The following table sets forth certain financial and operating data of the Company. The selected consolidated financial data below for each of the four years ending December 31, 1996 are derived from the Consolidated Financial Statements of the Company, which financial statements have been audited by KPMG Peat Marwick LLP, independent auditors. The selected consolidated financial data provided below for the year ending December 31, 1992 are derived from the unaudited consolidated financial statements of the Company. In the opinion of management, the unaudited financial data for the year ended December 31, 1992 presents fairly the consolidated financial statements for such period in conformity with GAAP. (Dollars in millions except earnings per share information.)
(A) The merger of American Mutual Life into Central Life, which was consummated in 1994, has been accounted for as a pooling of interests transaction.
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 Company is engaged in the business of underwriting, marketing and distributing a broad range of individual life insurance and annuity products to individuals and businesses in 45 states and the District of Columbia. The Company's primary product offerings consist of whole life, universal life and term life insurance policies and fixed annuities. Since April 1, 1996 the Company has been a party to the Ameritas Joint Venture with Ameritas Life Insurance Corp., through which it now markets fixed annuities and has begun to sell variable annuities and variable life insurance products.
Premium revenues reported for traditional life insurance products are recognized as revenues when due. Future policy benefits and policy acquisition costs are recognized as expenses over the life of the policy by means of a provision for future policy benefits and amortization of deferred policy acquisition costs.
The contribution to the operating income of the Company from the Closed Block is reported as a single line item in the income statement. Accordingly, premiums, product charges, investment income, realized gains (losses) on investments, policyowner benefits and dividends attributable to the Closed Block, less certain minor expenses and the amortization of deferred policy acquisition costs, are shown as a net number under the caption "Contribution from the Closed Block." This results in material reductions in the respective line items in the income statement while having no effect on net income. The expenses associated with the administration of the policies included in the Closed Block and the renewal commissions on these policies are not charged against the Contribution from the Closed Block, but rather are grouped with underwriting, acquisition and insurance expenses. Also, all assets allocated to the Closed Block are grouped together and shown as a separate item entitled "Closed Block Assets." Likewise, all liabilities attributable to the Closed Block are combined and disclosed as the "Closed Block Liabilities."
Since the operating results from the Closed Block for the six months ended December 31, 1996 are reported on one line of the income statement, "Contribution from the Closed Block," the individual income statement components for 1996 are not fully comparable with those for 1995 and 1994, prior to the establishment of the Closed Block. Management believes that the presentation of the results of operations for 1996 on a combined basis as if the Closed Block had not been formed facilitates comparability with the results of operations for 1995 and 1994. 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.
Net investment income increased by $1.0 million to $286.2 million in 1996 compared to $285.2 million in 1995, and $275.7 million in 1994. The increases in net investment income in 1996 and 1995 were both attributable to increases in average invested assets partially offset by declines in the effective yields on average invested assets. Average invested assets (excluding market value adjustments) increased by $171.8 million to $3,790.1 million in 1996, compared to $3,618.3 million in 1995, and $3,462.2 million in 1994. The increase in average invested assets in 1996 was largely attributable to the investment of the $175.0 million 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 and 7.96% in 1994. The decrease in effective yield in 1996 was primarily due to lower bond yields and the timing of the investment of the proceeds from the bank borrowing. The decrease in effective yield in 1995 reflected a reduction in interest income on both bonds and commercial mortgages as a result of lower market interest rates on new investments.
Realized gains on investments were $66.4 million in 1996 compared to gains of $51.4 million in 1995 and losses of $19.9 million in 1994. The increase in gains of $15.0 million in 1996 resulted primarily from increased sales of common stock in the investment portfolio. The increase of $71.3 million in 1995 resulted primarily from the combination of increased gains of $32.5 million over 1994 amounts from the sale of common stock and a gain of $9.4 million in 1995 compared to a loss of $25.5 million in 1994 from sales of fixed maturity securities. Of the losses incurred in 1994, $21.1 million were incurred in connection with sales of fixed maturity securities which resulted from a planned investment strategy that maximized the after-tax proceeds from the sale of selected fixed maturity securities. The sales of common stock in 1996 and 1995 were 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.
Management would not consider this charge a normal recurring type and as such would add back this item net of tax in determining operating earnings. If such an adjustment would have been made, adjusted operating earnings for 1997 would have been $40.9 million. Other underwriting, acquisition and insurance expenses, net of deferrals, decreased in 1995 by $10.9 million, or 18.5%, to $48.2 million. 1995 was the first year of the consolidated operations of Central Life and American Mutual Life. As a result of the combination, approximately $7.8 million of cost reductions were realized in 1995 from 1994 combined levels, excluding the merger-related expenses described below. These reductions in 1995 were partially offset by increased legal and settlement costs of $1.1 million, higher incentive compensation of $1.0 million and $2.2 million of expenses related to the investigation and review of alternative capital structures, including implementation of the Reorganization. Included in 1994 expenses were approximately $10.0 million of expenses related to the merger of the two companies compared to $2.2 million of merger-related costs in 1995.
Income before income taxes increased by $7.5 million to $118.0 million in 1996 compared to $110.5 million in 1995, and $26.1 million in 1994. The increase in 1996 resulted primarily from the increase in realized gains on investments. The significant increase in income before taxes in 1995 resulted largely from net realized gains on investments of $51.4 million in 1995 compared to net realized losses on investments of $19.9 million in 1994; the $9.5 million increase in net investment income and the reduced expenses in 1995, partially offset by higher dividends to policyowners in 1995.
Net income increased by $4.9 million in 1996 to $74.2 million compared to $69.3 million in 1995, and $6.7 million in 1994. The increased net income in 1996 resulted largely from the higher pre-tax income due primarily to the increased realized gains on investments. The significant increase in net income in 1995 resulted from the increases in pre-tax income discussed above.
The Company's cash flow from operations will 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 will charge AmerUs Group, AmerUs Life and certain other of its affiliates for management services, offset by the expenses incurred for debt service, salaries and other expenses.
In December, 1996, the Company entered into a bank credit agreement, which was comprised of $100 million in term debt and $75 million under a revolving line of credit ("Bank Credit Facility"). Immediately after establishing the Bank Credit Facility the Company borrowed $100 million under the term debt component of the facility and $75 million under the revolving line of credit. The Company contributed $125 million of the borrowings under the Bank Credit Facility to AmerUs Life and used $50 million to purchase a 9% surplus note, due December 1, 2006, from AmerUs Life. Proceeds from the Company's common stock and capital note offerings were used to repay $50 million of borrowings outstanding under the term facility and $75 million of borrowing outstanding under the revolving line of credit. The Company has $75 million of unused borrowing capacity under its revolving line of credit.
The Company may from time to time review potential acquisition opportunities. The Company anticipates that funding for any such acquisition may be provided from available cash resources or from debt or equity financing. As of December 31, 1996 the Company had no material commitments for capital expenditures. In the future the Company anticipates that its liquidity and capital needs will be met through interest and dividends from AmerUs Life, accessing the public equity and debt markets depending upon market conditions, or alternatively from bank financing.
AmerUs Life generated cash flows from operating activities of $147.6 million, $189.1 million and $172.4 million, for the years ended December 31, 1996, 1995 and 1994, respectively. Excess operating cash flows were primarily used to increase AmerUs Life's fixed maturity investment portfolio consistent with the long-term investment objective of the Company to reduce the level of equity investments and mortgages as a percentage of its 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. AmerUs Life continuously monitors benefits and surrenders to provide projections of future cash requirements. As part of this monitoring process, AmerUs Life performs cash flow testing of its assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing its investment strategy, AmerUs Life 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 AmerUs Life's claims-paying and financial strength ratings.
AmerUs Life takes into account asset-liability management considerations. Contract terms for AmerUs Life's interest-sensitive products include surrender and withdrawal provisions which mitigate the risk of losses due to early withdrawals. These provisions generally do one or more of the following: limit the amount of penalty-free withdrawals, limit the circumstances under which withdrawals are permitted, or assess a surrender charge or market value adjustment relating to the underlying assets. The following table summarizes statutory liabilities for interest-sensitive life products and annuities by their contractual withdrawal provisions at December 31, 1996 (dollars in millions):
Not subject to discretionary withdrawal $ 209 Subject to discretionary withdrawal with adjustments: Specified surrender charges (A) $885 Market value adjustments 393 -------- Subtotal 1,278 Subject to discretionary withdrawal without adjustments 579 -------- Total $2,066 -------- -------- - --------------
The objective of the Company's mortgage backed securities ("MBS") investments 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 ("CMO"s) 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, 1996, the Company's MBS investment portfolio composition was approximately 15% fixed rate pass-throughs backed by seasoned loan pools, 18% floating rate pass-throughs and 67% 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 Company has improved the quality of its investment portfolio in recent years in a number of respects. The Company has reduced real estate-related assets (defined as real estate loans and real estate equity investments) as a percentage of total invested assets from previous levels. Real estate related assets, which totaled 19.2% of total invested assets as of December 31, 1993, were reduced to 5.8% of total invested assets as of December 31, 1996. The Company's problem loan ratio (defined as aggregate delinquent, in process of foreclosure and restructured mortgage loans) also decreased from 21.3% of the loan portfolio as of December 31, 1994 to 9.4% as of December 31, 1995, and to 3.5% as of December 31, 1996.
In connection with the Reorganization, an arrangement, known as a closed block ("Closed Block"), was formalized to give certain policyowners additional assurances as to the dividend policies of the Company. As a result of establishing the Closed Block on June 30, 1996, the Company allocated certain assets from its investment portfolio to the Closed Block (see Note 1 to the consolidated financial statements for further discussion). The following table summarizes consolidated invested assets by asset category as of December 31, 1996 and 1995, and sets forth the allocation of such assets between the Closed Block and the general account. The remaining information relating to the Company's investment portfolio presents information about the investment portfolio on a combined basis (including invested assets in both the Closed Block and the general account).
The fixed maturity securities portfolio consists primarily of investment grade corporate fixed maturity securities, high-quality MBS and United States government and agency obligations. As of December 31, 1996, fixed maturity securities were $3,316.1 million, or 83.5% of the carrying value of invested assets with public and private fixed maturity securities constituting $2,993.8 million, or 90.3%, and $322.3 million, or 9.7%, of total fixed maturity securities, respectively.
The following table summarizes the composition of the fixed maturity securities by category as of December 31, 1996 and 1995:
The Company's portfolio of investment grade fixed maturity securities is diversified by number and type of issuer. As of December 31, 1996, investment grade fixed maturity securities included the securities of over 657 issuers, with 1,027 different issues of securities. No issuer represents more than 2.8% of investment grade fixed maturity securities.
Below-investment grade fixed maturity securities as of December 31, 1996 included the securities of 49 issuers representing 6.4% of total invested assets, with the largest being a $10.0 million investment.
The Company uses interest rate swaps and caps to reduce its exposure to changes in interest rates and to manage duration mismatches. Although the Company is subject to the risk that counterparties will fail to perform, credit standings of counterparties are monitored regularly. The Company's policy is to contract only with counterparties that are rated "AA" or higher; accordingly, it is expected that counterparties will be able to satisfy their obligations under such contracts. The Company is also subject to the risk associated with changes in the value of contracts. However, such adverse changes in value generally are offset by changes in the value of the items being hedged. The notional principal amounts of the swaps and caps, which represent the extent of the Company's involvement in such contracts but not the risk of loss, at December 31, 1996, amounted to $980.0 million. The swaps had a carrying value and a fair value which amounted to a net receivable position of $5.9 million at December 31, 1996. The carrying value and fair value of interest rate caps and swaptions amounted to $9.2 million and $8.1 million, respectively, and are reflected as "other investments" on the Company's consolidated financial statements as of December 31, 1996. The net amount payable or receivable from interest rate swaps and caps is accrued as an adjustment to interest income.
In the last several years, the Company has significantly reduced its mortgage loan investments as a percentage of its invested assets through sales of certain mortgage loan assets, decreased originations of new loans and write-downs of delinquent loans. As of December 31, 1993, mortgage loans totaled $652.2 million, or 17.9% of invested assets. By December 31, 1996, such investments totaled $225.8 million, or 5.7% of invested assets. Commercial mortgage loans consist primarily of fixed-rate mortgage loans on complete properties. As of December 31, 1996, the Company held 142 individual commercial mortgage loans having an average interest rate, maturity and balance of 9.3%, 74 months and $1.6 million, respectively.
The Company is not originating new commercial mortgage loans although it is renewing existing loans in its portfolio in selected cases. The Company annually estimates the current loan-to-value ratios of its commercial mortgage loans based on an analysis of the operating statements of each mortgaged property.
In recent years the Company has significantly reduced its equity real estate portfolio. As of December 31, 1996, investment real estate consisted of two properties located in two states. The carrying value of investment real estate as of December 31, 1996 was $4.6 million.
The Company held $232.0 million of policy loans on individual insurance products as of December 31, 1996. Policy loans are permitted to the extent of a policy's contractual limits and are fully collateralized by policy cash values.
In June 1996, the FASB issued Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 provides consistent accounting standards for securitizations and other transfers of financial assets, determines when financial assets (liabilities) should be considered sold (settled) and removed from the balance sheet, and determines when related revenues and expenses should be recognized. FASB Statement No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. This statement will be applicable to the Company, however, management believes that it will have no material effect on the Company's consolidated financial statements.
Additional financial statement schedules are included on pages S-3 through S-10 herein. Reference is made to the Index to Financial Statement Schedules on page S-1 herein.