributory plan. Contributions to the ESORP are discretionary by the directors of GAFRI. Qualified employees having vested rights in the ESORP are entitled to benefit payments at age 60. The 401(k) Plan is a trusteed, contributory plan, under which GAFRI matches a specific portion of employee contributions. Company contributions to the ESORP and 401(k) plans are charged against earnings in the year for which they are declared.
Prior to 1999, certain costs associated with introducing new products and distribution channels were deferred and amortized on a straight-line basis over five years. In 1999, GAFRI implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." The SOP required that (i) costs of start-up activities be expensed as incurred and (ii) unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, GAFRI expensed previously capitalized start-up costs in 1999 of $4.7 million (net of tax) or $0.11 per diluted share.
In 1999, GAFRI acquired United Teacher Associates Insurance Company ("UTA"), Consolidated Financial Corporation, an insurance agency, and Great American Life Insurance Company of New York for approximately $129 million in cash.
GAFRI's life and annuity operations offer fixed and variable annuity products and traditional life insurance products. GAFRI's annuity products are sold through managing general agents and independent agents to employees of primary and secondary educational institutions, hospitals and in the non-qualified markets. Traditional term, universal and whole life insurance products are sold through national marketing organizations.
GAFRI's supplemental insurance businesses (UTA and Loyal American Life Insurance Company) offer a variety of supplemental health and life products. UTA offers its products through independent agents. Loyal's marketing strategy emphasizes third-party sponsorship, including employers and credit unions. At December 31, 2001, Loyal reinsured a substantial portion of its life insurance business and expects to reduce its marketing efforts in the future.
GA Life of Puerto Rico sells in-home life and supplemental health products through a network of company-employed agents. Sales in Puerto Rico accounted for nearly 20% of GAFRI's life, accident and health premiums in 2001.
UTA revenues for a full year as opposed to only one quarter in 1999.
The distribution of maturities based on amortized cost is generally the same. Mortgage-backed securities had an estimated average life of approximately four and one-half years at December 31, 2001.
At December 31, 2001 and 2000, gross unrealized gains on its marketable equity securities were $23.4 million and $39.8 million, respectively. At December 31, 2001 and 2000, gross unrealized losses were $2.2 million and $2.4 million, respectively. Realized gains and changes in unrealized appreciation on fixed maturity and equity security investments are summarized as follows (in millions):
In January 2001, Chiquita announced a restructuring initiative that included discontinuing all interest and principal payments on its public debt. Due to the expected restructuring, GAFRI recorded a pretax charge of $5.1 million in the fourth quarter of 2000 to write down its investment in Chiquita to quoted market value. In 2001, GAFRI suspended accounting for the investment under the equity method, reclassified the investment to "Equity Securities" and recorded an additional writedown of $0.9 million, reducing its cost basis in Chiquita to $1.8 million. On March 8, 2002, the court approved Chiquita's plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code. The plan calls for the conversion of over $700 million in principal and accrued interest related to Chiquita's public debt into common equity. As a result, GAFRI will receive approximately 19,000 "new" shares in the reorganized company plus warrants expiring in 2009 to purchase approximately 318,000 additional shares at $19.23 per share.
In January 2001, AAG Holding replaced its existing bank line with a $155 million unsecured credit agreement. Loans under the credit agreement mature on December 31, 2004. At December 31, 2001 and 2000, the weighted-average interest rates on amounts borrowed under its credit line were 2.88% and 7.31%, respectively.
At December 31, 2001, scheduled principal payments on debt for the subsequent five years were as follows (in millions):
Cash interest payments were $9.9 million in 2001, $13.2 million in 2000 and $11.2 million in 1999.
Cash payments with respect to the preferred securities were $18.4 million in 2001 and 2000.
At December 31, 2001, there were 4.0 million shares of GAFRI Common Stock reserved for issuance under GAFRI's stock option plans. Under the plans, the exercise price of each option equals the market price of GAFRI Common Stock at the date of grant. Options generally become exercisable at the rate of 20% per year commencing one year after grant. All options expire ten years after the date of grant.
The average remaining life of GAFRI's options was 6.8 years at December 31, 2001. The exercise prices of options issued during the year ranged from $17.09 to $18.89 in 2001, $15.00 to $17.50 in 2000 and $21.73 to $24.25 in 1999.
No compensation cost has been recognized for stock option grants. Had compensation cost been determined for stock option awards based on the fair values at grant dates consistent with the method prescribed by SFAS No. 123, GAFRI's net income (in millions) and earnings per share would have been lower by the following amounts:
At December 31, 2001, GAFRI had net operating loss carryforwards for federal income tax purposes of approximately $84 million which are scheduled to expire from 2003 through 2020.
Future minimum lease payments, net of sublease revenues, under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2001 are payable as follows: 2002 - $6.9 million; 2003 - $6.9 million; 2004 - $7.8 million; 2005 - $3.9 million; 2006 - $2.9 million; 2007 and beyond - $2.0 million.
Rental expense for operating leases, net of sublease revenues, was $5.5 million in 2001, $6.0 million in 2000 and $5.6 million in 1999.
Securities owned by insurance subsidiaries having a carrying value of about $106 million at December 31, 2001, were on deposit as required by regulatory authorities.
GAFRI has a line of credit with a company owned by AFG and brothers of GAFRI's Chairman. Under the agreement, which matures in March 2003, this company may borrow up to $8 million at 13%. At December 31, 2001 and 2000, $6.4 million and $8.0 million, respectively, was due under the credit line.
The following table provides an analysis of changes in the liability for unpaid claims included in GAFRI's accident and health reserves over the past three years on a GAAP basis (in millions):
Quarterly results necessarily rely heavily on estimates. These estimates and certain other factors, such as the seasonal nature of the Company's hotel operations and the discretionary sales of assets, cause the quarterly results not to be necessarily indicative of results for longer periods of time. The following table represents quarterly results of operations for the years ended December 31, 2001 and 2000 (in millions, except per share data).
Includes $27.2 million gain on the redemption of minority ownership by related party.
(b) Includes net unrealized gains on marketable securities of $89.8 million and
2000 amount includes a ($27.2) million gain on the redemption of minority ownership by related party.