The Company's executive offices and its principal office are in leased premises at 733 Third Avenue, New York, New York 10017. The Company, through an affiliate, also leases office space in Los Angeles, Woodland Hills and Torrance, California.
NET INCOME totaled $1.1 million in 1997, compared with $0.7 million in 1996 and $0.5 million in 1995.
PRETAX INCOME totaled $2.1 million in 1997, $1.2 million in 1996 and $0.7 million in 1995. The 75.0% improvement in 1997 over 1996 primarily resulted from net realized investment gains of $0.4 million, compared to net realized investment losses of $0.5 million in 1996. Pretax income was also favorably impacted by an increase in fee income, partially offset by increased amortization of deferred acquisition costs and increased general and administrative expenses. The 66.1% improvement in 1996 over 1995 primarily resulted from a decline in net realized investment losses, partially offset by increased general and administrative expenses.
NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities, totaled $2.7 million in 1997 and $2.8 million in each of 1996 and 1995. These amounts equal 1.52%
Total interest expense equalled $10.1 million in 1997, $7.2 million in 1996 and $5.0 million in 1995. The average rate paid on fixed annuity contracts was 5.97% in 1997, 5.93% in 1996 and 5.90% in 1995. Fixed annuity contracts averaged $168.9 million during 1997, compared with $120.6 million during 1996 and $85.5 million during 1995.
assets sectors, individual securities within the investment portfolio and the reallocation of investments from sectors that are perceived to be relatively overvalued to sectors that are perceived to be relatively undervalued. The intent of the Company's active portfolio management is to maximize total returns on the investment portfolio, taking into account credit and interest- rate risk.
VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $1.7 million in 1997, $0.7 million in 1996 and $0.4 million in 1995. These increased fees reflect growth in average variable annuity assets, principally due to the receipt of variable annuity premiums, increased market values and net exchanges into the separate accounts from the fixed accounts of variable annuity contracts, partially offset by surrenders. Variable annuity assets averaged $111.8 million during 1997, $46.2 million during 1996 and $27.8 million during 1995. Variable annuity premiums, which exclude premiums allocated to the fixed accounts of variable annuity products, totaled $56.3 million in 1997, $28.6 million in 1996 and $5.9 million in 1995. Sales of variable annuity products (which include premiums allocated to the fixed accounts) ("Variable Annuity Product Sales") amounted to $125.2 million, $69.8 million and $8.8 million in 1997, 1996 and 1995, respectively. Increases in Variable Annuity Product Sales are due, in part, to market share gains through enhanced distribution efforts and growing consumer demand for flexible retirement savings products that offer a variety of equity, fixed income and guaranteed fixed account investment choices. The Company has encountered increased competition in the variable annuity marketplace during recent years and anticipates that the market will remain highly competitive for the foreseeable future.
SURRENDER CHARGES on fixed and variable annuities totaled $304,000 in 1997, compared with $221,000 in 1996 and $194,000 in 1995. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first seven years of an annuity contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $20.6 million in 1997, compared with $12.7 million in 1996 and $17.7 million in 1995. These payments represent 7.58%, 8.06% and 16.93%, respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity withdrawals from the separate accounts totaling $5.3 million in 1997, $2.8 million in 1996 and $3.6 million in 1995. Higher withdrawal payments in 1997 are due to the significant growth in the Company's annuity reserves. Higher withdrawals in 1995 compared to 1996 are due to policies coming off surrender charge restrictions. Management anticipates that withdrawal rates will gradually increase in future periods.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $1.8 million in 1997, compared with $1.5 million in 1996 and $1.0 million in 1995. General and administrative expenses remain closely controlled through a company-wide cost containment program and continue to represent less than 1% of average total assets.
ANNUAL COMMISSIONS represent renewal commissions paid quarterly in arrears to maintain the persistency of certain of the Company's annuity contracts. Annual commissions totaled $18,000 in 1997, $19,000 in 1996 and $33,000 in 1995. Based on current sales, the Company estimates that such annual commissions will increase in future periods.
SHAREHOLDER'S EQUITY increased 9.7% to $25.5 million at September 30, 1997 from $23.2 million at September 30, 1996, primarily due to $1.1 million of net income recorded in 1997 and $0.9 million of net unrealized gains on debt and equity securities available for sale (credited directly to shareholder's equity), versus $0.2 million of net unrealized losses on such securities recorded at September 30, 1996.
The Company manages most of its invested assets internally. The Company's general investment philosophy is to hold fixed-rate assets for long-term investment. Thus, it does not have a trading portfolio. However, the Company has determined that all of its portfolio of bonds and notes (the "Bond Portfolio") is available to be sold in response to changes in market interest rates, changes in relative value of asset sectors and individual securities, changes in prepayment risk, changes in the credit quality outlook for certain securities, the Company's need for liquidity and other similar factors.
THE BOND PORTFOLIO, which comprises 99% of the Company's total investment portfolio (at amortized cost), had an aggregate fair value that exceeded its amortized cost by $3.8 million at September 30, 1997. At September 30, 1996, the amortized cost exceeded the fair value of the Bond Portfolio by $0.5 million. The net unrealized gains on the Bond Portfolio since September 30, 1996 principally reflect the lower prevailing interest rates at September 30, 1997 and the corresponding effect on the fair value of the Bond Portfolio.
At September 30, 1997, the Bond Portfolio (at amortized cost) included $179.8 million of bonds rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service ("Moody's"), Duff & Phelps Credit Rating Co. ("DCR"), Fitch Investors Service, L.P. ("Fitch") or the National Association of Insurance Commissioners ("NAIC"), and $4.9 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At September 30, 1997, approximately $171.6 million of the Bond Portfolio was investment grade, including $79.6 million of U.S. government/agency securities and mortgage- backed securities ("MBSs").
At September 30, 1997, the Bond Portfolio included $13.1 million (at amortized cost with a fair value of $14.0 million) of bonds that were not investment grade. Based on their September 30, 1997 amortized cost, these non- investment-grade bonds accounted for 3.4% of the Company's total assets and 7.0% of its invested assets.
As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what it pays on its liabilities by designing its fixed- rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company's fixed-rate assets include cash and short-term investments, and bonds and notes. At September 30, 1997, these assets had an aggregate fair value of $190.2 million with a duration of 3.3. At September 30, 1997, the Company's fixed annuity liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $171.8 million with a duration of 3.6. The Company's potential exposure due to a relative 10% increase in interest rates prevalent at September 30, 1997 is immaterial.
There are risks associated with some of the techniques the Company uses to provide liquidity, enhance its spread income and match its assets and liabilities. The primary risk associated with the Company's Reverse Repos is counterparty risk. The Company believes, however, that the counterparties to its Reverse Repos are financially responsible and that the counterparty risk associated with those transactions is minimal. 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. As part of its decision to purchase an MBS, the Company assesses the risk of prepayment by analyzing the security's projected performance over an array of interest-rate scenarios. Once an MBS is purchased, the Company monitors its actual prepayment experience monthly to reassess the relative attractiveness of the security with the intent to maximize total return.
INVESTED ASSETS EVALUATION routinely includes a review by the Company of its portfolio of debt securities. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying values of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of any collateral, compliance with contractual covenants, the borrower's recent financial performance, news reports and other externally generated information concerning the creditor's affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. The carrying values of bonds that are determined to have declines in value that are other than temporary are reduced to net realizable value and no further accruals of interest are made.
The Company's financial statements begin on page. Reference is made to the Index to Financial Statements on page herein.