The following selected consolidated financial data of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are included elsewhere herein. Per-share amounts have been restated to reflect a three-for-two stock split paid in the form of a stock dividend on November 10, 1995.
(2) In computing the ratio of earnings to fixed charges (including interest incurred on fixed annuities, guaranteed investment contracts and trust deposits), fixed charges consist of interest expense on senior and subordinated indebtedness, fixed annuity contracts, guaranteed investment contracts and trust deposits and dividends paid on the preferred securities of a subsidiary grantor trust. Earnings are computed by adding interest incurred on senior and subordinated indebtedness, fixed annuity contracts, guaranteed investment contracts and trust deposits and dividends paid on the preferred securities of a subsidiary grantor trust to pretax income.
(3) In computing the ratio of earnings to combined fixed charges and preferred stock dividends (excluding interest incurred on fixed annuities, guaranteed investment contracts and trust deposits), combined fixed charges and preferred stock dividends consist of interest expense on senior and subordinated indebtedness, dividends paid on the preferred securities of a subsidiary grantor trust and dividends on preferred stock of the Company on a tax-equivalent basis. Earnings are computed by adding interest incurred on senior and subordinated indebtedness and dividends paid on the preferred securities of a subsidiary grantor trust to pretax income.
(4) In computing the ratio of earnings to combined fixed charges and preferred stock dividends (including interest incurred on fixed annuities, guaranteed investment contracts and trust deposits), combined fixed charges and preferred stock dividends consist of interest expense on senior and subordinated indebtedness, fixed annuity contracts, guaranteed investment contracts and trust deposits, dividends paid on the preferred securities of a subsidiary grantor trust and dividends on preferred stock of the Company on a tax-equivalent basis. Earnings are computed by adding interest incurred on senior and subordinated indebtedness, fixed annuity contracts, guaranteed investment contracts and trust deposits and dividends paid on the preferred securities of a subsidiary grantor trust to pretax income.
The following is management's discussion and analysis of financial condition and results of operations of SunAmerica Inc. (the "Company") for the three years in the period ended September 30, 1995.
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR INCOME TAXES totaled $194.2 million or $2.84 per share in 1995, compared with $165.3 million or $2.39 per share in 1994 and $127.0 million or $1.83 per share in 1993. The cumulative effect of the change in accounting for income taxes resulting from the 1994 implementation of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," amounted to a nonrecurring non-cash charge of $33.5 million or $0.54 per share. Accordingly, net income amounted to $131.8 million or $1.85 per share in 1994.
PRETAX INCOME totaled $279.6 million in 1995, $240.0 million in 1994 and $184.0 million in 1993. The $39.6 million improvement in 1995 over 1994 primarily resulted from increased net investment income and fee income, partially offset by increased general and administrative expenses, additional amortization of deferred acquisition costs and higher net realized investment losses. The $56.0 million improvement in 1994 over 1993 primarily resulted from increased net investment income and fee
income, partially offset by additional amortization of deferred acquisition costs. In addition, 1993 results include a $22.0 million provision for future guaranty fund assessments.
The decline in investment yield in 1994 resulted primarily from sales of higher-yielding securities and the reinvestment of sales proceeds in a greater volume of lower-yielding securities. The Company principally made such sales to obtain certain securities desirable in dollar roll transactions ("Dollar Rolls"), to take advantage of changes in relative value between its portfolio sectors and to more closely match its assets to its liabilities (see "Asset-Liability Matching"). In addition, investment yield declined in 1994 as the net cash provided by the Company's operating and financing activities, as well as the cash flows from redemptions and maturities of securities in the Company's investment portfolio, was invested in lower-yielding securities due to the lower interest rate environment prevailing during 1993 and the first half of 1994.
The Company also historically has enhanced investment yield through its use of Dollar Rolls, whereby the proceeds from sales of mortgage-backed securities ("MBSs") are invested in short-term securities pending the contractual repurchase of substantially the same securities at discounted prices in the forward market. The Company has been able to engage in Dollar Rolls due to the market demand for MBSs for formation of collateralized mortgage obligations, which was particularly high in 1993. The Company recorded $4.6 million of enhanced yield on a weighted average volume of $387.0 million of such transactions during 1995, compared with $15.6 million of enhanced yield on a weighted average volume of $1.05 billion of such transactions during 1994 and $21.0 million of enhanced yield on a weighted average volume of $1.01 billion during 1993. The declines in enhanced yield relative to the volume of Dollar Rolls in 1995 and 1994 are primarily due to a narrowing of market spreads on such transactions. (See "Asset-Liability Matching" for additional discussion of Dollar Rolls.)
In addition, the Company has enhanced investment yield since 1993 through total return corporate bond swap agreements (the "Total Return Agreements"). The Company recorded income of $13.0 million on the Total Return Agreements during 1995, compared with the $1.3 million recorded in 1994 and the $14.6 million recorded in 1993. The fluctuations in income recorded on the
Total Return Agreements reflect changes in the fair values of the underlying assets resulting primarily from changes in prevailing interest rates. (See "Asset-Liability Matching" for additional discussion of Total Return Agreements.)
Total interest and dividend expense aggregated $540.2 million in 1995, $463.7 million in 1994 and $490.6 million in 1993. The average rate paid on all interest-bearing liabilities was 5.90% in 1995, compared with 5.60% in 1994 and 6.19% in 1993. Interest-bearing liabilities averaged $9.16 billion during 1995, compared with $8.27 billion during 1994 and $7.92 billion during 1993.
The increase in the average rate paid on all interest-bearing liabilities during 1995 primarily resulted from increased average crediting rates on the Company's guaranteed investment contracts ("GICs"). The average GIC crediting rate was 6.68% in 1995, compared with 6.20% in 1994. During 1995, 1994 and 1993, approximately 27%, 24% and 15%, respectively, of the Company's average GIC portfolio were variable-rate obligations that reprice periodically based upon certain defined indexes. At September 30, 1995, approximately 31% of the Company's GIC portfolio was composed of such obligations. In addition, in fiscal 1995, the Company increased its crediting rates on new fixed-rate GIC obligations relative to those issued during 1994 in response to higher prevailing interest rates. The average rate paid on all interest-bearing liabilities also increased as a result of a modest increase in the average crediting rate on the Company's fixed annuity contracts. The average fixed annuity crediting rate was 5.48% in 1995, compared with 5.43% in 1994.
The decrease in the average rate paid on all interest-bearing liabilities during 1994 was primarily due to a decline in prevailing interest rates that began during the latter half of fiscal 1992 and continued into the first half of fiscal 1994. This was reflected in a corresponding decline in the average crediting rate on GIC contracts and on fixed annuity contracts, the majority of which reprice annually as interest rate guarantees are renewed. In 1993, the average crediting rate was 7.02% on GIC contracts and 6.11% on fixed annuity contracts.
GROWTH IN AVERAGE INVESTED ASSETS since 1993 primarily reflects sales of the Company's fixed-rate products, consisting of both fixed annuities (including the fixed accounts of variable annuity products) and GICs, and $143.4 million of aggregate net proceeds from the issuances of long-term notes and debentures. Fixed annuity premiums totaled $944.7 million in 1995, up significantly from $230.0 million in 1994 and $223.8 million in 1993. These premiums include premiums for the fixed accounts of variable annuities totaling $286.7 million, $140.6 million, and $63.9 million, respectively. GIC premiums increased to $1.77 billion in 1995 from $1.04 billion in 1994 and $691.6 million in 1993.
The $714.7 million increase in fixed annuity premiums during 1995 reflects higher market demand for fixed-rate products, due, in part, to the increase in prevailing long-term interest rates that began during the latter half of fiscal 1994 and continued into the first quarter of fiscal 1995.
The increases in GIC sales during 1995 and 1994 reflect the success of the Company's efforts to broaden its distribution channels and its product line and to increase its GIC client base.
The GICs issued by the Company and its life insurance subsidiaries generally guarantee the payment of principal and interest at a fixed rate for a fixed term of three to five 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 life insurance subsidiaries impose surrender penalties in the event of other withdrawals prior to maturity. Contracts purchased by banks or state and local governmental authorities may also permit scheduled book value withdrawals subject to the terms of the underlying indenture or agreement. Contracts purchased by asset management firms either prohibit withdrawals or permit withdrawals with notice ranging from seven 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 (see "Financial Condition and Liquidity").
NET REALIZED INVESTMENT LOSSES totaled $33.0 million in 1995, $21.1 million in 1994 and $21.3 million in 1993, and represent 0.33%, 0.24% and 0.25%, respectively, of average invested assets.
Net realized investment losses include impairment writedowns of $42.7 million in 1995, $55.9 million in 1994 and $114.3 million in 1993. Therefore, net gains from sales of investments totaled $9.7 million in 1995, $34.8 million in 1994 and $93.0 million in 1993.
Net gains in 1995 include $20.9 million of net gains realized on $30.7 million of sales of common stocks and $15.6 million of net losses realized on $6.77 billion of sales of bonds that were made primarily to maximize total return.
Net gains in 1993 include $69.1 million of net gains realized on $4.82 billion of sales of bonds that were made primarily to maximize total return. Bond sales in 1993 also include sales of $68.6 million of certain interest-only strips ("IOs") and $251.0 million of sales of senior secured loans ("Secured Loans") that were made primarily to improve the overall credit quality of the portfolio. Net gains in 1993 also include $21.5 million of net gains realized on $171.6 million of sales of certain partnership interests.
Impairment writedowns in 1993 include $11.8 million of provisions applied to mortgage loans that were restructured during 1993 and reduced to the aggregate appraised value of the underlying real estate, and $11.1 million of provisions applied to the Company's investment in a real estate-related separate account of Anchor National Life Insurance Company, which separate account was liquidated through sales of underlying assets to affiliated and nonaffiliated parties during 1993. Impairment writedowns in 1993 also include $88.2 million of additional provisions applied to bonds. These bond writedowns include $25.0 million applied to certain IOs. IOs, a type of MBS used as an asset-liability matching tool to hedge against rising interest rates, are investment-grade securities that give the holder the right to receive only the interest payments on a pool of underlying mortgage loans. As would be anticipated in a lower interest rate environment, the amortized cost of these IOs became impaired as a result of increased prepayments of the underlying loans. At September 30, 1995, the amortized cost, which is net of impairment writedowns, of the IOs held by the Company was $13.2 million and their fair value was $12.9 million.
LOAN SERVICING FEES are earned by the Company's subsidiary, Imperial Premium Finance, Inc. ("Imperial"). Imperial provides short-term installment loans for businesses to fund their commercial property and casualty insurance premiums. These loans are secured by the unearned premium associated with the underlying insurance policies. Currently, Imperial sells most of the short-term loans it originates and earns fee income by servicing these sold loans. Such fee income totaled $19.8 million on average loans serviced of $438.3 million in 1995. Imperial's net assets were acquired on November 30, 1994, and, therefore, no such fee income was earned in 1994 or 1993.
SURRENDER CHARGES on fixed and variable annuities totaled $11.9 million in 1995, compared with $10.7 million in 1994 and $9.8 million in 1993. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first seven years of the contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $1.31 billion in 1995, $1.13 billion in 1994 and $824.5 million in 1993. These payments represent 14.8%, 13.2% and 10.0%, respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity payments from the separate accounts totaling $650.0 million in 1995, $461.5 million in 1994 and $314.6 million in 1993. Variable annuity surrenders have increased over the three years primarily due to surrenders on a closed block of business, policies coming off surrender charge restrictions and increased competition in the marketplace. The decrease in fixed annuity surrenders during 1995 and the increase in such surrenders during 1994 reflect changes in the relative amount of policies coming off surrender charge restrictions during those years. Management anticipates that withdrawal rates will remain relatively stable for the foreseeable future and the Company's investment portfolio has been structured to provide sufficient liquidity for anticipated withdrawals.
expenses remain closely controlled through a company-wide cost containment program and represent approximately 1% of average total assets.
BOOK VALUE PER SHARE amounted to $17.78 at September 30, 1995, compared with $12.60 at September 30, 1994 and $15.09 at September 30, 1993. Excluding net unrealized gains and losses on debt and equity securities available for sale, book value per share amounted to $17.86 at September 30, 1995, $15.05 at September 30, 1994 and $13.44 at September 30, 1993.
TOTAL ASSETS increased by $2.18 billion to $16.84 billion at September 30, 1995 from $14.66 billion at September 30, 1994, principally due to a $1.53 billion increase in invested assets and a $749.9 million increase in the separate accounts for variable annuities.
The following table summarizes the Company's rated bonds by rating classification as of September 30, 1995 (dollars in thousands):
(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 rating groups listed above, with categories 1 and 2 considered investment grade. A substantial portion of the assets in the NAIC categories were rated by the Company based on its implementation of NAIC rating guidelines.
While the trading market for Secured Loans is more limited than for publicly traded corporate debt issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. Although, as a result of restrictive financial covenants, Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities, management believes that the risk of loss upon default for its Secured Loans is mitigated by their financial covenants and senior secured positions. The majority of the Company's Secured Loans are not rated by S&P or Moody's.
Approximately 36% of the mortgage loans in the portfolio at September 30, 1995 were seasoned loans underwritten to the Company's standards and purchased at or near par from the Resolution Trust Corporation and other financial institutions, many of which were downsizing their portfolios. Such loans generally have higher average interest rates than loans that could be originated today. The balance of the mortgage loan portfolio has been originated by the Company under strict underwriting standards. Commercial mortgage loans on properties such as offices, hotels and shopping centers generally represent a higher level of risk than do mortgage loans secured by multifamily residences. This greater risk is due to several factors, including the larger size of such loans and the effects of general economic conditions on these commercial properties. However, due to the seasoned nature of the Company's mortgage loans, its emphasis on multifamily loans and its strict underwriting standards, the Company believes that it has reduced the risk attributable to its mortgage loan portfolio while maintaining attractive yields.
marketability of the tax credits they generate. The Company believes that these risks are acceptable in light of anticipated partnership returns and the contractual termination provisions contained in the partnership agreements.
There are risks associated with some of the techniques the Company uses to enhance its spread income and match its assets and liabilities. The primary risk associated with Dollar Rolls, Reverse Repos and Swap Agreements is the risk associated with counterparty nonperformance. In addition, Swap Agreements also have interest rate risk. However, the Company's Swap Agreements hedge variable-rate assets or liabilities, and interest rate fluctuations that adversely affect the net cash received or paid under the terms of the Swap Agreement would be offset by increased interest income earned on the variable-rate assets or reduced interest expense paid on the variable-rate liabilities. The primary risks associated with Total Return Agreements are the risk of potential loss due to bond market fluctuation and counterparty risk. The Company believes, however, that the counterparties to its Dollar Rolls, Reverse Repos, Swap Agreements and Total Return Agreements are financially responsible and that the counterparty risk associated with those transactions is minimal. Counterparty risk associated with Dollar Rolls is further mitigated by the Company's participation in an MBS trading clearinghouse. The sell and buy transactions that are submitted to this clearinghouse are marked to market on a daily basis and each participant is required to over-collateralize its net loss position by 30% with either cash, letters of credit or government securities. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase.
SOURCES OF LIQUIDITY are readily available to the Company in the form of existing cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At September 30, 1995, approximately $4.95 billion of the Company's Bond Portfolio had an aggregate unrealized gain of $142.5 million, while approximately $2.38 billion of the Bond Portfolio had an aggregate unrealized loss of $155.1 million. In addition, the Company's investment portfolio also currently provides approximately $104.7 million of monthly cash flow from scheduled principal and interest payments.
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.
The Parent received dividends from its regulated life insurance subsidiaries of $69.2 million in March 1995, $43.0 million in December 1993 and $30.0 million in December 1992. The Parent also received dividends of $2.4 million in fiscal 1994 and $4.7 million in fiscal 1993 from its other directly owned subsidiaries.