EX-13 14 h83029ex13.txt PORTIONS OF 2000 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 MANAGEMENT'S DISCUSSION AND ANALYSIS ================================================================================ For the three years ended December 31, 2000 In millions Management's Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page 38. CONSOLIDATED RESULTS Summary Income Statement
2000 1999 1998 -------- -------- -------- Retirement Services $ 661 $ 564 $ 466 Life Insurance 770 721 674 Consumer Finance 247 226 201 -------- -------- -------- Business division earnings 1,678 1,511 1,341 Corporate capital costs (258) (228) (216) Corporate expense (62) (56) (32) Goodwill amortization (48) (48) (45) -------- -------- -------- OPERATING EARNINGS 1,310 1,179 1,048 Investment gains (losses) (114) (12) 4 Non-recurring items* (193) (36) (288) -------- -------- -------- Net income $ 1,003 $ 1,131 $ 764 -------- -------- --------
*Includes litigation settlements, other charges, and certain Y2K costs. OPERATING EARNINGS PER SHARE
Year $ per share ---- ----------- 98 2.02 99 2.30 00 2.58
ASSETS*
Year $ in billions ---- ------------- 98 102.662 99 116.876 00 120.360
*Excludes fair value adjustment. [Pie Chart] BUSINESS DIVISION EARNINGS Retirement Services 39% Life Insurance 46% Consumer Finance 15%
[Pie Chart] BUSINESS DIVISION ASSETS Retirement Services 57% Life Insurance 32% Consumer Finance 11%
Overview. American General Corporation (American General) and its subsidiaries (collectively, the company or we) is a diversified financial services organization with assets in excess of $120 billion and a market capitalization of $21 billion at December 31, 2000. We are a leading provider of retirement services, life insurance, consumer loans, and investments to over 12 million customers. Our operating earnings per share increased 12% to $2.58 in 2000, which is within our long-term objective of 12%-14% growth. We anticipate a comparable increase in operating earnings per share in 2001. Our financial highlights for the three years ended December 31, 2000, restated to reflect a two-for-one stock split subsequent to year end, were as follows:
2000 1999 1998 --------- -------- --------- Revenues and deposits $ 22,368 $ 20,232 $ 17,653 Operating earnings 1,310 1,179 1,048 Per share Operating earnings 2.58 2.30 2.02 Shareholders' equity* 16.07 15.43 14.36 Assets* 120,360 116,876 102,662 Return on equity* 16.7% 16.0% 15.4%
*Excludes fair value adjustment under accounting standard SFAS 115. Reporting Structure. During the three years ended December 31, 2000, we managed our business operations in three divisions - retirement services, life insurance, and consumer finance - based on products and services offered. Consistent with the manner in which we review and evaluate the divisions, results of each division include earnings from its operations and earnings on the amount of equity we consider necessary to support its business. Corporate capital costs, goodwill amortization, investment gains (losses), and non-recurring items are excluded from division results. Division assets and liabilities exclude the fair value adjustment under Statement of Financial Accounting Standards (SFAS) 115 and goodwill. To better respond to market demands and capitalize on opportunities for growth, we recently announced the realignment of our organization into two strategic business groups - Financial Services and Asset Accumulation. Our new Financial Services group will include the life insurance and consumer finance businesses, while the Asset Accumulation group will encompass our retirement services and asset management businesses. During first quarter 2001, we will finalize our reporting structure for the two business groups. 2000 ANNUAL REPORT page 23 2 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions RETIREMENT SERVICES Retirement Services Highlights Summary Income Statement
2000 1999 1998 -------- -------- -------- Fixed margin $ 1,009 $ 938 $ 792 Variable fees 239 185 136 Asset management fees 59 36 25 Other revenue 73 34 28 -------- -------- -------- Net revenues 1,380 1,193 981 -------- -------- -------- Operating expenses 378 332 247 Commissions 414 366 258 Change in DPAC/CIP (414) (360) (223) -------- -------- -------- Total expenses 378 338 282 -------- -------- -------- Pretax earnings 1,002 855 699 Income taxes 341 291 233 -------- -------- -------- DIVISION EARNINGS $ 661 $ 564 $ 466 -------- -------- --------
EARNINGS
Year $ in millions ---- ------------- 98 466 99 564 00 661
ASSETS UNDER MANAGEMENT Average, $ in billions
Year Invested Assets Separate Accounts Mutual Funds ---- --------------- ----------------- ------------ 98 33.90 12.60 .2 99 39.80 17.50 .8 00 43.0 22.20 2.400
NET REVENUES
Year $ in billions ---- ------------- 98 .981 99 1.193 00 1.380
DEPOSITS $ in billions
Year Fixed Variable Mutual Funds ---- ----- -------- ------------ 98 3.9 2.50 0.00 99 5.00 3.00 0.30 00 5.60 3.30 0.90
Our retirement services division is a leading provider of retirement products and services, and ranks as the nation's third-largest writer of annuities. We market our products through two major distribution systems. Tax-qualified annuities and mutual funds are sold by our 1,900 financial advisors to employees of educational, health care, and government entities and other not-for-profit organizations. Non-qualified annuities are sold through 37,000 representatives of over 300 banks and other financial institutions, as well as through 22,000 agents, including 15,000 in our life insurance division. We classify annuity receipts as fixed or variable deposits depending on the investment option selected by the customer. Fixed deposits are invested in our general account investment portfolio. The difference between investment income we earn on these invested assets and interest credited to the policyholder accounts is our fixed margin. Fixed investment spread measures this difference in terms of interest rates. Variable deposits are invested in separate account mutual funds in accordance with the policyholder's instructions. A key feature of these deposits is that the investment risk lies predominantly with the policyholder, rather than the company. Separate accounts fluctuate as a result of deposits, surrenders, benefits, and changes in market value of the underlying mutual funds. Separate accounts generate earnings through variable fees, primarily mortality and expense charges, and asset management fees. These fees are based on the account balances. We also sell mutual funds to group retirement plans, as well as to individuals on a retail basis. Although these assets are not on our balance sheet, they generate asset management and plan administration fees. We earn gross dealer concessions from distributing retail mutual funds. Earnings. Retirement services earnings are a function of the level of our managed assets, fixed margin, variable fees, asset management fees, and operating expenses. Division earnings increased 17% in 2000 and 21% in 1999 due to growth in assets under management, as well as wider fixed investment spread and higher asset management fee rates. Assets Under Management. The division's assets under management include invested assets, separate accounts, and mutual funds. Average assets under management increased 16% in 2000 and 25% in 1999. Assets under management were as follows:
2000 1999 1998 -------- -------- -------- Average Invested assets $ 43,056 $ 39,819 $ 33,929 Separate accounts 22,170 17,545 12,578 Mutual funds 2,364 766 166 -------- -------- -------- Total $ 67,590 $ 58,130 $ 46,673 -------- -------- -------- Balance at December 31 $ 66,602 $ 63,552 $ 53,346 -------- -------- --------
page 24 AMERICAN GENERAL 3 General Account. Activity in our general account reserves was as follows:
2000 1999 1998 -------- -------- -------- Balance at January 1 $ 39,714 $ 36,792 $ 32,233 Deposits 5,558 5,011 3,909 Interest credited 2,209 2,034 1,962 Surrenders (3,559) (2,715) (2,153) Benefits and other (1,720) (1,408) 841 -------- -------- -------- Balance at December 31 $ 42,202 $ 39,714 $ 36,792 -------- -------- --------
Fixed deposits grew 11% in 2000, despite the competitive interest rate environment. The 28% growth in fixed deposits in 1999 resulted from exceptional growth in sales of fixed annuities through banks. Fixed Margin. Net investment income and the components of fixed investment spread were as follows:
2000 1999 1998 --------- --------- --------- Net investment income $ 3,218 $ 2,972 $ 2,753 --------- --------- --------- Average investment yield 7.80% 7.72% 7.96% Average crediting rate 5.39 5.35 5.87 --------- --------- --------- Fixed investment spread 2.41% 2.37% 2.09% --------- --------- ---------
The higher level of invested assets in 2000 generated 8% growth in net investment income and a $71 million increase in fixed margin. The fluctuations in investment yield reflected changes in market interest rates and investment mix, as well as lower prepayment-related income. Crediting rates were adjusted to reflect changes in market conditions, including both interest rates and the competitive environment. Separate Accounts. Activity in the separate accounts was as follows:
2000 1999 1998 -------- -------- -------- Balance at January 1 $ 21,594 $ 14,794 $ 10,599 Deposits 3,329 2,982 2,451 Change in market value (3,394) 4,533 2,043 Surrenders (1,242) (821) (530) Benefits and other (203) 106 231 -------- -------- -------- Balance at December 31 $ 20,084 $ 21,594 $ 14,794 -------- -------- --------
Variable deposits grew 12% in 2000 and 22% in 1999, reflecting the continuing popularity of variable investment options provided through our group retirement plans. Average separate account assets increased 26% in 2000 and 39% in 1999. These strong returns were moderated by a $3.1 billion decline in market value in fourth quarter 2000. Mutual Funds. Our acquisition of the North American Funds retail mutual fund operation in March 2000 increased our mutual funds under management $1.1 billion. Deposits in 2000 increased $678 million to $955 million due to the acquisition and growth in our group mutual fund business. Variable and Asset Management Fees. Variable fees as a percentage of average separate account assets were 1.08%, 1.06%, and 1.08% in 2000, 1999, and 1998, respectively. Asset management fees as a percentage of average separate account and mutual fund assets under management increased to .24% in 2000 from .19% in 1999 and .20% in 1998, reflecting more favorable revenue-sharing agreements with third-party asset managers. Other Revenue. Surrender charges and surrender ratios were as follows:
2000 1999 1998 ------ ------ ------ Surrender charges $ 40 $ 30 $ 25 ------ ------ ------ Surrender ratio Fixed 9.67% 7.86% 7.15% Variable 5.73 4.78 4.20
Increases in surrender charges and surrender ratios were due to competitive factors and the expiration of surrender charge periods for a growing number of policies. Gross dealer concessions, which represent distribution fees we receive primarily from third-party retail mutual funds, were $14 million in 2000. Operating Expenses. Operating expenses included a $43 million software write-off in 2000. The operating expense ratio, excluding this write-off, was .50% of average assets under management in 2000, compared to .57% in 1999 and .52% in 1998. The 1999 expense ratio increased as a result of new marketing and customer service initiatives. Deferred Policy Acquisition Costs. Deferred policy acquisition costs (DPAC) and cost of insurance purchased (CIP) are amortized in proportion to current and expected future gross profits. We recorded adjustments to DPAC and CIP in 2000 to reflect revisions to underlying interest spread and surrender assumptions to more closely approximate past and expected future experience. These adjustments reduced amortization expense $48 million. Outlook. Although the decline in the equity markets in fourth quarter 2000 may impact growth in variable fees and asset management fees, we expect growth in sales and deposits, as well as operating efficiencies, to contribute to continued strong earnings growth. As demographics change and more Americans approach retirement, we anticipate a growing demand for our integrated retirement solutions. We are leveraging our strong individual customer and group relationships to offer more comprehensive financial planning services and products in the tax-qualified market. In addition, we are positioning ourselves to be the premier provider in the government market as individuals shift from defined benefit to defined contribution plans. We are leveraging our position as the number one provider of fixed annuities to financial institutions to expand the distribution of variable annuities. 2000 ANNUAL REPORT page 25 4 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions LIFE INSURANCE Life Insurance Highlights Summary Income Statement
2000 1999 1998 ------- ------- ------- Premiums and insurance charges $ 3,014 $ 3,022 $ 3,113 Net investment income 2,198 2,199 2,240 Other income 218 173 153 ------- ------- ------- Total revenues 5,430 5,394 5,506 ------- ------- ------- Insurance and annuity benefits 2,860 2,846 2,959 Operating expenses 659 705 720 Commissions 835 856 797 Change in DPAC/CIP (88) (116) 9 ------- ------- ------- Total expenses 4,266 4,291 4,485 ------- ------- ------- Pretax earnings 1,164 1,103 1,021 Income taxes 394 382 347 ------- ------- ------- DIVISION EARNINGS $ 770 $ 721 $ 674 ------- ------- -------
EARNINGS
Year $ in millions ---- ------------- 98 674 99 721 00 770
ASSETS
Year $ in billions ---- ------------- 98 34.354 99 36.401 00 37.308
DIRECT PREMIUMS AND DEPOSITS $ in billions
Year Life Insurance Other ---- -------------- ----- 98 3.188 1.289 99 3.571 1.353 00 3.615 1.435
LIFE INSURANCE IN FORCE
Year $ in billions ---- ------------- 98 340.951 99 364.104 00 388.470
Our life insurance division is a leading provider of life insurance products used for financial and estate planning and wealth transfer, and ranks as the nation's second-largest issuer of life insurance policies. We distribute our products and services through independent and career agent distribution systems. Our primary focus is our independent distribution system, which includes 33,000 independent agents and strategic alliance partnerships with independent broker/dealers, banks, and financial planners. We distribute a broad portfolio of life insurance products, as well as fixed and variable annuities. Our independent distribution channels market this portfolio to middle- and upper-income individuals, small business owners, and corporations. Our 4,500 career agents market products to moderate- and middle-income customers. When interest-sensitive life insurance and annuities are sold, the premiums and deposits we receive are invested in our general account investment portfolio. We manage investment spread by seeking to optimize the return on these invested assets and, when appropriate, resetting the interest rates credited to policyholder liabilities. Deposits received on variable life and annuity products are held in separate accounts. Revenues from these policies consist of mortality and expense charges and asset management fees. Earnings. The division's profitability is driven by growth in insurance in force and insurance and annuity liabilities, as well as interest spread, mortality and persistency experience, and operating expenses. Division earnings increased 7% in both 2000 and 1999. These increases reflected lower operating expenses and higher insurance in force, which grew 7% each year to over $388 billion at year-end 2000. Sales. Sales, which represent annualized premium and deposits for new products issued, were as follows:
2000 1999 1998 ---- ---- ---- Individual life Independent distribution $415 $371 $345 Career agent distribution 119 163 164 Annuities 837 659 523 Corporate markets 275 385 103 Group and credit 169 138 140
Individual life sales through our independent distribution channels increased 12% in 2000 and 8% in 1999 as we focused on making our interest-sensitive life, term life, and variable life product lines more competitive. During 2000, we initiated a number of changes to reposition our career agent distribution channel for future growth. We eliminated unproductive agents, de-emphasized home collection of premiums for new sales, raised underwriting standards, and introduced new life insurance products to this channel. We also stopped selling certain less profitable page 26 AMERICAN GENERAL 5 lines of business. As expected, sales and premiums in the career agent channel decreased during this period of transition. Annuity sales grew 27% and 26% in 2000 and 1999, respectively, driven by sales of variable annuities through financial institutions. In addition, our life insurance division sold $432 million of annuities manufactured and reported by our retirement services division in 2000, up from $50 million in 1999. We market other products in addition to our core individual life and annuities. Sales of bank-owned and corporate-owned life insurance products fluctuated due to the large size of these cases. Group and credit sales increased 23% in 2000 due to our expanding partnerships in employer and financial institution markets. Policyholder Accounts. The balances in our customer account liabilities were as follows:
2000 1999 1998 ------- ------- ------- General account $25,941 $26,303 $25,671 Separate accounts 3,151 2,503 1,364 ------- ------- ------- Balance at December 31 $29,092 $28,806 $27,035 ------- ------- -------
The decline in the general account liability in 2000 resulted from fixed annuity surrenders, transfers to separate accounts, and run-off of discontinued business lines. Separate accounts reflected strong sales of variable products and transfers from the general account, as well as changes in market value. Direct premiums and deposits (before net reinsurance) were as follows:
2000 1999 1998 ------ ------ ------ Life insurance $3,311 $3,141 $3,100 Annuities 861 704 601 Corporate markets 304 430 88 Other 574 649 688 ------ ------ ------ Total $5,050 $4,924 $4,477 ------ ------ ------
Direct life insurance premiums and deposits increased 5% in 2000 due to increased sales in our independent distribution channel. The increase in annuity deposits arose primarily from sales of variable annuities through financial institutions. Corporate market deposits fluctuated in line with sales. Other direct premiums and deposits, which included discontinued lines, declined 11%. Investment Spread. We seek to maximize the return on invested assets, subject to our asset/liability management and credit quality requirements. Investment spread was as follows:
2000 1999 1998 ---- ---- ---- Average investment yield 8.14% 8.21% 8.50% Average crediting rate 5.89 5.90 5.96 ---- ---- ---- Fixed investment spread 2.25% 2.31% 2.54% ---- ---- ----
Investment yield decreased in 2000 and 1999, reflecting lower market interest rates and reduced prepayment-related income. We decreased the rates credited to policyholders' accounts in 2000 and 1999, partially reducing the effect of the yield declines on the fixed investment spread. We have the ability, subject to certain minimum rate guarantees, to adjust crediting rates on approximately 58% of the division's insurance and annuity liabilities. Mortality and Persistency. We manage mortality and persistency through product design, prudent underwriting, and our agent selection standards. Death claims per $1,000 in force and premium termination rates were as follows:
2000 1999 1998 ------ ------ ------ Death claims/$1,000 in force $ 3.82 $ 3.66 $ 3.60 Premium termination rate 12.42% 12.71% 12.58%
The increase in death claims per $1,000 reflects the increasing average age of the in force business and higher mortality on business in the career agent channel. Mortality and persistency are expected to fluctuate and, overall, experience remained within pricing assumptions. Operating Expenses. We improved the ratio of operating expenses to direct premiums and deposits to 13.0% in 2000, compared to 14.3% in 1999 and 16.1% in 1998. Operating costs declined in 2000 as a result of our ongoing shared service initiatives, reduction of certain postretirement benefits, and lower premium tax expense. Operating expenses in 1999 included costs of terminating certain reinsurance arrangements and Y2K initiatives, offset by lower pension and employee benefit expenses. Deferred Policy Acquisition Costs. During 2000, we reduced the amortization rate for certain deferred costs due to our revised assumptions about the profitability of certain product lines. These revisions were required to reflect lower expenses from improved operating efficiencies, better-than-expected mortality and interest spreads, and higher surrenders in our career agent channel. The 1999 change in DPAC/CIP reflected higher deferrals related to a change in our agent compensation plan and strong corporate market sales. Outlook. We anticipate continued sales growth in 2001 through introduction of new products and development of additional strategic alliance partnerships in our independent distribution channels. We expect increasing business in the upper-income markets through estate and wealth transfer planning and sales of corporate and private placement life insurance. Our broad product portfolio provides solutions to meet customer needs, regardless of the changing economic environment. We intend to maintain our focus on operating efficiencies and cost control, while continuing to grow the level of life insurance in force. We expect these activities to contribute to continued earnings growth. 2000 ANNUAL REPORT page 27 6 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions CONSUMER FINANCE Consumer Finance Highlights Summary Income Statement
2000 1999 1998 ------ ------ ------ Finance margin $ 925 $ 881 $ 842 Other income, net* 162 160 147 ------ ------ ------ Net revenues 1,087 1,041 989 ------ ------ ------ Operating expenses 496 483 465 Provision for loan losses 206 207 212 ------ ------ ------ Total expenses 702 690 677 ------ ------ ------ Pretax earnings 385 351 312 Income taxes 138 125 111 ------ ------ ------ DIVISION EARNINGS $ 247 $ 226 $ 201 ------ ------ ------
*Primarily income from credit-related insurance products. EARNINGS
Year $ in millions ---- ------------- 98 201 99 226 00 247
FINANCE RECEIVABLES Average, $ in billions
Year Real Estate Other ---- ----------- ----- 98 4.681 3.838 99 6.228 3.781 00 7.211 4.198
FINANCE MARGIN
Year $ in billions ---- ------------- 98 0.842 99 0.881 00 0.925
CHARGE-OFF RATIO
Year % of average finance receivables ---- -------------------------------- 98 2.6 99 2.08 00 1.81
Our consumer finance division provides a wide variety of consumer finance products, including mortgages, consumer loans, retail sales finance, and credit-related insurance, to over 2 million customers. In addition to marketing these products through our nationwide network of 1,340 branch offices, we introduced an Internet-based lending system this year. We supplement receivables growth from internally generated loans with bulk purchases of loan portfolios. We fund our finance receivables primarily by issuing fixed-rate debt and floating-rate commercial paper. Earnings. Division earnings are a function of the amount and mix of finance receivables, interest spread, credit quality, and operating expenses. Earnings increased 9% to $247 million in 2000 and 12% in 1999 as a result of growth in our receivables portfolio, improved credit quality, and operating efficiencies, partially offset by lower interest spread. The lower percentage increase in 2000 was due to higher borrowing costs and lower yields on finance receivables, reflecting our continued focus on real estate loans as a significant portion of our portfolio. Finance Receivables. Different types of loans have different degrees of risk, which are reflected in the finance charges we earn. For example, loans secured by real estate have less risk and generally carry lower interest rates. Over the past five years, we increased the percentage of real estate loans in our portfolio from 35% to 62%. The mix of finance receivables at December 31 was as follows:
2000 1999 1998 -------- -------- -------- Real estate loans $ 7,280 $ 7,104 $ 5,757 Non-real estate loans 3,027 2,576 2,560 Retail sales finance 1,454 1,350 1,340 -------- -------- -------- Total finance receivables 11,761 11,030 9,657 Allowance for losses (383) (396) (382) -------- -------- -------- Finance receivables, net $ 11,378 $ 10,634 $ 9,275 -------- -------- -------- Average finance receivables $ 11,409 $ 10,009 $ 8,519 -------- -------- --------
Activity in our finance receivable portfolio was as follows:
2000 1999 1998 -------- -------- -------- Balance at January 1 $ 11,030 $ 9,657 $ 8,012 Originations and renewals 6,732 6,208 5,790 Purchases, net of sales 923 1,728 1,921 Repayments (6,718) (6,356) (5,846) Charge offs, net of recoveries (206) (207) (220) -------- -------- -------- Balance at December 31 $ 11,761 $ 11,030 $ 9,657 ======== ======== ========
page 28 AMERICAN GENERAL 7 Interest Spread. Finance margin is the difference between the finance charges paid by our customers and interest expense on the debt required to fund finance receivables. Interest spread measures this difference in terms of interest rates. Finance margin and the components of interest spread were as follows:
2000 1999 1998 --------- --------- --------- Finance charges $ 1,619 $ 1,455 $ 1,354 Interest expense 694 574 512 --------- --------- --------- Finance margin $ 925 $ 881 $ 842 --------- --------- --------- Average yield on finance receivables 14.19% 14.54% 15.90% Average borrowing cost 6.59 6.23 6.55 --------- --------- --------- Interest spread 7.60% 8.31% 9.35% --------- --------- ---------
Finance charges increased 11% in 2000 and 7% in 1999 due to increases in our average finance receivables, offset by declines in yield. The decline in yield since 1998 resulted from the change in business mix, as well as a more competitive environment. Increases in both average debt and our related borrowing cost resulted in higher interest expense in 2000. Our average debt grew to fund the increase in finance receivables. Credit Quality. We have improved the credit quality of our portfolio by increasing the percentage of lower-risk real estate loans and enhancing credit risk management systems. We conduct regular reviews of the systems, financial models, and assumptions used in our risk management process, which includes statistically-based risk scoring and prediction tools and early warning systems. As a result, we have improved our underwriting process and our ability to identify problem loans and to respond quickly with corrective action. We also conduct an extensive review of the loan portfolios we purchase. Credit quality information for the past three years was as follows:
2000 1999 1998 ------- ------- ------- Charge offs $ 206 $ 207 $ 220 Delinquencies 421 399 384 Allowance for losses 383 396 382 ------- ------- ------- Ratios Charge-off 1.81% 2.08% 2.60% Delinquency 3.41 3.46 3.75 Allowance 3.26 3.59 3.96 Charge-off coverage 1.86x 1.91x 1.74x ------- ------- ------- Risk-adjusted yield 12.38% 12.46% 13.30% ------- ------- -------
Charge offs decreased in both 2000 and 1999, while average finance receivables increased, reducing the charge-off ratio as a percentage of average receivables. Delinquencies increased as a result of growth in finance receivables and as a natural function of the aging of our acquired portfolios. The 2000 delinquency ratio decreased, reflecting increased receivables, improved credit quality, and the sale of $27 million of fully reserved receivables. The allowance for finance receivable losses is maintained at a level that we consider adequate to absorb anticipated credit losses in our existing portfolio. The allowance as a percentage of finance receivables declined, reflecting improved credit quality and the portfolio mix. The charge-off coverage ratio, which compares the allowance for finance receivable losses to charge offs, remained at a conservative level. Risk-adjusted yield represents the yield on finance receivables less the charge-off ratio. Risk-adjusted yield declined less than the yield on finance receivables because of the improvement in the charge-off ratio. Operating Expenses. Our continued emphasis on cost control, in addition to benefits realized from our investment in technology, has resulted in cost savings and operating efficiencies. While our average finance receivables grew 14% in 2000 and 17% in 1999, we limited operating expense increases to 3% and 4% in these years. Operating expenses as a percentage of average finance receivables improved to 4.4% in 2000 from 4.8% in 1999 and 5.5% in 1998, primarily as a result of branch productivity improvements. Net receivables per employee improved 8% to $1.5 million in 2000 from $1.4 million in 1999. Outlook. Recent market interest rate decreases will lower our short-term borrowing rate and ease the pressure on our interest spread. New loan originations and portfolio acquisitions should also reflect the lower rates. In addition, real estate loan liquidations should increase as more loans are refinanced at lower rates. We anticipate continued growth in finance receivables from marketing initiatives and portfolio acquisitions. In a deteriorating economy, the benefits of a decline in short-term interest rates could be partially offset by an increase in delinquencies and charge offs. Our strong credit risk management procedures and large percentage of real estate loans should mitigate the impact of any resulting change in credit quality. 2000 ANNUAL REPORT page 29 8 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions INVESTMENTS Investment Highlights
2000 1999 1998 -------- -------- -------- Average invested assets* $ 72,596 $ 68,738 $ 64,848 Net investment income 5,453 5,232 5,095 Investment gains (losses) (176) (19) 6 Average investment yield* 7.83% 7.85% 8.16%
*Excludes fair value adjustment under accounting standard SFAS 115. INVESTED ASSETS*
Year Average $ in billions ---- --------------------- 98 64.848 99 68.738 00 72.596
*Excludes fair value adjustment. NET INVESTMENT INCOME
Year $ in billions ---- ------------- 98 5.095 99 5.232 00 5.453
[Pie Chart] 2000 INVESTED ASSETS Mortgage-backed securities 19% Private investment grade bonds 16% Below investment grade bonds 5% Other 6% Mortgage loans 5% Public investment grade bonds 49%
[Pie Chart] 2000 FIXED MATURITY SECURITIES BY RATING A 32% BBB 27% Below investment grade 6% AAA 25% AA 10%
Investment activities are an integral part of our operations. Our investment strategy is twofold: (1) maintain a predominantly investment-grade, fixed-income portfolio that provides adequate liquidity and cash flow to meet our general account liability requirements and (2) optimize investment return through active investment management. We had $72.6 billion of investments supporting our general account insurance and annuity liabilities at year-end 2000. Fixed maturity securities accounted for approximately 90% of these investments. We also provided investment management, advisory, and administrative services for $23.2 billion of separate account assets. In addition to the investments and separate account assets on our balance sheet, we have built a significant fee-based asset management capability. Mutual funds under management increased $1.8 billion to $2.8 billion, primarily from our acquisition of the North American Funds, a family of 16 sub-advised mutual funds, in first quarter 2000. We also managed $3.8 billion in third-party and collateralized bond obligation amounts. Collateralized bond obligations under management increased $1.7 billion as a result of four new offerings during 2000. INVESTMENT RESULTS Net Investment Income. Net investment income increased 4% in 2000 and 3% in 1999, while average invested assets increased 6% for each year. Higher reinvestment rates were more than offset by lower prepayment-related income resulting in a two basis point decline in investment yield for 2000. The 1999 investment yield was 31 basis points lower due to reduced prepayment-related income. Investment Gains (Losses). Investment gains (losses) include the pretax realized gains or losses and any related DPAC amortization associated with the disposition of securities, the write-down of securities for other than temporary declines in value, and our share of changes in fair value of the underlying equity investments held by equity partnerships. Investment losses during 2000 reflected our ongoing active management of the investment portfolio to maximize relative value and to optimize our tax position. Investment losses during 2000 were also impacted by the deteriorating corporate credit cycle in the economy. These losses were partially offset by a $22 million increase in fair value of the underlying equity investments held by equity partnerships. FAIR VALUE OF SECURITIES We report our fixed maturity and equity securities at fair value in accordance with SFAS 115. Accounting rules do not permit us to report the insurance and annuity liabilities supported by these securities at fair value. As a result, changes in interest rates create volatility in shareholders' page 30 AMERICAN GENERAL 9 equity since only unrealized gains (losses) on fixed maturity and equity securities are reported on the balance sheet. The components of the fair value adjustment at December 31 were as follows:
2000 1999 1998 ------- ------- ------- Fair value adjustment to fixed maturity securities $ (328) $(1,750) $ 3,519 Related increase (decrease) in DPAC/CIP 88 347 (1,073) Related decrease (increase) in deferred income taxes 85 495 (863) Valuation allowance on deferred tax asset (130) (381) -- ------- ------- ------- Net unrealized gains (losses) Fixed maturity securities (285) (1,289) 1,583 Other, net (19) 11 16 ------- ------- ------- Net unrealized gains (losses) on securities $ (304) $(1,278) $ 1,599 ------- ------- -------
During 2000, the Federal Reserve Board increased the federal funds rate, its key short-term interest rate, 100 basis points to 6.50% at year end. During the same period, the ten-year treasury bond yield declined 133 basis points to 5.11%, compared to a 180 basis point increase in 1999. As measured by the Salomon Brothers Broad Investment Grade Bond Index, the 2000 decrease in yield resulted in average bond prices increasing almost 5% during the year, compared to a 7% decrease in 1999. At December 31, 2000, the market value of our fixed maturity securities was 99% of amortized cost, compared to 97% of amortized cost at year-end 1999. The negative fair value adjustment to our fixed maturity securities portfolio decreased $1.4 billion, with a related $1.0 billion positive change in shareholders' equity, during 2000. We established a valuation allowance on the deferred tax asset related to the unrealized losses on fixed maturity securities at December 31, 1999 because a portion of the deferred tax asset may not be realized. This valuation allowance had no impact on earnings. FIXED MATURITY SECURITIES At year-end 2000, fixed maturity securities included $48.1 billion of corporate bonds and $14.0 billion of mortgage-backed securities. The average credit ratings of our fixed maturity securities by category at December 31, 2000 were as follows:
Average 2000 Rating ------- --- ------- Investment grade $46,960 73% A Mortgage-backed 13,964 22 AAA Below investment grade 3,208 5 B+ ------- --- --- Total fixed maturity securities $64,132 100% A ------- --- ---
We have a well-diversified portfolio with no exposure to any non-government issuer exceeding .6% of total invested assets. The mix of our fixed maturity securities portfolio at December 31 was as follows:
2000 1999 1998 ---- ---- ---- Corporates Industrial 39% 41% 40% Financial services 22 22 21 Utilities 14 13 13 --- --- --- Total corporates 75 76 74 Mortgage-backed 22 21 21 Governments 3 3 5 --- --- --- Total portfolio 100% 100% 100% --- --- ---
Mortgage-Backed Securities. We invest in mortgage-backed securities (MBSs) to diversify our portfolio risk characteristics from primarily corporate credit risk to a mix of credit and cash flow risk. The majority of our MBSs have relatively low cash flow variability. In addition, 88% of our MBSs are residential with minimal credit risk because the underlying collateral is guaranteed by Federal agencies. These MBSs are highly liquid and offer higher yields than corporate debt securities of similar credit quality and expected average lives. Our MBSs at December 31 were as follows:
2000 1999 1998 ------- ------- ------- Collateralized mortgage obligations (CMOs) Planned amortization class $ 3,619 $ 3,765 $ 4,622 Sequential 2,812 2,851 3,948 Other 960 1,087 828 ------- ------- ------- Total CMOs 7,391 7,703 9,398 Pass-through securities 4,948 3,955 3,013 Commercial MBSs 1,625 1,235 608 ------- ------- ------- Total MBSs $13,964 $12,893 $13,019 ------- ------- -------
The principal risks inherent in holding MBSs are prepayment and extension risks arising from changes in market interest rates. In rising interest rate environments, underlying mortgages are prepaid at a slower rate, causing MBS principal payments to be extended. In declining interest rate environments, the mortgages underlying MBSs are prepaid more rapidly, causing early repayment of MBSs. Although early MBS repayments may result in acceleration of income from recognition of any unamortized discount, we typically have to reinvest the proceeds at lower current yields, resulting in a net reduction of future investment income. We manage our prepayment and extension risks by actively managing our portfolio of pass-through securities to focus on current coupon collateral, investing in commercial mortgage-backed securities with fixed payment terms, and investing in CMO tranches that provide greater 2000 ANNUAL REPORT page 31 10 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions stability of cash flows. The planned amortization class tranche is structured to give the investor more certain cash flows; therefore, this tranche is subject to less prepayment and extension risk than other CMO tranches. Sequentials allocate all principal payments to tranches based on maturity, retiring the shortest maturity tranches first. Below Investment Grade Securities. We invest in below investment grade securities to enhance the overall yield of our portfolio. Below investment grade securities have credit ratings below BBB- and represented less than 6% of fixed maturity securities at each year end. Earnings from below investment grade securities were as follows:
2000 1999 1998 ----- ----- ----- Average investment yield 10.5% 10.4% 9.8% Investment income $ 396 $ 371 $ 287 Realized gains (losses) (138) (79) (42)
Surveillance List. We actively manage our fixed maturity security portfolio to minimize our risk by limiting our exposure to any one issuer, monitoring collateral performance, analyzing the impact of general economic conditions, and conducting ongoing surveillance of high-risk securities. Below investment grade bond issuers are generally more sensitive to changes in their competitive position and the economic climate than more highly-rated issuers. The securities on our surveillance list, which totaled $1.4 billion or 2% of fixed maturity securities at December 31, 2000, are closely monitored in terms of their vulnerability to such external changes. While default rates in the below investment grade portfolio increased in 2000, defaults have not had a significant impact on our results in the past three years. Non-Performing Bonds. We classify bonds as non-performing when the payment of interest is sufficiently uncertain as to preclude the accrual of interest. Non-performing bonds were less than .2% of total fixed maturity securities at each of the prior three year ends. MORTGAGE LOANS Mortgage loans on real estate, consisting primarily of loans on office and retail properties, represented 5% of our invested assets at year-end 2000. Mortgage loan statistics at December 31 were as follows:
2000 1999 1998 -------- -------- -------- Mortgage loans $ 3,937 $ 3,712 $ 3,402 Allowance for losses (17) (26) (34) -------- -------- -------- Mortgage loans, net $ 3,920 $ 3,686 $ 3,368 -------- -------- -------- Yield on total loans 8.2% 8.3% 8.6% Yield on restructured loans 7.9 7.8 7.9 Percentage of total loans Restructured 1.3 1.7 2.1 Delinquent (60+ days) -- .6 .6 Watchlist .8 .9 2.4 -------- -------- --------
OUTLOOK We expect the economy to slow during the first half of 2001, followed by modest growth later in the year. We anticipate the corporate credit outlook will remain weak overall, particularly in the high yield market. Continued Federal Reserve Board actions during the first half of 2001 should minimize any significant rise in long-term interest rates. We expect our average investment yield to remain near its current level. ASSET/LIABILITY MANAGEMENT We manage our exposure to fluctuations in interest rates through an asset/liability management program designed to achieve our liquidity and profitability objectives by maintaining a reasonable balance in the durations of assets and liabilities. We perform asset/liability management on an ongoing basis for each operating company, as well as on an aggregate basis. RETIREMENT SERVICES AND LIFE INSURANCE General Account. The earnings of our retirement services and life insurance divisions are largely driven by the spread between the yields on our investments and the rates credited to policyholders on general account liabilities. We respond to fluctuations in interest rates through pricing of new products and periodic adjustment of interest crediting rates on existing products, where possible. We have been able to manage the investment spread to maintain overall margins on interest-sensitive products despite wide swings in market interest rates over the past several years. Our ability to manage interest crediting rates and durations is largely due to the nature of our insurance and annuity products. We had the ability, subject to certain minimum rate guarantees, to adjust interest crediting rates on approximately 84% of our insurance and annuity liabilities at December 31, 2000. Additionally, we use swaptions (options to enter into swap agreements) to limit our exposure to reduced spreads between investment yields and interest crediting rates during prolonged periods of significant increases or decreases in market interest rates. We manage our investment portfolio by purchasing investments that are aligned with our specific portfolio objectives and, to a lesser extent, by restructuring the page 32 AMERICAN GENERAL 11 portfolio. We also use derivative financial instruments on a very limited and selective basis. We establish investment portfolio objectives that maximize investment returns consistent with the duration and cash flow characteristics of the insurance and annuity liabilities being supported. The estimated duration of the company's insurance and annuity liabilities was in the range of 4.9 to 5.9 years at year-end 2000, while the estimated duration of the assets supporting these liabilities was 5.2 years. We perform simulations of the cash flows generated by our businesses under various interest rate scenarios to manage the gap between our interest rate-sensitive assets and liabilities. Our cash flow testing performed as of December 31, 2000 indicated that our insurance companies would have sufficient cash flows to meet their insurance obligations under the broad range of selected scenarios. Separate Accounts. Because the investment risk on separate account assets lies predominantly with the policyholder, our liability is equal to the value of the account assets. Fees earned on separate accounts are a function of the value of the assets, rather than interest rates. Therefore, asset/liability management is not a material issue for separate accounts. CONSUMER FINANCE The primary products offered by our consumer finance division are real estate loans, which have an expected life of 3.7 years (although this can change in response to interest rate changes); consumer loans, which have an average term of 1.5 years; and retail sales finance with average terms of 9 months. We fund these receivables with a combination of fixed-rate and floating-rate debt (typically 88%) and equity (typically 12%). We use interest rate swap agreements to convert a portion of floating-rate debt to a fixed rate. The weighted-average years to maturity for our fixed-rate debt was 2.5 years at December 31, 2000. We determine the mix of fixed-rate and floating-rate debt based in part on the nature of the receivables being supported. Generally, floating-rate assets are funded with floating-rate debt, fixed-rate assets are funded with 20% to 30% floating-rate debt, and the remainder is funded with fixed-rate debt. CORPORATE The primary assets of our parent company are long-term investments in its subsidiaries. These assets are supported by our corporate capital structure consisting of corporate debt, redeemable equity, and shareholders' equity. The average lives of our long-term corporate debt and redeemable equity are 11 and 39 years, respectively. To reduce the earnings impact of a change in interest rates, we limit floating-rate debt to 10% to 12% of our target capital. Floating-rate debt was 11.3% of total capital at December 31, 2000. This percentage included the effect of interest rate swap agreements that convert floating-rate debt to a fixed rate. SENSITIVITY ANALYSIS The fair values of certain of our assets and liabilities are sensitive to changes in market interest rates. The impact of changes in interest rates would be reduced by the fact that increases (decreases) in fair values of assets would be partially offset by corresponding changes in fair values of liabilities. In aggregate, the estimated impact of an immediate and sustained 100 basis point increase or decrease in interest rates on the fair values of our interest rate-sensitive financial instruments would not be material to our financial position. The estimated increases (decreases) in fair values of interest rate-sensitive financial instruments at December 31, 2000 were as follows:
+100 bp -100 bp -------- ------- Assets Fixed maturity securities $(3,737) $ 3,096 Mortgage loans (186) 143 Policy loans (117) 135 Finance receivables (322) 349 Liabilities Insurance investment contracts (1,927) 2,069 Long-term debt Corporate (104) 116 Consumer finance (187) 195 Redeemable equity (216) 271
These estimated changes in fair values were not materially different from the changes we estimated at December 31, 1999 or 1998. At each year end, we derived the changes in fair values by modeling estimated cash flows of certain of the company's assets and liabilities. The assumptions we used adjusted cash flows to reflect changes in prepayments, calls, surrenders, and interest crediting rates in response to the changes in interest rates, as well as the effects of derivative financial instruments used as hedges. These cash flows did not consider new investment purchases, loan originations, product sales, or debt issuances. Readers should exercise care in drawing conclusions based on the above analysis. While these changes in fair values provide a measure of interest rate sensitivity, they do not represent our expectations about the impact of interest rate changes. A meaningful assessment of our net interest rate exposure cannot be made without a revaluation of our other insurance and annuity liabilities, which are not considered to be interest rate-sensitive financial instruments under current accounting standards. This analysis was also based on our exposure at a particular point in time and incorporated numerous 2000 ANNUAL REPORT page 33 12 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions assumptions and estimates. It also assumed an immediate change in interest rates, without regard to the impact of certain business decisions or initiatives that we would likely undertake to mitigate or eliminate some or all of the adverse effects of the modeled scenarios. Additionally, this analysis did not reflect the impact of fair value fluctuations on deferred income taxes, deferred policy acquisition costs, or cost of insurance purchased. Adjustments to these accounts would partially offset the changes to the fair values of interest rate-sensitive financial instruments. CAPITAL RESOURCES The level of our corporate capital is determined primarily by the required equity of our business divisions. We have established target levels of equity for each division, based on their targeted ratings, differing operations, and regulatory requirements. RETIREMENT SERVICES AND LIFE INSURANCE Risk-Based Capital. The amount of statutory equity required to support the business of our retirement services and life insurance companies is principally a function of four factors: (1) the quality of assets invested to support insurance and annuity reserves, (2) mortality and other insurance-related risks, (3) interest-rate risk resulting from potential mismatching of asset and liability durations, and (4) general business risks. Each of these items is a key factor in the National Association of Insurance Commissioners' (NAIC) risk-based capital (RBC) formula, used to evaluate the adequacy of a life insurance company's statutory equity. Financial Strength Ratings. Rating agencies use the RBC approach as a factor in assigning an insurance company its financial strength rating. This rating serves as an indicator of the insurance company's ability to meet its future obligations to policyholders. At December 31, 2000, our principal retirement services and life insurance companies were rated as follows:
Rating Description ------ ----------- Standard & Poor's AA+ Very Strong Fitch AA+ Very Strong Moody's Aa2/Aa3 Excellent A.M. Best A+ Superior
To maintain our very high financial strength ratings, we manage the statutory equity of our principal retirement services and life insurance companies to a target that is significantly more than the equity required by insurance regulators. During the past three years, our target was 2.5 times the Company Action Level RBC (or 5.0 times the Authorized Control Level RBC). We adjust dividends from, or contributions to, these companies to maintain this target. At December 31, 2000, our principal retirement services and life insurance companies had statutory equity with a weighted-average of 2.79 times the Company Action Level RBC. The NAIC has issued the Codification of Statutory Accounting Principles that prescribes certain changes in statutory accounting practices effective January 1, 2001. While codification may change reported statutory equity, we intend to continue managing our insurance and annuity companies' statutory equity at levels necessary to maintain our very high financial strength ratings. CONSUMER FINANCE The capital of our consumer finance division varies directly with the level of its finance receivables. This capital, totaling $12.3 billion at year-end 2000, consisted of $1.5 billion of equity and $10.8 billion of consumer finance debt, which was not guaranteed by American General. The capital mix of consumer finance debt and equity is based upon maintaining leverage at a level that supports cost-effective funding. The consumer finance division's target ratio of debt to tangible net worth, a standard measure of financial risk in the consumer finance industry, is currently 7.5 to 1. This ratio was 7.5 to 1 at year-end 2000, 7.6 to 1 at year-end 1999, and 7.5 to 1 at year-end 1998. Consumer finance debt ratings at December 31, 2000 were as follows:
Commercial Paper Long-term Debt ---------------------- -------------------- Rating Description Rating Description ------ ----------- ------ ----------- Standard & Poor's A-1 Strong A+ Strong Fitch F1+ Highest A+ High Moody's P-1 Highest A2 Favorable
page 34 AMERICAN GENERAL 13 The weighted-average interest rates on consumer finance debt, including the effect of interest rate swap agreements, were as follows:
2000 1999 1998 ---- ---- ---- Floating-rate debt 6.47% 5.28% 5.60% Fixed-rate debt 6.67 6.68 7.05 Total consumer finance debt 6.59 6.23 6.55
CORPORATE The mix of corporate capital between debt and equity is influenced by our overall corporate strategy and structure. Our target capital structure consists of 25% corporate debt, 15% redeemable equity, and 60% shareholders' equity. The amount and mix of our corporate capital at December 31 were as follows:
2000 1999 1998 ------- ------- ------- Corporate capital* $13,449 $12,768 $11,767 ------- ------- ------- Corporate debt 24% 24% 23% Redeemable equity 15 15 15 Shareholders' equity 61 61 62 ------- ------- -------
*Excludes fair value adjustment under accounting standard SFAS 115 Capital Costs. Corporate capital costs consist of interest on corporate debt and dividends on preferred securities. Corporate capital costs were as follows:
2000 1999 1998 ----- ----- ----- Interest on corporate debt $ 239 $ 210 $ 196 Dividends on preferred securities 158 142 137 Tax benefit (139) (124) (117) ----- ----- ----- Corporate capital costs $ 258 $ 228 $ 216 ----- ----- -----
The increases in corporate capital costs reflect the growth in corporate capital, in addition to higher market rates on new issuances of debt and preferred securities. Corporate Debt. Our corporate debt ratings at December 31, 2000 were as follows:
Commercial Paper Long-term Debt ----------------------- ---------------------- Rating Description Rating Description ------ ----------- ------ ----------- Standard & Poor's A-1+ Highest AA- Very Strong Fitch F1+ Highest AA- Very High Moody's P-1 Highest A2 Favorable
The weighted-average interest rates on corporate debt, including the effect of interest rate swap agreements, were as follows:
2000 1999 1998 ---- ---- ---- Floating-rate debt 6.57% 6.03% 5.54% Fixed-rate debt 7.40 7.62 7.77 Total corporate debt 6.91 6.63 6.46
Redeemable Equity. During the last three years, we issued $600 million of preferred securities, which are recorded on our balance sheet as redeemable equity. We used the proceeds primarily to reduce short-term debt. The weighted-average dividend rate on our redeemable equity was 7.7% in 2000. Current ratings on our redeemable equity are as follows:
Rating Description ------ ----------- Standard & Poor's A Strong Fitch A+ High Moody's a2 Favorable ------ ---------
In 2000, holders of $250 million of 6% convertible preferred securities issued by American General Delaware, L.L.C. converted their securities into 12.3 million shares of American General common stock. Shareholders' Equity. During the last three years, we issued $623 million of common stock in connection with acquisitions. During 2000, all $85 million of our mandatorily convertible preferred stock was converted into 3.8 million shares of American General common stock. Since 1987, American General has repurchased 259.1 million common shares for an aggregate cost of $3.7 billion. Our share repurchases for the past three years were as follows:
2000 1999 1998 ------ ------ ------ Shares repurchased 14.0 11.8 5.9 Cost of shares repurchased $ 460 $ 425 $ 195
We use share repurchases as a means of maintaining our target capital structure. Our future repurchase activity will be based on the company's corporate development activities, capital management strategy, corporate growth rates, and fluctuations in our common stock price. 2000 ANNUAL REPORT page 35 14 MANAGEMENT'S DISCUSSION AND ANALYSIS In millions LIQUIDITY Our overall liquidity is based on cash flows from the business divisions and our ability to borrow in both the long-term and short-term markets at competitive rates. We believe that our overall sources of liquidity will continue to be sufficient to satisfy our foreseeable financial obligations. RETIREMENT SERVICES Principal sources of cash for our retirement services division were as follows:
2000 1999 1998 ------ ------ ------ Cash from operating activities $1,953 $1,570 $1,625 Deposits, net of withdrawals Fixed 852 1,532 626 Variable 2,477 2,465 2,294 Mutual funds 420 212 --
The 2000 decline in net fixed deposits reflected the expiration of surrender charge periods for a growing number of policies, as well as increased competition. The 1999 increase in net fixed deposits was due to exceptional growth in fixed annuities sold through financial institutions. The increase in net mutual fund deposits resulted from the division's increased concentration on sales of these products. Because the investment risk on variable and mutual fund products lies predominantly with the policyholder, deposits and withdrawals related to separate accounts and mutual funds are not included in the company's cash flow statement. The division's major use of cash was the net purchase of investments necessary to support increases in its insurance and annuity liabilities. LIFE INSURANCE Principal sources of cash for our life insurance division were as follows:
2000 1999 1998 ----- ----- ----- Cash from operating activities $ 142 $ 155 $ 361 Deposits, net of withdrawals Fixed (108) 394 57 Variable 899 643 356
Operating cash flows declined from 1998 as a result of fluctuations in assumed reinsurance activity. The $502 million decline in net fixed deposits and the $256 million increase in net variable deposits in 2000 resulted from the transfer of lump sum fixed deposits to separate accounts and higher withdrawals. The division's major uses of cash were the net purchase of investments necessary to support increases in insurance and annuity liabilities and net dividends paid to the parent company. CONSUMER FINANCE Principal sources of cash for our consumer finance division were as follows:
2000 1999 1998 ------ ------ ------ Cash from operating activities $ 620 $ 494 $ 439 Increase in debt 623 1,295 1,593 ------ ------ ------
Net cash provided by operating activities increased in 2000 due to an increase in finance charges from higher average net receivables. Cash generated by borrowings did not increase as much in 2000 as in 1999 and 1998 due to lower growth in finance receivables, principally from the reduced level of bulk purchases in 2000. The division's major use of cash was to fund finance receivables growth. Net cash used to fund finance receivables was $1.0 billion in 2000, down from $1.6 billion in 1999 and $1.8 billion in 1998. CORPORATE The primary sources of cash for corporate operations include net dividends from our business divisions and the proceeds from issuances of debt and redeemable equity. Our subsidiary capitalization targets are the major factor in determining the amount of dividends paid by our operating companies. Additionally, state insurance regulations for insurance and annuity companies and long-term debt covenants for our consumer finance operations restrict the amount of dividends our business divisions may pay. These restrictions are not expected to affect American General's ability to meet its cash obligations in 2001. page 36 AMERICAN GENERAL 15 Net dividends received from our business divisions were as follows:
2000 1999 1998 ---- ---- ---- Dividends received Retirement Services $211 $124 $182 Life Insurance 466 599 599 Consumer Finance 107 110 -- ---- ---- ---- Total received 784 833 781 ---- ---- ---- Contributions paid Retirement Services 132 119 281 Life Insurance 141 230 -- Consumer Finance -- -- 47 ---- ---- ---- Total paid 273 349 328 ---- ---- ---- Net dividends received $511 $484 $453 ---- ---- ----
Net dividends from our retirement services division were lower in 1999 and 1998 because additional capital was required to support target capital levels and new business growth. The life insurance division received contributions in 2000 and 1999 to partially fund industrial life and market conduct litigation settlements. Corporate operations use cash to pay dividends to shareholders, to pay interest on corporate debt and dividends on preferred securities, to repurchase common stock, and to pay corporate expenses not allocated to the business divisions. We expect to fund maturities of debt and preferred securities and potential future acquisitions through external sources, while maintaining our capital mix. REGULATION AND OTHER REGULATION On November 12, 1999, the Financial Services Modernization Act became federal law, eliminating regulatory barriers between banks, insurance companies, and securities firms that had existed for over 60 years. This act provides new opportunities and increased competition among diversified financial services companies and will hasten the pace of consolidation in the financial services industry. Insurance regulators monitor capital adequacy and market conduct to protect policyholders. Market conduct includes sales and advertising practices, agent licensing and compensation, policyholder service, complaint handling, underwriting, and claims practices. As a result of increased regulatory scrutiny, market conduct compliance costs for our insurance subsidiaries have increased in recent years. Market conduct issues are also a concern for our consumer finance business. State legislators and consumer groups have raised concerns that some subprime lenders may be charging excessive rates. While some predatory lending proposals under consideration are appropriate, others are excessive and could adversely impact lenders and reduce availability of credit for borrowers. Federal and state laws and regulations have been enacted, and others are likely to be enacted in the near future, to protect the privacy of certain types of customer information. These laws and regulations include requirements for financial services companies to disclose their privacy policy and, in certain circumstances and with respect to certain types of information, to obtain customer consent before information could be shared with affiliates or third parties. We are monitoring both state and federal legislative and regulatory activities to ensure the company's continued adherence to privacy rules. We are monitoring proposals to repeal or reform the federal estate tax. While there is general agreement in Congress that the current estate tax should be reformed, there is no clear consensus on how it should be reformed. Any changes in tax laws or regulations could adversely affect the sale and/or profitability of some of our products. LITIGATION SETTLEMENTS AND OTHER CHARGES We report significant litigation settlements and other non-recurring charges as a component of corporate operations. In 2000, we recorded charges of $265 million ($175 million aftertax) for the settlement of class action litigation and regulatory inquiries concerning sales of industrial life insurance and $50 million ($32 million aftertax) for a loss related to fraud committed against one of our subsidiaries that conducts mortgage warehouse lending activities. In 1999, we recorded a charge of $57 million ($36 million aftertax) for the settlement of litigation related to the financing of satellite dishes. In 1998, we recorded a charge of $378 million ($246 million aftertax) related to the settlement of market conduct class action lawsuits. These charges are discussed in Note 17 to our financial statements. We are currently in arbitration to rescind a quota share reinsurance agreement covering workers' compensation claims, as discussed in Note 17.1 to our financial statements. We believe that our ultimate loss, if any, related to our workers' compensation business will not have a material adverse effect on our future results of operations and financial position. FORWARD-LOOKING STATEMENTS All statements, trend analyses, and other information contained herein relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. We have made these forward-looking statements based upon our current expectations and beliefs concerning future developments and their potential effects on the company. There can be no assurance that future developments affecting the company will be those we anticipated. Actual results may differ materially from those included in the forward-looking statements. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: (1) changes in general economic conditions, including the performance of financial markets and interest rates; (2) customer responsiveness to both products and distribution channels; (3) competitive, regulatory, accounting, or tax changes that affect the cost of, or demand for, our products; (4) our ability to secure necessary regulatory approvals, including approvals for dividends and products; (5) our ability to realize projected expense savings; (6) adverse litigation or arbitration results or resolution of litigation or arbitration, including proceedings related to satellite dish financing and workers' compensation insurance; and (7) the formation of strategic alliances or business combinations among our competitors or our business partners. Investors are also directed to other risks and uncertainties discussed in documents we filed with the Securities and Exchange Commission. We undertake no obligation to update or revise any forward-looking information, whether as a result of new information, future developments, or otherwise. 2000 ANNUAL REPORT page 37 16 CONSOLIDATED INCOME STATEMENT AMERICAN GENERAL CORPORATION
For the years ended December 31 In millions, except per share data 2000 1999 1998 -------- -------- -------- REVENUES Premiums and other considerations $ 3,839 $ 3,772 $ 3,605 Net investment income 5,453 5,232 5,095 Finance charges 1,619 1,455 1,354 Investment gains (losses) (176) (19) 6 Other revenues 328 239 191 -------- -------- -------- Total revenues 11,063 10,679 10,251 -------- -------- -------- BENEFITS Insurance and annuity benefits 5,500 5,313 5,159 AND Operating costs and expenses 1,647 1,643 1,608 EXPENSES Commissions 1,258 1,230 1,063 Change in deferred policy acquisition costs and cost of insurance purchased (504) (477) (213) Provision for finance receivable losses 206 207 212 Goodwill amortization 48 48 45 Interest expense Corporate 225 197 181 Consumer Finance 694 574 512 Litigation settlements and other charges 315 57 378 -------- -------- -------- Total benefits and expenses 9,389 8,792 8,945 -------- -------- -------- NET INCOME Income before income tax expense 1,674 1,887 1,306 Income tax expense 568 664 453 -------- -------- -------- Income before net dividends on preferred securities of subsidiaries 1,106 1,223 853 Net dividends on preferred securities of subsidiaries 103 92 89 -------- -------- -------- Net income $ 1,003 $ 1,131 $ 764 -------- -------- -------- PER SHARE Net income per share (Post-split) Basic $ 2.01 $ 2.26 $ 1.51 Diluted 1.98 2.20 1.48 -------- -------- --------
See Notes to Financial Statements. page 38 AMERICAN GENERAL 17 CONSOLIDATED BALANCE SHEET AMERICAN GENERAL CORPORATION
At December 31 In millions 2000 1999 1998 --------- --------- --------- ASSETS Investments Fixed maturity securities (amortized cost: $64,460; $62,375; $59,212) $ 64,132 $ 60,625 $ 62,731 Mortgage loans on real estate 3,920 3,686 3,368 Equity securities (cost: $832; $633; $444) 831 673 481 Policy loans 2,433 2,375 2,329 Real estate and other long-term investments 306 300 300 Short-term investments 671 676 654 --------- --------- --------- Total investments 72,293 68,335 69,863 --------- --------- --------- Assets held in separate accounts 23,234 24,097 16,158 Finance receivables, net 11,378 10,634 9,275 Deferred policy acquisition costs 5,464 4,980 3,253 Cost of insurance purchased 994 1,170 956 Goodwill 1,448 1,501 1,590 Other assets 5,283 4,730 4,012 --------- --------- --------- Total assets $ 120,094 $ 115,447 $ 105,107 --------- --------- --------- LIABILITIES Insurance and annuity liabilities $ 68,309 $ 66,401 $ 62,844 Liabilities related to separate accounts 23,234 24,097 16,158 Debt (short-term) Corporate ($1,921; $1,932; $1,607) 3,259 3,120 2,743 Consumer Finance ($5,162; $4,489; $3,686) 10,833 10,206 8,863 Income tax liabilities 1,151 833 1,543 Other liabilities 3,421 2,446 2,357 --------- --------- --------- Total liabilities 110,207 107,103 94,508 --------- --------- --------- REDEEMABLE Company-obligated mandatorily redeemable EQUITY preferred securities of subsidiaries holding solely company subordinated notes 2,067 1,924 1,728 --------- --------- --------- SHAREHOLDERS' Convertible preferred stock -- 85 85 EQUITY Common stock (post-split) Shares issued: 538.6; 538.6; 538.6 Shares outstanding: 500.7; 496.1; 503.6 887 962 939 Retained earnings 8,294 7,732 7,007 Accumulated other comprehensive income (loss) (304) (1,278) 1,599 Cost of treasury stock (1,057) (1,081) (759) --------- --------- --------- Total shareholders' equity 7,820 6,420 8,871 --------- --------- --------- Total liabilities and equity $ 120,094 $ 115,447 $ 105,107 --------- --------- ---------
See Notes to Financial Statements. 2000 ANNUAL REPORT page 39 18 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY AMERICAN GENERAL CORPORATION
For the years ended December 31 In millions, except per share data 2000 1999 1998 ------- ------- ------- PREFERRED Balance at beginning of year $ 85 $ 85 $ 85 STOCK Conversion into common shares (85) -- -- ------- ------- ------- Balance at end of year -- 85 85 ------- ------- ------- COMMON Balance at beginning of year 962 939 326 STOCK Conversion of preferred stock and preferred securities (83) -- -- Issuance of common shares for acquisition -- -- 580 Issuance of stock options for acquisition -- -- 37 Issuance of treasury shares for acquisition and other 8 23 (4) ------- ------- ------- Balance at end of year 887 962 939 ------- ------- ------- RETAINED Balance at beginning of year 7,732 7,007 6,624 EARNINGS Net income 1,003 1,131 764 Cash dividends (per share) Common ($.88; $.80; $.75) (440) (400) (375) Preferred ($.64; $2.57; $2.57) (1) (6) (6) ------- ------- ------- Balance at end of year 8,294 7,732 7,007 ------- ------- ------- ACCUMULATED Balance at beginning of year (1,278) 1,599 1,169 OTHER Change in net unrealized gains (losses) on securities 974 (2,877) 430 COMPREHENSIVE ------- ------- ------- INCOME (LOSS) Balance at end of year (304) (1,278) 1,599 ------- ------- ------- TREASURY Balance at beginning of year (1,081) (759) (621) STOCK Repurchase of common shares (460) (425) (195) Conversion of preferred stock and preferred securities 418 -- -- Issuance for acquisition -- 43 -- Issuance under employee benefit plans and other 66 60 57 ------- ------- ------- Balance at end of year (1,057) (1,081) (759) ------- ------- ------- SHAREHOLDERS' EQUITY Balance at end of year $ 7,820 $ 6,420 $ 8,871 ------- ------- -------
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
2000 1999 1998 ------- ------- ------- NET INCOME Net income $ 1,003 $ 1,131 $ 764 ------- ------- ------- OTHER Change in net unrealized gains (losses) on securities COMPREHENSIVE Fair value of fixed maturity securities 1,422 (5,269) 733 INCOME Deferred policy acquisition costs and cost of insurance purchased (259) 1,420 (21) Deferred income taxes (159) 977 (253) ------- ------- ------- Change in fixed maturity securities 1,004 (2,872) 459 Change in equity securities and other (30) (5) (29) ------- ------- ------- Total 974 (2,877) 430 ------- ------- ------- COMPREHENSIVE Comprehensive income (loss) $ 1,977 $(1,746) $ 1,194 INCOME (LOSS) ------- ------- -------
See Notes to Financial Statements. page 40 AMERICAN GENERAL 19 CONSOLIDATED STATEMENT OF CASH FLOWS AMERICAN GENERAL CORPORATION
At December 31 In millions 2000 1999 1998 -------- -------- -------- OPERATING Net income $ 1,003 $ 1,131 $ 764 ACTIVITIES Reconciling adjustments Insurance and annuity liabilities 1,440 1,206 1,619 Deferred policy acquisition costs and cost of insurance purchased (504) (477) (213) Deferred income taxes 198 267 (30) Provision for finance receivable losses 206 207 212 Investment losses (gains) 176 19 (6) Other, net (9) (324) (135) -------- -------- -------- Net cash provided by operating activities 2,510 2,029 2,211 -------- -------- -------- INVESTING Investment purchases (17,772) (22,804) (14,504) ACTIVITIES Investment dispositions and repayments 15,304 19,062 12,155 Finance receivable originations and purchases (6,282) (6,654) (6,589) Finance receivable principal payments received 5,314 5,102 4,775 Net (increase) decrease in short-term investments 5 (14) 444 Acquisitions (17) (29) (591) Other, net (168) (167) (252) -------- -------- -------- Net cash used for investing activities (3,616) (5,504) (4,562) -------- -------- -------- FINANCING Retirement Services and Life Insurance ACTIVITIES Policyholder account deposits 7,197 6,648 4,981 Policyholder account withdrawals (6,453) (4,722) (4,298) -------- -------- -------- Total Retirement Services and Life Insurance 744 1,926 683 -------- -------- -------- Consumer Finance Net increase in short-term debt 673 758 431 Long-term debt issuances 1,240 1,108 2,028 Long-term debt redemptions (1,290) (571) (866) -------- -------- -------- Total Consumer Finance 623 1,295 1,593 -------- -------- -------- Corporate Net increase (decrease) in short-term debt (11) 325 937 Long-term debt issuances 495 150 -- Long-term debt redemptions (350) (100) (354) Issuances of preferred securities of subsidiaries 392 194 -- Common stock repurchases (455) (425) (195) Dividends on common stock (440) (400) (375) Non-recourse obligation collateralized by bonds -- 483 -- Other, net 80 (20) 140 -------- -------- -------- Total Corporate (289) 207 153 -------- -------- -------- Net cash provided by financing activities 1,078 3,428 2,429 -------- -------- -------- NET CHANGE Net increase (decrease) in cash (28) (47) 78 IN CASH Cash at beginning of year 294 341 263 -------- -------- -------- Cash at end of year $ 266 $ 294 $ 341 -------- -------- --------
See Notes to Financial Statements. 2000 ANNUAL REPORT page 41 20 NOTES TO FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES 1.1 Preparation of Financial Statements The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) and include the accounts of American General Corporation (American General) and its subsidiaries (collectively, the company or we). All material intercompany transactions have been eliminated in consolidation. All share amounts have been restated to reflect a two-for-one stock split effective March 1, 2001. To conform with the 2000 presentation, certain items in the prior year financial statements have been reclassified. Management must make estimates and assumptions that affect amounts reported in the financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from our estimates. 1.2 Investments Fixed Maturity and Equity Securities. Substantially all fixed maturity and equity securities held at December 31, 2000, 1999, and 1998 were classified as available-for-sale and reported at fair value. We adjust related balance sheet accounts as if the unrealized gains (losses) had been realized, and record the net adjustment in accumulated other comprehensive income (loss) in shareholders' equity. If the fair value of a security classified as available-for-sale declines below its cost and we consider the decline to be other than temporary, we reduce the security's amortized cost to its fair value and recognize a realized loss. At various times, we hold trading securities and report them at fair value. Our trading security portfolio was immaterial at year-end 2000, 1999, and 1998. Realized and unrealized gains (losses) related to trading securities are included in net investment income; however, trading securities did not have a material effect on net investment income in 2000, 1999, or 1998. Equity partnerships, which are reported in equity securities, are accounted for under the equity method of accounting. For those partnerships that report changes in the fair value of underlying equity investments in earnings, we record our proportionate interest in investment gains (losses). Mortgage Loans. Mortgage loans are reported at amortized cost, net of an allowance for losses. The allowance covers estimated losses based on our assessment of risk factors such as potential non-payment or non-monetary default. The allowance is primarily based on a loan-specific review. We consider loans to be impaired when collection of all amounts due under the contractual terms is not probable. The company generally looks to the underlying collateral for repayment of these loans. Therefore, impaired loans are reported at the lower of amortized cost or fair value of the underlying collateral, less estimated cost to sell. Policy Loans. Policy loans are reported at unpaid principal balance. Real Estate. We classify real estate as held for investment or available for sale, based on management's intent. Real estate held for investment is carried at cost, less accumulated depreciation and impairment write-downs. Real estate available for sale is carried at the lower of cost (less accumulated depreciation, if applicable) or fair value less cost to sell. Dollar Roll Agreements. Dollar rolls are agreements to sell mortgage-backed securities and to repurchase substantially the same securities at a specified price and date in the future. We account for dollar rolls as short-term collateralized financings and include the repurchase obligation in other liabilities. There were no dollar rolls outstanding at December 31, 2000, 1999, or 1998. Investment Income. Interest on fixed maturity securities and performing mortgage loans is recorded as income when earned and is adjusted for any amortization of premium or discount. Interest on delinquent mortgage loans is recorded as income when received. Dividends are recorded as income on ex-dividend dates. We recognize income on mortgage-backed securities using a constant effective yield based on estimated prepayments of the underlying mortgages. If actual prepayments differ from estimated prepayments, we calculate a new effective yield and adjust the net investment in the security accordingly. The adjustment is recognized in net investment income. Realized Investment Gains (Losses). We recognize realized investment gains (losses) using the specific identification method and report them in investment gains (losses). 1.3 Separate Accounts Separate accounts are assets and liabilities associated with certain contracts, principally annuities, for which the investment risk lies predominantly with the contract holder. The liability for these accounts equals the value of the account assets. Investment income, investment gains (losses), and policyholder account deposits and withdrawals related to separate accounts are excluded from the statements of income and cash flows. Assets held in separate accounts are primarily shares in mutual funds, which are carried at fair value, based on the quoted net asset value per share. 1.4 Finance Receivables Finance Charges. Finance charges are recognized as revenue using the interest method. We stop accruing revenue when contractual payments are not received for four page 42 AMERICAN GENERAL 21 consecutive months for loans and retail sales contracts, and for six months for revolving retail accounts and private label receivables. Extension fees, late charges, and prepayment penalties are recognized as revenue when received. Direct costs of originating loans, net of non-refundable points and fees, are deferred and included in the carrying amount of the related loans. The amount deferred is recognized as an adjustment to finance charge revenues, using the interest method over the lesser of the contractual term or the expected life based on prepayment experience. If loans are prepaid, any remaining deferral is charged or credited to revenue. Losses on Finance Receivables. We charge off finance receivables, except real estate loans, when minimal or no collections have been made for six months. For real estate loans, we initiate foreclosure proceedings when four monthly installments are past due. The carrying amount of a loan in excess of the fair value of the underlying real estate is charged off at foreclosure. The allowance for finance receivable losses is maintained at a level that we consider adequate to absorb anticipated credit losses in our existing portfolio. We periodically evaluate the portfolio on a pooled basis and consider factors such as economic conditions, portfolio composition, and loss and delinquency experience in our evaluation of the allowance. 1.5 Deferred Policy Acquisition Costs (DPAC) Certain costs of writing an insurance policy, including commissions, underwriting, and marketing expenses, are deferred and reported as DPAC. DPAC associated with interest-sensitive life insurance contracts, insurance investment contracts, and participating life insurance contracts is charged to expense in relation to the estimated gross profits of those contracts. If our estimate of future gross profits changes significantly, we recalculate DPAC balances using the new assumptions. Any resulting adjustment is included in current earnings as an adjustment to DPAC amortization. DPAC associated with all other insurance contracts is charged to expense over the premium-paying period or as the premiums are earned over the life of the contract. Interest is accreted on the unamortized balance of DPAC at rates used to compute policyholder reserves. DPAC also is adjusted for the impact on estimated future gross profits as if net unrealized gains (losses) on securities had been realized at the balance sheet date. The impact of this adjustment is included in accumulated other comprehensive income (loss) in shareholders' equity. We review the carrying amount of DPAC on at least an annual basis. We consider estimated future gross profits or future premiums, expected mortality, interest earned and credited rates, persistency, and expenses to determine whether the carrying amount is recoverable. Any amounts deemed unrecoverable are charged to expense. 1.6 Cost of Insurance Purchased (CIP) The cost assigned to certain acquired subsidiaries' insurance contracts in force at the acquisition date is reported as CIP. Interest is accreted on the unamortized balance of CIP at rates of 4.0% to 8.5%. CIP is charged to expense, including adjustments for revised assumptions, and adjusted for the impact of net unrealized gains (losses) on securities in the same manner as DPAC. We review the carrying amount of CIP on at least an annual basis using the same methods used to evaluate DPAC. 1.7 Goodwill Goodwill is charged to expense in equal amounts, generally over 40 years. We review goodwill for indicators of impairment in value which we believe are other than temporary, including unexpected or adverse changes in the following: (1) the economic or competitive environments in which the company operates, (2) profitability analyses, (3) cash flow analyses, and (4) the fair value of the relevant subsidiary. If facts and circumstances suggest that a subsidiary's goodwill is impaired, we assess the fair value of the underlying business based on an independent appraisal and reduce goodwill to an amount that results in the book value of the subsidiary approximating fair value. 1.8 Insurance and Annuity Liabilities Substantially all of the company's insurance and annuity liabilities relate to long-duration contracts. The company normally cannot change or cancel these contracts. For interest-sensitive life and insurance investment contracts, reserves equal the sum of the policy account balance and deferred revenue charges. Reserves for other contracts are based on our estimates of the cost of future policy benefits, using the net level premium method. Interest assumptions used to compute reserves ranged from 2.0% to 13.5% at December 31, 2000. 1.9 Premium Recognition Most receipts for annuities and interest-sensitive life insurance policies are classified as deposits instead of revenues. Revenues for these contracts include mortality, expense, and surrender charges. Policy charges that compensate the company for future services are deferred and recognized over the period earned, using the same assumptions used to amortize DPAC. For limited-payment contracts, net premiums are recorded as revenue, and the difference between the gross premium received and the net premium is deferred and recognized in a constant relationship to insurance in force. For all other contracts, premiums are recognized when due. 2000 ANNUAL REPORT page 43 22 NOTES TO FINANCIAL STATEMENTS In millions 1.10 Participating Life Insurance Participating life insurance accounted for less than 10% of life insurance in force and premiums and other considerations in 2000, 1999, and 1998. The portion of earnings allocated to participating policyholders is excluded from net income and shareholders' equity. We determine annual dividends to be paid on participating life insurance contracts based on estimates of the contracts' earnings. Policyholder dividends were $84 million in 2000 and 1999 and $90 million in 1998. 1.11 Reinsurance The company limits its exposure to loss on any individual life to $2.5 million by ceding additional risks through reinsurance contracts with other insurers. If a reinsurer is not able to meet its obligations, we remain liable. We record a receivable for the portion of benefits paid and insurance liabilities that have been reinsured. The cost of reinsurance is recognized over the life of the reinsured policies using assumptions consistent with those used to account for the underlying policies. 1.12 Stock-Based Compensation The company's long-term incentive plans provide for the award of stock options, restricted stock awards, and performance awards to key employees and directors. Stock options constitute the majority of awards. We recognize no expense for stock options since the market price equals the exercise price at the grant date. For restricted stock and performance awards, the grant date market value is amortized to expense over the vesting period. We adjust the expense to reflect changes in market value of our stock and anticipated performance levels for those awards with performance criteria. 1.13 Income Taxes Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities, using the enacted tax rates expected to be in effect when the temporary differences reverse. State income taxes are included in income tax expense. We provide a valuation allowance for deferred tax assets if it is more likely than not that some portion of the deferred tax asset will not be realized. We include in income any increase or decrease in a valuation allowance that results from a change in circumstances that causes a change in judgment about the realizability of the related deferred tax asset. We include in accumulated other comprehensive income (loss) in shareholders' equity any changes in a valuation allowance related to fluctuations in fair value of available-for-sale securities. 1.14 Earnings Per Share Basic earnings per share is computed by dividing earnings available to common shareholders by average common shares outstanding. Diluted earnings per share is computed assuming the conversion of dilutive convertible preferred securities and the exercise of dilutive stock options. 1.15 Derivative Financial Instruments Use of Derivatives. The company's use of derivative financial instruments is generally limited to reducing our exposure to interest rate and currency exchange risk. We use interest rate and currency swap agreements, treasury rate lock agreements, and options to enter into interest rate swap agreements. We account for these derivative financial instruments as hedges. Hedge accounting requires a high correlation between changes in fair values or cash flows of the derivative financial instrument and the specific item being hedged, both at inception and throughout the life of the hedge. Interest Rate and Currency Swap Agreements. Interest rate swap agreements convert specific investment securities from a floating-rate to a fixed-rate basis, or vice versa, and hedge against the risk of declining interest rates on anticipated security purchases. Interest rate swap agreements also convert a portion of floating-rate borrowings to a fixed rate and hedge against the risk of rising interest rates on anticipated debt issuances. Currency swap agreements convert cash flows from specific investment securities denominated in foreign currencies into U.S. dollars at specified exchange rates and hedge against currency rate fluctuations on anticipated security purchases. We record the difference between amounts paid and received on swap agreements as an adjustment to net investment income or interest expense, as appropriate, on an accrual basis over the periods covered by the agreements. The related amounts payable to, or receivable from, counterparties are included in other liabilities or other assets. The fair values of swap agreements are recognized in the balance sheet if they hedge investments carried at fair value or if they hedge anticipated purchases of such investments. Changes in the fair value of these swap agreements are reported in accumulated other comprehensive income (loss) in shareholders' equity, consistent with the treatment of the related investment security. The fair values of swap agreements hedging debt are not recognized in the balance sheet. For swap agreements hedging anticipated investment purchases or debt issuances, we defer the net swap settlement amount or unrealized gain or loss and include it in the recorded amount of the anticipated transaction when it occurs. page 44 AMERICAN GENERAL 23 Swap agreements generally have terms of two to ten years. Gains or losses from early termination of a swap agreement are deferred and amortized into income over the remaining term of the related investment or debt. If the underlying investment or debt is extinguished or sold, any related gain or loss on swap agreements is recognized in income. Treasury Rate Lock Agreements. Treasury rate lock agreements hedge against the risk of rising interest rates on anticipated debt issuances. These agreements provide for future cash settlements that are a function of specified U.S. Treasury rates. We account for treasury rate lock agreements in the same manner as interest rate swap agreements that hedge anticipated debt issuances. Swaptions. Options to enter into interest rate swap agreements limit the company's exposure to reduced spreads between investment yields and interest rates credited to policyholders should interest rates decrease or increase significantly over prolonged periods. During prolonged periods of decreasing interest rates, the spread between investment yields and interest crediting rates may be reduced as a result of minimum rate guarantees on certain insurance and annuity contracts, which limit our ability to reduce interest crediting rates. Call swaptions, which allow the company to enter into interest rate swap agreements to receive fixed rates and pay lower floating rates, effectively maintain the spread between investment yields and interest crediting rates during such periods. During prolonged periods of increasing interest rates, the spread between investment yields and interest crediting rates may be reduced if the company decides to increase interest crediting rates to limit surrenders. Put swaptions, which allow the company to enter into interest rate swap agreements to pay fixed rates and receive higher floating rates, effectively maintain the spread between investment yields and interest crediting rates during such periods. Premiums paid to purchase swaptions are included in investments and are amortized to net investment income over the exercise period of the swaptions. If a swaption is terminated, any gain is deferred and amortized to insurance and annuity benefits over the expected life of the related contracts and any unamortized premium is charged to income. If a swaption ceases to be an effective hedge, we recognize any related gain or loss in income. 1.16 Future Accounting Change On January 1, 2001, we will adopt Statement of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivative instruments to be recognized at fair value in the balance sheet. Changes in the fair value of a derivative instrument will be reported in net income or other comprehensive income, depending upon the intended use of the derivative instrument. Upon adoption, we will record aftertax cumulative adjustments to reduce other comprehensive income in shareholders' equity $29 million and to reduce net income $1 million. The reduction of other comprehensive income is primarily the result of recognizing the fair value of interest rate swaps related to debt on the balance sheet. Since we anticipate holding the swaps for their full term, we do not expect this amount to impact earnings in future periods. The reduction of net income relates to the company's use of swaptions, which do not meet the new requirements for hedge accounting. We do not expect SFAS 133 to have a material impact on the company's results of operations and financial position in future periods. The impact of the fair value adjustments on derivatives which do not qualify for hedge accounting and any ineffectiveness resulting from hedging activities will be recorded in investment gains (losses). 2. ACQUISITIONS 2.1 Accounting for Acquisitions The company's acquisitions during the past three years have been accounted for using the purchase method. Under this method, the results of operations for each acquisition were included in our income statement from the acquisition date. We allocated the purchase price of each acquisition to specific assets and liabilities based on our best estimate of their fair values at the acquisition date. The difference between the aggregate purchase price and the net assets acquired was recorded as goodwill. 2.2 2000 Acquisition On March 10, 2000, we acquired the North American Funds retail mutual fund operation through our acquisition of CypressTree Investments, Inc. The purchase price was $17 million. 2.3 1999 Acquisitions On November 12, 1999, we acquired North Central Life Insurance Company, a credit life insurance company. On May 31, 1999, we acquired Standard Pacific Savings, F.A., which we renamed American General Bank, FSB. The combined purchase price of these acquisitions was $95 million. 2.4 1998 Acquisitions Western National. Prior to 1997, the company acquired a 46% investment in Western National Corporation (Western National), the holding company of Western National Life Insurance Company, for $400 million. This investment was recorded on an equity basis. 2000 ANNUAL REPORT page 45 24 NOTES TO FINANCIAL STATEMENTS In millions On February 25, 1998, we acquired the remaining 54% equity interest for $1.2 billion. The purchase price consisted of $580 million cash and 20.3 million shares (post-split) of our common stock. We consolidated Western National's assets, liabilities, and results of operations in our financial statements effective January 1, 1998. Pretax earnings of $17 million attributable to minority interests through February 25, 1998 were reflected as a charge against 1998 income. During 1998, we changed Western National Life Insurance Company's name to American General Annuity Insurance Company. Coinsurance Transaction. On May 21, 1998, we acquired a block of individual annuity business in a coinsurance transaction. This transaction increased invested assets and annuity liabilities of our retirement services division by $2.4 billion. 2.5 Non-Cash Activities Non-cash activities related to the above acquisitions that are not reflected in the cash flow statements were as follows:
2000 1999 1998 ------- ------- ------- Fair value of assets acquired $ 19 $ 396* $ 9,732 Liabilities assumed (2) (301) (8,524) Issuance of common stock -- (66) (580) Issuance of stock options -- -- (37) ------- ------- ------- Net cash paid $ 17 $ 29 $ 591 ------- ------- -------
* Includes $55 million of cash equivalents. 3. INVESTMENTS 3.1 Fixed Maturity and Equity Securities Valuation. Amortized cost and fair value of fixed maturity and equity securities at December 31 were as follows:
Gross Gross Amortized Cost Unrealized Gains Unrealized Losses ------------------------- ---------------------- --------------------------- 2000 1999 1998 2000 1999 1998 2000 1999 1998 ------- ------- ------- ------ ------ ------ ------- ------- ------- Fixed maturity securities Corporate bonds Investment grade $45,020 $43,644 $41,019 $1,112 $353 $2,809 $(1,218) $(1,756) $(137) Below investment grade 3,836 3,542 3,286 -- 33 93 (628) (281) (106) Mortgage-backed 13,652 13,013 12,422 344 117 605 (32) (237) (8) States/political subdivisions 710 809 627 27 10 44 (6) (23) -- U.S. government 623 661 899 43 32 121 (1) (8) (1) Foreign governments 549 562 843 29 14 99 (4) (7) (2) Redeemable preferred stocks 70 144 116 7 7 2 (1) (4) -- ------- ------- ------- ------ ---- ------ ------- ------- ----- Total fixed maturity securities $64,460 $62,375 $59,212 $1,562 $566 $3,773 $(1,890) $(2,316) $(254) ------- ------- ------- ------ ---- ------ ------- ------- ----- Equity securities $ 832 $ 633 $ 444 $ 17 $ 47 $ 38 $ (18) $ (7) $ (1) ------- ------- ------- ------ ---- ------ ------- ------- ----- Fair Value ------------------------- 2000 1999 1998 ------- ------- ------- Fixed maturity securities Corporate bonds Investment grade $44,914 $42,241 $43,691 Below investment grade 3,208 3,294 3,273 Mortgage-backed 13,964 12,893 13,019 States/political subdivisions 731 796 671 U.S. government 665 685 1,019 Foreign governments 574 569 940 Redeemable preferred stocks 76 147 118 ------- ------- ------- Total fixed maturity securities $64,132 $60,625 $62,731 ------- ------- ------- Equity securities $ 831 $ 673 $ 481 ------- ------- -------
Maturities. The contractual maturities of fixed maturity securities at December 31, 2000 were as follows:
Amortized Fair Cost Value --------- ------- Fixed maturity securities, excluding mortgage-backed securities, due In one year or less $ 1,415 $ 1,414 In years two through five 11,224 11,243 In years six through ten 17,903 17,639 After ten years 20,266 19,872 Mortgage-backed securities 13,652 13,964 ------- ------- Total fixed maturity securities $64,460 $64,132 ------- -------
Actual maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations. The company may sell investments before maturity to achieve corporate requirements and investment strategies. Net Unrealized Gains (Losses). Net unrealized gains (losses) on fixed maturity and equity securities included in accumulated other comprehensive income (loss) at December 31 were as follows:
2000 1999 1998 ------- ------- ------- Gross unrealized gains $ 1,579 $ 613 $ 3,811 Gross unrealized losses (1,908) (2,323) (255) DPAC and CIP fair value adjustments 88 347 (1,073) Deferred income taxes (35) 107 (874) Other, net (28) (22) (10) ------- ------- ------- Net unrealized gains (losses) on securities $ (304) $(1,278) $ 1,599 ------- ------- -------
page 46 AMERICAN GENERAL 25 3.2 Mortgage Loans on Real Estate Diversification. Diversification of the geographic location and type of property collateralizing mortgage loans reduces the concentration of credit risk. For new loans, the company generally requires loan-to-value ratios of 75% or less, based on our credit assessment of the borrower. At December 31, the mortgage loan portfolio was distributed as follows:
2000 1999 1998 ---- ---- ---- Geographic distribution Atlantic 45% 46% 51% Central 34 31 27 Pacific and Mountain 21 23 22 ---- ---- ---- Total mortgage loans 100% 100% 100% ---- ---- ---- Property type Office 39% 34% 32% Retail 35 39 39 Industrial 13 14 15 Apartments 7 8 9 Other 6 5 5 ---- ---- ---- Total mortgage loans 100% 100% 100% ---- ---- ----
Allowance. Activity in the allowance for mortgage loan losses was as follows:
2000 1999 1998 ---- ---- ---- Balance at January 1 $ 26 $ 34 $ 54 Provision for mortgage loan losses -- (3) (15) Deductions (9) (5) (5) ---- ---- ---- Balance at December 31 $ 17 $ 26 $ 34 ---- ---- ----
Impaired Loans. Impaired mortgage loans were $3 million, $24 million, and $28 million at December 31, 2000, 1999, and 1998, respectively. Interest income related to impaired loans was $1 million in 2000 and 1999 and $3 million in 1998. 3.3 Investment Income Investment income was as follows:
2000 1999 1998 ------- ------- ------- Fixed maturity securities $ 4,783 $ 4,676 $ 4,513 Mortgage loans on real estate 313 293 326 Other 443 331 307 ------- ------- ------- Investment income 5,539 5,300 5,146 Investment expense (86) (68) (51) ------- ------- ------- Net investment income $ 5,453 $ 5,232 $ 5,095 ------- ------- -------
The carrying amount of investments that produced no investment income during 2000 was less than 1% of total invested assets. The ultimate disposition of these investments is not expected to have a material effect on our results of operations and financial position. Derivative financial instruments related to investment securities did not have a material effect on net investment income in 2000, 1999, or 1998. 3.4 Investment Gains (Losses) Investment gains (losses) were as follows:
2000 1999 1998 ----- ----- ----- Fixed maturity securities Gross gains $ 142 $ 251 $ 64 Gross losses (380) (267) (137) ----- ----- ----- Total fixed maturity securities (238) (16) (73) ----- ----- ----- Equity securities Gross gains 37 7 8 Gross losses (25) (1) -- ----- ----- ----- Total equity securities 12 6 8 ----- ----- ----- Mortgage loans on real estate 5 4 16 Other long-term investments (29) 4 83 Fair value adjustments in equity partnerships 22 -- -- DPAC/CIP amortization and investment expense 52 (17) (28) ----- ----- ----- Investment gains (losses) $(176) $ (19) $ 6 ----- ----- -----
3.5 Cash Flows from Investing Activities Uses of cash for investment purchases were as follows:
2000 1999 1998 ------- ------- ------- Fixed maturity securities $16,905 $21,894 $13,809 Other 867 910 695 ------- ------- ------- Total $17,772 $22,804 $14,504 ------- ------- -------
Sources of cash from investment dispositions and repayments were as follows:
2000 1999 1998 ------- ------- ------- Fixed maturity securities Sales $10,915 $14,042 $ 7,535 Maturities 1,777 1,875 613 Calls and tenders 1,227 1,335 1,808 Repayments of mortgage-backed securities 806 1,277 1,248 Mortgage loans 384 345 667 Equity securities 99 59 41 Other 96 129 243 ------- ------- ------- Total $15,304 $19,062 $12,155 ------- ------- -------
2000 ANNUAL REPORT page 47 26 NOTES TO FINANCIAL STATEMENTS In millions 4. FINANCE RECEIVABLES 4.1 Detail of Finance Receivables Finance receivables, which we report net of unearned finance charges, were as follows at December 31:
2000 1999 1998 -------- -------- -------- Real estate loans $ 7,280 $ 7,104 $ 5,757 Non-real estate loans 3,027 2,576 2,560 Retail sales finance 1,454 1,350 1,340 -------- -------- -------- Total finance receivables 11,761 11,030 9,657 Allowance for losses (383) (396) (382) -------- -------- -------- Finance receivables, net $ 11,378 $ 10,634 $ 9,275 -------- -------- --------
4.2 Allowance for Finance Receivable Losses Activity in the allowance for finance receivable losses was as follows:
2000 1999 1998 ------ ------ ------ Balance at January 1 $ 396 $ 382 $ 373 Provision for finance receivable losses 206 207 212 Charge offs, net of recoveries (206) (207) (220) Acquired (sold) receivables (13) 14 17 ------ ------ ------ Balance at December 31 $ 383 $ 396 $ 382 ------ ------ ------
4.3 Contractual Maturities Contractual maturities of finance receivables at December 31, 2000 were as follows:
After 2001 2002 2003 2004 2005 2005 ------ ------ ------ ----- ----- ------ Maturities $1,331 $1,597 $1,179 $ 708 $ 437 $6,509
Contractual maturities are not a forecast of future cash collections. A substantial portion of finance receivables may be renewed, converted, or repaid prior to maturity. 4.4 Cash Collections Cash collections of principal were as follows:
2000 1999 1998 ------ ------ ------ Real estate loans Cash collections $1,855 $1,886 $1,553 % of average balances 26% 30% 33% Non-real estate loans Cash collections $1,610 $1,519 $1,569 % of average balances 57% 61% 62% Retail sales finance Cash collections $1,849 $1,697 $1,653 % of average balances 132% 133% 127%
4.5 Geographic Concentration The geographic concentration of finance receivables at December 31 was as follows:
2000 1999 1998 ---- ---- ---- California 13% 14% 15% North Carolina 7 7 8 Florida 6 6 6 Illinois 6 6 6 Ohio 6 6 6 Indiana 5 5 5 Other 57 56 54 --- --- --- Total finance receivables 100% 100% 100% --- --- ---
5. DEFERRED POLICY ACQUISITION COSTS (DPAC) Activity in DPAC was as follows:
2000 1999 1998 ------- ------- ------- Balance at January 1 $ 4,980 $ 3,253 $ 2,718 Deferrals 1,145 1,125 880 Accretion of interest 300 264 242 Consolidation of Western National -- -- 157 Amortization (805) (771) (761) Effect of net unrealized gains (losses) on securities (200) 1,119 41 Other 44 (10) (24) ------- ------- ------- Balance at December 31 $ 5,464 $ 4,980 $ 3,253 ------- ------- -------
6. COST OF INSURANCE PURCHASED (CIP) Activity in CIP was as follows:
2000 1999 1998 ------- ------- ------- Balance at January 1 $ 1,170 $ 956 $ 680 Accretion of interest 74 81 88 Additions from acquisitions -- 49 359 Consolidation of Western National -- -- 125 Amortization (220) (233) (249) Effect of net unrealized gains (losses) on securities (59) 301 (62) Other 29 16 15 ------- ------- ------- Balance at December 31 $ 994 $ 1,170 $ 956 ------- ------- -------
CIP amortization, net of accretion, expected to be recorded in each of the next five years is $112 million, $95 million, $83 million, $75 million, and $68 million. page 48 AMERICAN GENERAL 27 7. DEBT 7.1 Short-Term Debt and Credit Facilities Short-term debt consists primarily of commercial paper. The weighted-average interest rates on short-term borrowings at December 31 were as follows:
2000 1999 1998 ------ ------ ------ Corporate 6.7% 6.0% 5.3% Consumer Finance 6.7 6.0 5.4
The company uses unsecured bank credit facilities to support commercial paper borrowings. At December 31, 2000, we maintained unsecured committed credit facilities of $6.2 billion with 57 domestic and foreign banks. There were no borrowings under these facilities during 2000. Annual commitment fees range from five to seven basis points. 7.2 Long-Term Debt Long-term debt at December 31 was as follows:
2000 1999 1998 ------ ------ ------ Corporate 6.3% - 7.8%, through 2029 $1,338 $1,188 $1,136 Consumer Finance 5.4% - 8.5%, through 2009 $5,671 $5,717 $5,177
7.3 Long-Term Debt Maturities Scheduled maturities of long-term debt for each of the next five years at December 31, 2000 were as follows:
2001 2002 2003 2004 2005 ------ ------ ------ ------ ------ Corporate $ -- $ -- $ 100 $ 149 $ 294 Consumer Finance 1,265 1,389 1,572 376 722
7.4 Interest Interest paid was as follows:
2000 1999 1998 ---- ---- ---- Corporate $205 $193 $186 Consumer Finance 685 553 493
Derivative financial instruments related to debt securities did not have a material effect on reported interest expense or the weighted-average borrowing rate in 2000, 1999, or 1998. 8. INCOME TAXES 8.1 Tax Expense Components of income tax expense were as follows:
2000 1999 1998 ---- ---- ---- Current Federal $ 400 $ 379 $ 458 State 12 9 14 ----- ----- ----- Total current 412 388 472 Deferred 156 276 (19) ----- ----- ----- Income tax expense* $ 568 $ 664 $ 453 ----- ----- -----
* Excludes tax benefit of $55 million, $50 million, and $48 million, respectively, related to preferred securities of subsidiaries. A reconciliation between the Federal income tax rate and the effective tax rate follows:
2000 1999 1998 ---- ---- ---- Federal income tax rate 35% 35% 35% Tax-exempt investments (1) (1) (2) Tax credits (1) -- -- Utilization of operating loss carryovers (1) -- -- Goodwill 1 1 1 State taxes 1 -- 1 ---- ---- ---- Effective tax rate 34% 35% 35% ---- ---- ----
8.2 Deferred Tax Liabilities Components of deferred tax liabilities and assets, included in income tax liabilities on the balance sheet, at December 31 were as follows:
2000 1999 1998 ------- ------- ------- Deferred tax liabilities, applicable to Basis differential of investments $ -- $ -- $ 1,303 DPAC and CIP 1,776 1,701 1,025 Prepaid pension expense 135 112 96 Other 500 484 455 ------- ------- ------- Total deferred tax liabilities 2,411 2,297 2,879 ------- ------- ------- Deferred tax assets, applicable to Basis differential of investments (47) (493) -- Policy reserves (924) (998) (839) Litigation settlements (101) (66) (129) Other (367) (369) (389) ------- ------- ------- Gross deferred tax assets (1,439) (1,926) (1,357) Valuation allowance 187 448 69 ------- ------- ------- Total deferred tax assets, net (1,252) (1,478) (1,288) ------- ------- ------- Net deferred tax liabilities $ 1,159 $ 819 $ 1,591 ------- ------- -------
2000 ANNUAL REPORT page 49 28 NOTES TO FINANCIAL STATEMENT In millions The deferred tax assets applicable to basis differential of investments at year-end 2000 and 1999 were due to recognition of unrealized losses on available-for-sale securities on the balance sheet. Since a portion of these deferred tax assets may not be realized, we established valuation allowances of $130 million in 2000 and $381 million in 1999. These balance sheet adjustments had no income statement impact. The remaining deferred tax asset valuation allowances at year-end 2000, 1999, and 1998 were related to Federal and state income tax operating loss carryovers that we do not expect to utilize. At December 31, 2000, the company had operating loss carryovers for Federal income tax purposes of $57 million, which are available to offset future taxable income through 2012. The operating loss carryovers are predominantly associated with acquired companies; therefore, they are subject to certain limitations. A component of life insurance surplus accumulated prior to 1984 is not taxable unless it exceeds certain statutory limitations or is distributed to shareholders. This surplus, accumulated in policyholder surplus accounts, totaled $912 million at December 31, 2000. We have not recorded deferred income taxes of $319 million on this surplus since future distributions are not anticipated. 8.3 Taxes Paid Income taxes paid were as follows:
2000 1999 1998 ---- ---- ---- Federal $320 $245 $361 State 11 8 17
8.4 Tax Return Examinations American General and the majority of its subsidiaries file a consolidated Federal income tax return. The Internal Revenue Service (IRS) has completed examinations of our tax returns through 1992. During 2000, we finalized certain tax issues associated with our tax returns for 1989 through 1992 under examination by the IRS. As a result, we reduced goodwill by $27 million and recognized a $14 million tax benefit to reflect the use of acquired operating loss carryovers. The IRS is currently examining our tax returns for 1993 through 1999. Although the final outcome of any issues raised is uncertain, we believe that the ultimate liability, including interest, will not exceed amounts recorded in the financial statements. 9. BENEFIT PLANS 9.1 Pension Plans The company has non-contributory defined benefit pension plans covering most employees. Pension benefits are based on the participant's compensation and length of credited service. At December 31, 2000, the plans' assets were invested as follows: (1) 65% in equity mutual funds managed outside the company; (2) 28% in fixed income mutual funds managed by one of our subsidiaries; and (3) 6% in our common stock. The benefit plans have purchased annuity contracts from our subsidiaries to provide approximately $58 million of future annual benefits to certain retirees. The company's funding policy is to contribute annually no more than the maximum amount deductible for Federal income tax purposes. The funded status of the plans and the prepaid pension expense included in other assets at December 31 were as follows:
2000 1999 1998 ------- ------- ------- Projected benefit obligation (PBO) $ 825 $ 740 $ 750 Plan assets at fair value 1,492 1,447 1,280 ------- ------- ------- Plan assets at fair value in excess of PBO 667 707 530 Other unrecognized items, net (274) (372) (269) ------- ------- ------- Prepaid pension expense $ 393 $ 335 $ 261 ------- ------- -------
The components of pension expense and underlying assumptions were as follows:
2000 1999 1998 ------- ------- ------- Service cost (benefits earned) $ 23 $ 22 $ 20 Interest cost 62 55 50 Expected return on plan assets (134) (117) (95) Amortization (8) (1) -- ------- ------- ------- Pension expense (income) $ (57) $ (41) $ (25) ------- ------- ------- Discount rate on benefit obligation 8.00% 7.75% 7.00% Rate of increase in compensation levels 4.50% 4.25% 4.25% Expected long-term rate of return on plan assets 10.35% 10.35% 10.25% ------- ------- -------
9.2 Postretirement Benefits Other Than Pensions We provide life, medical, supplemental major medical, and dental benefits for certain retired employees and agents. Most plans are contributory, with retiree contributions adjusted annually to limit employer contributions to predetermined amounts. The company reserves the right to change or eliminate these benefits at any time. page 50 AMERICAN GENERAL 29 The life plans are insured through December 31, 2001. The majority of the retiree medical and dental plans are unfunded and self-insured. The accrued liability for postretirement benefits was $134 million, $163 million, and $175 million at year-end 2000, 1999, and 1998, respectively. These liabilities were discounted at the same rates used for the pension plans. Postretirement benefit expense was immaterial in each of the three years. 10. STOCK AND INCENTIVE PLANS 10.1 Stock Options Stock option activity was as follows:
2000 1999 1998 ------------------- ------------------- ------------------- AVERAGE Average Average Options in EXERCISE Exercise Exercise thousands OPTIONS PRICE Options Price Options Price ------- -------- ------- -------- ------- -------- Balance at January 1 19,698 $ 28.32 11,522 $ 22.41 7,275 $ 17.24 Granted 9,389 32.03 10,318 34.15 5,039 29.91 For acquisition -- -- -- -- 2,767 12.39 Exercised (1,873) 20.51 (1,164) 19.22 (2,989) 12.82 Forfeited (1,136) 32.66 (978) 30.89 (570) 24.35 ------- ------- ------- ------- ------- ------- Balance at December 31 26,078 $ 30.03 19,698 $ 28.32 11,522 $ 22.41 ------- ------- ------- ------- ------- ------- Exercisable at December 31 10,187 $ 25.98 6,738 $ 19.86 5,033 $ 15.68 ------- ------- ------- ------- ------- -------
Options may not be exercised within at least six months of, nor after 10 years from, grant date. For certain stock options, one reload option is granted for each previously-owned share of common stock tendered to exercise options. Reload options vest immediately and are exercisable for the remaining term of the original options. Information about options outstanding at December 31, 2000 was as follows:
Outstanding Exercisable ------------------------------ ----------------- Average Average Average Range of Options Remaining Exercise Options Exercise Exercise Prices (000's) Life Price (000's) Price --------------- ------- --------- -------- ------- -------- $ 9.36-$14.99 1,578 3 $11.45 1,578 $11.45 15.00- 19.99 1,101 5 17.13 1,101 17.13 20.00- 24.99 1,542 6 21.88 1,436 21.73 25.00- 29.99 3,829 7 29.54 2,443 29.62 30.00- 34.99 17,474 9 33.12 3,383 33.97 35.00- 39.99 503 8 37.01 215 37.07 40.00- 44.99 51 8 40.34 31 40.09 ------ ------ ------ ------ ------ Total 26,078 8 $30.03 10,187 $25.98 ------ ------ ------ ------ ------
10.2 Shares Available Shares available for issuance under our stock and incentive plans totaled 17.4 million, 26.2 million, and 12.5 million at December 31, 2000, 1999, and 1998, respectively. 10.3 Pro Forma Disclosures Under an alternative accounting method, compensation expense arising from stock options would be measured at the estimated fair value of the options at the grant date and recognized over the options' vesting period. Had we determined compensation expense using this method, net income and net income per share would have been as follows:
2000 1999 1998 --------- --------- --------- Net income As reported $ 1,003 $ 1,131 $ 764 Pro forma 956 1,102 753 --------- --------- --------- Net income per share Basic As reported $ 2.01 $ 2.26 $ 1.51 Pro forma 1.92 2.20 1.49 Diluted As reported 1.98 2.20 1.48 Pro forma 1.89 2.15 1.46 --------- --------- ---------
The average fair values of the options granted were $9.80 in 2000, $8.45 in 1999, and $7.64 in 1998. We estimated the fair value of each option at the grant date using a Black-Scholes option pricing model and the following assumptions:
2000 1999 1998 ------ ------ ------ Dividend yield 2.5% 2.5% 2.5% Expected volatility 27.6% 24.4% 23.0% Risk-free interest rate 6.7% 4.9% 5.7% Expected life 6 YEARS 6 years 6 years
11. REDEEMABLE EQUITY One subsidiary and five subsidiary trusts (collectively, subsidiaries) have issued preferred securities. The sole assets of these subsidiaries are Junior Subordinated Debentures (Subordinated Debentures) issued by American General and, in some cases, U.S. Treasury bonds. These subsidiaries have no independent operations. The Subordinated Debentures are eliminated in the company's consolidated financial statements. The interest terms and payment dates of the Subordinated Debentures held by the subsidiaries correspond to those of the subsidiaries' preferred securities. American General's obligations under the Subordinated Debentures and related agreements, when taken together, constitute a full and unconditional guarantee of payments due on the preferred securities. The Subordinated Debentures are redeemable, under certain conditions, at the option of the company on a proportionate basis. 2000 ANNUAL REPORT page 51 30 NOTES TO FINANCIAL STATEMENTS In millions Dividends paid on the preferred securities totaled $137 million in 2000, $140 million in 1999, and $135 million in 1998. Additional information about the preferred securities and the assets held by the issuing subsidiaries at December 31, 2000 was as follows:
American American American American American American American General General General General General General General Institutional Institutional Capital, Capital, Capital III Capital II Capital I Capital B Capital A L.L.C. L.L.C. ----------- ---------- --------- ------------- ------------- --------- --------- Preferred securities Total par value outstanding $ 100 $ 300 $ 200 $ 500 $ 500 $ 215 $ 287 Dividend rate 8.05% 8.50% 7.875% 8.125% 7.57% 8.125% 8.45% Shares issued and outstanding 4.0 .3 8.0 .5 .5 8.6 11.5 Date issued 12/7/00 6/27/00 9/8/99 3/14/97 12/4/96 8/29/95 6/5/95 Earliest/mandatory redemption date 2005/2049 2030/2030 2004/2048 2046/2046 2045/2045 2000/2025* 2000/2025* --------- --------- --------- --------- --------- --------- --------- Subordinated Debentures held by issuing subsidiary Principal $ 103 $ 309 $ 206 $ 516 $ 516 $ 269 $ 360 Mandatory redemption date 2049 2030 2048 2046 2045 2025 2025 --------- --------- --------- --------- --------- --------- ---------
* Subject to possible extension to 2044. 12. CAPITAL STOCK 12.1 Classes of Capital Stock American General has two classes of capital stock: preferred stock ($1.50 par value, 60 million shares authorized) that may be issued in series with rights to be determined by the board of directors, and common stock ($.50 par value, 800 million shares authorized). At December 31, 2000, approximately 26.9 million shares of common stock were reserved for issuance of stock under employee stock and incentive plans. 12.2 Stock Split On January 23, 2001, we declared a two-for-one stock split effected in the form of a 100% common stock dividend, payable March 1, 2001 to holders of record on February 8, 2001. The distribution, which will consist of 269.3 million newly issued shares, has been reflected as of December 31, 2000 in these financial statements. The distribution will have no impact on total shareholders' equity or results of operations. All share amounts have been restated to reflect the stock split on a retroactive basis. 12.3 Convertible Preferred Stock On March 1, 2000, we redeemed all 2.3 million shares, or $85 million, of our 7% convertible preferred stock by issuing 3.8 million shares (post-split) of common stock. 12.4 Convertible Preferred Securities On June 30, 2000, holders of approximately 5 million shares, or $250 million, of 6% convertible preferred securities issued by American General Delaware, L.L.C. converted their securities into 12.3 million shares (post-split) of American General common stock. 12.5 Common Stock Activity Common stock activity was as follows:
In thousands 2000 1999 1998 ------------ -------- -------- -------- Shares issued Balance at January 1 269,298 269,298 259,135 Issuance for acquisition -- -- 10,163 Two-for-one stock split, post year end 269,299 -- -- ------- ------- ------- Balance at December 31 538,597 269,298 269,298 ------- ------- ------- Treasury shares Balance at January 1 (21,238) (17,494) (15,929) Share repurchases (7,004) (5,885) (2,971) Conversion of preferred stock and securities 8,046 -- -- Issuance under employee benefit plans and other 1,236 1,302 1,406 Issuance for acquisition -- 839 -- Two-for-one stock split, post year end (18,959) -- -- ------- ------- ------- Balance at December 31 (37,919) (21,238) (17,494) ------- ------- ------- Outstanding at December 31 500,678 248,060 251,804 ------- ------- ------- Restated for two-for-one stock split 496,121 503,609 ------- ------- -------
page 52 AMERICAN GENERAL 31 13. FAIR VALUE OF FINANCIAL INSTRUMENTS Carrying amounts and fair values for certain of the company's financial instruments at December 31 are presented below. Care should be exercised in drawing conclusions based on fair value, since (1) the fair values presented do not include the value associated with all of the company's assets and liabilities, including the values of underlying customer relationships and distribution systems, and (2) the reporting of investments at fair value without a corresponding revaluation of related policyholder liabilities can be misinterpreted.
2000 1999 1998 ----------------- ------------------ ------------------ FAIR CARRYING Fair Carrying Fair Carrying VALUE AMOUNT Value Amount Value Amount ------- ------- ------- -------- ------- -------- Assets Fixed maturity and equity securities $64,963 $64,963 $61,298 $61,298 $63,212 $63,212 Mortgage loans on real estate 3,961 3,920 3,565 3,686 3,501 3,368 Policy loans 2,492 2,433 2,283 2,375 2,448 2,329 Short-term investments 671 671 676 676 654 654 Assets held in separate accounts 23,234 23,234 24,097 24,097 16,158 16,158 Finance receivables, net 10,897 11,378 10,570 10,634 9,325 9,275 Liabilities Insurance investment contracts 44,690 44,354 41,011 42,820 39,959 40,670 Liabilities related to separate accounts 23,234 23,234 24,097 24,097 16,158 16,158 Short-term debt 7,083 7,083 6,421 6,421 5,293 5,293 Long-term debt Corporate 1,381 1,338 1,168 1,188 1,222 1,136 Consumer Finance 5,736 5,671 5,641 5,717 5,342 5,177 Redeemable equity 2,034 2,067 1,810 1,924 1,956 1,728
We used the following methods and assumptions to estimate the fair value of our financial instruments. Fixed Maturity and Equity Securities. Fair values of fixed maturity and equity securities were based on quoted market prices, where available. For investments not actively traded, we estimated the fair values using values obtained from independent pricing services or, in the case of some private placements, by discounting expected future cash flows using a current market rate applicable to yield, credit quality, and average life of the investments. Mortgage Loans on Real Estate. We estimated the fair value of mortgage loans primarily using discounted cash flows, based on contractual maturities and risk-adjusted discount rates. Policy Loans. We valued policy loans using discounted cash flows and actuarially determined assumptions, incorporating market rates. Assets and Liabilities Related to Separate Accounts. We valued separate account assets and liabilities based on quoted net asset value per share of the underlying mutual funds. Finance Receivables. We estimated the fair value of finance receivables using projected cash flows discounted at the weighted-average rates currently being offered for similar finance receivables. Insurance Investment Contracts. We estimated the fair value of insurance investment contracts using cash flows discounted at market interest rates. Debt. The fair value of short-term debt approximated its carrying amount. We estimated the fair value of long-term debt using cash flows discounted at current borrowing rates. Redeemable Equity. We estimated the fair value of our redeemable equity based on quoted market prices. Off-Balance Sheet Derivative Financial Instruments. Had we elected to terminate our interest rate swap and treasury rate lock agreements related to debt, we would have paid $44 million and $61 million at December 31, 2000 and 1998, respectively, and received $46 million at December 31, 1999. These fair values were estimated using cash flows discounted at current market rates. 2000 ANNUAL REPORT page 53 32 NOTES TO FINANCIAL STATEMENTS In millions 14. DERIVATIVE FINANCIAL INSTRUMENTS 14.1 Interest Rate and Currency Swap Agreements Interest rate and currency swap agreements related to investment securities at December 31 were as follows:
2000 1999 1998 -------- -------- -------- Interest rate swap agreements to receive fixed rate Notional amount $ 185 $ 185 $ 474 Average receive rate 6.81% 6.81% 6.24% Average pay rate 6.98 6.59 5.48 Interest rate swap agreements to pay fixed rate Notional amount $ 50 $ 55 $ 55 Average receive rate 8.50% 7.64% 6.73% Average pay rate 7.01 6.88 6.88 -------- -------- -------- Currency swap agreements Receive U.S. $/pay Canadian $ Notional amount $ 74 $ 124 $ 124 Average exchange rate 1.43 1.50 1.50 Australian $ Notional amount $ 23 $ 23 $ -- Average exchange rate 1.85 1.85 -- -------- -------- --------
Interest rate swap agreements related to debt at December 31 were as follows:
2000 1999 1998 -------- -------- -------- Interest rate swap agreements to pay fixed rate Corporate Notional amount $ 400 $ 400 $ 400 Average receive rate 6.51% 5.13% 4.90% Average pay rate 6.15 6.15 6.15 Consumer Finance Notional amount $ 2,450 $ 1,295 $ 935 Average receive rate 6.72% 5.40% 4.57% Average pay rate 6.71 6.70 6.94
Deferred settlement costs related to the termination of interest rate swaps in conjunction with anticipated debt issuances were $7 million, $8 million, and $9 million at December 31, 2000, 1999, and 1998, respectively. 14.2 Treasury Rate Lock Agreements In conjunction with an anticipated debt issuance, we entered into a treasury rate lock agreement with a notional amount of $123 million in 1998. We settled this agreement in 1999. Deferred settlement costs related to all treasury rate lock agreements were $13 million, $16 million, and $17 million at December 31, 2000, 1999, and 1998, respectively. There were no treasury rate lock agreements outstanding at year-end 2000 and 1999. 14.3 Swaptions Swaptions at December 31 were as follows:
2000 1999 1998 -------- -------- -------- Call swaptions Notional amount $ 3,000 $ 10,150 $ 3,875 Average strike rate 5.00% 4.64% 4.07% Put swaptions Notional amount $ 2,300 $ 6,600 $ 4,200 Average strike rate 8.72% 8.61% 8.33%
The swaptions outstanding at December 31, 2000 expire in 2001. Should the strike rates remain below market rates (for call swaptions) and above market rates (for put swaptions), the swaptions will expire and the company's exposure would be limited to the premiums paid. These premiums were immaterial. 14.4 Credit and Market Risk Derivative financial instruments expose the company to credit risk in the event of nonperformance by counterparties. We limit this exposure by entering into agreements with counterparties having high credit ratings and by regularly monitoring the ratings. We do not expect any counterparty to fail to meet its obligation; however, nonperformance would not have a material impact on the company's results of operations and financial position. The company's exposure to market risk is mitigated by the offsetting effects of changes in the value of the agreements and the related items being hedged. 15. REINSURANCE Reinsurance premiums included in premiums and other considerations were as follows:
2000 1999 1998 ------- ------- ------- Direct premiums and other considerations $ 4,206 $ 4,023 $ 3,717 Reinsurance assumed 65 303 373 Reinsurance ceded (432) (554) (485) ------- ------- ------- Premiums and other considerations $ 3,839 $ 3,772 $ 3,605 ------- ------- -------
Reinsurance recoveries on ceded reinsurance contracts were $179 million in 2000, $348 million in 1999, and $251 million in 1998. 16. STATUTORY ACCOUNTING State insurance laws and regulations prescribe accounting practices for calculating statutory net income and equity of insurance companies. In addition, state regulators may permit statutory accounting practices that differ from page 54 AMERICAN GENERAL 33 prescribed practices. The use of such permitted practices by our insurance subsidiaries did not have a material effect on their statutory equity at December 31, 2000. Effective January 1, 2001, insurance companies are required to prepare statutory financial statements in accordance with the National Association of Insurance Commissioners' Codification of Statutory Accounting Principles. We do not expect codification to have a material impact on our insurance companies' statutory net income or equity. Significant differences between statutory accounting practices and GAAP for our insurance subsidiaries for the three years ended December 31, 2000 were as follows:
2000 1999 1998 -------- -------- -------- Statutory net income $ 936 $ 996 $ 760 Change in DPAC and CIP 502 476 213 Investment valuation differences (116) (1) 87 Policy reserve adjustments 9 (105) (33) Deferred income taxes (223) (274) (43) Litigation settlements (168) -- (191) Other, net 169 115 12 -------- -------- -------- GAAP net income $ 1,109 $ 1,207 $ 805 -------- -------- -------- Statutory equity $ 4,285 $ 4,082 $ 3,857 Asset valuation reserve 732 758 664 Investment valuation differences* (43) (1,537) 3,450 DPAC and CIP 6,446 6,139 4,198 Goodwill 1,205 1,266 1,275 Non-admitted assets 227 242 197 Policy reserve adjustments (34) 136 180 Deferred income taxes (1,168) (906) (1,582) Other, net 225 34 (125) -------- -------- -------- GAAP equity $ 11,875 $ 10,214 $ 12,114 -------- -------- --------
* Primarily GAAP unrealized gains (losses) on securities. 17. LITIGATION, OTHER CHARGES, AND CONTINGENCIES 17.1 Litigation Satellite Dish. In the mid-1990s, one of our subsidiaries, A.G. Financial Service Center, Inc. (formerly named American General Financial Center), provided financing for satellite dishes sold by independent unaffiliated dealers. On May 18, 1999, a Mississippi state court rendered a judgment against A.G. Financial Service Center for approximately $500,000 in compensatory damages and $167 million in punitive damages, in a lawsuit brought by 29 individuals who had each purchased a satellite dish. In 1999, A.G. Financial Service Center voluntarily filed for bankruptcy. As part of the resolution process, certain settlement agreements were executed in January 2000. Accordingly, we recorded a charge of $57 million ($36 million aftertax) in fourth quarter 1999 to cover the proposed settlements of this and other litigation. On September 1, 2000, payment was made as final settlement of these agreements. In 2000, A.G. Financial Service Center filed a plan of reorganization to resolve the remaining claims filed in the bankruptcy. In January 2001, A.G. Financial Service Center and the creditors' committee in the bankruptcy entered into a settlement that has been approved by the bankruptcy court. The plan of reorganization was confirmed by the bankruptcy court in February 2001. Certain creditors may appeal the confirmation of the plan, but we do not expect the appeals to prevail. We expect our remaining recorded liability related to this matter to be sufficient to cover the costs of the plan of reorganization. Workers' Compensation. Prior to our acquisition of USLIFE Corporation, one of its subsidiaries entered the workers' compensation reinsurance business in 1997. We discontinued writing new workers' compensation reinsurance business in 1998. Our largest contract was a quota share reinsurance agreement with Superior National Insurance Group, Inc. and its affiliates (collectively, Superior National), effective May 1, 1998. On November 29, 1999, we initiated an arbitration proceeding to rescind this contract from its inception, based in part on misrepresentations and nondisclosures which we believe were made by Superior National. In 2000, the California Department of Insurance ordered seizure of certain of Superior National's insurance subsidiaries as a result of their financial condition, and Superior National Insurance Group, Inc. voluntarily filed for bankruptcy. Through the arbitration with Superior National, we plan to fully pursue all remedies. Although we believe, based on the advice of counsel, that the company will succeed in rescinding the contract, risks and uncertainties remain with respect to the ultimate outcome. In the unlikely event the company does not prevail in the arbitration, we do not expect the additional aftertax losses from our workers' compensation business to exceed $85 million, after recoveries from reinsurers. We believe that any ultimate loss related to our workers' compensation business will not have a material adverse effect on our future results of operations and financial position. Other. The company is also party to various other lawsuits and proceedings arising in the ordinary course of business. These lawsuits and proceedings include certain class action claims and claims filed by individuals who excluded themselves from industrial life and market conduct settlements relating to life insurance pricing and sales practices. In addition, many of these proceedings are pending in jurisdictions that permit damage awards disproportionate to the actual economic damages alleged to have been incurred. Based upon information presently available, 2000 ANNUAL REPORT page 55 34 NOTES TO FINANCIAL STATEMENTS In millions we believe that the total amounts that will ultimately be paid arising from these lawsuits and proceedings will not have a material adverse effect on the company's results of operations and financial position. However, it should be noted that the frequency of large damage awards, including large punitive damage awards that bear little or no relation to actual economic damages incurred by plaintiffs in some jurisdictions, continues to create the potential for an unpredictable judgment in any given suit. 17.2 Other Charges Industrial Life. In second quarter 2000, we recorded a charge of $265 million ($175 million aftertax) for the settlement of class action litigation and related regulatory inquiries primarily concerning sales of industrial life insurance. The charge covered the cost of policyholder benefits, including premium adjustments and benefit enhancements, and other charges and expenses resulting from the settlements, as well as related administrative and legal costs. The class action settlement became final and no longer subject to appeal in fourth quarter 2000. Mortgage Warehouse Lending. In June 2000, we discovered a potential fraud committed against one of our subsidiaries that conducts mortgage warehouse lending activities. Mortgages processed by one originator allegedly had been funded based on fraudulent information. In July 2000, the originator's license was suspended and the originator and its parent company filed for bankruptcy. Based on the available information, we recorded a charge of $50 million ($32 million aftertax) in second quarter 2000 for our loss related to this alleged fraud. We are pursuing all appropriate remedies and believe our recorded liability is sufficient to cover this loss. Market Conduct. In 1998, certain of our life insurance subsidiaries entered into agreements to resolve substantially all material pending market conduct class action lawsuits. Concurrently, we recorded a charge of $378 million ($246 million aftertax). The charge covered the cost of additional policyholder benefits and other anticipated expenses resulting from the proposed settlements, as well as other administrative and legal costs. 17.3 Subsidiary Dividend Restrictions Our insurance subsidiaries are restricted by state insurance laws as to the amounts they may pay as shareholder dividends without prior approval from their respective state insurance departments. Certain non-insurance subsidiaries are similarly restricted in the payment of dividends by long-term debt agreements. The amount of dividends available from subsidiaries during 2001 not limited by such restrictions is approximately $1.4 billion. 18. EARNINGS PER SHARE We calculate basic and diluted earnings per share as follows:
2000 1999 1998 --------- --------- --------- Net income $ 1,003 $ 1,131 $ 764 Net dividends on convertible preferred stock -- (6) (6) --------- --------- --------- Basic earnings 1,003 1,125 758 Net dividends on dilutive securities Convertible preferred securities of subsidiary 5 11 11 Convertible preferred stock -- 6 6 --------- --------- --------- Diluted earnings $ 1,008 $ 1,142 $ 775 --------- --------- --------- Average basic shares outstanding 498.6 498.1 502.4 Dilutive securities Convertible preferred securities of subsidiary 6.1 12.3 12.3 Convertible preferred stock -- 4.6 4.6 Stock options 2.5 2.7 3.3 Restricted stock 1.6 .7 .3 --------- --------- --------- Average diluted shares outstanding 508.8 518.4 522.9 --------- --------- --------- Net income per share Basic $ 2.01 $ 2.26 $ 1.51 Diluted 1.98 2.20 1.48 --------- --------- ---------
page 56 AMERICAN GENERAL 35 19. DIVISION OPERATIONS 19.1 Nature of Operations During the last three years, we managed our business operations through three divisions, which were based on products and services offered. Retirement Services. Our retirement services division markets retirement products and services through two major distribution systems. Our financial advisors sell tax-qualified annuities and mutual funds to employees of educational, health care, and government entities and other not-for-profit organizations. We also market non-qualified annuities through representatives of banks and other financial institutions. Life Insurance. Our life insurance division provides life insurance products used for financial and estate planning and wealth transfer. We distribute our products and services through independent and career agent distribution systems. We sell a broad portfolio of products, including interest-sensitive life, variable life, term life, whole life, and fixed and variable annuities. Consumer Finance. Our consumer finance division provides a wide variety of consumer finance products, including mortgages, consumer loans, retail sales finance, and credit-related insurance. We market these products through a nationwide network of branch offices. 19.2 Division Results Results of each division include earnings from its business operations and earnings on that amount of equity considered necessary to support its business, and exclude goodwill amortization, investment gains (losses), and non-recurring items. Division assets and liabilities exclude the fair value adjustment under accounting standard SFAS 115 and goodwill. This methodology is consistent with the manner in which management reviews division results. Corporate operations include parent company expenses, the cost of corporate borrowings, and earnings on corporate assets. Division earnings information was as follows:
Revenues Income before Taxes Net Income ------------------------------ ------------------------------ ------------------------------ 2000 1999 1998 2000 1999 1998 2000 1999 1998 -------- -------- -------- -------- -------- -------- -------- -------- -------- Retirement Services $ 3,932 $ 3,570 $ 3,095 $ 1,002 $ 855 $ 699 $ 661 $ 564 $ 466 Life Insurance 5,430 5,394 5,506 1,164 1,103 1,021 770 721 674 Consumer Finance 1,902 1,729 1,609 385 351 312 247 226 201 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total divisions 11,264 10,693 10,210 2,551 2,309 2,032 1,678 1,511 1,341 -------- -------- -------- -------- -------- -------- -------- -------- -------- Corporate operations (25) 5 35 (338) (298) (244) (217) (192) (159) Goodwill amortization (48) (48) (45) (48) (48) (45) Net dividends on preferred securities of subsidiaries (103) (92) (89) -------- -------- -------- -------- -------- -------- -------- -------- -------- Operating earnings 1,310 1,179 1,048 -------- -------- -------- -------- -------- -------- -------- -------- -------- Investment gains (losses) (176) (19) 6 (176) (19) 6 (114) (12) 4 Non-recurring items Litigation settlements and other charges(a) (315) (57) (378) (207) (36) (246) Other(b) -- -- (65) 14 -- (42) -------- -------- -------- -------- -------- -------- -------- -------- -------- Total $ 11,063 $ 10,679 $ 10,251 $ 1,674 $ 1,887 $ 1,306 $ 1,003 $ 1,131 $ 764 -------- -------- -------- -------- -------- -------- -------- -------- --------
(a) See Note 17. (b) Includes NOL tax benefit in 2000 and Y2K costs in 1998. Division balance sheet information was as follows:
Assets Liabilities ----------------------------------- ---------------------------------- 2000 1999 1998 2000 1999 1998 --------- --------- --------- --------- --------- --------- Retirement Services $ 68,043 $ 65,744 $ 55,659 $ 63,787 $ 62,081 $ 52,395 Life Insurance 37,308 36,404 34,345 30,893 30,329 28,701 Consumer Finance 13,153 12,311 10,807 11,709 10,975 9,619 --------- --------- --------- --------- --------- --------- Total divisions 118,504 114,459 100,811 106,389 103,385 90,715 --------- --------- --------- --------- --------- --------- SFAS 115 adjustment (266) (1,429) 2,445 37 (125) 870 Corporate and other 1,856 2,417 1,851 3,781 3,843 2,923 --------- --------- --------- --------- --------- --------- Total $ 120,094 $ 115,447 $ 105,107 $ 110,207 $ 107,103 $ 94,508 --------- --------- --------- --------- --------- ---------
2000 ANNUAL REPORT page 57 36 NOTES TO FINANCIAL STATEMENTS In millions 20. QUARTERLY DATA (UNAUDITED) Selected quarterly financial data was as follows:
2000 1999 ------------------------------------------------ ------------------------------------------------ 4TH 3RD 2ND 1ST 4th 3rd 2nd 1st --------- --------- --------- --------- --------- --------- --------- --------- Premiums and other considerations $ 936 $ 937 $ 973 $ 993 $ 906 $ 952 $ 990 $ 924 Net investment income 1,399 1,379 1,345 1,330 1,335 1,300 1,312 1,285 Total revenues 2,798 2,793 2,735 2,737 2,670 2,676 2,713 2,620 Insurance and annuity benefits 1,372 1,377 1,367 1,384 1,293 1,329 1,378 1,313 Operating costs and expenses 449 402 400 396 428 407 416 392 Total benefits and expenses 2,299 2,260 2,571(a) 2,259 2,232(b) 2,188 2,229 2,143 Net income 305 319 94(a) 285 257(b) 294 293 287 --------- --------- --------- --------- --------- --------- --------- --------- Per common share Net income Basic $ .61 $ .63 $ .19(a) $ .57 $ .52(b) $ .59 $ .58 $ .57 Diluted .60 .63 .19(a) .56 .50(b) .57 .57 .55 Dividends paid .22 .22 .22 .22 .20 .20 .20 .20 Market price High 41.72 39.94 33.75 36.81 41.09 40.69 38.72 39.41 Low 35.63 30.56 25.84 22.81 30.94 31.50 34.69 32.41 Close 40.75 39.00 30.50 28.06 37.94 31.63 37.69 35.25 --------- --------- --------- --------- --------- --------- --------- --------- 1998 ------------------------------------------------ 4th 3rd 2nd 1st --------- --------- --------- --------- Premiums and other considerations $ 920 $ 916 $ 891 $ 878 Net investment income 1,305 1,284 1,280 1,226 Total revenues 2,627 2,589 2,556 2,479 Insurance and annuity benefits 1,312 1,337 1,286 1,224 Operating costs and expenses 442 382 385 399 Total benefits and expenses 2,600(c) 2,173 2,104 2,068 Net income 1(c) 255 264 244 --------- --------- --------- --------- Per common share Net income Basic $ .00(c) $ .50 $ .52 $ .49 Diluted .00(c) .49 .51 .48 Dividends paid .18 .19 .19 .19 Market price High 39.50 37.84 35.81 32.47 Low 26.28 29.94 31.53 26.16 Close 39.00 31.94 35.59 32.34 --------- --------- --------- ---------
(a) Includes litigation settlements and other charges of $315 million pretax ($207 million aftertax or $.41 per share). (b) Includes litigation settlements of $57 million pretax ($36 million aftertax or $.07 per share). (c) Includes litigation settlements of $378 million pretax ($246 million aftertax or $.49 per share). page 58 AMERICAN GENERAL 37 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders American General Corporation We have audited the accompanying consolidated balance sheet of American General Corporation and subsidiaries as of December 31, 2000, 1999, and 1998, and the related consolidated statements of income, shareholders' equity, comprehensive income, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American General Corporation and subsidiaries as of December 31, 2000, 1999, and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Houston, Texas January 23, 2001 2000 ANNUAL REPORT page 59