The Company's principal office is in leased premises at 733 Third Avenue, New York, New York 10017. The Company, through an affiliate, also leases office space in Los Angeles, California and Torrance, California, which are utilized for certain policy administration, recordkeeping and data processing functions.
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR INCOME TAXES totaled $0.7 million in 1996, compared with $0.5 million in 1995 and $1.1 million in 1994. 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 $0.7 million. Accordingly, net income amounted to $0.4 million in 1994.
PRETAX INCOME totaled $1.2 million in 1996, $0.7 million in 1995 and $1.7 million in 1994. The $0.5 million increase in 1996 over 1995 primarily resulted from a decline in net realized investment losses, partially offset by
increased general and administrative expenses. The $1.0 million decline in 1995 over 1994 primarily resulted from net realized investment losses incurred, partially offset by an increase in net investment income.
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, totaled $2.8 million in each of 1996 and 1995, compared with $1.9 million in 1994. These amounts represent 2.08% on average invested assets (computed on a daily basis) of $134.5 million in 1996, 2.70% on average invested assets of $103.2 million in 1995 and 2.24% on average invested assets of $84.5 million in 1994.
The growth in average invested assets since 1994 reflects sales of the Company's fixed-rate products (including the fixed accounts of variable annuity products). Fixed annuity premiums totaled $45.4 million in 1996, $51.7 million in 1995 and $7.8 million in 1994. These premiums include premiums for the fixed accounts of variable annuities totaling $41.2 million, $2.9 million and $0.5 million, respectively. The increased premiums for the fixed accounts of variable annuities in 1996 resulted primarily from greater inflows into the one-year fixed account of the Company's Polaris variable annuity product.
NET REALIZED INVESTMENT LOSSES totaled $0.5 million in 1996 and $1.3 million in 1995, compared to net realized investment gains of $0.4 million in 1994, and represent 0.40%, 1.31% and 0.53%, respectively, of average invested assets. Net realized investment losses include impairment writedowns of $0.1 million in 1996, which were applied to defaulted bonds. Therefore, net losses from sales of investments totaled $0.4 million in 1996. There were no impairment writedowns for 1995 and 1994.
SURRENDER CHARGES on fixed and variable annuities totaled $221,000 in 1996, $194,000 in 1995 and $367,000 in 1994. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first five to seven years of the contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $12.7 million in 1996, $17.7 million in 1995 and $12.9 million in 1994. These payments represent 8.1%, 16.9% and 15.0%, respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity payments from the separate accounts totaling $2.8 million in 1996, $3.6 million in 1995 and $2.4 million in 1994, and represent 6.2%, 12.9% and 9.3%, respectively, of average variable annuity liabilities. Variable annuity withdrawal rates declined in 1996 principally as a result of significant growth in the variable annuity separate accounts, while the increase in 1995 was primarily due to the maturing of an older block of business. Fixed annuity surrenders totaled $9.9 million in 1996, $14.1 million in 1995 and $10.5 million in 1994. Fixed annuity surrenders decreased in 1996 primarily due to unusually high surrenders in 1995, which resulted from a block of policies coming off surrender charge restrictions. Management anticipates that withdrawal rates will stabilize for the foreseeable future at moderately higher levels than the current rates.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $1.4 million in 1996, compared with $1.1 million in 1995 and $1.0 million in 1994. General and administrative expenses remain closely controlled through a company-wide cost containment program and represent approximately 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 $19,000 in 1996, $33,000 in 1995 and
$30,000 in 1994. Based on current sales, the Company estimates that such annual commissions will increase in future periods.
INCOME TAX EXPENSE totaled $0.4 million in 1996, $0.2 million in 1995 and $0.7 million in 1994, representing effective tax rates of 38% in 1996, 26% in 1995 and 38% in 1994. The lower tax rate in 1995 reflects a prior period state income tax benefit.
THE BOND PORTFOLIO had an aggregate amortized cost that exceeded its fair value by $0.5 million at September 30, 1996, compared with $1.5 million at September 30, 1995 (including net unrealized losses of $1.4 million on the portion of the portfolio that was designated as available for sale at September 30, 1995). The net decrease in unrealized losses on the Bond Portfolio since September 30, 1995 principally reflects improvement in the fair value of certain segments of the Bond Portfolio since September 30, 1995 despite the higher relative prevailing interest rates at September 30, 1996.
All of the Bond Portfolio at September 30, 1996 was rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service ("Moody's"), Duff and Phelps Credit Rating Co. ("D&P"), Fitch Investor Service, Inc. ("Fitch") or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners ("NAIC") and implemented by either the NAIC or the Company. At September 30, 1996, approximately $137.0 million of the Bond Portfolio (at amortized cost) was rated investment grade by one or more of these agencies or by the Company or the NAIC, pursuant to applicable NAIC guidelines, including $85.5 million of U.S. government/agency securities and MBSs.
At September 30, 1996, the Bond Portfolio included $9.9 million (fair value, $10.4 million) of bonds not rated investment grade by S&P, Moody's, D&P, Fitch or the NAIC. Based on their September 30, 1996 amortized cost, these non-investment-grade bonds accounted for 4.2% of the Company's total assets and 6.4% of invested assets.
The table on the following page summarizes the Company's rated bonds by rating classification as of September 30, 1996.
(1) S&P and Fitch rate debt securities in rating categories ranging from AAA (the highest) to D (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Moody's rates debt securities in rating categories ranging from Aaa (the highest) to C (extremely poor prospects of ever attaining any real investment standing). The number 1, 2 or 3 (with 1 the highest and 3 the lowest) indicates the debt's relative standing within the rating category. A security rated Baa3 or higher is considered investment grade. D&P rates debt securities in rating categories ranging from AAA (the highest) to DD (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Issues are categorized based on the highest of the S&P, Moody's, D&P and Fitch ratings if rated by multiple agencies.
The Company designs its fixed-rate products and conducts its investment operations in order to closely match the duration of the assets in its investment portfolio to its annuity obligations. The Company seeks to achieve a predictable spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed-rate securities. The Company's fixed-rate products incorporate surrender charges or other limitations on when contracts can be surrendered for cash to encourage persistency. Approximately 96% of the Company's fixed annuity reserves had surrender penalties or other restrictions at September 30, 1996.
The Company also seeks to provide liquidity by using reverse repurchase agreements ("Reverse Repos"), and by investing in MBSs. It also seeks to enhance its spread income by using Reverse Repos. Reverse Repos involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed upon price and are generally over-collateralized. MBSs are generally investment-grade securities collateralized by large pools of mortgage loans. MBSs generally pay principal and interest monthly. The amount of principal and interest payments may fluctuate as a result of prepayments of the underlying mortgage loans.
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 collateral (if any), 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.
DEFAULTED INVESTMENTS, comprising all investments (at amortized cost) that are in default as to the payment of principal or interest, totaled $0.2 million (fair value, $0.2 million) of bonds and notes at September 30, 1996 and constituted 0.1% of total invested assets at amortized cost. At September 30, 1995, the defaulted investments totaled $0.7 million (fair value, $0.5 million), which constituted 0.6% of total invested assets at amortized cost.
SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company's existing portfolio of cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At September 30, 1996, approximately $81.0 million of the Company's Bond Portfolio had an aggregate unrealized gain of $1.3 million, while approximately $65.9 million of the Bond Portfolio had an aggregate unrealized loss of $1.8 million. In addition, the Company's investment portfolio currently provides approximately $1.7 million of monthly cash flow from scheduled principal and interest payments.