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 and Woodland Hills, California.
The following selected financial data of the Company should be read in conjunction with the 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.
PRETAX INCOME totaled $28.6 million in 1998, $13.9 million in 1997 and
NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest- bearing liabilities, increased to $36.8 million in 1998 from $19.2 million in 1997 and $2.8 million in 1996. These amounts equal 2.37% on average invested assets (computed on a daily basis) of $1.55 billion in 1998, 2.16% on average invested assets of $887.4 million in 1997 and 2.08% on average invested assets of $134.5 million in 1996. On a pro forma basis, assuming the merger had been consummated on October 1, 1995, net investment income on related average invested assets would have been 2.05% in 1997 and 1.83% in 1996.
Net investment spreads include the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. This excess amounted to $47.3 million in 1998, $21.4 million in 1997 and $13.8 million in 1996. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.20% in 1998, 2.04% in 1997 and 1.47% in 1996. On a pro forma basis, assuming the merger had been consummated on October 1, 1995, the Spread Difference would have been 1.91% in 1997 and 1.67% in 1996.
Total interest expense totaled $80.7 million in 1998, $46.4 million in 1997 and $7.2 million in 1996. The average rate paid on all interest-bearing liabilities was 5.36% in 1998, 5.35% in 1997 and 5.93% in 1996. Interest- bearing liabilities averaged $1.51 billion during 1998, $866.0 million during 1997 and $120.6 million during 1996. On a pro forma basis, assuming the merger had been consummated on October 1, 1995, the average rate paid on all interest- bearing liabilities would have been 5.45% in 1997 and 5.47% in 1996.
GROWTH IN AVERAGE INVESTED ASSETS in 1998 over 1997 primarily reflects the impact of the merger. The Company acquired $1.40 billion of invested assets associated with the merger on March 31, 1997.
NET REALIZED INVESTMENT GAINS totaled $4.7 million in 1998, compared to $5.0 million in 1997 and $0.5 million of losses in 1996. Net realized investment gains and losses include impairment writedowns of $0.4 million in 1998, $0.1 million in 1997 and $0.2 million in 1996. Therefore, net gains from sales and redemptions of investments totaled $5.1 million in 1998 and 1997, and net losses from sales of investments totaled $0.3 million in 1996.
investors paused to re-evaluate their investment decisions in light of volatile markets. The Company believes that fluctuating market conditions increase the value of financial planning services and make the flexibility and security of variable annuities even more attractive.
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. Also, from time to time, Federal initiatives are proposed which could affect the taxation of variable annuities and annuities generally.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $3.3 million in 1998, compared with $3.2 million in 1997 and $1.5 million in 1996. 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 fixed and variable annuity contracts. Annual commissions totaled $348,000 in 1998, $195,000 in 1997 and $19,000 in 1996. These increases are primarily attributable to the fixed annuity contracts acquired in the merger. Based on current sales, the Company estimates that such annual commissions will increase in future periods.
SHAREHOLDER'S EQUITY increased 10.7% to $186.1 million at September 30, 1998 from $168.1 million at September 30, 1997, due to $16.5 million of net income recorded in 1998 and a $1.4 million increase in net unrealized gains on bonds and notes available for sale.
The table on the following page summarizes the Company's rated bonds by rating classification as of September 30, 1998.
(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/DCR/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. The NAIC categories include $43.9 million of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed rate investments are priced over the yield curve, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 90% of the Company's fixed annuity reserves had surrender penalties or other restrictions at September 30, 1998.
INVESTED ASSETS EVALUATION is routinely conducted by the Company. 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. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and, if available, the current fair value of the underlying collateral.
lessors and others with which it does business to evaluate their year 2000 compliance plans and state of readiness and to determine the extent to which the Company's systems and applications may be affected by the failure of others to remediate their own year 2000 issues. To date, however, the Company has received only preliminary feedback from such parties and has not independently confirmed any information received from other parties with respect to the year 2000 issues. Therefore, there can be no assurance that such other parties will complete their year 2000 conversions in a timely fashion or will not suffer a year 2000 business disruption that may adversely affect the Company's financial condition and results of operations.