The liquidity and requirements of American are met by premiums received from annuity sales, net investment income received, and proceeds from investments upon maturity, sale or redemption. The primary uses of funds by American are the payment of surrenders, policy benefits, operating expenses and commissions, as well as the purchase of assets for investment. For purposes of the company's consolidated statements of cash flows, financing activities include premiums received from sales of SPDAs, surrenders and death benefits paid, and surrender and policy charges collected on these contracts. The net cash provided by (used in) these particular financing activities for the years ended December 31, 1994, 1993 and 1992, was $26.6 million, ($91.5) million and ($27.7) million, respectively. The increase in net cash provided by annuity contracts without life contingencies in 1994 resulted primarily from a $72.3 million decrease in surrender and death benefits paid from $318.9 million (approximately 16.1% of beginning reserves for future policy benefits) to $246.6 million (approximately 12.3% of beginning reserves for future policy benefits) along with a $45.6 million increase in premiums received from $222.2 million to $267.8 million. The decline in net cash provided by annuity contracts without life contingencies in 1993 resulted primarily from a $115.8 million increase in surrender and death benefits paid from $203.1 million (approximately 11.1% of beginning reserves for future policy benefits) to $318.9 million (approximately 16.1% of beginning reserves for future policy benefits) offset by a $53.5 million increase in premiums received from $168.7 million to $222.2 million. The decline in net cash provided by annuity contracts without life contingencies in 1992 resulted primarily from a $50.5 million decline in premiums received from $219.2 million to $168.7 million, and a $5.8 million increase in surrender and death benefits paid from $197.3 million (approximately 12.6% of beginning reserves for future policy benefits) to $203.1 million (approximately 11.1% of beginning reserves for future policy benefits). Net cash provided by the company's operating activities was $130.5 million, $129.7 million and $142.9 million in 1994, 1993 and 1992, respectively. Cash provided by financing and operating activities and by the sale and maturity of portfolio investments is used primarily to purchase portfolio investments and for the payment of acquisition costs (commissions and expenses associated with the sale and issue of policies). To meet its anticipated liquidity requirements, the company purchases investments taking into account the anticipated future cash flow requirements of its underlying liabilities. In addition, the company invests a portion of its assets in short-term investments and maturities of less than one year (2%, 3% and 7% as of December 31, 1994, 1993 and 1992, respectively). The weighted average duration of the company's investment portfolio was 4.7 years as of December 31, 1994. The company continually assesses its capital requirements in light of business developments and various capital and surplus adequacy ratios which affect insurance companies. During the past five years, the company has met its capital needs and those of American through several different sources including bank borrowing and the sale of both preferred and common stock. On December 31, 1991, the company issued 172,000 shares of its $2.00 Series B Convertible Preferred Stock with a total stated value of $4.3 million. The Preferred Stock was convertible at $7.50 per share into 573,332 shares of the company's Common Stock. On December 30, 1992, the company issued and sold 235,294 shares of Common Stock at $10.625 per share to the company's Leveraged Employee Stock Ownership Plan ("LESOP"). This purchase was financed with the proceeds of a $2.5 million loan from American. For additional information regarding the LESOP, see Note 7 of Notes to Consolidated Financial Statements. In 1993, the company raised $29.4 million through the sale of 3,451,668 shares of Common Stock. In December, 1994, the company entered into a credit agreement with The First National Bank of Chicago and Boatman's First National Bank of Kansas City, as Lenders. Under the terms of this agreement, the Lenders have committed to lend up to $25,000,000 in the form of a 5-year reducing credit facility. For
additional information regarding this credit agreement, see Note 6 of Notes to Consolidated Financial Statements. As of December 31, 1994, the company owned bonds of 39 issuers in amounts exceeding 10% of stockholders' equity. The book value of such bonds was $546.4 million which represented 29% of the company's invested assets. See Note 2 of Notes to Consolidated Financial Statements. A default by any one of these issuers could materially adversely affect the results of operations and financial condition of the company. Twenty-six bonds with an aggregate book value of $364.7 million were REMIC Trusts established by government-sponsored enterprises. The remaining $181.7 million of such bonds represent 13 issuers, of which all but one in the amount of $10.1 million are rated investment grade. Recent regulatory actions against certain large life insurers encountering financial difficulty have prompted the various state guaranty associations to begin assessing life insurance companies for the resulting losses. For further information regarding the effects of guaranty fund assessments, see Note 13 of Notes to Consolidated Financial Statements. REINSURANCE. The company had amounts receivable under reinsurance agreements of $149.7 million and $151.4 million as of December 31, 1994 and 1993, respectively. Of the amounts, $147.9 million and $149.5 million, respectively, were associated with a single insurer, ERC. In 1989, the company entered into a coinsurance agreement which ceded 90% of the risk on the company's block of SPWL written prior to 1989 to ERC. The agreement provides that ERC assumes 90% of all risks associated with each policy in the block. Under the terms of the contract the company continues to administer the policies and is reimbursed for all payments made under the terms of those policies. Additionally, the company receives a fee from the reinsurer for administering such policies. Cash settlements under the contract are made with ERC on a monthly basis. If ERC were to become insolvent, American would remain responsible for the payment of all policy liabilities. In addition, the company is a party to two assumption reinsurance agreements with other reinsurers. See Item 1.(c)(l) Business Done and Intended to be Done-Other Insurance Products. EFFECT OF INFLATION AND CHANGES IN INTEREST RATES. The company does not believe that inflation has had a material effect on its consolidated results of operations during the past three years. The company seeks to manage its investment portfolio in part to reduce its exposure to interest rate fluctuations. In general, the market value of the company's fixed income securities increases or decreases directly with interest rate changes. For example, if interest rates decline (as was the case in 1992 and 1993), the company's fixed income investments generally will increase in market value, while net investment income will decrease. Conversely, if interest rates rise (as was the case in 1994), fixed income investments generally will decrease in market value, while net investment income will increase. In a rising interest rate environment (such as that experienced in 1994), the company's average cost of funds would increase over time as it prices its new and renewing annuities to maintain a generally competitive market rate. During such a rise in interest rates, new funds would be invested in bonds with higher yields than the liabilities assumed. In a declining interest rate environment, the company's cost of funds would decrease over time, reflecting lower interest crediting rates on its fixed annuities. In addition to the increase in the company's average cost of funds caused by a rising interest rate environment, surrenders of annuities that are no longer protected by surrender charges increase. While the company experienced a decrease in total surrenders during 1994, the decrease was primarily due to the large number of bailout surrenders in 1993. Throughout 1994, the company saw an increase in surrenders of policies which no longer were covered by surrender charges. Management believes the increased surrenders experienced in 1994 were due to the increasing interest rates throughout 1994. This trend