Assets under management, excluding the effect of FAS 115, at December 31, 1995 of $25.1 billion, were 24% above 1994 levels, primarily reflecting continued business growth and overall improvement in the stock and bond markets.
(1) Included above are net unrealized capital gains (losses) of $689.9 million, $(337.7) million and $646.2 million at December 31, 1995, 1994 and 1993, respectively.
Adjusted earnings in the Financial Services segment (after-tax) follow (in millions):
Adjusted earnings increased 5% in both 1995 and 1994. The 1995 improvement in adjusted earnings reflected an increase in charges assessed against policyholders and increased net investment income related to the growth in assets under management which were partially offset by an increase in operating expenses. The 1994 improvement in adjusted earnings reflected an increase in assets under management offset in part by an increase in operating expenses.
Charges assessed against policyholders for certain annuity contracts increased by 19% and 16% in 1995 and 1994, respectively, reflecting the increase in assets under management.
Operating expenses, excluding the impact of moving the two service organizations into the Company as discussed above, increased by 23% in 1995 and 19% in 1994. The 1995 increase primarily reflects continued business growth. The 1994 increase primarily reflected expenses associated with the implementation of the new contract administration system.
Adjusted earnings in 1995 remained level with the prior year adjusted earnings, reflecting an increase in the volume of business in force as a result of strong sales offset by an increase in operating expenses. Adjusted earnings in 1994 increased 7% when compared to 1993 adjusted earnings. The 1994 adjusted earnings improvement reflected higher business in force offset in part by lower net investment income.
Premiums, related to term and whole life insurance, decreased by 11% in 1995 following an 8% increase in 1994. The decrease in premiums in 1995 is primarily due to lower whole life insurance premiums. Deposits, related to universal life and interest-sensitive whole life insurance, grew by 71% and 20% in 1995 and 1994, respectively. Deposits in 1995 included the assumption of a $172.4 million universal life block of business from an unaffiliated insurer and also reflected strong first year sales and retention. The increase in premiums and deposits in 1994 reflected strong first year sales and retention.
Assets under management, excluding the effect of FAS 115, at December 31, 1995 of $2.6 billion, were 17% above 1994 levels, primarily reflecting continued business growth and overall improvement in the stock and bond markets.
It is management's objective that the portfolio of debt securities be of high quality and be well-diversified by market sector. The debt securities in the Company's portfolio are generally rated by external rating agencies, and, if not externally rated, are rated by the Company on a basis believed to be similar to that used by the rating agencies. The average quality rating of the Company's debt security portfolio was AA- at December 31, 1995 and AA at December 31, 1994.
Asset-backed securities (securities backed by auto loans, credit card receivables, etc.) and commercial/multifamily mortgage-backed securities (securitized pools of mortgages) are predominantly AAA rated, and are not subject to the prepayment risk of residential mortgage-backed securities.
Consolidated Statements of Changes in Shareholder's Equity for the Years Ended December 31, 1995, 1994 and 1993 23
As discussed in Note 1 to the consolidated financial statements, in 1993 the Company changed its methods of accounting for certain investments in debt and equity securities.
Aetna Life Insurance and Annuity Company and its wholly owned subsidiaries (collectively, the "Company") is a provider of financial services and life insurance products in the United States. The Company has two business segments, financial services and life insurance.
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. Intercompany transactions have been eliminated. Certain reclassifications have been made to 1994 and 1993 financial information to conform to the 1995 presentation.
At December 31, 1995 and 1994, all of the Company's debt securities are classified as available for sale and carried at fair value. These securities are written down (as realized losses) for other than temporary decline in value. Unrealized gains and losses related to these securities, after deducting amounts allocable to experience-rated contractholders and related taxes, are reflected in shareholder's equity.
Fair values for debt securities are based on quoted market prices or dealer quotations. Where quoted market prices or dealer quotations are not available, fair values are measured utilizing quoted market prices for similar securities or by using discounted cash flow methods. Cost for mortgage-backed securities is adjusted for unamortized premiums and discounts, which are amortized using the interest method over the estimated remaining term of the securities, adjusted for anticipated prepayments.
Purchases and sales of debt securities are recorded on the trade date.
The investment in affiliated mutual funds represents an investment in the Aetna Series Fund, Inc., a retail mutual fund which has been seeded by the Company, and is carried at fair value.
Mortgage loans and policy loans are carried at unpaid principal balances net of valuation reserves, which approximates fair value, and are generally secured. Purchases and sales of mortgage loans are recorded on the closing date.
Short-term investments, consisting primarily of money market instruments and other debt issues purchased with an original maturity of over ninety days and less than one year, are considered available for sale and are carried at fair value, which approximates amortized cost.
Certain costs of acquiring insurance business have been deferred. These costs, all of which vary with and are primarily related to the production of new business, consist principally of commissions, certain expenses of underwriting and issuing contracts and certain agency expenses. For fixed ordinary life contracts, such costs are amortized over expected premium-paying periods. For universal life and certain annuity contracts, such costs are amortized in proportion to estimated gross profits and adjusted to reflect actual gross profits. These costs are amortized over twenty years for annuity pension contracts, and over the contract period for universal life contracts.
Deferred policy acquisition costs are written off to the extent that it is determined that future policy premiums and investment income or gross profits would not be adequate to cover related losses and expenses.
The Company's liabilities include reserves related to fixed ordinary life, fixed universal life and fixed annuity contracts. Reserves for future policy benefits for fixed ordinary life contracts are computed on the basis of assumed investment yield, assumed mortality, withdrawals and expenses, including a margin for adverse deviation, which generally vary by plan, year of issue and policy duration. Reserve interest rates range from 2.25% to 10.00%. Assumed investment yield is based on the Company's experience. Mortality and withdrawal rate assumptions are based on relevant Aetna experience and are periodically reviewed against both industry standards and experience.
Assets held under variable universal life, variable life and variable annuity contracts are segregated in Separate Accounts and are invested, as designated by the contractholder or participant under a contract, in shares of Aetna Variable Fund, Aetna Income Shares, Aetna Variable Encore Fund, Aetna Investment Advisers Fund, Inc., Aetna GET Fund, or The Aetna Series Fund Inc., which are managed by the Company or other selected mutual funds not managed by the Company. Separate Accounts assets and liabilities are carried at fair value except for those relating to a guaranteed interest option which is offered through a Separate Account. The assets of the Separate Account supporting the guaranteed interest option are carried at an amortized cost of $322.2 million for 1995 (fair value $343.9 million) and $149.7 million for 1994 (fair value $146.3 million), since the Company bears the investment risk where the contract is held to maturity. Reserves relating to the guaranteed interest option are maintained at fund value and reflect interest credited at rates ranging from 4.5% to 8.38% in both 1995 and 1994. Separate Accounts assets and liabilities are shown as separate captions in the Consolidated Balance Sheets. Deposits, investment income and net realized and unrealized capital gains (losses) of the Separate Accounts are not reflected in the Consolidated Statements of Income (with the exception of realized capital gains (losses) on the sale of assets supporting the guaranteed interest option). The Consolidated Statements of Cash Flows do not reflect investment activity of the Separate Accounts.
The Company is included in the consolidated federal income tax return of Aetna. The Company is taxed at regular corporate rates after adjusting income reported for financial statement purposes for certain items. Deferred income tax benefits result from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities.
Investments in debt securities available for sale as of December 31, 1995 were as follows:
Investments in debt securities available for sale as of December 31, 1994 were as follows:
Amortized Fair Cost Value --------- ------ (millions) Due to mature: One year or less $ 348.8 $ 351.1 After one year through five years 2,100.2 2,159.5 After five years through ten years 2,516.0 2,663.4 After ten years 2,315.0 2,573.2 Mortgage-backed securities 3,682.5 3,977.4 Other asset-backed securities 961.2 996.2 --------- --------- Total $11,923.7 $12,720.8 --------- --------- --------- ---------
The Company engages in securities lending whereby certain securities from its portfolio are loaned to other institutions for short periods of time. Cash collateral, which is in excess of the market value of the loaned securities, is deposited by the borrower with a lending agent, and retained and invested by the lending agent to generate additional income for the Company. The market value of the loaned securities is monitored on a daily basis with additional collateral obtained or refunded as the market value fluctuates. At December 31, 1995, the Company had loaned securities (which are reflected as invested assets on the Consolidated Balance Sheets) with a market value of approximately $264.5 million.
The valuation reserve for mortgage loans was $3.1 million at December 31, 1994. There was no valuation reserve for mortgage loans at December 31, 1995. The carrying value of non-income producing investments was $0.1 million and $0.2 million at December 31, 1995 and 1994, respectively.
General Electric Corporation $314.9 $329.3 General Motors Corporation 273.9 284.5 Associates Corporation of North America 230.2 239.1 Society National Bank 203.5 222.3 Ciesco, L.P. 194.9 194.9 Countrywide Funding 171.2 172.7 Baxter International 168.9 168.9 Time Warner 158.6 166.1 Ford Motor Company 156.7 162.6
The portfolio of debt securities at December 31, 1995 and 1994 included $662.5 million and $318.3 million, respectively, (5% and 3%, respectively, of the debt securities) of investments that are considered "below investment grade". "Below investment grade" securities are defined to be securities that carry a rating below BBB-/Baa3, by Standard & Poors/Moody's Investor Services, respectively. The increase in below investment grade securities is the result of a change in investment strategy, which has reduced the Company's holdings in residential mortgage-back securities and increased the Company's holdings in corporate securities. Residential mortgage-back securities are subject to higher prepayment risk and lower credit risk, while corporate securities earning a comparable yield are subject to higher credit risk and lower prepayment risk. We expect the percentage of below investment grade securities will increase in 1996, but we expect that the overall average quality of the portfolio of debt securities will remain at AA-. Of these below investment grade assets, $14.5 million and $31.8 million, at December 31, 1995 and 1994, respectively, were investments that were purchased at investment grade, but whose ratings have since been downgraded.
If due to declining interest rates, principal was to be repaid earlier than originally anticipated, the Company could be affected by a decrease in investment income due to the reinvestment of these funds at a lower interest rate. Such prepayments may result in a duration mismatch between assets and liabilities which could be corrected as cash from prepayments could be reinvested at an appropriate duration to adjust the mismatch.
The risk inherent in holding IOs is prepayment risk related to dramatic decreases in interest rates whereby future IO cash flows could be much less than originally anticipated and in some cases could be less than the original cost of the IO. The risks inherent in IOs are mitigated somewhat by holding offsetting positions in POs. During dramatic decreases in interest rates POs would generate future cash flows much quicker than originally anticipated.
Gross Gross Fair Cost Unrealized Unrealized Value Gains Losses ---- ---------- ---------- ----- (millions) ---- Equity Securities $231.6 $27.2 $1.2 $257.6 ------ ----- ---- ------ ------ ----- ---- ------ ---- Equity Securities $230.5 $ 6.5 $7.9 $229.1 ------ ----- ---- ------ ------ ----- ---- ------
Realized capital gains or losses are the difference between proceeds received from investments sold or prepaid, and amortized cost. Net realized capital gains as reflected in the Consolidated Statements of Income are after deductions for net realized capital gains (losses) allocated to experience-rated contracts of $61.1 million, $(29.1) million and $(54.8) million for the years ended December 31, 1995, 1994, and 1993, respectively. Net realized capital gains (losses) allocated to experience-rated contracts are deferred and subsequently reflected in credited rates on an amortized basis. Net unamortized gains (losses), reflected as a component of Policyholders' Funds Left With the Company, were $7.3 million and $(50.7) million at the end of December 31, 1995 and 1994, respectively.
Changes to the mortgage loan valuation reserve and writedowns on debt securities are included in net realized capital gains (losses) and amounted to $3.1 million, $1.1 million and $(98.5) million, of which $2.2 million, $0.8 million and $(91.5) million were allocable to experience-rated contractholders, for the years ended December 31, 1995, 1994 and 1993, respectively. The 1993 losses were primarily related to writedowns of interest-only mortgage-backed securities to their fair value.
Debt securities $32.8 $1.0 $9.6 Equity securities 8.3 0.2 0.1 Mortgage loans 0.2 0.3 (0.2) ----- ---- ------ Pretax realized capital gains $41.3 $1.5 $9.5 ----- ---- ------ ----- ---- ------
Debt securities $255.9 $(242.1) $164.3 Equity securities 27.3 (13.3) 10.6 Limited partnership 1.8 (1.8) -- ------ -------- ------ 285.0 (257.2) 174.9
Deferred federal income taxes (See Note 6) (36.5) 46.3 61.2 ------ -------- ------
Shareholder's equity included the following unrealized capital gains (losses), which are net of amounts allocable to experience-rated contractholders, at December 31:
Debt securities Gross unrealized capital gains $179.3 $ 27.4 $164.3 Gross unrealized capital losses (1.3) (105.2) -- ------ ------- ------ 178.0 (77.8) 164.3 ------ ------- ------ Equity securities Gross unrealized capital gains 27.2 6.5 12.0 Gross unrealized capital losses (1.2) (7.9) (0.1) ------ ------- ------ 26.0 (1.4) 11.9 Limited Partnership Gross unrealized capital gains -- -- -- Gross unrealized capital losses -- (1.8) -- ------ ------- ------ -- (1.8) --
Debt securities $891.5 $823.9 $828.0 Preferred stock 4.2 3.9 2.3 Investment in affiliated mutual funds 14.9 5.2 2.9 Mortgage loans 1.4 1.4 1.5 Policy loans 13.7 11.5 10.8 Reinsurance loan to affiliate 46.5 51.5 53.3 Cash equivalents 38.9 29.5 16.8 Other 8.4 6.7 7.7 -------- ------ ------ Gross investment income 1,019.5 933.6 923.3 Less investment expenses (15.2) (16.4) (11.4) -------- ------ ------ Net investment income $1,004.3 $917.2 $911.9 -------- ------ ------ -------- ------ ------
At December 31, 1995 and December 31, 1994, the Company does not utilize any statutory accounting practices which are not prescribed by insurance regulators that, individually or in the aggregate, materially affect statutory shareholder's equity.
The Company is included in the consolidated federal income tax return of Aetna. Aetna allocates to each member an amount approximating the tax it would have incurred were it not a member of the consolidated group, and credits the member for the use of its tax saving attributes in the consolidated return.
In August 1993, the Omnibus Budget Reconciliation Act of 1993 (OBRA) was enacted which resulted in an increase in the federal corporate tax rate from 34% to 35% retroactive to January 1, 1993. The enactment of OBRA resulted in an increase in the deferred tax liability of $3.4 million at date of enactment, which is included in the 1993 deferred tax expense.
The "Policyholders' Surplus Account," which arose under prior tax law, is generally that portion of a life insurance company's statutory income that has not been subject to taxation. As of December 31, 1983, no further additions could be made to the Policyholders' Surplus Account for tax return purposes under the Deficit Reduction Act of 1984. The balance in such account was approximately $17.2 million at December 31, 1995. This amount would be taxed only under certain conditions. No income taxes have been provided on this amount since management believes the conditions under which such taxes would become payable are remote.
Employee Pension Plans - The Company, in conjunction with Aetna, has non-contributory defined benefit pension plans covering substantially all employees. The plans provide pension benefits based on years of service and average annual compensation (measured over sixty consecutive months of highest earnings in a 120 month period). Contributions are determined using the Projected Unit Credit Method and, for qualified plans subject to ERISA requirements, are limited to the amounts that are currently deductible for tax reporting purposes. The accumulated benefit obligation and plan assets are recorded by Aetna. The accumulated plan assets exceed accumulated plan benefits. There has been no funding to the plan for the years 1993 through 1995, and therefore, no expense has been recorded by the Company.
Agent Pension Plans - The Company, in conjunction with Aetna, has a non-qualified pension plan covering certain agents. The plan provides pension benefits based on annual commission earnings. The accumulated plan assets exceed accumulated plan benefits. There has been no funding to the plan for the years 1993 through 1995, and therefore, no expense has been recorded by the Company.
Employee Postretirement Benefits - In addition to providing pension benefits, Aetna also provides certain postretirement health care and life insurance benefits, subject to certain caps, for retired employees. Medical and dental benefits are offered to all full-time employees retiring at age 50 with at least 15 years of service or at age 65 with at least 10 years of service. Retirees are required to contribute to the plans based on their years of service with Aetna.
Agent Postretirement Benefits - The Company, in conjunction with Aetna, also provides certain postemployment health care and life insurance benefits for certain agents.
Incentive Savings Plan - Substantially all employees are eligible to participate in a savings plan under which designated contributions, which may be invested in common stock of Aetna or certain other investments, are matched, up to 5% of compensation, by Aetna. Pretax charges to operations for the incentive savings plan were $4.9 million, $3.3 million and $3.1 million in 1995, 1994 and 1993, respectively.
The Company is compensated by the Separate Accounts for bearing mortality and expense risks pertaining to variable life and annuity contracts. Under the insurance contracts, the Separate Accounts pay the Company a daily fee which, on an annual basis, ranges, depending on the product, from .25% to 1.80% of their average daily net assets. The Company also receives fees from the variable life and annuity mutual funds and The Aetna Series Fund for serving as investment adviser. Under the advisory agreements, the Funds pay the Company a daily fee which, on an annual basis, ranges, depending on the fund, from .25% to 1.00% of their average daily net assets. The advisory agreements also call for the variable funds to pay their own administrative expenses and for The Aetna Series Fund to pay certain administrative expenses. The Company also receives fees (expressed as a percentage of the average daily net assets) from The Aetna Series Fund for providing administration, shareholder services and promoting sales. The amount of compensation and fees received from the Separate Accounts and Funds, included in Charges Assessed Against Policyholders, amounted to $128.1 million, $104.6 million and $93.6 million in 1995, 1994 and 1993, respectively. The Company may waive advisory fees at its discretion.
Since 1981, all domestic individual non-participating life insurance of Aetna and its subsidiaries has been issued by the Company. Effective December 31, 1988, the Company entered into a reinsurance agreement with Aetna Life Insurance Company ("Aetna Life") in which substantially all of the non-participating individual life and annuity business written by Aetna Life prior to 1981 was assumed by the Company. A $108.0 million commission, paid by the Company to Aetna Life in 1988, was capitalized as deferred policy acquisition costs. The Company maintained insurance reserves of $655.5 million and $690.3 million as of December 31, 1995 and 1994, respectively, relating to the business assumed. In consideration for the assumption of this business, a loan was established relating to the assets held by Aetna Life which support the insurance reserves. The loan is being reduced in accordance with the decrease in the reserves. The fair value of this loan was $663.5 million and $630.3 million as of December 31, 1995 and 1994, respectively, and is based upon the fair value of the underlying assets. Premiums of $28.0 million, $32.8 million and $33.3 million and current and future benefits of $43.0 million, $43.8 million and $55.4 million were assumed in 1995, 1994 and 1993, respectively.
Investment income of $46.5 million, $51.5 million and $53.3 million was generated from the reinsurance loan to affiliate in 1995, 1994 and 1993, respectively. Net income of approximately $18.4 million, $25.1 million and $13.6 million resulted from this agreement in 1995, 1994 and 1993, respectively.
On December 16, 1988, the Company assumed $25.0 million of premium revenue from Aetna Life for the purchase and administration of a life contingent single premium variable payout annuity contract. In addition, the Company also is responsible for administering fixed annuity payments that are made to annuitants receiving variable payments. Reserves of $28.0 million and $24.2 million were maintained for this contract as of December 31, 1995 and 1994, respectively.
The Company received no capital contributions in 1995, 1994 or 1993.
The Company distributed $2.9 million in the form of dividends of two of its subsidiaries, SBA and AISI, to Aetna Retirement Services, Inc. in 1995.
Premiums due and other receivables include $5.7 million and $27.6 million due from affiliates in 1995 and 1994, respectively. Other liabilities include $12.4 million and $27.9 million due to affiliates for 1995 and 1994, respectively.
Ceded to Assumed Direct Other from Other Net Amount Companies Companies Amount ------ --------- ---------- ------ (millions) ----
Premiums: Life Insurance $ 28.8 $ 8.6 $28.0 $ 48.2 Accident and Health 7.5 7.5 -- -- Insurance Annuities 82.1 -- 0.5 82.6 --------------------------------------------- Total earned premiums $118.4 $16.1 $28.5 $130.8 --------------------------------------------- ---------------------------------------------
Premiums: Life Insurance $ 27.3 $ 6.0 $32.8 $ 54.1 Accident and Health 9.3 9.3 -- -- Insurance Annuities 69.9 -- 0.2 70.1 --------------------------------------------- Total earned premiums $106.5 $15.3 $33.0 $124.2 --------------------------------------------- ---------------------------------------------
Premiums: Life Insurance $22.4 $ 5.6 $33.3 $ 50.1 Accident and Health 12.9 12.9 -- -- Insurance Annuities 31.3 -- 0.7 32.0 --------------------------------------------- Total earned premiums $66.6 $18.5 $34.0 $82.1 ---------------------------------------------
Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, such as estimates of timing and amount of expected future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument. In evaluating the Company's management of interest rate and liquidity risk, the fair values of all assets and liabilities should be taken into consideration, not only those above.
SHORT-TERM INSTRUMENTS: Fair values are based on quoted market prices or dealer quotations. Where quoted market prices are not available, the carrying amounts reported in the Consolidated Balance Sheets approximates fair value. Short-term instruments have a maturity date of one year or less and include cash and cash equivalents, and short-term investments.
DEBT AND EQUITY SECURITIES: Fair values are based on quoted market prices or dealer quotations. Where quoted market prices or dealer quotations are not available, fair value is estimated by using quoted market prices for similar securities or discounted cash flow methods.
The Company did not have transactions in derivative instruments in 1994.
The Company also holds investments in certain debt and equity securities with derivative characteristics (i.e., including the fact that their market value is at least partially determined by, among other things, levels of or changes in interest rates, prepayment rates, equity markets or credit ratings/spreads). The amortized cost and fair value of these securities, included in the $13.4 billion investment portfolio, as of December 31, 1995 was as follows:
The Company's operations are reported through two major business segments: Life Insurance and Financial Services.
Summarized financial information for the Company's principal operations was as follows: