-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HzH4AJK2zl40roEJ2bAQIVCU+jsLRn81c4jGHZDi7OO4kLsnBl8lK6THgiTe1/hb 0r8DlTPP6iXV9uPvl0ROiA== 0000054727-98-000003.txt : 19980218 0000054727-98-000003.hdr.sgml : 19980218 ACCESSION NUMBER: 0000054727-98-000003 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980217 SROS: NYSE SROS: PCX FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUNAMERICA INC CENTRAL INDEX KEY: 0000054727 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 860176061 STATE OF INCORPORATION: MD FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-04618 FILM NUMBER: 98540239 BUSINESS ADDRESS: STREET 1: 1 SUNAMERICA CENTER CITY: LOS ANGELES STATE: CA ZIP: 90067-6022 BUSINESS PHONE: 3107726000 FORMER COMPANY: FORMER CONFORMED NAME: KAUFMAN & BROAD INC DATE OF NAME CHANGE: 19890515 FORMER COMPANY: FORMER CONFORMED NAME: KAUFMAN & BROAD BUILDING CO DATE OF NAME CHANGE: 19711006 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ______________ FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 1997 -------------------------------------- OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from_________________to__________________ Commission file number 1-4618 SUNAMERICA INC. (Exact Name of Registrant as Specified in Its Charter) Maryland 86-0176061 (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 1 SunAmerica Center, Los Angeles, California 90067-6022 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (310) 772-6000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes X No . --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, par value $1.00 per share, 178,899,221 shares outstanding Nontransferable Class B Stock, par value $1.00 per share, 16,272,702 shares outstanding SUNAMERICA INC. INDEX Page Number(s) --------- Part I - Financial Information Consolidated Balance Sheet (Unaudited) - December 31, 1997 and September 30, 1997 3-4 Consolidated Income Statement (Unaudited) - Three Months Ended December 31, 1997 and 1996 5 Consolidated Statement of Cash Flows (Unaudited) - Three Months Ended December 31, 1997 and 1996 6-7 Notes to Consolidated Financial Statements (Unaudited) 8-12 Management's Discussion and Analysis of Financial Condition and Results of Operations 13-30 Part II - Other Information 31-32 SUNAMERICA INC. CONSOLIDATED BALANCE SHEET (In thousands - unaudited) December 31, September 30, 1997 1997 ------------ ------------- ASSETS Investments: Cash and short-term investments $ 1,163,180 $ 993,349 Bonds, notes and redeemable preferred stocks available for sale, at fair value (amortized cost: December 31, 1997, $17,610,665; September 30, 1997, $18,124,837) 18,084,215 18,523,655 Mortgage loans 3,090,069 3,139,309 Common stocks available for sale, at fair value (cost: December 31, 1997, $32,874; September 30, 1997, $32,821) 91,011 96,541 Partnerships 1,487,444 1,286,793 Real estate 53,054 81,569 Other invested assets 378,506 286,962 ------------ ------------- Total investments 24,347,479 24,408,178 Variable annuity assets 9,797,579 9,514,675 Accrued investment income 283,657 296,637 Deferred acquisition costs 1,121,847 1,118,582 Other assets 408,184 298,814 ------------ ------------- TOTAL ASSETS $ 35,958,746 $ 35,636,886 ============ ============= See accompanying notes SUNAMERICA INC. CONSOLIDATED BALANCE SHEET (Continued) (In thousands - unaudited) December 31, September 30, 1997 1997 ------------ ------------- LIABILITIES AND SHAREHOLDERS' EQUITY Reserves, payables and accrued liabilities: Reserves for fixed annuity contracts $ 14,047,244 $ 14,445,126 Reserves for guaranteed investment contracts 5,887,177 5,553,292 Trust deposits 439,554 427,433 Payable to brokers for purchases of securities 108,032 266,477 Income taxes currently payable 2,827 2,025 Other liabilities 733,348 828,916 ------------ ------------- Total reserves, payables and accrued liabilities 21,218,182 21,523,269 ------------ ------------- Variable annuity liabilities 9,797,579 9,514,675 ------------ ------------- Long-term notes and debentures 1,236,181 1,136,072 ------------ ------------- Deferred income taxes 494,057 383,764 ------------ ------------- Company-obligated mandatorily redeemable preferred securities of subsidiary grantor trusts whose sole assets are junior subordinated debentures of the Company 495,000 495,000 ------------ ------------- Shareholders' equity: Preferred Stock 248,000 248,000 Nontransferable Class B Stock 16,273 16,273 Common Stock 178,810 179,076 Additional paid-in capital 738,141 750,401 Retained earnings 1,281,407 1,180,446 Net unrealized gains on debt and equity securities available for sale 255,116 209,910 ------------ ------------- Total shareholders' equity 2,717,747 2,584,106 ------------ ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 35,958,746 $ 35,636,886 ============ ============= See accompanying notes SUNAMERICA INC. CONSOLIDATED INCOME STATEMENT For the three months ended December 31, 1997 and 1996 (In thousands, except per-share amounts - unaudited) 1997 1996 ---------- ---------- Investment income $ 520,310 $ 370,545 ---------- ---------- Interest expense on: Fixed annuity contracts (189,528) (128,895) Guaranteed investment contracts (90,685) (67,179) Trust deposits (2,336) (2,422) Senior indebtedness (29,313) (19,791) ---------- ---------- Total interest expense (311,862) (218,287) ---------- ---------- Dividends paid on preferred securities of grantor trusts (10,295) (8,589) ---------- ---------- NET INVESTMENT INCOME 198,153 143,669 ---------- ---------- NET REALIZED INVESTMENT GAINS (LOSSES) 3,194 (9,304) ---------- ---------- Fee income: Variable annuity fees 45,063 30,898 Net retained commissions 24,596 13,322 Surrender charges 12,548 7,597 Asset management fees 6,903 6,418 Loan servicing fees 5,663 5,769 Trust fees 4,574 4,455 Other fees 1,475 1,608 ---------- ---------- TOTAL FEE INCOME 100,822 70,067 ---------- ---------- GENERAL AND ADMINISTRATIVE EXPENSES (77,362) (59,254) ---------- ---------- AMORTIZATION OF DEFERRED ACQUISITION COSTS (55,468) (30,410) ---------- ---------- PRETAX INCOME 169,339 114,768 Income tax expense (45,700) (34,400) ---------- ---------- NET INCOME $ 123,639 $ 80,368 ========== ========== NET INCOME PER SHARE: Basic $ 0.63 $ 0.43 ========== ========== Diluted $ 0.56 $ 0.39 ========== ========== See accompanying notes SUNAMERICA INC. CONSOLIDATED STATEMENT OF CASH FLOWS For the three months ended December 31, 1997 and 1996 (In thousands - unaudited) 1997 1996 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 123,639 $ 80,368 Adjustments to reconcile net income to net cash provided by operating activities: Interest credited to: Fixed annuity contracts 189,528 128,895 Guaranteed investment contracts 90,685 67,179 Trust deposits 2,336 2,422 Net realized investment losses (gains) (3,194) 9,304 Accretion of net discounts on investments (2,942) (7,602) Provision for deferred income taxes 89,977 (11,150) Change in: Accrued investment income 12,848 (21,938) Deferred acquisition costs (2,865) (25,651) Other assets (13,062) (12,810) Income taxes currently payable (37,147) 11,012 Other liabilities (99,176) 9,094 Other, net (9,560) 12,182 ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 341,067 241,305 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of: Bonds, notes and redeemable preferred stocks (4,313,693) (4,119,409) Mortgage loans (81,475) (125,265) Partnerships (450,813) (352,389) Other investments, excluding short-term investments (218,348) (77,912) Net assets of Financial Service Corporation (41,295) -- Sales of: Bonds, notes and redeemable preferred stocks 3,682,335 2,542,057 Partnerships 169,292 100,126 Other investments, excluding short-term investments 35,621 21,140 Redemptions and maturities of: Bonds, notes and redeemable preferred stocks 1,045,679 665,599 Mortgage loans 132,946 71,553 Partnerships 34,651 311,424 Other investments, excluding short-term investments 149,008 15,887 ------------ ------------ NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 143,908 (947,189) ------------ ------------ See accompanying notes SUNAMERICA INC. CONSOLIDATED STATEMENT OF CASH FLOWS (Continued) For the three months ended December 31, 1997 and 1996 (In thousands - unaudited) 1997 1996 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Payments of cash dividends to shareholders $ (22,678) $ (17,352) Premium receipts on: Fixed annuity contracts 338,742 427,420 Guaranteed investment contracts 585,041 540,622 Net exchanges from the fixed accounts of variable annuity contracts (258,594) (91,348) Receipts of trust deposits 179,187 149,407 Withdrawal payments on: Fixed annuity contracts (555,631) (233,901) Guaranteed investment contracts (341,841) (185,918) Trust deposits (169,403) (126,052) Claims and annuity payments on fixed annuity contracts (114,783) (75,286) Net proceeds from issuances of long-term notes 99,078 429,383 Net borrowings (repayments) of other short-term financings (54,262) 5,510 Net proceeds from issuances of preferred securities of subsidiary grantor trusts -- 300,202 Net payment for redemption of Series C Preferred Stock -- (48,680) Payment of issuance costs of 8-1/2% Premium Equity Redemption Cumulative Security Units -- (45,362) ------------ ------------ NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (315,144) 1,028,645 ------------ ------------ NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS 169,831 322,761 CASH AND SHORT-TERM INVESTMENTS AT BEGINNING OF PERIOD 993,349 529,363 ------------ ------------ CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 1,163,180 $ 852,124 ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid on indebtedness $ 42,549 $ 24,757 ============ ============ Income taxes paid, net of refunds received $ 7,130 $ 34,538 ============ ============ See accompanying notes SUNAMERICA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation --------------------- In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the Company's consolidated financial position as of December 31, 1997 and September 30, 1997, and the results of its consolidated operations and its consolidated cash flows for the three months ended December 31, 1997 and 1996. The results of operations for the three months ended December 31, 1997 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended September 30, 1997, contained in the Company's 1997 Annual Report to Shareholders. 2. Acquisitions ------------ On March 31, 1997, the Company completed the acquisition of 1) a block of annuity contracts from John Alden Life Insurance Company, a subsidiary of John Alden Financial Corporation, and 2) all of the outstanding common stock of John Alden Life Insurance Company of New York. This acquisition has been accounted for by using the purchase method of accounting. Accordingly, the income statement for the three-month period ended December 31, 1996 does not include the operating results of this acquisition. On a pro forma basis, assuming the acquisition occurred on October 1, 1996, the beginning of the three-month period ended December 31, 1996, revenues (investment income, net realized investment losses and fee income) would have been $523,914,000 and net income would have been $90,648,000 ($0.49 per basic share and $0.44 per diluted share) for the three months ended December 31, 1996. SUNAMERICA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 3. Company-Obligated Preferred Securities of Subsidiary Grantor Trusts ------------------------------------------------------------------- Preferred securities of subsidiary grantor trusts comprise $185,000,000 liquidation amount of 8.35% Trust Originated Preferred Securities issued by SunAmerica Capital Trust II in October 1995 and $310,000,000 liquidation amount of 8.30% Trust Originated Preferred Securities issued by SunAmerica Capital Trust III in November 1996. In connection with the issuance of the 8.35% Trust Originated Preferred Securities and the related purchase by the Company of the grantor trust's common securities, the Company issued to the grantor trust $191,224,250 principal amount of 8.35% junior subordinated debentures, due 2044, which are redeemable at the option of the Company on or after September 30, 2000 at a redemption price of $25 per debenture plus accrued and unpaid interest. In connection with the issuance of the 8.30% Trust Originated Preferred Securities and the related purchase by the Company of the grantor trust's common securities, the Company issued to the grantor trust $320,670,000 principal amount of 8.30% junior subordinated debentures, due 2045, which are redeemable at the option of the Company on or after November 13, 2001 at a redemption price of $25 per debenture plus accrued and unpaid interest. On June 16, 1997, SunAmerica Capital Trust I redeemed $52,630,875 liquidation amount of the 9.95% Trust Originated Preferred Securities for a cash payment equal to the liquidation amount of $52,630,875 plus accrued and unpaid dividends to the redemption date of $1,105,541. Concurrently, the Company redeemed all of the related 9.95% junior subordinated debentures, due 2044, for a liquidation of $54,258,650 plus accrued and unpaid interest. The grantor trusts are wholly owned subsidiaries of the Company. The debentures issued to the grantor trusts and the common securities purchased by the Company from the grantor trusts are eliminated in the balance sheet. SUNAMERICA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued) 4. Earnings per Share ------------------ The calculations of basic and diluted earnings per share for the three months ended December 31, 1997 and 1996 are as follows (in thousands, except per-share amounts): BASIC EARNINGS PER SHARE: 1998 1997 -------- -------- Net income $123,639 $ 80,368 -------- -------- Less preferred stock dividends: 9-1/4% Preferred Stock, Series B -- (2,031) Adjustable Rate Cumulative Preferred Stock, Series C -- (28) Series E Mandatory Conversion Premium Dividend Preferred Stock (3,100) (3,100) -------- -------- Total preferred stock dividends (3,100) (5,159) -------- -------- Income available to common shareholders $120,539 $ 75,209 ======== ======== Average common shares issued and outstanding 195,227 179,392 Less common shares issued and outstanding, but not vested to participants under various employee stock plans (2,760) (3,310) -------- -------- Average shares outstanding 192,467 176,082 ======== ======== Basic earnings per share $ 0.63 $ 0.43 ======== ======== SUNAMERICA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued) 4. Earnings per Share (continued) ------------------ DILUTED EARNINGS PER SHARE: 1998 1997 -------- -------- Net income $123,639 $ 80,368 -------- -------- Less preferred stock dividends: 9-1/4% Preferred Stock, Series B -- (2,031) Adjustable Rate Cumulative Preferred Stock, Series C -- (28) -------- -------- Total preferred stock dividends -- (2,059) -------- -------- Income available to common shareholders $123,639 $ 78,309 ======== ======== Average shares outstanding 195,227 179,392 Plus incremental shares from potential common stock: Average number of shares arising from outstanding employee stock plans 8,597 4,814 Average number of shares issuable upon conversion of Series E Mandatory Conversion Premium Dividend Preferred Stock 12,939 15,194 Average number of shares issuable upon conversion of Premium Equity Redemption Cumulative Security Units 5,397 1,061 -------- -------- Average shares outstanding 222,160 200,461 ======== ======== Diluted earnings per share $ 0.56 $ 0.39 ======== ======== SUNAMERICA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued) 5. Ratio of Earnings to Fixed Charges ---------------------------------- The ratios of earnings to fixed charges for the three months ended December 31, 1997 and 1996 are as follows: Three months ended December 31, ------------------ 1997 1996 ------- ------- Ratio of earnings to fixed charges (which include dividends paid on preferred securities of grantor trusts and interest incurred on senior debt, but exclude interest incurred on fixed annuities, guaranteed investment contracts and trust deposits) 5.3x 5.0x ======= ======= Ratio of earnings to fixed charges (which include dividends paid on preferred securities of grantor trusts and interest incurred on senior debt, fixed annuities, guaranteed investment contracts and trust deposits) 1.5x 1.5x ======= ======= Ratio of earnings to combined fixed charges and preferred stock dividends (which include dividends paid on preferred securities of grantor trusts and interest incurred on senior debt, but exclude interest incurred on fixed annuities, guaranteed investment contracts and trust deposits) 4.8x 4.0x ======= ======= Ratio of earnings to combined fixed charges and preferred stock dividends (which include dividends paid on preferred securities of grantor trusts and interest incurred on senior debt, fixed annuities, guaranteed investment contracts and trust deposits) 1.5x 1.5x ======= ======= MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's discussion and analysis of financial condition and results of operations of SunAmerica Inc. (the "Company") for the three months ended December 31, 1997 ("Fiscal 1998") and December 31, 1996 ("Fiscal 1997") follows. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission (the "SEC"). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect," "anticipate," "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company's beliefs concerning future levels of sales and redemptions of the Company's products, investment spreads and yields, or the earnings and profitability of the Company's activities. Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable developments. Some may be national in scope, such as general economic conditions, changes in tax law and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation. Others may relate to the Company specifically, such as credit, volatility and other risks associated with the Company's investment portfolio. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the SEC. The Company disclaims any obligation to update forward-looking information. RESULTS OF OPERATIONS NET INCOME totaled $123.6 million ($0.63 per basic share and $0.56 per diluted share) in Fiscal 1998, compared with $80.4 million ($0.43 per basic share and $0.39 per diluted share) in Fiscal 1997. On March 31, 1997, the Company acquired certain annuity contracts from John Alden Life Insurance Company and all of the outstanding common stock of John Alden Life Insurance Company of New York (collectively, the "Acquisition"). The Acquisition was accounted for under the purchase method of accounting, and, therefore, results of operations include those of the Acquisition only from the date of acquisition. Consequently, operating results for Fiscal 1998 and Fiscal 1997 are not comparable. On a pro forma basis, using the historical operating results of the acquired businesses and assuming the Acquisition had been consummated on October 1, 1996, the beginning of the prior-year period discussed herein, net income would have been $90.6 million ($0.49 per basic share and $0.44 per diluted share) in Fiscal 1997. PRETAX INCOME totaled $169.3 million in Fiscal 1998 and $114.8 million in 1997. The 47.5% improvement in Fiscal 1998 over Fiscal 1997 primarily resulted from increased net investment income and fee income and investment gains realized in Fiscal 1998, compared with net investment losses realized in Fiscal 1997. These favorable factors were partially offset by increased amortization of deferred acquisition costs and higher general and administrative expenses. NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest-bearing liabilities, increased to $198.2 million in Fiscal 1998 from $143.7 million in Fiscal 1997. These amounts equal 3.28% on average invested assets (computed on a daily basis) of $24.17 billion in Fiscal 1998 and 3.37% on average invested assets of $17.07 billion in Fiscal 1997. The invested assets associated with the Acquisition included high-grade corporate, government and government/agency bonds and cash and short-term investments, which are generally lower yielding than a significant portion of the invested assets that comprise the remainder of the Company's portfolio. As a result of the Acquisition, net investment income as a percent of average invested assets in Fiscal 1998 has declined. However, on a pro forma basis, assuming the Acquisition had been consummated on October 1, 1996, net investment income on related average invested assets would have been 3.11% in Fiscal 1997. Net investment spreads include the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. This excess amounted to $1.66 billion in Fiscal 1998 and $1.15 billion in Fiscal 1997. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.89% in Fiscal 1998 and 2.98% in Fiscal 1997. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1996, the Spread Difference would have been 2.91% in Fiscal 1997. Investment income (and the related yields on average invested assets) totaled $520.3 million (8.61%) in Fiscal 1998, compared with $370.5 million (8.68%) in Fiscal 1997. Investment income and the related yields in Fiscal 1998 reflect the effects of the Acquisition. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1996, the yield on related average invested assets would have been 8.50% in Fiscal 1997. This increased yield (on a pro forma basis) in Fiscal 1998 reflects a partial reallocation of lower-yielding invested assets acquired as part of the Acquisition into generally higher-yielding asset classes in which the Company has historically invested a portion of its portfolio. Increased investment income in Fiscal 1998 also reflects higher returns from the Company's investments in total return bond swap agreements (the "Total Return Agreements") and increased income from the Company's investment in partnerships, as well as the effects of an increase in average invested assets (in excess of those acquired through the Acquisition). Partnership income increased to $66.3 million (a yield of 18.80% on related average assets of $1.41 billion) in Fiscal 1998, compared with $57.8 million (a yield of 20.00% on related average assets of $1.16 billion) in Fiscal 1997. Partnership income includes income recognized by using the cost method of accounting, which amounted to $25.6 million and $17.1 million in Fiscal 1998 and Fiscal 1997, respectively. Such income is based upon cash distributions received from limited partnerships, the operations of which the Company does not influence. Consequently, such income is not predictable and there can be no assurance that the Company will realize comparable levels of such income in the future. The Company has enhanced investment yield from time to time through Total Return Agreements. The Company recorded income of $16.7 million on Total Return Agreements in Fiscal 1998, compared with $8.2 million recorded in Fiscal 1997. The improved results in Fiscal 1998 reflect improved overall performance of the non-investment-grade bonds underlying the Total Return Agreements and increases in the average notional principal amount of the Total Return Agreements. (See "Asset-Liability Matching" for additional discussion of Total Return Agreements.) Total interest and dividend expense equalled $322.2 million in Fiscal 1998 and $226.9 million in Fiscal 1997. The average rate paid on all interest-bearing liabilities was 5.72% in Fiscal 1998, compared with 5.70% in Fiscal 1997. Interest-bearing liabilities averaged $22.52 billion during Fiscal 1998, compared with $15.91 billion during Fiscal 1997. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1996, the average rate paid on all interest-bearing liabilities would have been 5.59% in Fiscal 1997. The nominal increase in the actual overall rate paid since Fiscal 1997 primarily resulted from a corresponding two basis point increase in the average rate paid on the Company's fixed annuity contracts. The increase in overall rate paid in Fiscal 1998 as compared with the pro forma overall rate paid in Fiscal 1997 primarily reflects period-over-period increases in the percentage of average interest-bearing liabilities composed of senior debt and guaranteed investment contracts ("GICs"), which, on average, bear higher interest rates than those of the Company's other interest-bearing liabilities. GROWTH IN AVERAGE INVESTED ASSETS to $24.17 billion in Fiscal 1998 from $17.07 billion in Fiscal 1997 primarily reflects the impact of the Acquisition. The Company acquired $5.00 billion of invested assets associated with the Acquisition on March 31, 1997. The Company intends to continue to pursue a strategy of enhancing its internal growth with complementary acquisitions. Average invested assets also increased as a result of sales of the Company's fixed-rate products, consisting of both fixed annuity premiums (including those for the fixed accounts of variable annuity products) and GIC premiums, and $805.7 million of aggregate net proceeds from the issuances of Common Stock and long-term notes and debentures. Since December 31, 1996, fixed annuity premiums have totaled $1.40 billion and GIC premiums have aggregated $2.12 billion. Fixed annuity premiums totaled $338.7 million in Fiscal 1998, compared with $427.4 million in Fiscal 1997. These premiums include premiums for the fixed accounts of variable annuities totaling $268.8 million and $388.4 million, respectively. This decline in premiums allocated to the fixed accounts of variable annuity contracts may be attributed to more restrictive fixed-rate promotions in Fiscal 1998 than in Fiscal 1997. GIC premiums increased to $585.0 million in Fiscal 1998 from $540.6 million in Fiscal 1997. The increase in GIC premiums in Fiscal 1998 reflects an expansion of the GIC client base due, in part, to a broadening of the Company's products and distribution channels, including its AAA-rated company, SunAmerica National Life Insurance Company, and its AAA/Aaa-rated credit- enhanced GIC products. The GICs issued by the Company generally guarantee the payment of principal and interest at a fixed rate for a fixed term of three to five years. In the case of GICs sold to pension plans, certain withdrawals may be made at book value in the event of circumstances specified in the plan document, such as employee retirement, death, disability, hardship withdrawal or employee termination. The Company generally imposes surrender penalties in the event of other withdrawals prior to maturity. GICs purchased by banks and asset management firms for their long-term portfolios, certain trusts or state and local governmental entities either prohibit withdrawals or permit scheduled book value withdrawals subject to the terms of the underlying indenture or agreement. GICs purchased by asset management firms for their short-term portfolios either prohibit withdrawals or permit withdrawals with notice ranging from 90 to 270 days. In pricing GICs, the Company analyzes cash flow information and prices accordingly so that it is compensated for possible withdrawals prior to maturity. NET REALIZED INVESTMENT GAINS totaled $3.2 million in Fiscal 1998, compared with net realized investment losses of $9.3 million in Fiscal 1997. Net realized investment gains in Fiscal 1998 include impairment writedowns of $9.8 million and net realized investment losses in Fiscal 1997 include impairment writedowns of $7.6 million. Therefore, the Company realized $13.0 million of net gains from sales of investments in Fiscal 1998 and $1.7 million of net losses from sales of investments in Fiscal 1997. The Company sold invested assets, principally bonds and notes, aggregating $3.89 billion and $2.57 billion in Fiscal 1998 and Fiscal 1997, respectively. Sales of investments result from the active management of the Company's investment portfolio. Because sales of investments are made in both rising and falling interest rate environments, net gains and losses from sales of investments fluctuate from period to period, and represent 0.21% and 0.04% of average invested assets for Fiscal 1998 and Fiscal 1997, respectively. Active portfolio management involves the ongoing evaluation of asset sectors, individual securities within the investment portfolio and the reallocation of investments from sectors that are perceived to be relatively overvalued to sectors that are perceived to be relatively undervalued. The intent of the Company's active portfolio management is to maximize total returns on the investment portfolio, taking into account credit and interest-rate risk. Impairment writedowns primarily have been applied to defaulted bonds and mortgage loans. Impairment writedowns, on an annualized basis, represent 0.16% and 0.18% of average invested assets for Fiscal 1998 and Fiscal 1997, respectively. For the 17 fiscal quarters beginning October 1, 1993, impairment writedowns as a percentage of average invested assets have ranged from 0.16% to 1.54% and have averaged 0.35%. Such writedowns are based upon estimates of the net realizable value of the applicable assets. Actual realization will be dependent upon future events. VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $45.1 million in Fiscal 1998 and $30.9 million in Fiscal 1997. These increased fees reflect growth in average variable annuity assets, principally due to the receipt of variable annuity premiums, increased market values and net exchanges into the separate accounts from the fixed accounts of variable annuity contracts, partially offset by surrenders. Variable annuity assets averaged $9.58 billion during Fiscal 1998 and $6.68 billion during Fiscal 1997. Variable annuity premiums, which exclude premiums allocated to the fixed accounts of variable annuity products, have aggregated $1.51 billion since December 31, 1996. Variable annuity premiums increased to $434.3 million in Fiscal 1998 from $231.7 million in Fiscal 1997. Sales of variable annuity products (which include premiums allocated to the fixed accounts) ("Variable Annuity Product Sales") amounted to $703.1 million and $620.1 million in Fiscal 1998 and Fiscal 1997, respectively. Increases in Variable Annuity Product Sales are due, in part, to market share gains through enhanced distribution efforts and growing consumer demand for flexible retirement savings products that offer a variety of equity, fixed income and guaranteed fixed account investment choices. The Company has encountered increased competition in the variable annuity marketplace during recent years and anticipates that the market will remain highly competitive for the foreseeable future. Also, recent administration budget proposals include the proposed taxation of exchanges involving variable annuity contracts and reallocation within variable annuity contracts and certain other proposals relating to annuities (see "Regulation"). NET RETAINED COMMISSIONS are primarily derived from commissions on the sales of nonproprietary investment products by the Company's broker-dealer subsidiaries, after deducting the substantial portion of such commissions that is passed on to registered representatives. Net retained commissions totaled $24.6 million in Fiscal 1998 and $13.3 million in Fiscal 1997. Broker-dealer sales (mainly sales of general securities, mutual funds and annuities) totaled $7.00 billion in Fiscal 1998 and $3.28 billion in Fiscal 1997. The increases in sales and net retained commissions reflect a greater number of registered representatives, higher average production per representative and generally favorable market conditions. The greater number of registered representatives was primarily due to acquisitions, including the October 1, 1997 acquisition of Financial Service Corporation and the January 22, 1997 acquisition of The Financial Group, Inc. At their respective dates of acquisition, these acquired companies licensed through their subsidiaries approximately 1,500 and 400 independent registered representatives, respectively. Increases in net retained commissions may not be proportionate to increases in sales primarily due to differences in sales mix. SURRENDER CHARGES on fixed and variable annuities totaled $12.5 million (including $4.5 million attributable to the Acquisition) in Fiscal 1998, compared with $7.6 million in Fiscal 1997. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first seven years of an annuity contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $776.4 million (including $212.4 million attributable to the Acquisition) in Fiscal 1998, compared with $410.4 million in Fiscal 1997. These payments represent 13.6% (17.8% of average fixed annuity reserves associated with the Acquisition) and 10.5%, respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity withdrawals from the separate accounts totaling $221.1 million in Fiscal 1998 (9.2% of average variable annuity reserves) and $177.3 million (10.6% of average variable annuity reserves) in Fiscal 1997. Consistent with the assumptions used in connection with the Acquisition, and other acquisitions of annuity businesses in Fiscal 1996, management anticipates that the level of withdrawal payments will continue to reflect higher relative withdrawal rates in the near future because of higher surrenders on the annuity business acquired in the Acquisition and on the annuity businesses acquired in fiscal year 1996. Excluding the effects of all recent acquisitions, withdrawal payments represented 9.3% and 10.8% of related average fixed and variable annuity reserves in Fiscal 1998 and Fiscal 1997, respectively. This lower surrender rate in Fiscal 1998 reflects the continued decrease in the percentage of non- acquisition-related annuity contracts that are free of surrender charges. ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1 distribution fees, are based on the market value of assets managed in mutual funds by SunAmerica Asset Management Corp. Such fees totaled $6.9 million on average assets managed of $2.69 billion in Fiscal 1998 and $6.4 million on average assets managed of $2.21 billion in Fiscal 1997. Asset management fees are not proportionate to average assets managed, principally due to changes in product mix. Sales of mutual funds, excluding sales of money market accounts, have aggregated $558.3 million since December 31, 1996. Mutual fund sales totaled $165.8 million in Fiscal 1998, up 166% from the $62.3 million in Fiscal 1997. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to $92.0 million in Fiscal 1998 and $103.7 million in Fiscal 1997. The significant increases in sales during Fiscal 1998 over Fiscal 1997 principally resulted from the introduction in November 1996 of the Company's "Style Select Series" product. LOAN SERVICING FEES are earned by Imperial Premium Finance, Inc. ("Imperial"). Imperial provides short-term installment loans for borrowers to fund their property and casualty insurance premiums. These loans are secured by the unearned premium associated with the underlying insurance policies. Currently, Imperial sells most of the loans it originates and earns fee income by servicing the sold loans. Such fee income totaled $5.7 million on average loans serviced of $494.0 million in Fiscal 1998, compared with $5.8 million on average loans serviced of $478.1 million in Fiscal 1997. Although average loans serviced have increased during Fiscal 1998, loan servicing fees have not increased proportionately, largely due to increased competition in the premium finance marketplace. TRUST FEES are earned by Resources Trust Company for providing administrative and custodial services primarily for individual retirement accounts, as well as for other qualified retirement plans. Trust fees increased to $4.6 million in Fiscal 1998 (on an average of 210,000 trust accounts) from $4.5 million in Fiscal 1997 (on an average of 203,000 trust accounts). GENERAL AND ADMINISTRATIVE EXPENSES totaled $77.4 million in Fiscal 1998, up 31% from $59.3 million in Fiscal 1997. General and administrative expenses in Fiscal 1998 reflect the impact of the Acquisition, as well as the acquisitions of Financial Service Corporation and The Financial Group, Inc. During 1997, the number of employees increased 34% to 2,212 employees at December 31, 1997. As a result, compensation (net of deferrals) has increased to $44.9 million in Fiscal 1998 from $34.4 million in Fiscal 1997. General and administrative expenses remains closely controlled through a company-wide cost containment program and continue to represent less than 1% of average total assets. AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $55.5 million in Fiscal 1998, compared with $30.4 million in Fiscal 1997. The increases in amortization primarily reflect the amortization of the deferred acquisition costs attributable to the Acquisition, which aggregated $16.0 million in Fiscal 1998. Amortization has also increased due to additional fixed and variable annuity and mutual fund sales and the subsequent amortization of related deferred commissions and other direct selling costs. INCOME TAX EXPENSE totaled $45.7 million in Fiscal 1998, compared with $34.4 million in Fiscal 1997, representing effective tax rates of 27% in Fiscal 1998 and 30% in Fiscal 1997. These tax rates reflect the favorable impact of tax credits associated with tax-advantaged investments in affordable housing partnerships owned by the Company. Financial Condition and Liquidity SHAREHOLDERS' EQUITY increased 5.2% to $2.72 billion at December 31, 1997 from $2.58 billion at September 30, 1997, primarily due to $123.6 million of net income recorded in Fiscal 1998 and the $45.2 million improvement of net unrealized gains on debt and equity securities available for sale (credited directly to shareholders' equity). These favorable factors were partially offset by $22.7 million of dividends paid to shareholders. BOOK VALUE PER SHARE amounted to $13.08 at December 31, 1997, up from $12.40 at September 30, 1997. Excluding net unrealized gains on debt and equity securities available for sale, book value per share amounted to $11.85 at December 31, 1997 and $11.39 at September 30, 1997. On a pro forma basis, assuming that the 8-1/2% Premium Equity Redemption Cumulative Security Units were converted to Common Stock, book value per share would have been $14.13 at December 31, 1997, compared with $13.40 at September 30, 1997 and, excluding net unrealized gains on debt and equity securities available for sale, would have been $12.99 at December 31, 1997 and $12.47 at September 30, 1997. INVESTED ASSETS at December 31, 1997 totaled $24.35 billion, compared with $24.41 billion at September 30, 1997. The Company manages most of its invested assets internally. The Company's general investment philosophy is to hold fixed-rate assets for long-term investment. Thus, it does not have a trading portfolio. However, the Company has determined that all of its portfolio of bonds, notes and redeemable preferred stocks (the "Bond Portfolio") is available to be sold in response to changes in market interest rates, changes in relative value of asset sectors and individual securities, changes in prepayment risk, changes in the credit quality outlook for certain securities, the Company's need for liquidity and other similar factors. THE BOND PORTFOLIO, which constitutes 74% of the Company's total investment portfolio (at amortized cost), had an aggregate fair value that exceeded its amortized cost by $473.6 million at December 31, 1997, compared with an excess of $398.8 million at September 30, 1997. The net unrealized gains on the Bond Portfolio since September 30, 1997 principally reflect the lower prevailing interest rates at December 31, 1997 and the corresponding effect on the fair value of the Bond Portfolio. At December 31, 1997, the Bond Portfolio (at amortized cost, excluding $182.7 million of redeemable preferred stocks) included $16.65 billion of bonds rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service ("Moody's"), Duff & Phelps Credit Rating Co. ("DCR"), Fitch Investors Service, L.P. ("Fitch") or the National Association of Insurance Commissioners ("NAIC"), and $773.7 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 1997, approximately $15.70 billion of the Bond Portfolio was investment grade, including $6.42 billion of U.S. government/agency securities and mortgage-backed securities ("MBSs"). At December 31, 1997, the Bond Portfolio included $1.73 billion (at amortized cost with a fair value of $1.79 billion) of bonds that were not investment grade. Based on their December 31, 1997 amortized cost, these non-investment-grade bonds accounted for 4.9% of the Company's total assets and 7.3% of its invested assets. In addition to its direct investment in non-investment-grade bonds, the Company has entered into Total Return Agreements with an aggregate notional principal amount of $633.2 million at December 31, 1997 (see "Asset-Liability Matching"). Non-investment-grade securities generally provide higher yields and involve greater risks than investment-grade securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment-grade issuers. In addition, the trading market for these securities is usually more limited than for investment-grade securities. The Company had no material concentrations of non-investment-grade securities at December 31, 1997. The table on the following page summarizes the Company's rated bonds by rating classification as of December 31, 1997 (dollars in thousands): RATED BONDS BY RATING CLASSIFICATION (Dollars in thousands)
Issues not rated by S&P/Moody's/ Issues rated by S&P/Moody's/D&P/Fitch DCR/Fitch, by NAIC category Total - ---------------------------------------------- ----------------------------------- ---------------------------------- S&P/(Moody's)/ Estimated NAIC Estimated Percent of Estimated [DCR]/{Fitch} Amortized fair category Amortized fair Amortized invested fair category(1) cost value (2) cost value cost assets(3) value - --------------- ---------- ---------- -------- ---------- ----------- ---------- --------- ---------- AAA to A- (Aaa to A3) [AAA to A-] {AAA to A-} $9,940,741 $10,150,141 1 $1,432,564 $1,513,061 $11,373,305 47.76% $11,663,202 BBB+ to BBB- (Baa1 to Baa3) [BBB+ to BBB-] {BBB+ to BBB-} 3,775,242 3,838,691 2 548,951 573,012 4,324,193 18.16 4,411,703 BB+ to BB- (Ba1 to Ba3) [BB+ to BB-] {BB+ to BB-} 138,332 149,044 3 107,773 104,394 246,105 1.03 253,438 B+ to B- (B1 to B3) [B+ to B-] {B+ to B-} 1,196,397 1,246,958 4 188,657 188,708 1,385,054 5.82 1,435,666 CCC+ to C (Caa to C) [CCC] {CCC+ to C-} 18,378 21,344 5 75,832 78,227 94,210 0.40 99,571 CI to D [DD] {D} -- -- 6 5,063 5,944 5,063 0.02 5,944 ----------- ----------- ---------- ---------- ----------- ----------- TOTAL RATED ISSUES $15,069,090 $15,406,178 $2,358,840 $2,463,346 $17,427,930 $17,869,524 =========== =========== ========== ========== =========== =========== Footnotes appear on the following page.
Footnotes to the table of rated bonds by rating classification --------------------------------------------------------------- (1) S&P and Fitch rate debt securities in rating categories ranging from AAA (the highest) to D (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Moody's rates debt securities in rating categories ranging from Aaa (the highest) to C (extremely poor prospects of ever attaining any real investment standing). The number 1, 2 or 3 (with 1 the highest and 3 the lowest) indicates the debt's relative standing within the rating category. A security rated Baa3 or higher is considered investment grade. DCR rates debt securities in rating categories ranging from AAA (the highest) to DD (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Issues are categorized based on the highest of the S&P, Moody's, DCR and Fitch ratings if rated by multiple agencies. (2) Bonds and short-term promissory instruments are divided into six quality categories for NAIC rating purposes, ranging from 1 (highest) to 5 (lowest) for nondefaulted bonds plus one category, 6, for bonds in or near default. These six categories correspond with the S&P/Moody's/DCR/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. The NAIC categories include $773.7 million (at amortized cost) of assets that were rated by the Company pursuant to applicable NAIC rating guidelines. (3) At amortized cost. Senior secured loans ("Secured Loans") are included in the Bond Portfolio and their amortized cost aggregated $2.44 billion at December 31, 1997. Secured Loans are senior to subordinated debt and equity, and are secured by assets of the issuer. At December 31, 1997, Secured Loans consisted of $1.45 billion of publicly traded securities and $989.0 million of privately traded securities. These Secured Loans are composed of loans to 341 borrowers spanning 46 industries, with 24% of these assets (at amortized cost) concentrated in financial institutions and 12% concentrated in utilities. No other industry concentration constituted more than 6% of these assets. While the trading market for the Company's privately traded Secured Loans is more limited than for publicly traded issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. As a result of restrictive financial covenants, these Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities. However, management believes that the risk of loss upon default for these Secured Loans is mitigated by such financial covenants and the collateral values underlying the Secured Loans. The Company's Secured Loans are rated by S&P, Moody's, DCR, Fitch, the NAIC or by the Company, pursuant to comparable statutory ratings guidelines established by the NAIC. MORTGAGE LOANS aggregated $3.09 billion at December 31, 1997 and consisted of 1,234 commercial first mortgage loans with an average loan balance of approximately $2.5 million, collateralized by properties located in 45 states. Approximately 30% of this portfolio was multifamily residential, 27% was retail, 14% was office, 9% was manufactured housing, 7% was industrial and 13% was other types. At December 31, 1997, approximately 19%, 10% and 9% of this portfolio was secured by properties located in California, New York and Florida, respectively, and no more than 8% of this portfolio was secured by properties located in any other single state. At December 31, 1997, there were 51 mortgage loans with outstanding balances of $10 million or more, which loans collectively aggregated approximately 29% of this portfolio. At December 31, 1997, approximately 35% of the mortgage loan portfolio consisted of loans with balloon payments due before January 1, 2001. During Fiscal 1998 and Fiscal 1997, loans delinquent by more than 90 days, foreclosed loans and restructured loans have not been significant in relation to the total mortgage loan portfolio. At December 31, 1997, approximately 42% of the mortgage loans were seasoned loans underwritten to the Company's standards and purchased at or near par from other financial institutions. Such loans generally have higher average interest rates than loans that could be originated today. The balance of the mortgage loan portfolio has been originated by the Company under strict underwriting standards. Commercial mortgage loans on properties such as offices, hotels and shopping centers generally represent a higher level of risk than do mortgage loans secured by multifamily residences. This greater risk is due to several factors, including the larger size of such loans and the more immediate effects of general economic conditions on these commercial property types. However, due to the seasoned nature of the Company's mortgage loan portfolio, its emphasis on multifamily loans and its strict underwriting standards, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields. PARTNERSHIP investments totaled $1.49 billion at December 31, 1997, constituting investments in approximately 600 separate partnerships with an average size of approximately $2.5 million. This portfolio includes: (i) $765.0 million of partnerships managed by independent money managers that invest in a broad selection of equity and fixed-income securities, currently including approximately 3,925 separate issuers; (ii) $612.9 million of partnerships that make tax-advantaged investments in affordable housing properties, currently involving approximately 538 multifamily projects in 43 states; and (iii) $109.5 million of partnerships that invest in mortgage loans and income-producing real estate. At December 31, 1997, $831.9 million of the Company's partnerships was accounted for by using the cost method and $655.5 million by using the equity method. The risks generally associated with partnerships include those related to their underlying investments (i.e. equity securities, debt securities and real estate), plus a level of illiquidity, which is mitigated, to some extent, a) for the affordable housing partnerships by the marketability of the tax credits they generate; and b) in the case of many of the other partnerships, by the existence of contractual termination provisions. ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges, two-tiered interest rate structures or other restrictions in order to encourage persistency. Approximately 87% of the Company's fixed annuity and GIC reserves had surrender penalties or other restrictions at December 31, 1997. As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what it pays on its liabilities by designing its fixed- rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company's fixed-rate assets include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; and investments in limited partnerships that invest primarily in fixed-rate securities and are accounted for by using the cost method. At December 31, 1997, these assets had an aggregate fair value of $22.72 billion with a duration of 3.6. The Company's fixed-rate liabilities include: fixed annuities; GICs; trust deposits; long- term notes and debentures; and preferred securities of subsidiary grantor trusts. At December 31, 1997, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $21.16 billion with a duration of 3.1. The Company's potential exposure due to a relative 10% increase in interest rates prevalent at December 31, 1997 is a loss of approximately $90.7 million in fair value of its fixed-rate assets that is not offset by an increase in the fair value of its fixed-rate liabilities. Because the Company actively manages its assets and liabilities and has strategies in place to minimize its exposure to loss as interest rate changes occur, it expects that actual losses would be less than the estimated potential loss. Duration is a common option-adjusted measure for the price sensitivity of a fixed-maturity portfolio to changes in interest rates. It measures the approximate percentage change in the market value of a portfolio if interest rates change by 100 basis points, recognizing the changes in cash flows resulting from embedded options such as policy surrenders, investment prepayments and bond calls. It also incorporates the assumption that the Company will continue to utilize its existing strategies of pricing its fixed annuity and GIC products, allocating its available cash flow amongst its various investment portfolio sectors and maintaining sufficient levels of liquidity. Because the calculation of duration involves estimation and incorporates assumptions, potential changes in portfolio value indicated by the portfolio's duration will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. As a component of its asset and liability management strategy, the Company utilizes interest rate swap agreements ("Swap Agreements") to match assets more closely to liabilities. Swap Agreements are agreements to exchange with a counterparty interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company typically utilizes Swap Agreements to create a hedge that effectively converts floating-rate assets and liabilities into fixed-rate instruments. At December 31, 1997, the Company had 40 outstanding Swap Agreements with an aggregate notional principal amount of $1.96 billion. These agreements mature in various years through 2009 and have an average remaining maturity of 48 months. The Company also seeks to provide liquidity from time to time by using reverse repurchase agreements ("Reverse Repos") and by investing in MBSs. It also seeks to enhance its spread income by using Reverse Repos and Total Return Agreements. Reverse Repos involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed upon price and are generally over-collateralized. Total Return Agreements effectively exchange a fixed rate of interest on the notional amount for the coupon income plus or minus the increase or decrease in the fair value of specified non-investment-grade bonds. MBSs are generally investment-grade securities collateralized by large pools of mortgage loans. MBSs generally pay principal and interest monthly. The amount of principal and interest payments may fluctuate as a result of prepayments of the underlying mortgage loans. There are risks associated with some of the techniques the Company uses to provide liquidity, enhance its spread income and match its assets and liabilities. The primary risks associated with Total Return Agreements are the credit risk on the underlying non-investment-grade bonds, the risk of potential loss due to bond market fluctuations and the risk associated with counterparty nonperformance. The primary risk associated with the Company's Reverse Repos and Swap Agreements is counterparty risk. The Company believes, however, that the counterparties to its Total Return Agreements, Reverse Repos and Swap Agreements are financially responsible and that the counterparty risk associated with those transactions is minimal. In addition to counterparty risk, Swap Agreements also have interest rate risk. However, the Company's Swap Agreements typically hedge variable-rate assets or liabilities, and interest rate fluctuations that adversely affect the net cash received or paid under the terms of a Swap Agreement would be offset by increased interest income earned on the variable-rate assets or reduced interest expense paid on the variable-rate liabilities. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase. As part of its decision to purchase an MBS, the Company assesses the risk of prepayment by analyzing the security's projected performance over an array of interest-rate scenarios. Once an MBS is purchased, the Company monitors its actual prepayment experience monthly to reassess the relative attractiveness of the security with the intent to maximize total return. INVESTED ASSETS EVALUATION routinely includes a review by the Company of its portfolio of debt securities. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying values of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of any collateral, compliance with contractual covenants, the borrower's recent financial performance, news reports and other externally generated information concerning the creditor's affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and, if available, the current fair value of the underlying collateral. The carrying values of bonds that are determined to have declines in value that are other than temporary are reduced to net realizable value and no further accruals of interest are made. The valuation allowances on mortgage loans are based on losses expected by management to be realized on transfers of mortgage loans to real estate, on the disposition and settlement of mortgage loans and on mortgage loans that management believes may not be collectible in full. Accrual of interest is suspended when principal and interest payments on mortgage loans are past due more than 90 days. DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of principal or interest, totaled $42.0 million at December 31, 1997 (at amortized cost after impairment writedowns, with a fair value of $42.0 million), including $11.8 million of bonds and notes and $30.2 million of mortgage loans. At December 31, 1997, defaulted investments constituted 0.2% of total invested assets. At September 30, 1997, defaulted investments totaled $38.5 million, including $15.6 million of bonds and notes and $22.9 million of mortgage loans, and constituted 0.2% of total invested assets. SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company's existing portfolio of cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At December 31, 1997, approximately $15.83 billion of the Company's Bond Portfolio had an aggregate unrealized gain of $547.2 million, while approximately $1.78 billion of the Bond Portfolio had an aggregate unrealized loss of $73.6 million. In addition, the Company's investment portfolio currently provides approximately $186.6 million of monthly cash flow from scheduled principal and interest payments. Further, $3.23 billion remains available to the Company to issue securities under a shelf registration statement filed in July 1997. Historically, cash flows from operations and from the sale of the Company's annuity and GIC products have been more than sufficient in amount to satisfy the Company's liquidity needs. Management is aware that prevailing market interest rates may shift significantly and has strategies in place to manage either an increase or decrease in prevailing rates. In a rising interest rate environment, the Company's average cost of funds would increase over time as it prices its new and renewing annuities and GICs to maintain a generally competitive market rate. Management would seek to place new funds in investments that were matched in duration to, and higher yielding than, the liabilities assumed. The Company believes that liquidity to fund withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or Reverse Repos on the Company's substantial MBS segment of the Bond Portfolio, thereby avoiding the sale of fixed-rate assets in an unfavorable bond market. In a declining rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its fixed annuities and GICs. Should increased liquidity be required for withdrawals, the Company believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening that would be expected in the bond market. On a parent company stand-alone basis, SunAmerica Inc. (the "Parent"), at December 31, 1997, had invested assets with a fair value of $2.83 billion and outstanding senior indebtedness of $1.24 billion, comprising all of the Company's outstanding senior indebtedness. Additionally, as of December 31, 1997, the Parent had three GICs purchased by local government entities which aggregated $231.4 million. During November 1996 and October 1995, respectively, the Parent purchased the common securities of SunAmerica Capital Trust III and SunAmerica Capital Trust II (collectively, the "Grantor Trusts") and issued an aggregate of $511.9 million of junior subordinated debentures (the "Debentures") to the Grantor Trusts in connection with the public issuance of the preferred securities of the Grantor Trusts (see Note 3 of Notes to Consolidated Financial Statements). The Parent's annual debt service (principal and interest payments) with respect to its senior indebtedness, GIC obligations and Debentures totals $155.4 million for the remainder of fiscal 1998, $292.0 million for fiscal 1999, $574.6 million for fiscal 2000, $139.0 million for fiscal 2001, $297.4 million for fiscal 2002 and $4.27 billion, in the aggregate, thereafter. On or before October 31, 1999, the Company is contractually scheduled to receive $431.3 million upon delivery of 17.3 million or fewer shares of the Company's Common Stock in accordance with the terms of the Company's 8-1/2% Premium Equity Redemption Cumulative Security Units. The Parent received dividends from its regulated life insurance subsidiaries totaling $118.7 million in April 1997 and $94.3 million in March 1996. The Parent also received dividends of $0.9 million during Fiscal 1998 and $17.5 million during fiscal 1997 from its other directly owned subsidiaries. The ability of the Company's life insurance subsidiaries to pay dividends is limited by statute. On January 1, 1998, there was approximately $141.1 million of dividends available to the Parent from its regulated life insurance subsidiaries. The Company has transferred to third-party investors certain of its interests in various partnerships that make tax-advantaged affordable housing investments. As part of these transactions, the Parent has agreed to advance monies to support the operations of the underlying housing projects, if required, and has guaranteed that the transferred partnerships will provide, as of the transfer date and under then current tax laws, a specified level of associated tax credits and deductions to the third-party investors. Based on an evaluation of the underlying housing projects, management does not anticipate any material cash payments with respect to the guarantees. In the ordinary course of business, the Company has agreed contingently to make capital contributions, aggregating approximately $663.1 million, to 92 limited partnerships over the next 6 years in exchange for ownership interests in such partnerships. The Company relies significantly on computer systems and applications in its daily operations. Many of these systems and applications are not presently year 2000 compliant. The Company's business, financial condition and results of operations could be materially and adversely affected by the failure of the Company's systems and applications (and those operated by third parties interfacing with the Company's systems and applications) to properly operate or manage dates beyond the year 1999. The Company has a coordinated plan to repair or replace these noncompliant systems and to obtain similar assurances from third parties interfacing with the Company's systems and applications and expects to significantly complete its plan by the end of calendar year 1998. In fiscal year 1997, the Company recorded a $15.0 million provision for estimated programming costs to make necessary repairs of certain specific noncompliant systems. Management believes that this provision is adequate and does not anticipate any material future expenses associated with the repair phase of this project. Management also expects to make an additional $15.0 million expenditure to replace certain other specific noncompliant systems, which expenditure will be capitalized as software costs and amortized over future periods. Regulation The Company's insurance subsidiaries are subject to regulation and supervision by the insurance regulatory agencies of the states in which they are authorized to transact business. State insurance laws establish supervisory agencies with broad administrative and supervisory powers. Principal among these powers are granting and revoking licenses to transact business, regulating marketing and other trade practices, operating guaranty associations, licensing agents, approving policy forms, regulating certain premium rates, regulating insurance holding company systems, establishing reserve requirements, prescribing the form and content of required financial statements and reports, performing financial, market conduct and other examinations, determining the reasonableness and adequacy of statutory capital and surplus, defining acceptable accounting principles, regulating the type, valuation and amount of investments permitted, and limiting the amount of dividends that can be paid and the size of transactions that can be consummated without first obtaining regulatory approval. During the last decade, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government and the NAIC. Various states have considered or enacted legislation that changes, and in many cases increases, the states' authority to regulate insurance companies. Legislation has been introduced from time to time in Congress that could result in the federal government assuming some role in the regulation of insurance companies or allowing combinations between insurance companies, banks and other entities. In recent years, the NAIC has approved and recommended to the states for adoption and implementation several regulatory initiatives designed to reduce the risk of insurance company insolvencies and market conduct violations. These initiatives include investment reserve requirements, risk- based capital standards, codification of insurance accounting principles, new investment standards and restrictions on an insurance company's ability to pay dividends to its stockholders. The NAIC is also currently developing model laws and regulations relating to product design, actuarial standards and illustrations for annuity products. Current proposals are still being debated and the Company is monitoring developments in this area and the effects any changes would have on the Company. SunAmerica Asset Management is registered with the SEC as a registered investment advisor under the Investment Advisors Act of 1940. The mutual funds that it markets are subject to regulation under the Investment Company Act of 1940. SunAmerica Asset Management and the mutual funds are subject to regulation and examination by the SEC. In addition, variable annuities and the related separate accounts of the Company's life insurance subsidiaries are subject to regulation by the SEC under the Securities Act of 1933 and the Investment Company Act of 1940. Resources Trust Company is subject to regulation by the Colorado State Banking Board and the Federal Deposit Insurance Corporation. The Company's broker-dealer subsidiaries are subject to regulation and supervision by the states in which they transact business, as well as by the SEC and the National Association of Securities Dealers ("NASD"). The SEC and the NASD have broad administrative and supervisory powers relative to all aspects of business and may examine the subsidiaries' business and accounts at any time. The Company's premium finance business is subject to regulation and supervision by substantially all of the states in which it is authorized to transact business. State premium finance laws establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, approving finance agreement forms, regulating certain finance charge rates, regulating marketing and other trade practices (including the procedures to cancel financed insurance policies for non-payment), prescribing the form and content of required financial statements and reports, performing financial and other examinations and other related matters. From time to time, Federal initiatives are proposed that could affect the Company's businesses. Such initiatives include employee benefit plan regulations and tax law changes affecting the taxation of insurance companies and the tax treatment of insurance products. Recent administration budget proposals include the proposed taxation of exchanges involving variable annuity contracts and reallocations within variable annuity contracts and certain other proposals relating to annuities. The Company believes these proposals have a small likelihood of being enacted, because they would discourage retirement savings and there is strong popular and industry opposition to them. Other proposals made in recent years to limit the tax deferral of annuities have not been enacted. The Company believes that certain of the proposals, if implemented, would have an adverse effect on the Company's ability to sell variable annuities, and, consequently, on its results of operations. However, the Company would not expect this to materially impact earnings in the near term because the Company believes that adoption of the administration proposals, however unlikely, would reduce annuity surrenders on the existing block of variable annuity contracts and the ongoing earnings potential arising from that block would offset the near-term economic impact of the potential decrease in sales. SUNAMERICA INC. PART II - OTHER INFORMATION ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- EXHIBITS 27 Financial Data Schedule. REPORTS ON FORM 8-K On October 7, 1997, the Company filed a Current Report on Form 8-K to file exhibits in connection with the issuance of its 6.75% Notes due October 1, 2007 pursuant to the Company's Registration Statement on Form S-3 (File No. 333-31619). On December 2, 1997, the Company filed a Current Report on Form 8-K to file exhibits in connection with its Medium Term Note Program. SUNAMERICA INC. PART II - OTHER INFORMATION (Continued) SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SUNAMERICA INC. ----------------------------------- Registrant Dated February 13, 1998 /s/ JAY S. WINTROB ---------------------------- ----------------------------------- Jay S. Wintrob Vice Chairman Dated February 13, 1997 /s/ SCOTT L. ROBINSON ---------------------------- ----------------------------------- Scott L. Robinson Senior Vice President and Controller SUNAMERICA INC. LISTS OF EXHIBITS FILED - ----------------------- 27 Financial Data Schedule. EX-27 2
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AND INCOME STATEMENT OF SUNAMERICA INC.'S FORM 10-Q FOR THE QUARTER ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS SEP-30-1998 DEC-31-1997 18,084,215 0 0 91,011 3,090,069 53,054 24,347,479 1,163,180 0 1,121,847 35,958,746 19,934,421 0 0 0 1,236,181 0 248,000 195,083 2,274,664 35,958,746 0 478,366 3,194 100,822 280,213 55,468 0 169,339 45,700 123,639 0 0 0 123,639 0.63 0.56 0 0 0 0 0 0 0
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