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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998 Commission file number 33-23376
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Aetna Life Insurance and Annuity Company
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(Exact name of registrant as specified in its charter)
Connecticut 71-0294708
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
151 Farmington Avenue, Hartford, Connecticut 06156
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(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code (860) 273-0123
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
As of February 28, 1999 there were 55,000 shares of common stock outstanding,
par value $50 per share, all of which shares were held by Aetna Retirement
Holdings, Inc.
Reduced Disclosure Format
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The registrant meets the conditions set forth in General Instruction I(1)(a)
and (b) of Form 10-K and is therefore filing this Form with the reduced
disclosure format.
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Annual Report on Form 10-K
For the year ended December 31, 1998
TABLE OF CONTENTS
Form 10-K
Item No. Page
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PART I
Item 1. Business** ......................................................... 3
Item 2. Properties** ....................................................... 12
Item 3. Legal Proceedings .................................................. 12
Item 4. Submission of Matters to a Vote of Security Holders* ............... 12
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters .............................................. 12
Item 6. Selected Financial Data* ........................................... 12
Item 7. Management's Analysis of the Results of Operations** ............... 13
Item 7A. Quantitative and Qualitative Disclosure About Market Risk .......... 26
Item 8. Financial Statements and Supplementary Data ........................ 27
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ......................................... 59
PART III
Item 10. Directors and Executive Officers of the Registrant* ................ 59
Item 11. Executive Compensation* ............................................ 59
Item 12. Security Ownership of Certain Beneficial Owners and
Management* ...................................................... 59
Item 13. Certain Relationships and Related Transactions* .................... 59
PART IV
Item 14. Exhibits, Consolidated Financial Statement Schedules,
and Reports on Form 8-K .......................................... 59
Index to Consolidated Financial Statement Schedules ................ 64
Signatures ......................................................... 70
* Item omitted pursuant to General Instruction I(2) of Form 10-K
** Item prepared in accordance with General Instruction I(2) of Form 10-K
2
PART I
Item 1. Business
Aetna Life Insurance and Annuity Company ("ALIAC") is a Connecticut stock life
insurance company originally organized in 1976. ALIAC, together with its wholly
owned subsidiary, Aetna Insurance Company of America, is herein called the
"Company". ALIAC is a wholly owned subsidiary of Aetna Retirement Holdings, Inc.
("HOLDCO"). HOLDCO is a wholly owned subsidiary of Aetna Retirement Services,
Inc. ("ARSI") whose ultimate parent is Aetna Inc. (together with its
subsidiaries, "Aetna").
The Company offers financial services products and, through September 1998,
offered individual life insurance products. On October 1, 1998, the Company
sold its domestic individual life insurance business to Lincoln National
Corporation ("Lincoln"). See "Overview" in Management's Analysis of the Results
of Operations and Note 2 of Notes to Consolidated Financial Statements for
further discussion on the sale.
As a result of the sale, the Company's financial services business is reported
as continuing operations and its individual life business is reported as
discontinued operations. Prior to the sale, the Company's operations were
reported through two major business segments: financial services and individual
life insurance.
Financial Services
Products and Services
Financial services products include annuity contracts that offer a variety of
funding and payout options for individual and employer-sponsored retirement
plans qualified under Internal Revenue Code Sections 401, 403, 408 and 457
(collectively "qualified plans") and non-qualified annuity contracts. These
contracts may be deferred or immediate ("payout annuities"). Financial services
also include investment advisory services and pension plan administrative
services.
Investment Options
Financial services products provide customers with variable and/or fixed
investment options. Variable ("non-guaranteed") options provide for full
assumption by the customer of investment risks (subject, in some cases, to
minimum guarantees). Assets supporting non-guaranteed variable options are held
in separate accounts that invest in Aetna mutual funds and/or unaffiliated
mutual funds. Aetna mutual funds include funds managed by Aeltus Investment
Management, Inc. ("Aeltus"), an affiliate of the Company, and, beginning in
1997, funds managed by outside investment advisors under subadvisory
arrangements. Separate account investment income and realized capital gains and
losses are not reflected in the Company's consolidated statements of income.
Fixed options can be either "fully guaranteed" or "experience rated". Fully
guaranteed options provide guarantees on investment return, maturity values
and, if applicable, benefit payments. Experience rated options require the
customer to assume investment (including realized capital gains and losses) and
other risks subject to, among other things, certain minimum guarantees. The
effect of investment performance (as long as minimum guarantees are not
triggered) does not impact the Company's consolidated results.
3
Item 1. Business. (continued)
Financial Services (continued)
Fees and Investment Margins
Insurance charges, investment management or other fees earned by the Company
vary by product and depend on, among other factors, the funding option selected
by the customer under the product. For variable products where assets are
allocated to variable funding options, the Company may charge the separate
account an asset-based mortality and expense charge. In addition, where the
customer selects an Aetna mutual fund as a variable funding option, the Company
receives a participation fee from Aeltus and, in the case of those funds
advised by the Company and subadvised by outside managers, the Company receives
an investment advisory fee from the fund and pays a subadvisory fee to the fund
manager. (See Note 10 of Notes to Consolidated Financial Statements.) For
unaffiliated mutual funds, the Company receives distribution fees and/or
expense reimbursements. For fixed funding options, the Company derives an
investment margin, which is based on the difference between income earned on
the investments supporting the liability and interest credited to customers.
Other fees or charges may be assessed depending on the nature of the products.
Assets Under Management
The substantial portion of fees or other charges and investment margins are
based on assets under management. Assets under management are principally
affected by deposits, investment growth (i.e., interest credited to customer
accounts for fixed options or market performance for variable options) and
persistency (i.e., customer retention). Assets under management, excluding net
unrealized capital gains and losses on debt securities other than those held in
separate accounts, were $43.1 billion, $37.6 billion and $27.3 billion at
December 31, 1998, 1997, and 1996, respectively. Approximately 94% of assets
under management at December 31, 1998 and 1997, respectively, allowed for
contractholder withdrawal. Approximately 81% at December 31, 1998 and 76% at
December 31, 1997 are subject to market value adjustments and/or deferred
surrender charges.
To encourage customer retention and recover acquisition expenses, contracts
typically impose a surrender charge on policyholder balances withdrawn within a
period of time after the contract's inception. The period of time and level of
the charge vary by product. This charge may be waived at the Company's
discretion. In addition, an approach incorporated into recent variable annuity
contracts with fixed funding options allows contractholders to receive an
incremental interest rate if withdrawals from the fixed account are spread over
a period of five years. Further, more favorable credited rates may be offered
after policies have been in force for a period of time. Existing tax penalties
on annuity distributions prior to age 59-1/2 provide further disincentive to
customers for premature surrenders of annuity balances, but generally do not
impede transfers of those balances to products of competitors.
4
Item 1. Business. (continued)
Financial Services (continued)
The following table summarizes assets under management for the principal
customer groups of the Financial Services segment. Amounts reflected exclude
unrealized gains of $497 million, $471 million, and $321 million at December
31, 1998, 1997, and 1996, respectively, related to market value adjustments
required under Financial Accounting Standard ("FAS") No. 115. See Management's
Analysis of the Results of Operations for further discussion on assets under
management.
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(Millions) 1998 1997 1996
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Corporate pensions $13,603.5 $10,970.5 $ 5,341.4
Not-for-profit organizations 19,058.7 16,679.6 14,041.0
Individuals 10,414.2 9,959.2 7,885.7
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Total $43,076.4 $37,609.3 $27,268.1
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Deposits, which are not included in premiums or revenue, are shown in the
following table:
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(Millions) 1998 1997 1996
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Corporate pensions $1,871.0 $1,634.6 $1,407.0
Not-for-profit organizations 1,591.7 1,404.4 1,360.6
Individuals 1,305.6 1,443.6 1,354.0
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Total $4,768.3 $4,482.6 $4,121.6
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Principal Markets and Method of Distribution
Financial services products and services are offered primarily to individuals,
pension plans, small businesses and employer sponsored groups in the health
care, government, education (collectively "not-for-profit" organizations) and
corporate markets. The Company's products generally are sold through pension
professionals, independent agents and brokers, third party administrators,
banks, dedicated career agents and financial planners.
Competition
Competition arises from other insurance companies, as well as an array of
financial services companies including banks, mutual funds and other investment
managers. Principal competitive factors are reputation for investment
performance, product features, service, cost and the perceived financial
strength of the investment manager or sponsor.
Competition may affect, among other matters, both business growth and the
pricing of the Company's products and services.
5
Item 1. Business. (continued)
Financial Services (continued)
Reserves
Reserves for limited payment contracts (annuities with life contingent payout)
are computed on the basis of assumed investment yield, mortality, and expenses
including a margin for adverse deviation. The assumptions vary by plan, year of
issue and policy duration. Reserves for investment contracts (deferred
annuities and immediate annuities without life contingent payouts) are equal to
cumulative deposits plus credited interest for fixed options less withdrawals
and charges thereon. Of those investment contracts which are experience rated,
the reserves also reflect net realized capital gains/losses (which the Company
reflects through credited rates on an amortized basis) and unrealized capital
gains/losses related to FAS No. 115.
Reserves, as described above, are computed amounts that, with additions from
premiums and deposits to be received, and with interest on such reserves
compounded annually at assumed rates, are expected to be sufficient to meet the
Company's policy obligations at their maturities or to pay expected death or
retirement benefits or other withdrawal requests.
Discontinued Operations--Individual Life Insurance
Products and Services
Individual life insurance products include universal life and variable
universal life, which have both life insurance and investment characteristics,
traditional whole life and term insurance.
Life Insurance In Force
For individual life insurance products, life insurance in force is a key
determinant of earnings as cost of insurance charges are typically based on
amounts of coverage in force less accumulated policy reserves. The key drivers
of life insurance in force are new sales, surrenders and mortality.
Individual life insurance products typically require high costs to acquire
business. As with financial services, retention is an important component of
profitability and is encouraged through product features. For example,
universal life contracts typically impose a surrender charge on policyholder
balances withdrawn within a period of time after the contract's inception. The
period of time and level of the charge vary by product. In addition, more
favorable credited rates and policy loan terms may be offered after policies
have been in force for a period of time. To further encourage retention, life
insurance agents are typically paid renewal commissions or service fees.
6
Item 1. Business. (continued)
Discontinued Operations--Individual Life Insurance (continued)
Life Insurance in Force and Other Statistical Data*
The following table summarizes changes in life insurance in force before
deductions for reinsurance ceded to other companies:
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(Millions, except as noted below) 1998(1) 1997 1996
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Sales and additions:
Direct:
Permanent $ 3,521.7 $ 4,255.3 $ 4,356.1
Term 512.3 846.9 1,381.1
Assumed:
Permanent -- 26.2 --
Term 603.7 736.6 --
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Total $ 4,637.7 $ 5,865.0 $ 5,737.2
==============================================================================================
Terminations:
Direct:
Surrenders and conversions $ 1,693.6 $ 1,749.3 $ 1,485.7
Lapses 1,409.2 1,296.9 1,166.1
Other 181.7 198.9 199.1
Assumed:
Surrenders and conversions 43.4 45.2 51.6
Lapses 16.4 15.0 58.0
Other 44.7 772.7 52.3
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Total $ 3,389.0 $ 4,078.0 $ 3,012.8
==============================================================================================
In force, end of year:
Direct:
Permanent $37,806.9 $37,070.3 $35,527.1
Term 5,076.0 5,063.1 4,749.2
Assumed:
Permanent 919.9 995.1 1,069.8
Term 1,585.5 1,011.1 1,006.5
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Total $45,388.3 $44,139.6 $42,352.6
==============================================================================================
Number of direct policies in force, end of year
(thousands) 419.8 452.5 472.9
==============================================================================================
Average size of direct policy in force, end of
year (thousands) $ 102.1 $ 93.1 $ 85.2
==============================================================================================
* Only nonparticipating business is written by the Company.
(1) As a result of the sale of the domestic individual life insurance business
on October 1, 1998, substantially all of the in force amounts are being
ceded to an outside company.
7
Item 1. Business. (continued)
Discontinued Operations--Individual Life Insurance (continued)
Investment Options, Fees and Investment Margins
Traditional insurance and universal life products provide customers with only
fixed investment options. Variable universal life products provide customers
with variable and/or fixed investment options. Investment margins and fees
(excluding cost of insurance) for these investment options are substantially
the same as for financial services products discussed previously. Cost of
insurance is based on the net amount at risk (insurance in force less
reserves). Investment margins and fees are based on assets under management.
Assets Under Management
Assets under management are principally affected by deposits, investment growth
(i.e., interest credited to customer accounts for fixed options or market
performance for variable options) and persistency (i.e., customer retention).
Investments supporting the domestic individual life business were sold in
conjunction with the sale to Lincoln, therefore, no assets under management
were reported for December 31, 1998. Assets under management, excluding net
unrealized capital gains and losses on debt securities related to market value
adjustments required under FAS No. 115, were $3.1 billion and $2.8 billion at
December 31, 1997 and 1996, respectively.
Principal Markets and Method of Distribution
Individual life insurance products were offered primarily to individuals, small
businesses, employer sponsored groups and executives of Fortune 2000 companies.
Individual life insurance products generally were sold through managing general
agents, regional brokers and broker/dealers.
Competition
The markets for individual life insurance products are highly competitive.
Principal competitive factors are product features and cost. Competition may
affect, among other matters, both business growth and the pricing of the
Company's products.
Reserves
Prior to the sale of the domestic individual life insurance business on October
1, 1998, reserves for universal life products were equal to cumulative deposits
less withdrawals and charges plus credited interest for fixed options thereon,
plus/less net realized capital gains/losses (which the Company reflected
through credited rates on an amortized basis). These reserves also included
unrealized capital gains/losses related to FAS No. 115. As a result of the sale
and transfer of assets supporting the business, reserves for universal life
products will no longer include net realized capital gains/losses and
unrealized gains/losses related to FAS No. 115 for the years ended December 31,
1998 and beyond. Reserves for all other fixed individual life contracts are
computed on a basis of assumed investment yield, mortality, morbidity and
expenses including a margin for adverse deviation. These assumptions vary by
plan, year of issue and policy duration.
8
Item 1. Business. (continued)
Discontinued Operations--Individual Life Insurance (continued)
Reserves, as described above, are computed amounts that, with additions from
premiums and deposits to be received and with interest on such reserves
compounded annually at assumed rates, are expected to be sufficient to meet the
Company's policy obligations at their maturities or to pay expected death or
retirement benefits or other withdrawal requests.
Because the sale of the domestic individual life business was substantially in
the form of an indemnity reinsurance agreement, the Company reported an
addition to its reinsurance recoverable approximating the Company's individual
life reserves at the sale date. This recoverable will increase or decrease
consistent with the computed reserves discussed previously.
General Account Investments
Consistent with the nature of the contract obligations involved in the
Company's operations, the majority of the general account assets are invested
in long-term debt securities such as: U.S. corporate debt securities,
residential mortgage-backed securities, foreign government and foreign
corporate debt securities, commercial and multifamily mortgage-backed
securities, other asset-backed securities and U.S. government securities. It is
management's objective that the portfolios be of high quality while achieving
competitive investment yields and returns. Investment portfolios generally
match the duration of the insurance liabilities they support. The general
account of the Company has been segmented to improve the asset/liability
matching process. The duration of investments is monitored and security
purchases and sales are executed with the objective of having adequate funds
available to satisfy the Company's maturing liabilities. See "General Account
Investments" in Management's Analysis of the Results of Operations for a
further discussion of investments.
Other Matters
a. Regulation
The Company's operations are subject to comprehensive regulation throughout the
United States. The laws of the various jurisdictions establish supervisory
agencies, including the state insurance departments, with broad authority to
grant licenses to transact business and regulate many aspects of the products
and services offered by the Company, as well as solvency and reserve adequacy.
Many agencies also regulate investment activities on the basis of quality,
diversification, and other quantitative criteria. The Company's operations and
accounts are subject to examination at regular intervals by certain of these
regulators.
Operations conducted by the Company are subject to regulation by various
insurance agencies where the Company conducts business, in particular the
insurance departments of Connecticut and New York. Among other matters, these
agencies may regulate premium rates, trade practices, agent licensing, policy
forms, underwriting and claims practices, the maximum interest rates that can
be charged on life insurance policy loans, and the minimum rates that must be
provided for accumulation of surrender value.
9
Item 1. Business. (continued)
Other Matters (continued)
The Securities and Exchange Commission ("SEC"), the National Association of
Securities Dealers ("NASD") and, to a lesser extent, the states regulate the
sales and investment management activities and operations of the Company.
Regulations of the SEC, Department of Labor ("DOL") and Internal Revenue
Service also impact certain of the Company's annuity, life insurance and other
investment and retirement products. These products involve Separate Accounts
and mutual funds registered under the Investment Company Act of 1940.
Federal Employee Benefit Regulation
The Company provides a variety of products and services to employee benefit
plans that are covered by the Employee Retirement Income Security Act of 1974
("ERISA").
In December 1993, in a case involving an employee benefit plan and an insurance
company, the United States Supreme Court ruled that assets in the insurance
company's general account that were attributable to a portion of a group
pension contract issued to the plan that was not a "guaranteed benefit
contract" were "plan assets" for purposes of ERISA and that the insurance
company was an ERISA fiduciary with respect to those assets. In reaching its
decision, the Court declined to follow a 1975 DOL interpretive bulletin that
had suggested that insurance company general account assets were not plan
assets.
The Small Business Job Protection Act (the "Act"), was signed into law in 1996.
The Act created a framework for resolving potential issues raised by the
Supreme Court decision. The Act provides that, absent criminal conduct,
insurers generally will not have liability with respect to general account
assets held under contracts that are not guaranteed benefit contracts based on
claims that those assets are plan assets. The relief afforded extends to
conduct that occurred before the date that is eighteen months after the DOL
issues final regulations required by the Act, except as provided in the
anti-avoidance portion of the regulations. The regulations, which were proposed
by the DOL on December 22, 1997, will address ERISA's application to the
general account assets of insurers attributable to contracts issued on or
before December 31, 1998 that are not guaranteed benefit contracts. The
conference report relating to the Act states that contracts issued after
December 31, 1998 that are not guaranteed benefit contracts will be subject to
ERISA's fiduciary obligations. The Company is not currently able to predict how
these matters may ultimately affect its businesses.
Insurance Holding Company Laws
A number of states, including Connecticut, regulate affiliated groups of
insurers such as the Company under holding company statutes. These laws, among
other things, place certain restrictions on transactions between affiliates
such as dividends and other distributions that may be paid to the Company's
parent corporation. For information regarding payments of dividends by the
Company, see "Liquidity & Capital Resources" in Management's Analysis of the
Results of Operations and Note 6 of Notes to Consolidated Financial Statements.
10
Item 1. Business. (continued)
Other Matters (continued)
Insurance Company Guaranty Fund Assessments
Under insurance guaranty fund laws existing in all states, insurers doing
business in those states can be assessed (up to prescribed limits) for certain
obligations of insolvent insurance companies to policyholders and claimants.
The after-tax charges to earnings for guaranty fund obligations for the years
ended December 31, 1998, 1997, and 1996 were $1 million, $3 million and $2
million, respectively. While the Company has historically recovered more than
half of its guaranty fund assessments through statutorily permitted premium tax
offsets, significant increases in assessments could jeopardize future efforts
to recover such assessments. For information regarding certain other potential
regulatory changes relating to the Company's businesses, see Management's
Analysis of the Results of Operations--Forward-Looking Information/Risk Factors
(See Note 1 of Notes to Consolidated Financial Statements for future accounting
standards related to guaranty fund assessments.)
b. Ratings
The Company's claims paying ratings are as follows:
Rating Agencies
--------------------------------------------------
Moody's
Duff & Investors Standard &
A.M. Best Phelps Service Poor's
--------------------------------------------------
November 3, 1998 A AA Aa3 AA-
February 1, 1999(1) A AA Aa3 AA-
(1) Ratings by Standard & Poor's and Moody's Investors Service are currently
under review until completion of their analysis of Aetna's pending
Prudential health care acquisition. Standard & Poor's has the Company's
rating on credit watch and Moody's Investors Service has the Company's
rating on outlook negative.
c. Miscellaneous
The Company had approximately 2,500 employees at December 31, 1998.
Management believes that the Company's computer facilities, systems and related
procedures are adequate to meet its business needs. The Company's data
processing systems and backup and security policies, practices and procedures
are regularly evaluated by the Company's management and internal auditors and
are modified as considered necessary. See Management's Analysis of the Results
of Operations for information regarding the Company's efforts to prepare its
systems, applications and facilities to accommodate Year 2000 date-sensitive
information.
The Company is not dependent upon any single customer and no single customer
accounted for more than 10% of consolidated revenue in 1998. In addition, the
loss of business from any one, or a few, independent brokers or agents would
not have a material adverse effect on the earnings of the Company.
11
Item 2. Properties.
The Company's home office is located at 151 Farmington Avenue, Hartford,
Connecticut 06156. All Company office space is owned or leased by Aetna Life
Insurance Company ("Aetna Life") or other affiliates. Expenses associated with
these offices are allocated on a direct and indirect basis to the Company and
the other subsidiaries of Aetna.
Item 3. Legal Proceedings.
The Company is involved in numerous lawsuits arising, for the most part, in the
ordinary course of its business operations. While the ultimate outcome of
litigation against the Company cannot be determined at this time, after
consideration of the defenses available to the Company and any related reserves
established, it is not expected to result in liability for amounts material to
the financial condition of the Company, although it may adversely affect
results of operations in future periods.
Item 4. Submission of Matters to a Vote of Security Holders.
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
All of the Company's outstanding shares are directly owned by HOLDCO, which is
a wholly owned subsidiary of ARSI whose ultimate parent is Aetna. The shares
were contributed to HOLDCO in 1996 from ARSI. The Company paid $553 million and
$17 million in cash dividends to HOLDCO in 1998 and 1997, respectively.
Additionally, in 1998, the Company accrued $206 million in dividends. Of the
$759 million dividends paid and accrued in 1998, $756 million (all of which was
approved by the Insurance Commissioner of the State of Connecticut) was
attributable to proceeds from the sale of the domestic individual life
insurance business.
In January 1999, the accrued dividends of $206 million were paid by the Company
to HOLDCO. Further dividends to be paid by the Company to HOLDCO during 1999
will need to be approved by the Insurance Department of the State of
Connecticut prior to payment.
The Company received capital contributions of $9 million and $10 million in
cash from HOLDCO in 1998 and 1996, respectively. The Company received no
capital contributions in 1997.
Item 6. Selected Financial Data.
Omitted Pursuant to General Instruction I(2)(a) of Form 10-K.
12
Item 7. Management's Analysis of the Results of Operations.
Management's narrative analysis of the results of operations is presented in
lieu of Management's Discussion and Analysis of Financial Condition and Results
of Operations, pursuant to General Instruction I(2)(a) of Form 10-K.
Overview
Sale of Domestic Individual Life Insurance Business
The Company's sale of its domestic individual life insurance business to
Lincoln National Corporation ("Lincoln") on October 1, 1998 included
approximately $45 billion of individual life insurance in force, as well as
access to the Company's life agency sales force and brokerage distribution
channel. The transaction was generally in the form of an indemnity reinsurance
arrangement and covers the following lines of insurance: traditional life,
universal life, sponsored life, corporate-owned life insurance and pension
life. Pension life results, which are reported in the financial services
business, are not material to the individual life insurance business and,
therefore, are not included below. Revenues from the business were $652 million
for 1998 through the sale date, $620 million for 1997 and $446 million for
1996.
The Company sold its domestic individual life insurance business for
approximately $1 billion in cash. The sale resulted in an after-tax gain of
approximately $117 million. Since the principal agreement to sell this business
was generally in the form of an indemnity reinsurance arrangement, the Company
will defer approximately $58 million of the gain and will amortize it over
approximately 15 years (as profits in the book of business sold emerge). The
Company recognized $59 million of the gain in the 1998 fourth quarter for the
portion that relates to the Company's agreement to provide Lincoln with access
to the agency sales force and brokerage distribution channel.
See Note 2 of Notes to Consolidated Financial Statements for additional
information relating to the sale.
Consolidated Results
Consolidated results include results from continuing operations and
discontinued operations. Continuing operations is comprised of the Company's
financial services business plus certain items not directly allocable to the
business segments. Discontinued Operations is comprised of the domestic
individual life insurance business. All prior year income statement data has
been restated to reflect the presentation as Discontinued Operations.
13
Item 7. Management's Analysis of the Results of Operations. (continued)
Overview (continued)
(Millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
Premiums (1) $ 79.4 $ 69.1 $ 84.9
Charges assessed against policyholders 324.3 262.0 197.0
Net investment income 877.6 878.8 852.6
Net realized capital gains 10.4 29.7 17.0
Other income 29.6 38.3 43.6
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Total revenue 1,321.3 1,277.9 1,195.1
- ------------------------------------------------------------------------------------------------------------
Current and future benefits 714.4 720.4 728.3
Operating expenses 313.2 286.5 275.8
Amortization of deferred policy acquisition costs 106.7 82.8 28.0
Severance and facilities charge -- -- 47.1
- ------------------------------------------------------------------------------------------------------------
Total benefits and expenses 1,134.3 1,089.7 1,079.2
- ------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 187.0 188.2 115.9
Income taxes 47.4 50.7 30.7
- ------------------------------------------------------------------------------------------------------------
Income from continuing operations 139.6 137.5 85.2
Discontinued Operations, net of tax:
Income from operations 61.8 67.8 55.9
Gain on sale 59.0 -- --
- ------------------------------------------------------------------------------------------------------------
Net income (2) $ 260.4 $ 205.3 $ 141.1
============================================================================================================
Net realized capital gains, net of tax (included in continuing
operations above) $ 7.3 $ 19.2 $ 11.1
============================================================================================================
Deposits not included in premiums above:
Annuities--fixed options $ 1,125.6 $ 1,191.4 $ 1,362.3
Annuities--variable options 3,642.7 3,291.2 2,759.3
- ------------------------------------------------------------------------------------------------------------
Financial Services 4,768.3 4,482.6 4,121.6
Discontinued Operations 374.2 486.4 443.2
- ------------------------------------------------------------------------------------------------------------
Total $ 5,142.5 $ 4,969.0 $ 4,564.8
============================================================================================================
Assets under management:
Annuities--fixed options $12,131.1 $12,056.3 $11,692.4
Annuities--variable options (3) 25,527.0 20,076.9 14,468.1
- ------------------------------------------------------------------------------------------------------------
Subtotal annuities 37,658.1 32,133.2 26,160.5
Other investment advisory (4) 5,418.3 5,476.1 1,107.6
- ------------------------------------------------------------------------------------------------------------
Financial Services (5) (6) 43,076.4 37,609.3 27,268.1
Discontinued Operations (7) -- 3,096.1 2,830.5
- ------------------------------------------------------------------------------------------------------------
Total $43,076.4 $40,705.4 $30,098.6
=============================================================================================================
(1) Includes $56.8 million, $59.1 million, and $71.8 million for 1998, 1997
and 1996, respectively, for annuity premiums on contracts converting from
the accumulation phase to payout options with life contingencies.
(2) Net income for the year ended December 31, 1998 includes a net benefit
from capitalizing internal-use software of $6.5 million ($5.3 million for
"income from continuing operations").
(3) Includes $7,467.5 million, $5,069.9 million, and $4,633.2 million at
December 31, 1998, 1997 and 1996, respectively, related to assets invested
through the Company's products in unaffiliated mutual funds.
(4) The December 31, 1997 balance includes the transfer of $4,078.5 million of
assets that were previously reported by an affiliate, reflecting the
migration of certain other pension products which complement the Company's
business strategy.
(5) Includes $32,972.6 million, $12,056.3 million and $11,692.4 million of
assets managed by Aeltus at December 31, 1998, 1997 and 1996,
respectively.
(6) Excludes net unrealized capital gains of $496.9 million, $471.3 million
and $321.1 million at December 31, 1998, 1997 and 1996, respectively.
(7) Excludes net unrealized capital gains of $80.3 million and $45.3 million
at December 31, 1997 and 1996, respectively.
14
Item 7. Management's Analysis of the Results of Operations. (continued)
Overview (continued)
The Company's consolidated net income increased $55 million and $64 million in
1998 and 1997, respectively. 1998 net income includes after-tax Year 2000 costs
of $21 million and an after-tax gain of $59 million related to the sale of the
domestic individual life insurance business for access to the agency sales
force and brokerage distribution channel; and, 1996 net income included an
after-tax severance and facilities charge of $31 million primarily related to
actions taken or expected to be taken to improve the Company's cost structure
relative to its competitors and a corporate severance and facilities charge of
$9 million allocated to the Company by Aetna. Excluding these unusual items and
after-tax realized capital gains (from continuing and discontinued operations)
of $11 million, $23 million and $13 million for 1998, 1997 and 1996,
respectively, consolidated net income increased $29 million in 1998 and $14
million in 1997.
Continuing Operations
Income from continuing operations increased $2 million and $52 million in 1998
and 1997, respectively. Excluding Year 2000 costs, severance and facilities
charges and realized capital gains of $7 million, $19 million and $11 million
in 1998, 1997 and 1996, respectively, earnings increased $35 million in 1998
and $14 million in 1997.
The increases in 1998 and 1997 earnings primarily reflect increased fee income
from higher levels of assets under management. Assets under management
increased by 15% in 1998 and 23% in 1997, excluding assets under management
that were previously reported by an affiliate. Assets under management grew
primarily because of appreciation in the stock market and additional net
deposits (i.e. deposits less surrenders). Operating expenses as a percentage of
assets under management declined in both years.
Premiums relate to annuity products containing life contingencies. Premiums
increased by $10 million in 1998 due to increased sales and decreased by $16
million in 1997 due to a shift from annuity products containing life
contingencies and, in part, from the Company's decision to cease writing
structured settlement business in the fourth quarter of 1995. Ceasing to write
this product did not and is not expected to have a material effect on the
results of the Company's continuing operations.
Annuity deposits relate to annuity contracts not containing life contingencies.
Deposits increased 6% and 9% in 1998 and 1997, respectively, reflecting
business growth.
Of the $12.1 billion, $12.1 billion and $11.7 billion of fixed annuity assets
under management at December 31, 1998, 1997 and 1996, respectively, 25% were
fully guaranteed and 75% were experience rated for each of these years. The
average earned rate on investments supporting fully guaranteed investment
contracts was 7.6%, 7.8%, and 7.9% and the average earned rate on investments
supporting experience rated investment contracts was 7.8%, 7.9%, and 8.0% for
the years ended December 31, 1998, 1997 and 1996, respectively. The average
credited rate on fully guaranteed investment contracts was 6.5%, 6.6%, and 6.8%
and the average credited rate on experience rated investment contracts was
5.8%, 5.9%, and 6.0% for the years ended December 31, 1998, 1997 and 1996,
respectively. The resulting interest margins on fully guaranteed investment
15
Item 7. Management's Analysis of the Results of Operations. (continued)
Continuing Operations (continued)
contracts were 1.1%, 1.2%, and 1.1% and on experience rated investment
contracts were 2.0% for the years ended December 31, 1998, 1997 and 1996,
respectively.
The duration of the investment portfolios supporting the Company's liabilities
is regularly monitored and adjusted in order to maintain an aggregate duration
that is within 0.5 years of the estimated duration of the underlying
liabilities (see "General Account Investments").
Outlook
The Company's strategy is to increase assets under management and improve
profitability by focusing on strategic markets and products in the financial
services business. In doing so, the Company may take a variety of actions
intended to improve its investment and product management, marketing,
distribution and customer service. The Company also may seek acquisitions or
divestitures in order to align its business with strategic and financial
targets or build scale.
See "Forward-Looking Information/Risk Factors" regarding other important
factors that may materially affect the Company.
Discontinued Operations--Individual Life Insurance
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln. See "Overview" and Note 2 of Notes to Consolidated
Financial Statements for further discussion on the sale.
Amounts reflected in the table below are summarized on the line, "Discontinued
Operations, net of tax: Income from operations", in the consolidated operating
results table of the "Overview" section. Results in the table below exclude
Year 2000 costs and the gain on sale of $59 million.
16
Item 7. Management's Analysis of the Results of Operations. (continued)
Discontinued Operations--Individual Life Insurance (continued)
Results of Discontinued Operations
(Millions) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
Premiums (1) $ 342.0 $ 198.0 $ 48.7
Charges assessed against policyholders 161.6 213.0 199.5
Net investment income 146.1 201.7 193.0
Net realized capital gains .6 6.3 2.7
Other income 1.9 1.4 1.8
- ----------------------------------------------------------------------------------------------------
Total revenue 652.2 620.4 445.7
- ----------------------------------------------------------------------------------------------------
Current and future benefits (1) 482.4 407.4 240.3
Operating expenses 41.3 60.9 66.4
Amortization of deferred policy acquisition costs 34.7 45.6 41.8
Severance and facilities charge (2) -- -- 14.2
- ----------------------------------------------------------------------------------------------------
Total benefits and expenses 558.4 513.9 362.7
- ----------------------------------------------------------------------------------------------------
Income before income taxes 93.8 106.5 83.0
Income taxes 32.0 38.7 27.1
- ----------------------------------------------------------------------------------------------------
Net income (3) $ 61.8 $ 67.8 $ 55.9
====================================================================================================
Net realized capital gains, net of tax (included above) $ 3.7 $ 4.0 $ 1.9
====================================================================================================
Deposits not included in premiums above $ 374.2 $ 486.4 $ 443.2
====================================================================================================
Assets under management (4) (5) -- $ 3,096.1 $ 2,830.5
====================================================================================================
Individual life insurance coverage issued $ 3,786.3 $ 5,005.6 $ 5,626.8
====================================================================================================
Individual life insurance coverage in force $45,388.3 $44,139.6 $42,352.6
====================================================================================================
(1) In 1998 and 1997, both premiums and current and future benefits reflect
offsetting amounts of $310.0 million and $150.6 million, respectively,
related to the transition of the reinsurance agreement with Aetna Life
from a modified coinsurance to a coinsurance arrangement effective January
1, 1997.
(2) Excludes any effect of the corporate facilities and severance charge
recorded in 1996 which is not directly allocable to the segment.
(3) Net income for the year ended December 31, 1998 includes a net benefit
from capitalizing internal-use software of $1.2 million and excludes any
effect of Year 2000 costs recorded in 1998.
(4) Excludes net unrealized capital gains of $80.3 million and $45.3 million
at December 31, 1997 and 1996, respectively.
(5) Includes $108.7 million and $91.6 million at December 31, 1997 and 1996,
respectively, related to assets held and managed by unaffiliated mutual
funds.
Net income for discontinued operations, which excludes Year 2000 costs,
decreased $6 million in 1998 and increased $12 million in 1997. The Company's
1996 net income includes an after-tax severance and facilities charge of $9
million primarily related to actions taken or expected to be taken to improve
the Company's cost structure relative to its competitors. Excluding net
realized capital gains and the severance and facilities charge, results
decreased by $6 million in 1998 and increased by $1 million in 1997. The
decrease in 1998 results reflects the sale of the domestic individual life
insurance business, which occurred on October 1, 1998.
17
Item 7. Management's Analysis of the Results of Operations. (continued)
Discontinued Operations--Individual Life Insurance (continued)
Premiums relate to traditional (term and whole life) life insurance. In 1998
and 1997, premiums and current and future benefits reflect offsetting amounts
relating to the transition of the reinsurance agreement with Aetna Life from a
modified coinsurance to a coinsurance arrangement effective January 1, 1997
(see Note 10 of Notes to Consolidated Financial Statements). Excluding the
additional premium from the transition of the reinsurance agreement, premiums
decreased $15 million in 1998 as a result of the sale of the domestic
individual life insurance business and were level in 1997 as increased premiums
relating to term insurance products were offset by declining traditional whole
life insurance premiums.
Deposits relate to universal life contracts. Deposits decreased 23% in 1998 and
increased 10% in 1997. The decrease in 1998 was due to the sale of the domestic
individual life insurance business; and, the increase in 1997 was a reflection
of business growth.
General Account Investments
The Company's investment strategies and portfolios are intended to match the
duration of the related liabilities and provide sufficient cash flow to meet
obligations while maintaining a competitive rate of return. The duration of
these investments is monitored, and investment purchases and sales are executed
with the objective of having adequate funds available to satisfy the Company's
maturing liabilities. The risks associated with investments supporting
experience rated products are assumed by those customers subject to, among
other things, certain minimum guarantees.
The Company's invested assets were comprised of the following:
(Millions) December 31, 1998 December 31, 1997
- -------------------------------------------------------------------------------------------------
Debt securities, available for sale, at fair value $12,067.2 $13,463.8
Equity securities, available for sale:
Nonredeemable preferred stock 203.3 147.6
Investment in affiliated mutual funds 100.1 83.0
Common stock 2.0 0.6
Short-term investments 47.9 95.6
Mortgage loans 12.7 12.8
Policy loans 292.2 469.6
- -------------------------------------------------------------------------------------------------
Total Investments $12,725.4 $14,273.0
=================================================================================================
Total investments decreased for 1998 primarily because investments supporting
the domestic individual life insurance business of approximately $1.8 billion
were sold in conjunction with the sale of that business (see "Overview" and
Note 2 of Notes to Consolidated Financial Statements for further discussion on
the sale).
18
Item 7. Management's Analysis of the Results of Operations. (continued)
General Account Investments (continued)
Debt Securities
At December 31, 1998 and 1997, the Company's carrying value of investments in
debt securities represented 95% and 94%, respectively, of the total general
account invested assets. For the same periods, $9.1 billion, or 76% of total
debt securities, and $10.7 billion, or 79% of total debt securities, supported
experience rated products.
It is management's objective that the portfolio of debt securities be of high
quality and be well-diversified by market sector. The debt securities in the
Company's portfolio are generally rated by external rating agencies, and, if
not externally rated, are rated by the Company on a basis believed to be
similar to that used by the rating agencies. The average quality rating of the
Company's debt security portfolio at December 31, 1998 and 1997 was AA-.
The percentage of total debt securities by quality rating category is as
follows:
December 31, 1998 December 31, 1997
- -----------------------------------------------------------------
AAA 43.3% 48.3%
AA 11.0 10.4
A 24.4 21.7
BBB 14.4 12.9
BB 3.7 3.8
B and Below 3.2 2.9
----------------------------------------
100.0% 100.0%
========================================
The portfolio of debt securities at December 31, 1998 and 1997 included $839
million (7% of the total debt securities) and $903 million (7% of the total
debt securities), respectively, of investments that are considered "below
investment grade". "Below investment grade" securities are defined to be
securities that carry a rating below BBB- and Baa3, by Standard & Poor's and
Moody's Investors Services, respectively.
The percentage of total debt securities investments by market sector is as
follows:
December 31, 1998 December 31, 1997
- ------------------------------------------------------------------------------------------------
U.S. Corporate Securities 45.7% 37.4%
Residential Mortgage-Backed Securities 22.4 24.3
Foreign Securities--U.S. Dollar Denominated 10.0 12.4
Commercial/Multifamily Mortgage-Backed Securities 9.4 8.6
U.S. Treasuries/Agencies 6.4 9.6
Asset-Backed Securities 6.1 7.7
----------------------------------------
100.0% 100.0%
========================================
19
Item 7. Management's Analysis of the Results of Operations. (continued)
General Account Investments (continued)
Risk Management and Market Sensitive Instruments
The Company regularly evaluates the appropriateness of investments relative to
its management approved investment guidelines (and operates within those
guidelines) and the business objective of the portfolios. The Company manages
interest rate risk by seeking to maintain a tight duration band, while credit
risk is managed by maintaining high average quality ratings and diversified
sector exposure within the debt securities portfolio. In connection with its
investment and risk management objectives, the Company also uses financial
instruments whose market value is at least partially determined by, among other
things, levels of or changes in domestic and/or foreign interest rates
(short-term or long-term), duration, exchange rates, prepayment rates, equity
markets or credit ratings/spreads.
The Company's use of derivatives is generally limited to hedging purposes and
has principally consisted of using futures contracts to hedge interest rate and
equity price risk. When used for hedging, the expectation is that these
instruments would reduce overall risk. (See Note 4 of Notes to Consolidated
Financial Statements for additional information.)
The risks associated with investments supporting experience rated pension and
annuity products are assumed by those contractholders, not by the Company
(subject to, among other things, certain minimum guarantees). Risks associated
with the investments and liabilities related to experience rated pension and
annuity products are not included in the sensitivity analysis presented below.
The following discussion about the Company's risk management activities
includes "forward-looking statements" that involve risk and uncertainties. Set
forth below are management's projections of hypothetical net losses in fair
value of shareholder's equity of the Company's market sensitive instruments if
certain assumed changes in market rates and prices were to occur (sensitivity
analysis). These instruments are not leveraged and are held for purposes other
than trading. While the Company believes that the assumed market rate changes
are reasonably possible in the near term, actual results may differ,
particularly as a result of any management actions that would be taken to
mitigate such hypothetical losses in fair value of shareholder's equity. Based
on the Company's overall exposure to interest rate risk and equity price risk,
the Company believes that these changes in market rates and prices would not
materially affect the consolidated near-term financial position, results of
operations or cash flows of the Company.
Interest Rate Risk
Assuming an immediate increase of 100 basis points in interest rates, the net
hypothetical loss in fair value of shareholder's equity related to financial
and derivative instruments is estimated to be $39 million (after tax), (2.9% of
total shareholder's equity) at December 31, 1998 and $35 million (after tax),
(1.9% of total shareholder's equity) at December 31, 1997. The Company believes
that an interest rate shift of this magnitude represents a moderately adverse
scenario, and is approximately equal to the historical annual volatility of
interest rate movements for the Company's intermediate term available for sale
debt securities. The Company has included corresponding changes in certain
insurance liabilities in this sensitivity analysis.
20
Item 7. Management's Analysis of the Results of Operations. (continued)
General Account Investments (continued)
The potential effect of interest rate risk on near-term net income, cash flow
and fair value was determined based on commonly used models. The models project
the impact of interest rate changes on a wide range of factors, including
duration, prepayment, put options and call options. Fair value was estimated
based on the net present value of cash flows or duration estimates, using a
representative set of likely future interest rate scenarios.
Equity Price Risk
The Company's available for sale equity securities are comprised primarily of
domestic stocks. Assuming an immediate decrease of 10% in equity prices for
domestic equity securities, the hypothetical loss in fair value of
shareholder's equity related to financial and derivative instruments is
estimated to be $7 million (after tax), (0.5% of total shareholder's equity) at
December 31, 1998 and $5 million (after tax), (0.3% of total shareholder's
equity) at December 31, 1997.
Liquidity and Capital Resources
Generally, the Company meets its operating requirements by maintaining
appropriate levels of liquidity in its investment portfolio and using overall
cash flows from premiums, deposits, asset maturities and income received on
investments. Cash provided from these sources is used primarily for benefit
payments, contract withdrawals and operating expenses. Subsequent to the close
of the sale of the domestic individual life insurance business on October 1,
1998, premiums received and benefits paid on policies assumed under the sale
agreement are generally deposited to or paid out of Lincoln funds.
Debt securities and mortgage loans have durations that were selected to
approximate the durations of the liabilities they support. The general account
of the Company has been segmented to improve the asset/liability matching
process. The duration of these investments is monitored, and investment
purchases and sales are executed with the objective of having adequate funds
available to satisfy the Company's maturing liabilities.
As the Company's investment strategy focuses on matching asset and liability
durations, and not specific cash flows, and since these duration assessments
are dependent on numerous cash flow assumptions, asset sales may, from time to
time, be required to satisfy liability obligations and/or rebalance asset
portfolios. The investment portfolios are closely monitored to assess asset and
liability matching in order to rebalance the portfolios as conditions warrant.
Given the high quality of the debt securities portfolio (see "General Account
Investments"), management expects the vast majority of the Company's
investments in debt securities to be repaid in accordance with contractual
terms. In addition, most of the debt securities in the portfolio are highly
marketable and can be sold to enhance cash flow before maturity.
The Company has no debt. The Company received capital contributions of $9
million and $10 million in cash from HOLDCO in 1998 and 1996, respectively. The
Company received no capital contributions in 1997. (See Note 10 of Notes to
Consolidated Financial Statements).
21
Item 7. Management's Analysis of the Results of Operations. (continued)
Liquidity and Capital Resources (continued)
The Company paid $553 million and $17 million in cash dividends to HOLDCO in
1998 and 1997, respectively. Additionally, in 1998, the Company accrued $206
million in dividends. Of the $759 million dividends paid and accrued in 1998,
$756 million (all of which was approved by the Insurance Commissioner of the
State of Connecticut) was attributable to proceeds from the sale of the
domestic individual life insurance business.
In January 1999, the accrued dividends of $206 million were paid by the Company
to HOLDCO. Further dividends to be paid by the Company to HOLDCO during 1999
will need to be approved by the Insurance Commissioner of the State of
Connecticut prior to payment.
See "Consolidated Statements of Cash Flows" for additional information.
Year 2000
The Company relies heavily on information technology ("IT") systems and other
systems and facilities such as telephones, building access control systems and
heating and ventilation equipment ("embedded systems") to conduct its business.
The Company also has business relationships with financial institutions,
financial intermediaries, public utilities and other critical vendors as well
as regulators and customers who are themselves reliant on IT and embedded
systems to conduct their businesses.
State of Readiness
In 1997, the Company's ultimate parent, Aetna, organized a multi-disciplinary
Year 2000 Project Team that includes outside consultants. The Year 2000 Project
Team and Aetna's businesses and subsidiaries, including the Company, have
developed and are currently executing a comprehensive plan designed to make
their mission-critical IT systems and embedded systems Year 2000 ready. Outside
consultants have reviewed Aetna's overall process, plan and progress to date.
Aetna's plan for IT systems consists of several phases: (i)
inventory--identifying all IT systems and risk rating each according to its
potential business impact; (ii) assessment--identifying IT systems that use
date functions and assessing them for Year 2000 functionality; (iii)
remediation--reprogramming, or replacing where necessary, inventoried items to
make them Year 2000 ready; and (iv) testing and certification--testing the code
modifications and new inventory with other associated systems, including
extensive date testing and performing quality assurance testing to determine if
they will successfully operate in the post-1999 environment. The Company is
addressing its IT systems in a manner consistent with Aetna's plan.
Aetna completed the inventory and assessment phases for substantially all of
its IT systems and those of its subsidiaries, including those of the Company,
by year-end 1997. The Company's IT systems are currently in the remediation and
testing and certification phases. Aetna has completed the remediation of
substantially all of its mission-critical IT systems and those of its
subsidiaries, including those of the Company, and is scheduled to complete the
remediation of its and their other IT systems by March 30, 1999, and the
testing and certification of its and their IT systems by mid-1999.
22
Item 7. Management's Analysis of the Results of Operations. (continued)
Year 2000 (continued)
Aetna is handling substantially all aspects of the Year 2000 issue as it
relates to the Company's embedded systems. Aetna has inventoried and risk rated
substantially all of its embedded systems and those of its subsidiaries,
including those of the facilities the Company occupies. The results of these
processes indicate that embedded systems should not present a material Year
2000 risk to the Company. Aetna's remaining steps include testing selected
embedded systems and remediating and certifying systems that exhibit Year 2000
issues. Aetna is focusing its testing and remediation efforts on select
embedded systems of its mission-critical facilities such as data centers,
service centers, communications centers and select office locations. Aetna
plans to complete testing of these systems by mid-1999, and the remediation and
certification of these systems by year-end 1999.
The Company believes that its Year 2000 project generally is on schedule.
External Relationships
The Company also faces the risk that one or more of its critical suppliers or
customers ("external relationships") will not be able to interact with the
Company due to the third party's inability to resolve its own Year 2000 issues,
including those associated with its own external relationships. The Company has
completed its inventory of external relationships and risk rated each external
relationship based upon the potential business impact, available alternatives
and cost of substitution. The Company is attempting to determine the overall
Year 2000 readiness of its external relationships. In the case of
mission-critical suppliers such as banks, financial intermediaries (such as
stock exchanges), telecommunications providers and other utilities, mutual fund
companies, IT vendors and financial market data providers, either Aetna or the
Company is engaged in discussions with the third parties and is attempting to
obtain detailed information as to those parties' Year 2000 plans and state of
readiness. The Company, however, does not have sufficient information at the
current time to predict whether its external relationships will be Year 2000
ready.
Year 2000 Costs
Total Year 2000 project costs for the Company were $21 million (after tax) in
1998 and are currently estimated to be $16 million (after tax) in 1999. A
majority of these costs are expected to be incremental expenses that will not
recur in the year 2000 or thereafter. Year 2000 costs were not material in
1997. The Company expenses these costs as incurred and funds these costs
through operating cash flows.
Year 2000 readiness is critical to the Company. The Company has redeployed some
resources from non-critical system enhancements to address Year 2000 issues.
Due to the importance of IT systems to the Company's business, management has
not deferred mission-critical systems enhancements to become Year 2000 ready.
The Company does not expect these redeployments and deferrals to have a
material impact on the Company's financial condition or results of operations.
Risks and Contingency/Recovery Planning
If the Company's Year 2000 issues were unresolved, potential consequences would
include, among other possibilities, the inability to accurately and timely
update customers' accounts, process
23
Item 7. Management's Analysis of the Results of Operations. (continued)
Year 2000 (continued)
financial transactions, price securities, bill customers, assess exposure to
investment risks, determine liquidity requirements or report accurate data to
management, shareholders, customers, regulators and others; as well as business
interruptions or shutdowns; financial losses; reputational harm; increased
scrutiny by regulators; and litigation related to Year 2000 issues. The Company
is attempting to limit the potential impact of the Year 2000 by monitoring the
progress of its own Year 2000 project and those of its critical external
relationships and by developing contingency/recovery plans. The Company cannot
guarantee that it will be able to resolve all of its Year 2000 issues. Any
critical unresolved Year 2000 issues at the Company or its external
relationships, however, could have a material adverse effect on the Company's
results of operations, liquidity or financial condition.
The Company has begun to develop contingency/recovery plans aimed at effecting
the continuity of critical business functions before and after December 31,
1999. As part of that process, the Company has begun to develop reasonably
possible failure scenarios for its critical IT systems and external
relationships, and the embedded systems in its critical facilities. Once these
scenarios are identified, the Company will develop plans that are designed to
reduce the impact on the Company, and provide methods of returning to normal
operations, if one or more of those scenarios occur. The Company expects
contingency/recovery planning to be substantially complete by September 1999.
See "Forward-Looking Information/Risk Factors" for factors that could cause
actual Year 2000 results to differ from the Company's expectations.
Forward-Looking Information/Risk Factors
The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides
a "safe harbor" for forward-looking statements, so long as (1) those statements
are identified as forward-looking and (2) the statements are accompanied by
meaningful cautionary statements that identify important factors that could
cause actual results to differ materially from those discussed in the
statement. The Company wants to take advantage of these safe harbor provisions.
Certain information contained in this Management's Analysis of the Results of
Operations is forward-looking within the meaning of the 1995 Act or SEC rules.
This information includes, but is not limited to: (1) the information that
appears under the headings "Outlook" in the discussion of results of the
Company's continuing operations, (2) "General Account Investments-Risk
Management and Market Sensitive Instruments" and (3) "Year 2000." In writing
this Management's Analysis, the following words, or variations of such words
and similar expressions, were used and were intended to identify
forward-looking statements:
o Expects o Plans
o Projects o Believes
o Anticipates o Seeks
o Intends o Estimates
These forward-looking statements rely on a number of assumptions concerning
future events, and are subject to significant uncertainties and contingencies,
many of which are outside the control of
24
Item 7. Management's Analysis of the Results of Operations. (continued)
Forward-Looking Information/Risk Factors (continued)
the Company, that could cause actual results to differ materially from these
statements. Undue reliance should not be placed on these forward-looking
statements. The Company disclaims any intention or obligation to update or
revise forward-looking statements, whether as a result of new information,
future events or otherwise.
Set forth below are certain important risk factors that, in addition to general
economic conditions and other factors (some of which are discussed elsewhere in
this report), may affect forward-looking statements and the Company's business
generally.
Significant changes in financial markets could affect earnings. Significant
changes in financial markets could impact the level of assets under management
in the Company's businesses, and, in turn, the Company's level of asset-based
fees. For example, significant increases in interest rates or decreases in
equity markets would directly affect the level of assets under management and,
in addition, may increase the level of withdrawals and decrease the level of
deposits by customers. Customers under those circumstances may seek to
diversify among asset managers or seek investment alternatives not offered by
the Company. Significant declines in the value of investments may also affect
the Company's ability to pass through investment losses to certain experience
rated customers, whether due to triggering minimum guarantees or other business
reasons.
Decreases in ratings could affect assets under management. Decreases in the
claims-paying ratings of the Company and its insurance subsidiary could have
the effect of decreasing new sales and deposits and increasing withdrawals and
surrenders in the Company's businesses, which would adversely affect the level
of asset-based fees. The claims paying ratings of the Company and its insurance
subsidiary are currently under review by certain rating agencies pending
completion of their analysis of Aetna's pending Prudential health care
acquisition.
Early withdrawal of assets could affect earnings. The Company incurs up-front
costs, such as commissions, when it sells annuity products and generally defers
and recognizes those costs over time. As a result, the retention of assets
under these products is an important component of profitability. The Company
generally seeks to structure its products and sales to encourage retention of
assets under management or recover costs through surrender charges, higher
credited rates to customers if the Company retains the assets for longer
periods, paying renewal commissions, paying service fees or other terms.
However, if customers withdraw assets earlier than the Company anticipated when
it priced its products, it would adversely affect profitability. The Company
may also experience competitive pressure to lower margins.
Retention of key senior executives is important to operations. The Company's
success is dependent, in part, on Aetna's ability to attract and retain key
senior executives. Aetna has entered into employment agreements with certain of
these executives, although an employment agreement does not guarantee that an
executive's services with the Company will continue.
25
Item 7. Management's Analysis of the Results of Operations. (continued)
Forward-Looking Information/Risk Factors (continued)
Adverse changes in regulation could affect the operations of the Company's
businesses. The Company's businesses are subject to comprehensive regulation.
These businesses could be adversely affected by:
o increases in minimum net capital and other financial viability requirements
for insurance operations.
o removal of barriers preventing banks from engaging in insurance and mutual
fund businesses.
o changes in the taxation of insurance companies. For example, the President of
the United States' revenue proposal would require life insurance companies
to pay tax on certain income earned prior to 1984. Under current law, that
income is deferred for tax purposes. If this tax change, which is currently
just a proposal, were enacted, then the Company would recognize a one-time
charge to income in the amount of the tax.
o changes in the tax treatment of annuity and other insurance products as well
as changes in capital gains tax rates. Certain of these changes should they
occur could affect the attractiveness to customers of the Company's annuity
products compared to investment alternatives offered by our competitors.
Successful completion of the Company's Year 2000 project is important to
operations. If the Company does not resolve critical Year 2000 issues, or if
third parties with whom the Company has external relationships do not resolve
critical Year 2000 issues, then those issues could have a material adverse
effect on the Company's results of operations, liquidity or financial
condition. In addition, the Company's expectations about the future costs and
timely and successful completion of its Year 2000 program are subject to
uncertainties that could cause actual results to differ materially from what
has been discussed above under "Year 2000." Factors that could influence the
amount of future costs and the completion dates and effectiveness of
remediation, testing and certification and contingency planning efforts include
the Company's success in identifying IT systems, and Aetna's success in
identifying embedded systems, that contain two-digit year codes, the nature and
amount of required reprogramming, testing and certification, the rate and
magnitude of related labor and consulting costs, the availability of qualified
personnel and the success of the Company's external relationships in addressing
their own Year 2000 issues. See "Year 2000".
Litigation can increase expenses. Litigation also could adversely affect the
Company, both through costs of defense and adverse results or settlements. See
Note 13 of Notes to Consolidated Financial Statements and Item 3 of this Form
10-K for information regarding litigation.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
See "General Account Investments" in Management's Analysis of the Results of
Operations.
26
Item 8. Financial Statements and Supplementary Data.
Index to Consolidated Financial Statements
Page
----
Independent Auditors' Report 28
Consolidated Financial Statements:
Consolidated Statements of Income for the Years Ended December 31, 1998,
1997 and 1996 29
Consolidated Balance Sheets as of December 31, 1998 and 1997 30
Consolidated Statements of Changes in Shareholder's Equity for the Years
Ended December 31, 1998, 1997 and 1996 31
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998,
1997 and 1996 32
Notes to Consolidated Financial Statements 33
27
Independent Auditors' Report
The Shareholder and Board of Directors
Aetna Life Insurance and Annuity Company:
We have audited the accompanying consolidated balance sheets of Aetna Life
Insurance and Annuity Company and Subsidiary as of December 31, 1998 and 1997,
and the related consolidated statements of income, changes in shareholder's
equity and cash flows for each of the years in the three-year period ended
December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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
statements presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the aforementioned consolidated financial statements present
fairly, in all material respects, the financial position of Aetna Life
Insurance and Annuity Company and Subsidiary at December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ KPMG LLP
Hartford, Connecticut
February 3, 1999
28
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Statements of Income
(millions)
Years Ended December 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
Revenue:
Premiums $ 79.4 $ 69.1 $ 84.9
Charges assessed against policyholders 324.3 262.0 197.0
Net investment income 877.6 878.8 852.6
Net realized capital gains 10.4 29.7 17.0
Other income 29.6 38.3 43.6
---------- ---------- ----------
Total revenue 1,321.3 1,277.9 1,195.1
---------- ---------- ----------
Benefits and expenses:
Current and future benefits 714.4 720.4 728.3
Operating expenses 313.2 286.5 275.8
Amortization of deferred policy acquisition costs 106.7 82.8 28.0
Severance and facilities charges -- -- 47.1
---------- ---------- ----------
Total benefits and expenses 1,134.3 1,089.7 1,079.2
---------- ---------- ----------
Income from continuing operations before
income taxes 187.0 188.2 115.9
Income taxes 47.4 50.7 30.7
---------- ---------- ----------
Income from continuing operations 139.6 137.5 85.2
Discontinued Operations, net of tax
Income from operations 61.8 67.8 55.9
Gain on sale 59.0 -- --
---------- ---------- ----------
Net income $ 260.4 $ 205.3 $ 141.1
========== ========== ==========
See Notes to Consolidated Financial Statements
29
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Balance Sheets
(millions, except share data)
December 31, December 31,
1998 1997
------------ ------------
Assets
Investments:
Debt securities available for sale, at fair value,
(amortized cost: $11,570.3 and $12,912.2) $12,067.2 $13,463.8
Equity securities, at fair value,
Nonredeemable preferred stock (cost: $202.6 and $131.7) 203.3 147.6
Investment in affiliated mutual funds (cost: $96.8 and$78.1) 100.1 83.0
Common stock (cost: $1.0 and $0.2) 2.0 .6
Short-term investments 47.9 95.6
Mortgage loans 12.7 12.8
Policy loans 292.2 469.6
------------ ------------
Total investments 12,725.4 14,273.0
Cash and cash equivalents 608.4 565.4
Short-term investments under securities loan agreement 277.3 --
Accrued investment income 151.6 163.0
Premiums due and other receivables 46.7 51.9
Reinsurance recoverable 2,959.8 11.8
Deferred policy acquisition costs 864.0 1,654.6
Reinsurance loan to affiliate -- 397.2
Deferred tax asset 120.6 --
Other assets 66.6 46.8
Separate accounts assets 29,458.4 22,982.7
------------ ------------
Total assets $47,278.8 $40,146.4
============ ============
Liabilities and Shareholder's Equity
Liabilities:
Future policy benefits $ 3,815.9 $ 3,763.7
Unpaid claims and claim expenses 18.8 38.0
Policyholders' funds left with the Company 11,305.6 11,143.5
------------ ------------
Total insurance reserve liabilities 15,140.3 14,945.2
Payables under securities loan agreement 277.3 --
Other liabilities 793.2 312.8
Income taxes:
Current 279.8 12.4
Deferred -- 72.0
Separate accounts liabilities 29,430.2 22,970.0
------------ ------------
Total liabilities 45,920.8 38,312.4
------------ ------------
Shareholder's equity:
Common stock, par value $50 (100,000 shares authorized;
55,000 shares issued and outstanding) 2.8 2.8
Paid-in capital 427.3 418.0
Accumulated other comprehensive income 104.8 92.9
Retained earnings 823.1 1,320.3
------------ ------------
Total shareholder's equity 1,358.0 1,834.0
------------ ------------
Total liabilities and shareholder's equity $47,278.8 $40,146.4
============ ============
See Notes to Consolidated Financial Statements
30
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Statements of Changes in Shareholder's Equity
(millions)
Years Ended December 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
Shareholder's equity, beginning of year $1,834.0 $1,609.5 $1,583.0
Comprehensive income
Net income 260.4 205.3 141.1
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities
($18.2 million, $49.9 million and
$(110.6) million, pretax, respectively) 11.9 32.4 (72.0)
---------- ---------- ----------
Total comprehensive income 272.3 237.7 69.1
---------- ---------- ----------
Capital contributions 9.3 -- 10.4
Other changes 1.4 4.1 (49.5)
Common stock dividends (759.0) (17.3) (3.5)
---------- ---------- ----------
Shareholder's equity, end of year $1,358.0 $1,834.0 $1,609.5
========== ========== ==========
See Notes to Consolidated Financial Statements
31
AETNA LIFE INSURANCE AND ANNUITY COMPANY AND SUBSIDIARY
(A wholly owned subsidiary of Aetna Retirement Holdings, Inc.)
Consolidated Statements of Cash Flows
(millions)
Years Ended December 31,
---------------------------------------
1998 1997 1996
--------- --------- ---------
Cash Flows from Operating Activities:
Net income $ 260.4 $ 205.3 $ 141.1
Adjustments to reconcile net income to net cash provided by
(used for) operating activities:
Net accretion of discount on investments (29.5) (66.4) (68.0)
Gain on sale of discontinued operations (88.3) -- --
--------- --------- ---------
Cash flows provided by operating activities and net realized capital
gains before changes in assets and liabilities 142.6 138.9 73.1
Net realized capital gains (11.1) (36.0) (19.7)
--------- --------- ---------
Cash flows provided by operating activities before changes in assets
and liabilities 131.5 102.9 53.4
Changes in assets and liabilities:
Decrease (increase) in accrued investment income 11.4 (4.0) 16.5
(Increase) decrease in premiums due and other receivables (16.3) (33.3) 1.6
Decrease (increase) in policy loans 177.4 (70.3) (60.7)
Increase in deferred policy acquisition costs (117.3) (139.3) (174.0)
Decrease in reinsurance loan to affiliate 397.2 231.1 27.2
Net increase in universal life account balances 122.9 157.1 146.6
Decrease in other insurance reserve liabilities (41.8) (120.3) (114.9)
Net (decrease) increase in other liabilities and other assets (50.8) (41.7) 3.1
Increase (decrease) in income taxes 100.4 (31.4) (26.7)
Other, net -- -- 1.1
--------- --------- ---------
Net cash provided by (used for) operating activities 714.6 50.8 (126.8)
--------- --------- ---------
Cash Flows from Investing Activities:
Proceeds from sales of:
Debt securities available for sale 6,790.2 5,311.3 5,182.2
Equity securities 150.1 103.1 190.5
Mortgage loans 0.3 0.2 8.7
Life business 966.5 -- --
Investment maturities and collections of:
Debt securities available for sale 1,290.3 1,212.7 885.2
Short-term investments 129.9 89.3 35.0
Cost of investment purchases in:
Debt securities available for sale (6,701.4) (6,732.8) (6,534.3)
Equity securities (125.7) (113.3) (118.1)
Other investments (2,725.9) -- --
Short-term investments (81.9) (149.9) (54.7)
Other, net -- -- (17.6)
--------- --------- ---------
Net cash used for investing activities (307.6) (279.4) (423.1)
--------- --------- ---------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 1,571.1 1,621.2 1,579.5
Withdrawals of investment contracts (1,393.1) (1,256.3) (1,146.2)
Capital contribution to Separate Account -- (25.0) --
Return of capital from Separate Account 1.7 12.3 --
Capital contribution from HOLDCO 9.3 -- 10.4
Dividends paid to shareholder (553.0) (17.3) (3.5)
--------- --------- ---------
Net cash (used for) provided by financing activities (364.0) 334.9 440.2
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 43.0 106.3 (109.7)
Cash and cash equivalents, beginning of year 565.4 459.1 568.8
--------- --------- ---------
Cash and cash equivalents, end of year $ 608.4 $ 565.4 $ 459.1
========= ========= =========
Supplemental cash flow information:
Income taxes paid, net $ 48.4 $ 119.6 $ 85.5
========= ========== ==========
See Notes to Consolidated Financial Statements
32
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Aetna Life Insurance and Annuity Company and its wholly owned subsidiary
(collectively, the "Company") are providers of financial services in the
United States. Prior to the sale of the domestic individual life insurance
business on October 1, 1998, the Company had two business segments: financial
services and individual life insurance. On October 1, 1998, the Company sold
its domestic individual life insurance operations to Lincoln National
Corporation ("Lincoln") and accordingly they are now classified as
Discontinued Operations. (Refer to note 2)
Financial services products include annuity contracts that offer a variety of
funding and payout options for individual and employer-sponsored retirement
plans qualified under Internal Revenue Code Sections 401, 403, 408 and 457,
and non-qualified annuity contracts. These contracts may be deferred or
immediate ("payout annuities"). Financial services also include investment
advisory services and pension plan administrative services.
Discontinued Operations include universal life, variable universal life,
traditional whole life and term insurance.
Basis of Presentation
---------------------
The consolidated financial statements include Aetna Life Insurance and
Annuity Company and its wholly owned subsidiary, Aetna Insurance Company of
America. Aetna Life Insurance and Annuity Company is a wholly owned
subsidiary of Aetna Retirement Holdings, Inc. ("HOLDCO"). HOLDCO is a wholly
owned subsidiary of Aetna Retirement Services, Inc. ("ARS"), whose ultimate
parent is Aetna Inc. ("Aetna").
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles. Certain reclassifications have been
made to 1997 and 1996 financial information to conform to the 1998
presentation.
New Accounting Standards
------------------------
Disclosures about Segments of an Enterprise and Related Information
As of December 31, 1998, the Company adopted Financial Accounting Standard
("FAS") No. 131, Disclosures about Segments of an Enterprise and Related
Information. This statement establishes standards for the reporting of
information relating to operating segments. This statement supersedes FAS No.
14, Financial Reporting for Segments of a Business Enterprise, which requires
reporting segment information by industry and geographic area (industry
approach). Under FAS No. 131, operating segments are defined as components of
a company for which separate financial information is available and is used
by management to allocate resources and assess performance (management
approach). The adoption of this statement did not change the composition or
the results of operations of any of the operating segments of the Company,
which are consistent with the management approach.
33
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Accounting for the Costs of Computer Software Developed and Obtained for
Internal Use
On January 1, 1998, the Company adopted Statement of Position ("SOP") 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use, issued by the American Institute of Certified Public
Accountants ("AICPA"). This statement requires that certain costs incurred in
developing internal use computer software (in process at, and subsequent to
the adoption date) be capitalized, and provides guidance for determining
whether computer software is considered to be for internal use. The Company
amortizes these costs over a period of 3 to 5 years. Previously, the Company
expensed the cost of internal-use computer software as incurred. The adoption
of this statement resulted in a net after-tax increase to the results of
operations of $6.5 million for the year ended December 31, 1998.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities
In June 1996, the Financial Accounting Standards Board ("FASB") issued FAS
No. 125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, that provides accounting and reporting
standards for transfers of financial assets and extinguishments of
liabilities. FAS No. 125 was effective for 1997 financial statements;
however, certain provisions relating to accounting for repurchase agreements
and securities lending were not effective until January 1, 1998. The adoption
of those provisions effective in 1998 did not have a material effect on the
Company's financial position or results of operations.
Future Application of Accounting Standards
------------------------------------------
Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That
Do Not Transfer Insurance Risk
In October 1998, the AICPA issued SOP 98-7, Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk,
which provides guidance on how to account for all insurance and reinsurance
contracts that do not transfer insurance risk, except for long-duration life
and health insurance contracts. This statement is effective for the Company's
financial statements beginning January 1, 2000, with early adoption
permitted. The Company is currently evaluating the impact of the adoption of
this statement and the potential effect on its financial position and results
of operations.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued FAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This standard requires companies to
record all derivatives on the balance sheet as either assets or liabilities
and measure those instruments at fair value. The manner in which companies
are to record gains or losses resulting from changes in the values of those
derivatives depends on the use of the derivative and whether it qualifies for
hedge accounting. This standard is effective for the Company's financial
statements beginning January 1, 2000, with early adoption permitted. The
Company is currently evaluating the impact of adoption of this statement and
the potential effect on its financial position and results of operations.
34
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments
In December 1997, the AICPA issued SOP 97-3, Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments, which provides guidance
for determining when an insurance or other enterprise should recognize a
liability for guaranty-fund and other insurance-related assessments and
guidance for measuring the liability. This statement is effective for 1999
financial statements with early adoption permitted. The Company does not
expect adoption of this statement to have a material effect on its financial
position or results of operations.
Use of Estimates
----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from reported results using those
estimates.
Cash and Cash Equivalents
-------------------------
Cash and cash equivalents include cash on hand, money market instruments and
other debt issues with a maturity of 90 days or less when purchased.
Investments
-----------
Debt and equity securities are classified as available for sale and carried
at fair value. These securities are written down (as realized capital losses)
for other than temporary declines in value. Unrealized capital gains and
losses related to available-for-sale investments, other than amounts
allocable to experience-rated contractholders, are reflected in shareholder's
equity, net of related taxes.
Fair values for debt and equity securities are based on quoted market prices
or dealer quotations. Where quoted market prices or dealer quotations are not
available, fair values are measured utilizing quoted market prices for
similar securities or by using discounted cash flow methods. Cost for
mortgage-backed securities is adjusted for unamortized premiums and
discounts, which are amortized using the interest method over the estimated
remaining term of the securities, adjusted for anticipated prepayments. The
Company does not accrue interest on problem debt securities when management
believes the collection of interest is unlikely.
The Company engages in securities lending whereby certain securities from its
portfolio are loaned to other institutions for short periods of time. Initial
collateral, primarily cash, is required at a rate of 102% of the market value
of a loaned domestic security and 105% of the market value of a loaned
foreign security. The collateral is deposited by the borrower with a lending
agent, and retained and invested by the lending agent according to the
Company's guidelines to generate additional income. The market value of the
loaned securities is monitored on a daily basis with additional collateral
obtained or refunded as the market value of the loaned securities fluctuates.
35
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
At December 31, 1998 and 1997, the Company loaned securities (which are
reflected as invested assets) with a fair value of approximately $277.3
million and $385.1 million, respectively.
Purchases and sales of debt and equity securities are recorded on the trade
date.
The investment in affiliated mutual funds represents an investment in Aetna
managed mutual funds which have been seeded by the Company, and is carried at
fair value.
Mortgage loans and policy loans are carried at unpaid principal balances, net
of impairment reserves. Sales of mortgage loans are recorded on the closing
date.
Short-term investments, consisting primarily of money market instruments and
other debt issues purchased with an original maturity of 91 days to one year,
are considered available for sale and are carried at fair value, which
approximates amortized cost.
The Company utilizes futures contracts for other than trading purposes in
order to hedge interest rate risk (i.e. market risk, refer to Note 4.)
Futures contracts are carried at fair value and require daily cash
settlement. Changes in the fair value of futures contracts allocable to
experience rated contracts are deducted from capital gains and losses with an
offsetting amount reported in future policy benefits. Changes in the fair
value of futures contracts allocable to non-experienced-rated contracts that
qualify as hedges are deferred and recognized as an adjustment to the hedged
asset or liability. Deferred gains or losses on such futures contracts are
amortized over the life of the acquired asset or liability as a yield
adjustment or through net realized capital gains or losses upon disposal of
an asset. Changes in the fair value of futures contracts that do not qualify
as hedges are recorded in net realized capital gains or losses. Hedge
designation requires specific asset or liability identification, a
probability at inception of high correlation with the position underlying the
hedge, and that high correlation be maintained throughout the hedge period.
If a hedging instrument ceases to be highly correlated with the position
underlying the hedge, hedge accounting ceases at that date and excess gains
or losses on the hedging instrument are reflected in net realized capital
gains or losses.
Included in common stock are warrants which represent the right to purchase
specific securities. Upon exercise, the cost of the warrants is added to the
basis of the securities purchased.
Deferred Policy Acquisition Costs
---------------------------------
Certain costs of acquiring insurance business are deferred. These costs, all
of which vary with and are primarily related to the production of new and
renewal business, consist principally of commissions, certain expenses of
underwriting and issuing contracts, and certain agency expenses. For fixed
ordinary life contracts (prior to the sale of the domestic individual life
insurance business to Lincoln on October 1, 1998, refer to Note 2), such
costs are amortized over expected premium-paying periods (up to 20 years).
For universal life (prior to the sale of the domestic individual life
insurance business to Lincoln on October 1, 1998, refer to Note 2), and
certain annuity contracts,
36
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
such costs are amortized in proportion to estimated gross profits and
adjusted to reflect actual gross profits over the life of the contracts (up
to 50 years for universal life and up to 20 years for certain annuity
contracts). Deferred policy acquisition costs are written off to the extent
that it is determined that future policy premiums and investment income or
gross profits are not adequate to cover related losses and expenses.
Insurance Reserve Liabilities
-----------------------------
Future policy benefits include reserves for universal life, immediate
annuities with life contingent payouts and traditional life insurance
contracts. Prior to the sale of the domestic individual life insurance
business on October 1, 1998, (refer to note 2), reserves for universal life
products were equal to cumulative deposits less withdrawals and charges plus
credited interest thereon, plus (less) net realized capital gains (losses)
(which were reflected through credited interest rates). These reserves also
included unrealized capital gains (losses) related to FAS No. 115. As a
result of the sale and transfer of assets supporting the business, reserves
for universal life products will no longer include net realized capital gains
(losses) and unrealized gains (losses) related to FAS No. 115 for the years
ended December 31, 1998 and beyond.
Reserves for immediate annuities with life contingent payouts and traditional
life insurance contracts are for immediate annuities with life
contingent-payouts and traditional life insurance contracts are computed on
the basis of assumed investment yield, mortality, and expenses, including a
margin for adverse deviations. Such assumptions generally vary by plan, year
of issue and policy duration. Reserve interest rates range from 1.50% to
11.25% for all years presented. Investment yield is based on the Company's
experience. Mortality and withdrawal rate assumptions are based on relevant
Aetna experience and are periodically reviewed against both industry
standards and experience.
Because the sale of the domestic individual life insurance business was
substantially in the form of an indemnity reinsurance agreement, the Company
reported an addition to its reinsurance recoverable approximating the
Company's total individual life reserves at the sale date.
Policyholders' funds left with the Company include reserves for deferred
annuity investment contracts and immediate annuities without life contingent
payouts. Reserves on such contracts are equal to cumulative deposits less
charges and withdrawals plus credited interest thereon (rates range from
3.00% to 8.10% for all years presented) net of adjustments for investment
experience that the Company is entitled to reflect in future credited
interest. These reserves also include unrealized gains/losses related to FAS
No. 115. Reserves on contracts subject to experience rating reflect the
rights of contractholders, plan participants and the Company.
Unpaid claims for all lines of insurance include benefits for reported losses
and estimates of benefits for losses incurred but not reported.
37
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Premiums, Charges Assessed Against Policyholders, Benefits and Expenses
-----------------------------------------------------------------------
For universal life (prior to the sale of the domestic individual life
insurance business to Lincoln on October 1, 1998, refer to Note 2) and
certain annuity contracts, charges assessed against policyholders' funds for
the cost of insurance, surrender charges, actuarial margin and other fees are
recorded as revenue in charges assessed against policyholders. Other amounts
received for these contracts are reflected as deposits and are not recorded
as revenue. Life insurance premiums, other than premiums for universal life
(prior to the sale of the domestic individual life insurance business to
Lincoln on October 1, 1998, refer to Note 2) and certain annuity contracts,
are recorded as premium revenue when due. Related policy benefits are
recorded in relation to the associated premiums or gross profit so that
profits are recognized over the expected lives of the contracts. When annuity
payments with life contingencies begin under contracts that were initially
investment contracts, the accumulated balance in the account is treated as a
single premium for the purchase of an annuity and reflected as an offsetting
amount in both premiums and current and future benefits in the Consolidated
Statements of Income.
Separate Accounts
-----------------
Assets held under variable universal life and variable annuity contracts are
segregated in Separate Accounts and are invested, as designated by the
contractholder or participant under a contract (who bears the investment risk
subject, in some cases, to minimum guaranteed rates) in shares of mutual
funds which are managed by an affiliate of the Company, or other selected
mutual funds not managed by the Company.
As of December 31, 1998, Separate Accounts assets are carried at fair value.
At December 31, 1998, unrealized gains of $10.0 million, after taxes, on
assets supporting a guaranteed interest option are reflected in shareholder's
equity. At December 31, 1997, Separate Account assets supporting the
guaranteed interest option were carried at an amortized cost of $658.6
million (fair value $668.7 million). Separate Accounts liabilities are
carried at fair value, except for those relating to the guaranteed interest
option. Reserves relating to the guaranteed interest option are maintained at
fund value and reflect interest credited at rates ranging from 3.00% to 8.10%
in 1998 and 4.10% to 8.10% in 1997.
Separate Accounts assets and liabilities are shown as separate captions in
the Consolidated Balance Sheets. Deposits, investment income and net realized
and unrealized capital gains and losses of the Separate Accounts are not
reflected in the Consolidated Financial Statements (with the exception of
realized and unrealized capital gains and losses on the assets supporting the
guaranteed interest option). The Consolidated Statements of Cash Flows do not
reflect investment activity of the Separate Accounts.
38
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Reinsurance
-----------
The Company utilizes indemnity reinsurance agreements to reduce its exposure
to large losses in all aspects of its insurance business. Such reinsurance
permits recovery of a portion of losses from reinsurers, although it does not
discharge the primary liability of the Company as direct insurer of the risks
reinsured. The Company evaluates the financial strength of potential
reinsurers and continually monitors the financial condition of reinsurers.
Only those reinsurance recoverables deemed probable of recovery are reflected
as assets on the Company's Consolidated Balance Sheets. The majority of the
reinsurance recoverable on the Consolidated Balance Sheets at December 31,
1998 is related to the reinsurance recoverable from Lincoln arising from the
sale of the domestic life insurance business. (Refer to Note 2)
Income Taxes
------------
The Company is included in the consolidated federal income tax return of
Aetna. The Company is taxed at regular corporate rates after adjusting income
reported for financial statement purposes for certain items. Deferred income
tax expenses/benefits result from changes during the year in cumulative
temporary differences between the tax basis and book basis of assets and
liabilities.
2. Discontinued Operations-Individual Life Insurance
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln for $1 billion in cash. The transaction was generally in
the form of an indemnity reinsurance arrangement, under which Lincoln
contractually assumed from the Company certain policyholder liabilities and
obligations, although the Company remains directly obligated to
policyholders. Insurance reserves ceded as of December 31, 1998 were $2.9
billion. Deferred policy acquisition costs related to the life policies of
$907.9 million were written off against the gain on the sale. Certain
invested assets related to and supporting the life policies were sold to
consummate the life sale, and the Company recorded a reinsurance recoverable
from Lincoln. The transaction resulted in an after-tax gain on the sale of
approximately $117 million, of which $58 million will be deferred and
amortized over approximately 15 years (as profits in the book of business
sold emerge). The remaining portion of the gain was recognized immediately in
net income and was largely attributed to the sale of the domestic life
insurance business for access to the agency sales force and brokerage
distribution channel. The unamortized portion of the gain is presented in
other liabilities on the Consolidated Balance Sheets.
The operating results of the domestic individual life insurance business are
presented as Discontinued Operations. All prior year income statement data
has been restated to reflect the presentation as Discontinued Operations.
Revenues for the individual life segment were $652.2 million, $620.4 million
and $445.7 million for 1998, 1997 and 1996, respectively. Premiums ceded and
reinsurance recoveries made in 1998 totaled $153.4 million and $57.7 million,
respectively.
39
Notes to Consolidated Financial Statements (continued)
3. Investments
Debt securities available for sale as of December 31, 1998 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
1998 (Millions) Cost Gains Losses Value
--------------------------------------------------------------------------------------------------------------
U.S. government and government agencies
and authorities $ 718.9 $ 60.4 $ 0.2 $ 779.1
States, municipalities and political subdivisions 0.3 -- -- 0.3
U.S. corporate securities:
Utilities 615.2 29.8 4.1 640.9
Financial 2,259.2 94.6 5.6 2,348.2
Transportation/capital goods 580.8 33.0 1.1 612.7
Health care/consumer products 1,328.2 69.8 4.8 1,393.2
Natural resources 254.5 6.9 2.3 259.1
Other corporate securities 261.7 5.8 7.4 260.1
--------------------------------------------------------------------------------------------------------------
Total U.S. corporate securities 5,299.6 239.9 25.3 5,514.2
--------------------------------------------------------------------------------------------------------------
Foreign securities:
Government, including political subdivisions 507.6 30.4 32.9 505.1
Utilities 147.0 32.4 -- 179.4
Other 511.2 14.9 1.8 524.3
--------------------------------------------------------------------------------------------------------------
Total foreign securities 1,165.8 77.7 34.7 1,208.8
--------------------------------------------------------------------------------------------------------------
Residential mortgage-backed securities:
Pass-throughs 671.9 38.4 2.9 707.4
Collateralized mortgage obligations 1,879.6 119.7 10.4 1,988.9
--------------------------------------------------------------------------------------------------------------
Total residential mortgage-backed securities 2,551.5 158.1 13.3 2,696.3
--------------------------------------------------------------------------------------------------------------
Commercial/Multifamily mortgage-backed
securities 1,114.9 30.9 9.8 1,136.0
Other asset-backed securities 719.3 13.8 0.6 732.5
--------------------------------------------------------------------------------------------------------------
Total debt securities $11,570.3 $580.8 $83.9 $12,067.2
==============================================================================================================
40
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
Debt securities available for sale as of December 31, 1997 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
1997 (Millions) Cost Gains Losses Value
--------------------------------------------------------------------------------------------------------------
U.S. government and government agencies
and authorities $ 1,219.7 $ 74.0 $ 0.1 $ 1,293.6
States, municipalities and political subdivisions 0.3 -- -- 0.3
U.S. corporate securities:
Utilities 521.3 23.5 0.9 543.9
Financial 2,370.7 84.6 1.3 2,454.0
Transportation & capital goods 528.2 33.2 0.1 561.3
Healthcare & consumer products 728.5 27.0 2.6 752.9
Natural resources 143.5 5.5 -- 149.0
Other corporate securities 545.2 27.2 0.1 572.3
--------------------------------------------------------------------------------------------------------------
Total U.S. corporate securities 4,837.4 201.0 5.0 5,033.4
--------------------------------------------------------------------------------------------------------------
Foreign securities:
Government, including political subdivisions 612.5 36.7 23.6 625.6
Utilities 177.5 28.7 -- 206.2
Other 857.9 27.7 42.8 842.8
--------------------------------------------------------------------------------------------------------------
Total foreign securities 1,647.9 93.1 66.4 1,674.6
--------------------------------------------------------------------------------------------------------------
Residential mortgage-backed securities:
Pass-throughs 784.4 71.3 2.0 853.7
Collateralized mortgage obligations 2,280.5 137.4 2.0 2,415.9
--------------------------------------------------------------------------------------------------------------
Total residential mortgage-backed securities 3,064.9 208.7 4.0 3,269.6
--------------------------------------------------------------------------------------------------------------
Commercial/Multifamily mortgage-backed
securities 1,127.8 34.0 0.4 1,161.4
Other asset-backed securities 1,014.2 17.1 0.4 1,030.9
--------------------------------------------------------------------------------------------------------------
Total debt securities $12,912.2 $627.9 $76.3 $13,463.8
==============================================================================================================
41
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
At December 31, 1998 and 1997, net unrealized appreciation of $496.9 million
and $551.6 million, respectively, on available-for-sale debt securities
included $355.8 million and $429.3 million, respectively, related to
experience-rated contracts, which were not reflected in shareholder's equity
but in insurance reserves.
The amortized cost and fair value of debt securities for the year ended
December 31, 1998 are shown below by contractual maturity. Actual maturities
may differ from contractual maturities because securities may be
restructured, called, or prepaid.
Amortized Fair
(Millions) Cost Value
---------------------------------------------------------------
Due to mature:
One year or less $ 553.5 $ 554.6
After one year through five years 2,619.7 2,692.4
After five years through ten years 1,754.0 1,801.7
After ten years 2,257.4 2,453.7
Mortgage-backed securities 3,666.4 3,832.3
Other asset-backed securities 719.3 732.5
---------------------------------------------------------------
Total $11,570.3 $12,067.2
===============================================================
At December 31, 1998 and 1997, debt securities carried at $8.8 million and
$8.2 million, respectively, were on deposit as required by regulatory
authorities.
The Company did not have any investments in a single issuer, other than
obligations of the U.S. government, with a carrying value in excess of 10% of
the Company's shareholder's equity at December 31, 1998.
Included in the Company's debt securities were residential collateralized
mortgage obligations ("CMOs") supporting the following:
1998 1997
----------------------- -----------------------
Fair Amortized Fair Amortized
(Millions) Value Cost Value Cost
- -------------------------------------------------------------------------------------------------------
Total residential CMOs (1) $ 1,988.9 $1,879.6 $ 2,415.9 $2,280.5
=======================================================================================================
Percentage of total:
Supporting experience rated products 81.7% 81.6%
Supporting remaining products 18.3% 18.4%
- -------------------------------------------------------------------------------------------------------
100.0% 100.0%
=======================================================================================================
(1) At December 31, 1998 and 1997, approximately 66% and 73%, respectively, of
the Company's residential CMO holdings were backed by government agencies
such as GNMA, FNMA, FHLMC.
42
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
There are various categories of CMOs which are subject to different degrees
of risk from changes in interest rates and, for nonagency-backed CMOs,
defaults. The principal risks inherent in holding CMOs are prepayment and
extension risks related to dramatic decreases and increases in interest rates
resulting in the repayment of principal from the underlying mortgages either
earlier or later than originally anticipated. At December 31, 1998 and 1997,
approximately 2% and 4%, respectively, of the Company's CMO holdings were
invested in types of CMOs which are subject to more prepayment and extension
risk than traditional CMOs (such as interest- or principal-only strips).
Investments in equity securities available for sale as of December 31 were as
follows:
(Millions) 1998 1997
-------------------------------------------------------
Amortized Cost $300.4 $210.0
Gross unrealized gains 13.1 21.3
Gross unrealized losses 8.1 .1
-------------------------------------------------------
Fair Value $305.4 $231.2
=======================================================
4. Financial Instruments
Estimated Fair Value
--------------------
The carrying values and estimated fair values of certain of the Company's
financial instruments at December 31, 1998 and 1997 were as follows:
1998 1997
--------------------- -----------------------
Carrying Fair Carrying Fair
(Millions) Value Value Value Value
- ----------------------------------------------------------------------------------------
Assets:
Mortgage loans $ 12.7 $ 12.3 $ 12.8 $ 12.4
Liabilities:
Investment contract liabilities:
With a fixed maturity $ 1,063.9 $ 984.3 $ 1,030.3 $1,005.4
Without a fixed maturity 10,241.7 9,686.2 10,113.2 9,587.5
- -----------------------------------------------------------------------------------------
Fair value estimates are made at a specific point in time, based on available
market information and judgments about the financial instrument, such as
estimates of timing and amount of future cash flows. Such estimates do not
reflect any premium or discount that could result from offering for sale at
one time the Company's entire holdings of a particular financial instrument,
nor do they consider the tax impact of the realization of unrealized gains or
losses. In many cases, the fair value estimates cannot be substantiated by
comparison to independent markets, nor can the disclosed value be realized in
immediate settlement of the instrument. In evaluating the Company's
management of interest rate, price and liquidity risks, the fair values of
all assets and liabilities should be taken into consideration, not only those
presented above.
43
Notes to Consolidated Financial Statements (continued)
4. Financial Instruments (continued)
The following valuation methods and assumptions were used by the Company in
estimating the fair value of the above financial instruments:
Mortgage loans: Fair values are estimated by discounting expected mortgage
loan cash flows at market rates which reflect the rates at which similar
loans would be made to similar borrowers. The rates reflect management's
assessment of the credit quality and the remaining duration of the loans.
Investment contract liabilities (included in Policyholders' funds left with
the Company):
With a fixed maturity: Fair value is estimated by discounting cash flows at
interest rates currently being offered by, or available to, the Company for
similar contracts.
Without a fixed maturity: Fair value is estimated as the amount payable to
the contractholder upon demand. However, the Company has the right under such
contracts to delay payment of withdrawals which may ultimately result in
paying an amount different than that determined to be payable on demand.
Off-Balance-Sheet and Other Financial Instruments
-------------------------------------------------
Futures Contracts:
Futures contracts are used to manage interest rate risk in the Company's bond
portfolio. Futures contracts represent commitments to either purchase or sell
securities at a specified future date and at a specified price or yield.
Futures contracts trade on organized exchanges and, therefore, have minimal
credit risk. Cash settlements are made daily based on changes in the prices
of the underlying assets. The notional amounts, carrying values and estimated
fair values of the Company's open treasury futures as of December 31, 1998
were $250.9 million, $.1 million, and $.1 million, respectively.
Warrants:
Included in common stocks are warrants which are instruments giving the
Company the right, but not the obligation to buy a security at a given price
during a specified period. The carrying values and estimated fair values of
the Company's warrants to purchase equity securities as of December 31, 1998
were $1.5 million, respectively. The carrying values and estimated fair
values as of December 31, 1997 were $.6 million, respectively.
44
Notes to Consolidated Financial Statements (continued)
4. Financial Instruments (continued)
Debt Instruments with Derivative Characteristics:
The Company also had investments in certain debt instruments with derivative
characteristics, including those whose market value is at least partially
determined by, among other things, levels of or changes in domestic and/or
foreign interest rates (short- or long-term), exchange rates, prepayment
rates, equity markets or credit ratings/spreads. The amortized cost and fair
value of these securities, included in the debt securities portfolio, as of
December 31, 1998 was as follows:
Amortized Fair
(Millions) Cost Value
-----------------------------------------------------------------------------
Residential collateralized mortgage obligations $1,879.6 $1,988.9
Principal-only strips (included above) 20.2 24.0
Interest-only strips (included above) 17.3 18.0
Other structured securities with derivative
characteristics (1) 87.3 80.6
-----------------------------------------------------------------------------
(1) Represents non-leveraged instruments whose fair values and credit risk
are based on underlying securities, including fixed income securities
and interest rate swap agreements.
5. Net Investment Income
Sources of net investment income were as follows:
1998 1997 1996
----------------------------------------------------------------------------
Debt securities $ 798.8 $ 814.6 $ 805.3
Nonredeemable preferred stock 18.4 12.9 5.8
Investment in affiliated mutual funds 6.6 3.8 10.8
Mortgage loans 0.6 0.3 0.6
Policy loans 7.2 5.7 6.4
Reinsurance loan to affiliate 2.3 5.5 9.3
Cash equivalents 44.6 38.8 27.1
Other 16.7 9.5 1.8
-----------------------------------------------------------------------------
Gross investment income 895.2 891.1 867.1
Less: investment expenses (17.6) (12.3) (14.5)
-----------------------------------------------------------------------------
Net investment income $ 877.6 $ 878.8 $ 852.6
=============================================================================
Net investment income includes amounts allocable to experience rated
contractholders of $655.6 million, $673.8 million and $649.5 million for the
years ended December 31, 1998, 1997 and 1996, respectively. Interest credited
to contractholders is included in current and future benefits.
45
Notes to Consolidated Financial Statements (continued)
6. Dividend Restrictions and Shareholder's Equity
The Company paid $553.0 million and $17.3 million in cash dividends to HOLDCO
in 1998 and 1997, respectively. Additionally, at December 31, 1998, the
Company accrued $206.0 million in dividends. Of the $759.0 million dividends
paid and accrued in 1998, $756.0 million (all of which was approved by the
Insurance Commissioner of the State of Connecticut) was attributable to
proceeds from the sale of the domestic individual life insurance business.
In January 1999, the accrued dividends of $206.0 million were paid by the
Company to HOLDCO. Further dividends to be paid by the Company to HOLDCO
during 1999 will need to be approved by the Insurance Department of the State
of Connecticut (the "Department") prior to payment.
The Department recognizes as net income and shareholder's capital and surplus
those amounts determined in conformity with statutory accounting practices
prescribed or permitted by the Department, which differ in certain respects
from generally accepted accounting principles. Statutory net income was
$148.1 million, $80.5 million and $57.8 million for the years ended December
31, 1998, 1997 and 1996, respectively. Statutory capital and surplus was
$773.0 million and $778.7 million as of December 31, 1998 and 1997,
respectively.
As of December 31, 1998, the Company does not utilize any statutory
accounting practices which are not prescribed by state regulatory authorities
that, individually or in the aggregate, materially affect statutory capital
and surplus.
7. Capital Gains and Losses on Investment Operations
Realized capital gains or losses are the difference between the carrying
value and sale proceeds of specific investments sold.
Net realized capital gains on investments were as follows:
(Millions) 1998 1997 1996
----------------------------------------------------------------------------
Debt securities $ 7.4 $21.1 $ 9.5
Equity securities 3.0 8.6 7.5
----------------------------------------------------------------------------
Pretax realized capital gains $10.4 $29.7 $17.0
============================================================================
After-tax realized capital gains $ 7.3 $19.2 $11.1
============================================================================
Net realized capital gains of $15.0 million, $83.7 million and $52.5 million
for 1998, 1997 and 1996, respectively, allocable to experience rated
contracts, were deducted from net realized capital gains and an offsetting
amount was reflected in Policyholders' funds left with the Company. Net
unamortized gains were $118.6 million and $120.1 million at December 31, 1998
and 1997, respectively.
46
Notes to Consolidated Financial Statements (continued)
7. Capital Gains and Losses on Investment Operations (continued)
Proceeds from the sale of available-for-sale debt securities and the related
gross gains and losses were as follows:
(Millions) 1998 1997 1996
----------------------------------------------------------------------------
Proceeds on sales $6,790.2 $5,311.3 $5,182.2
Gross gains 98.8 23.8 22.1
Gross losses 91.4 2.7 12.6
----------------------------------------------------------------------------
Changes in shareholder's equity related to changes in accumulated other
comprehensive income (unrealized capital gains and losses on securities,
excluding those related to experience-rated contractholders) were as follows:
(Millions) 1998 1997 1996
-----------------------------------------------------------------------------------
Debt securities $ 18.9 $44.3 $(100.1)
Equity securities (16.1) 5.6 (10.5)
Other 15.4 -- --
-----------------------------------------------------------------------------------
Subtotal 18.2 49.9 (110.6)
Increase (decrease) in deferred income taxes
(Refer to note 8) 6.3 17.5 (38.6)
-----------------------------------------------------------------------------------
Net changes in accumulated other
comprehensive income $ 11.9 $32.4 $ (72.0)
===================================================================================
Net unrealized capital gains allocable to experience-rated contracts of
$355.8 million at December 31, 1998 are reflected on the Consolidated Balance
Sheets in Policyholders' funds left with the Company and are not included in
shareholder's equity. At December 31, 1997, net unrealized capital gains of
$356.7 million and $72.6 million at December 31, 1997 are reflected on the
Consolidated Balance Sheets in policyholders' funds left with the Company and
future policy benefits, respectively, and are not included in shareholder's
equity.
47
Notes to Consolidated Financial Statements (continued)
7. Capital Gains and Losses on Investment Operations (continued)
Shareholder's equity included the following accumulated other comprehensive
income, which are net of amounts allocable to experience-rated
contractholders, at December 31:
(Millions) 1998 1997 1996
----------------------------------------------------------------------------------
Debt securities:
Gross unrealized capital gains $157.3 $140.6 $101.7
Gross unrealized capital losses (16.2) (18.4) (23.8)
----------------------------------------------------------------------------------
141.1 122.2 77.9
----------------------------------------------------------------------------------
Equity securities:
Gross unrealized capital gains 13.1 21.2 16.3
Gross unrealized capital losses (8.1) (0.1) (0.8)
----------------------------------------------------------------------------------
5.0 21.1 15.5
----------------------------------------------------------------------------------
Other:
Gross unrealized capital gains 17.1 -- --
Gross unrealized capital losses (1.7) -- --
----------------------------------------------------------------------------------
15.4 -- --
----------------------------------------------------------------------------------
Deferred income taxes (Refer to note 8) 56.7 50.4 32.9
----------------------------------------------------------------------------------
Net accumulated other comprehensive income $104.8 $ 92.9 $ 60.5
==================================================================================
Changes in accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities (excluding those related to
experience-rated contractholders) were as follows:
(Millions) 1998 1997 1996
----------------------------------------------------------------------------------
Unrealized holding gains (losses) arising
during the year (1) $38.3 $98.8 $(14.8)
Less: reclassification adjustment for gains and
other items included in net income (2) 26.4 66.4 57.2
-----------------------------------------------------------------------------------
Net unrealized gains (losses) on securities $11.9 $32.4 $(72.0)
===================================================================================
(1) Pretax unrealized holding gains (losses) arising during the year were
$58.8 million, $152.3 million and ($22.9) million for 1998, 1997 and
1996, respectively.
(2) Pretax reclassification adjustments for gains and other items included
in net income were $40.6 million, $102.4 million and $87.7 million for
1998, 1997 and 1996, respectively.
48
Notes to Consolidated Financial Statements (continued)
8. Income Taxes
The Company is included in the consolidated federal income tax return, the
combined returns of Connecticut and New York, and the Illinois unitary state
income tax returns of Aetna. Aetna allocates to each member an amount
approximating the tax it would have incurred were it not a member of the
consolidated group, and credits the member for the use of its tax saving
attributes in the consolidated federal income tax return.
Income taxes from continuing operations consist of the following:
(Millions) 1998 1997 1996
-------------------------------------------------------------------------------
Current taxes (benefits):
Federal $ 246.4 $ 28.7 $ 30.0
State 1.3 2.0 2.3
Net realized capital gains 16.8 39.1 24.4
------------------------------------------------------------------------------
264.5 69.8 56.7
------------------------------------------------------------------------------
Deferred taxes (benefits):
Federal (203.2) 9.4 (7.6)
Net realized capital (losses) (13.9) (28.5) (18.4)
------------------------------------------------------------------------------
(217.1) (19.1) (26.0)
------------------------------------------------------------------------------
Total $ 47.4 $ 50.7 $ 30.7
==============================================================================
Income taxes were different from the amount computed by applying the federal
income tax rate to income from continuing operations before income taxes for
the following reasons:
(Millions) 1998 1997 1996
------------------------------------------------------------------------------
Income from continuing operations before
income taxes $187.0 $188.2 $115.9
Tax rate 35% 35% 35%
------------------------------------------------------------------------------
Application of the tax rate 65.5 65.9 40.6
Tax effect of:
State income tax, net of federal benefit 0.9 1.3 1.5
Excludable dividends (17.1) (15.6) (10.8)
Other, net (1.9) (0.9) (0.6)
------------------------------------------------------------------------------
Income taxes $ 47.4 $ 50.7 $ 30.7
==============================================================================
49
Notes to Consolidated Financial Statements (continued)
8. Income Taxes (Continued)
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at December 31 are presented below:
(Millions) 1998 1997
------------------------------------------------------------------------
Deferred tax assets:
Insurance reserves $ 324.1 $415.8
Unrealized gains allocable to experience
rated contracts 124.5 150.1
Investment (gains) losses (0.3) 6.6
Postretirement benefits other than pensions 26.0 26.3
Deferred compensation 38.6 31.2
Restructuring charge 2.9 9.5
Depreciation 1.7 3.9
Sale of individual life 48.9 -
Other 16.0 8.8
------------------------------------------------------------------------
Total gross assets 582.4 652.2
------------------------------------------------------------------------
Deferred tax liabilities:
Deferred policy acquisition costs 272.7 515.6
Market discount 4.5 5.1
Net unrealized capital gains 181.2 200.5
Pension 3.9 3.6
Other (0.5) (0.6)
------------------------------------------------------------------------
Total gross liabilities 461.8 724.2
------------------------------------------------------------------------
Net deferred tax (asset) liability $(120.6) $ 72.0
========================================================================
Net unrealized capital gains and losses are presented in shareholder's equity
net of deferred taxes. As of December 31, 1998 and 1997, no valuation
allowances were required for unrealized capital gains and losses.
Management believes that it is more likely than not that the Company will
realize the benefit of the net deferred tax asset. The Company expects
sufficient taxable income in the future to realize the net deferred tax asset
because of the Company's long-term history of having taxable income, which is
projected to continue.
The "Policyholders' Surplus Account," which arose under prior tax law, is
generally that portion of a life insurance company's statutory income that
has not been subject to taxation. As of December 31, 1983, no further
additions could be made to the Policyholders' Surplus Account for tax return
purposes under the Deficit Reduction Act of 1984. The balance in such account
was approximately $17.2 million at December 31, 1998. This amount would be
taxed only under certain conditions.
50
Notes to Consolidated Financial Statements (continued)
8. Income Taxes (Continued)
No income taxes have been provided on this amount since management believes
under current tax law the conditions under which such taxes would become
payable are remote.
The Internal Revenue Service (the "Service") has completed examinations of
the consolidated federal income tax returns of Aetna through 1990.
Discussions are being held with the Service with respect to proposed
adjustments. Management believes there are adequate defenses against, or
sufficient reserves to provide for, any such adjustments. The Service has
commenced its examinations for the years 1991 through 1994.
9. Benefit Plans
Aetna has noncontributory defined benefit pension plans covering
substantially all employees. Aetna's accrued pension cost has been allocated
to its subsidiaries, including the Company, under an allocation based on
eligible salaries. Data on a separate company basis regarding the
proportionate share of the projected benefit obligation and plan assets is
not available. The accumulated benefit obligation and plan assets are
recorded by Aetna. As of the measurement date (i.e., September 30), the
accumulated plan assets exceeded accumulated plan benefits. Allocated pretax
charges to operations for the pension plan (based on the Company's total
salary cost as a percentage of Aetna's total salary cost) were $0.8 million,
$2.7 million and $4.3 million for the years ended December 31, 1998, 1997 and
1996, respectively.
In addition to providing pension benefits, Aetna currently provides certain
health care and life insurance benefits for retired employees. A
comprehensive medical and dental plan is offered to all full-time employees
retiring at age 50 with 15 years of service or at age 65 with 10 years of
service. There is a cap on the portion of the cost paid by the Company
relating to medical and dental benefits. Retirees are generally required to
contribute to the plans based on their years of service with Aetna. The costs
to the Company associated with the Aetna postretirement plans for 1998, 1997
and 1996 were $0.9 million, $2.7 million and $1.8 million, respectively.
As of December 31, 1996, Aetna transferred to the Company approximately $77.7
million of accrued liabilities, primarily related to the pension and
postretirement benefit plans described above, that had been previously
recorded by Aetna. The after-tax amount of this transfer (approximately $50.5
million) is reported as a reduction in retained earnings.
The Company, in conjunction with Aetna, has a non-qualified pension plan
covering certain agents. The plan provides pension benefits based on annual
commission earnings. As of the measurement date (i.e., September 30), the
accumulated plan assets exceeded accumulated plan benefits.
The Company, in conjunction with Aetna, also provides certain postretirement
health care and life insurance benefits for certain agents. The costs to the
Company associated with the agents' postretirement plans for 1998, 1997 and
1996 were $1.4 million, $0.6 million and $0.7 million, respectively.
Effective January 1, 1999, the Company, in conjunction with Aetna, changed
the formula for providing pension benefits from the existing final average
pay formula to a cash balance formula,
51
Notes to Consolidated Financial Statements (continued)
9. Benefit Plans (continued)
which will credit employees annually with an amount equal to a percentage of
eligible pay based on age and years of service as well as an interest credit
based on individual account balances. The formula also provides for a
transition period until December 1, 2006, which allows certain employees to
receive vested benefits at the higher of the final average pay or cash
balance formula. The changing of this formula will not have a material
effect on the Company's results of operations, liquidity or financial
condition.
Incentive Savings Plan--Substantially all employees are eligible to
participate in a savings plan under which designated contributions, which
may be invested in common stock of Aetna or certain other investments, are
matched, up to 5% of compensation, by Aetna. Pretax charges to operations
for the incentive savings plan were $4.7 million, $4.4 million and $5.4
million in 1998, 1997 and 1996, respectively.
Stock Plans--Aetna has a stock incentive plan that provides for stock
options, deferred contingent common stock or equivalent cash awards or
restricted stock to certain key employees. Executive and middle management
employees may be granted options to purchase common stock of Aetna at or
above the market price on the date of grant. Options generally become 100%
vested three years after the grant is made, with one-third of the options
vesting each year. Aetna does not recognize compensation expense for stock
options granted at or above the market price on the date of grant under its
stock incentive plans. In addition, executives may be granted incentive
units which are rights to receive common stock or an equivalent value in
cash. The incentive units may vest within a range from 0% to 175% at the end
of a four year period based on the attainment of performance goals. The
costs to the Company associated with the Aetna stock plans for 1998, 1997
and 1996, were $4.1 million, $2.9 million and $8.1 million, respectively. As
of December 31, 1996, Aetna transferred to the Company approximately $1.1
million of deferred tax benefits related to stock options. This amount is
reported as an increase in retained earnings. In 1998, other changes in
shareholder's equity include an additional increase of $0.7 million
reflecting revisions to the allocation of the deferred tax benefit.
10. Related Party Transactions
Investment Advisory and Other Fees
----------------------------------
In February 1998 and May 1998, Aeltus Investment Management Inc. ("Aeltus"),
an affiliate of the Company, assumed investment advisory services for Aetna
managed mutual funds and variable funds (collectively, the Funds),
respectively. In connection with that assumption of duties, Aeltus entered
into participation agreements with the Company. Participation fees paid to
the Company, from Aeltus, included in charges assessed against policyholders
amounted to $26.9 million for 1998. Prior to assuming investment advisory
services, Aeltus served as subadvisor to the Funds. Since August 1996,
Aeltus has served as advisor for most of the Company's General Account
assets. Fees paid by the Company to Aeltus, included in both charges
assessed against policyholders and net investment income, on an annual
basis, range from 0.06% to 0.55% of the average daily net assets under
management. For the years ended December 31, 1998, 1997 and 1996, the
Company paid $21.7 million, $45.5 million and $16.0 million, respectively,
in such fees.
Prior to February 1998 and May 1998, the Company served as investment
advisor to the Funds. Under the advisory agreements, the funds paid the
Company a daily fee which, on an annual basis, ranged,
52
Notes to Consolidated Financial Statements (continued)
10. Related Party Transactions (continued)
depending on the fund, from 0.25% to 0.85% of their average daily net
assets. The Company is also compensated by the Separate Accounts (variable
funds) for bearing mortality and expense risks pertaining to variable life
and annuity contracts. Under the insurance and annuity contracts, the
Separate Accounts pay the Company a daily fee which, on an annual basis is,
depending on the product, up to 2.15% of their average daily net assets. The
amount of compensation and fees received from the Funds and Separate
Accounts, included in charges assessed against policyholders, amounted to
$287.0 million, $271.2 million and $186.6 million in 1998, 1997 and 1996,
respectively.
Reinsurance Transactions
------------------------
Since 1981, all domestic individual non-participating life insurance of
Aetna and its subsidiaries has been issued by the Company. Effective
December 31, 1988, the Company entered into a reinsurance agreement with
Aetna Life Insurance Company ("Aetna Life") in which substantially all of
the non-participating individual life and annuity business written by Aetna
Life prior to 1981 was assumed by the Company. A $6.1 million and a $108.0
million commission, paid by the Company to Aetna Life in 1996 and 1988,
respectively, was capitalized as deferred policy acquisition costs. In
consideration for the assumption of this business, a loan was established
relating to the assets held by Aetna Life which support the insurance
reserves. Effective January 1, 1997, this agreement was amended to
transition (based on underlying investment rollover in Aetna Life) from a
modified coinsurance to a coinsurance arrangement. As a result of this
change, reserves were ceded to the Company from Aetna Life as investment
rollover occurred and the loan previously established was reduced. The
Company maintained insurance reserves of $574.5 million ($397.2 million
relating to the modified coinsurance agreement and $177.3 million relating
to the coinsurance agreement) as of December 31, 1997 relating to the
business assumed. The fair value of the loan relating to assets held by
Aetna Life was $412.3 million as of December 31, 1997 and was based upon the
fair value of the underlying assets.
Effective October 1, 1998, this agreement was fully transitioned to a
coinsurance arrangement and this business along with the Company's direct
domestic individual non-participating life insurance business was sold to
Lincoln. (Refer to note 2).
The operating results of the domestic individual life business are presented
as Discontinued Operations. Premiums of $336.3 million, $176.7 million and
$25.3 million and current and future benefits of $341.1 million, $183.9
million and $39.5 million, were assumed in 1998, 1997 and 1996,
respectively. Investment income of $17.0 million, $37.5 million and $44.1
million was generated from the reinsurance loan to affiliate for the years
ended December 31, 1998, 1997 and 1996, respectively.
Prior to the sale of the domestic individual life insurance business to
Lincoln on October 1, 1998, the Company's retention limit per individual
life was $2.0 million and amounts in excess of this limit, up to a maximum
of $8.0 million on any new individual life business was reinsured with Aetna
Life on a yearly renewable term basis. Premium amounts related to this
agreement were $2.0 million, $5.9 million and $5.2 million for 1998, 1997
and 1996, respectively. This agreement was terminated effective October 1,
1998.
Effective October 1, 1997, the Company entered into a reinsurance agreement
with Aetna Life to assume amounts in excess of $0.2 million for certain of
its participating life insurance, on a yearly
53
Notes to Consolidated Financial Statements (continued)
10. Related Party Transactions (continued)
renewable term basis. Premium amounts related to this agreement were $4.4
million and $0.7 million in 1998 and 1997, respectively. The business
assumed under this agreement was retroceded to Lincoln effective October 1,
1998.
On December 16, 1988, the Company assumed $25.0 million of premium revenue
from Aetna Life for the purchase and administration of a life contingent
single premium variable payout annuity contract. In addition, the Company is
also responsible for administering fixed annuity payments that are made to
annuitants receiving variable payments. Reserves of $87.8 million and $32.5
million were maintained for this contract as of December 31, 1998 and 1997,
respectively.
Capital Transactions
--------------------
The Company received a capital contribution of $9.3 million and $10.4
million in cash from HOLDCO in 1998 and 1996, respectively. The Company
received no capital contributions in 1997.
The Company paid $553.0 million, $17.3 million and 3.5 million in cash
dividends to HOLDCO in 1998, 1997 and 1996, respectively. Additionally, in
1998, the Company accrued $206.0 million in dividends. (Refer to Note 6)
Other
-----
Premiums due and other receivables include $1.6 million and $37.0 million
due from affiliates in 1998 and 1997, respectively. Other liabilities
include $2.2 million and $1.2 million due to affiliates for 1998 and 1997,
respectively.
As of December 31, 1998, Aetna transferred to the Company $0.7 million based
on its decision not to settle state tax liabilities for the years 1998 and
1997. The amount transferred as of December 31, 1997 was $2.5 million. This
amount has been reported as an other change in retained earnings.
Substantially all of the administrative and support functions of the Company
are provided by Aetna and its affiliates. The financial statements reflect
allocated charges for these services based upon measures appropriate for the
type and nature of service provided.
11. Reinsurance
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln for $1 billion in cash. The transaction is generally in
the form of an indemnity reinsurance arrangement, under which Lincoln
contractually assumed from the Company certain policyholder liabilities and
obligations, although the Company remains directly obligated to
policyholders. (Refer to note 2)
Effective January 1, 1998, 90% of the mortality risk on substantially all
individual universal life product business written from June 1, 1991 through
October 31, 1997 was reinsured externally. Beginning November 1, 1997, 90%
of new business written on these products was reinsured externally.
Effective October 1, 1998 this agreement was assigned from the third party
reinsurer to Lincoln.
54
Notes to Consolidated Financial Statements (continued)
11. Reinsurance (continued)
The following table includes premium amounts ceded/assumed to/from
affiliated companies as discussed in Note 10 above.
Ceded to Assumed
Direct Other from Other Net
(Millions) Amount Companies Companies Amount
------------------------------------------------------------------------------------
1998
----
Premiums:
Discontinued Operations $166.8 $165.4 $340.6 $342.0
Accident and Health Insurance 16.3 16.3 -- --
Annuities 80.8 2.9 1.5 79.4
------------------------------------------------------------------------------------
Total earned premiums $263.9 $184.6 $342.1 $421.4
====================================================================================
1997
----
Premiums:
Discontinued Operations $ 35.7 $ 15.1 $177.4 $198.0
Accident and Health Insurance 5.6 5.6 -- --
Annuities 67.9 -- 1.2 69.1
------------------------------------------------------------------------------------
Total earned premiums $109.2 $ 20.7 $178.6 $267.1
====================================================================================
1996
----
Premiums:
Discontinued Operations $ 34.6 $ 11.2 $ 25.3 $ 48.7
Accident and Health Insurance 6.3 6.3 -- --
Annuities 84.3 -- 0.6 84.9
------------------------------------------------------------------------------------
Total earned premiums $125.2 $ 17.5 $ 25.9 $133.6
====================================================================================
55
Notes to Consolidated Financial Statements (continued)
12. Segment Information
Prior to October 1, 1998, the Company's operations were reported through two
major business segments: Financial Services and Individual Life Insurance
(now Discontinued Operations). Summarized financial information for the
Company's principal operations was as follows:
(4) (4)
Financial Discontinued
1998 (Millions) Services Operations Other Total
----------------------------------------------------------------------------------------------------
Revenue from external customers $ 433.3 -- -- $ 433.3
Net investment income 877.6 -- -- 877.6
----------------------------------------------------------------------------------------------------
Total revenue excluding realized
capital gains $ 1,310.9 -- -- $ 1,310.9
====================================================================================================
Amortization of deferred policy
acquisition costs $ 106.7 -- -- $ 106.7
----------------------------------------------------------------------------------------------------
Income taxes $ 57.7 $ (10.3) $ 47.4
----------------------------------------------------------------------------------------------------
Operating earnings (1) $ 151.5 -- -- $ 151.5
Unusual items (2) -- -- $ (19.2) (19.2)
Realized capital gains, net of tax 7.3 -- -- 7.3
----------------------------------------------------------------------------------------------------
Income from continuing operations $ 158.8 -- $ (19.2) $ 139.6
Discontinued operations, net of tax:
Income from operations -- $ 61.8 -- 61.8
Gain on sale -- 59.0 -- 59.0
----------------------------------------------------------------------------------------------------
Net income $ 158.8 $ 120.8 $ (19.2) $ 260.4
====================================================================================================
Segment assets $43,458.6 $3,820.2 -- $47,278.8
----------------------------------------------------------------------------------------------------
Expenditures for long-lived assets (3) -- -- $ 5.3 $ 5.3
----------------------------------------------------------------------------------------------------
(1) Operating earnings are comprised of net income excluding net realized
capital gains and any unusual items.
(2) Unusual items excluded from operating earnings include an after-tax
severance benefit of $1.6 million and after-tax Year 2000 costs of
$20.8 million.
(3) Expenditures of long-lived assets represents additions to property and
equipment not allocable to business segments.
(4) Financial Services products include annuity contracts and Discontinued
Operations include life insurance products. (Refer to Note 1)
56
Notes to Consolidated Financial Statements (continued)
12. Segment Information (Continued)
(3) (3)
Financial Discontinued
1997 (Millions) Services Operations Other Total
----------------------------------------------------------------------------------------------
Revenue from external customers $ 369.4 -- -- $ 369.4
Net investment income 878.8 -- -- 878.8
----------------------------------------------------------------------------------------------
Total revenue excluding realized
capital gains $ 1,248.2 -- -- $ 1,248.2
==============================================================================================
Amortization of deferred policy
acquisition costs $ 82.8 -- -- $ 82.8
----------------------------------------------------------------------------------------------
Income taxes $ 50.7 -- -- $ 50.7
----------------------------------------------------------------------------------------------
Operating earnings (1) $ 118.3 -- -- $ 118.3
Realized capital gains, net of tax 19.2 -- -- 19.2
----------------------------------------------------------------------------------------------
Income from continuing operations $ 137.5 -- -- $ 137.5
Discontinued Operations, net of tax:
Income from operations -- $ 67.8 -- 67.8
----------------------------------------------------------------------------------------------
Net Income $ 137.5 $ 67.8 -- $ 205.3
==============================================================================================
Segment assets $36,638.8 $3,507.6 -- $40,146.4
----------------------------------------------------------------------------------------------
Expenditures for long-lived assets (2) -- -- $9.6 $ 9.6
----------------------------------------------------------------------------------------------
(1) Operating earnings are comprised of net income excluding net realized
capital gains and any unusual items.
(2) Expenditures for long-lived assets represents additions to property and
equipment not allocable to business segments.
(3) Financial Services products include annuity contracts and Discontinued
Operations include life insurance products. (Refer to Note 1)
57
Notes to Consolidated Financial Statements (continued)
12. Segment Information (Continued)
(3) (3)
Financial Discontinued
1996 (Millions) Services Operations Other Total
-----------------------------------------------------------------------------------------------------
Revenue from external customers $ 325.5 -- -- $ 325.5
Net investment income 852.6 -- -- 852.6
-----------------------------------------------------------------------------------------------------
Total revenue excluding realized capital
gains $1,178.1 -- -- $1,178.1
=====================================================================================================
Amortization of deferred policy acquisition
costs $ 28.0 -- -- $ 28.0
-----------------------------------------------------------------------------------------------------
Income taxes $ 35.6 -- $ (4.9) $ 30.7
-----------------------------------------------------------------------------------------------------
Operating earnings (losses) (1) $ 83.2 -- -- $ 83.2
Unusual items (2) -- -- (9.1) (9.1)
Realized capital gains, net of tax: 11.1 -- -- 11.1
-----------------------------------------------------------------------------------------------------
Income from continuing operations $ 94.3 $ (9.1) $ 85.2
Discontinued operations, net of tax
Income from operations -- $55.9 -- 55.9
-----------------------------------------------------------------------------------------------------
Net income (loss) $ 94.3 $55.9 $ (9.1) $ 141.1
=====================================================================================================
(1) Operating earnings are comprised of net income excluding net realized
capital gains and any unusual items.
(2) Unusual items excluded from operating earnings represent $9.1 million
after-tax corporate facilities and severance charges not directly
allocable to the business segments.
(3) Financial Services products include annuity contracts and Discontinued
Operations include life insurance products. (Refer to Note 1)
13. Commitments and Contingent Liabilities
Commitments
-----------
Through the normal course of investment operations, the Company commits to
either purchase or sell securities or money market instruments at a
specified future date and at a specified price or yield. The inability of
counterparties to honor these commitments may result in either higher or
lower replacement cost. Also, there is likely to be a change in the value of
the securities underlying the commitments. At December 31, 1998 and 1997,
the Company had commitments to purchase investments of $68.7 million and
$38.7 million, respectively. The fair value of the investments at December
31, 1998 and 1997 approximated $68.9 million and $39.0 million,
respectively.
Litigation
----------
The Company is involved in numerous lawsuits arising, for the most part, in
the ordinary course of its business operations. While the ultimate outcome
of litigation against the Company cannot be determined at this time, after
consideration of the defenses available to the Company and any related
reserves established, it is not expected to result in liability for amounts
material to the financial condition of the Company, although it may
adversely affect results of operations in future periods.
58
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Omitted pursuant to General Instruction I(2) of Form 10-K.
Item 11. Executive Compensation.
Omitted pursuant to General Instruction I(2) of Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Omitted pursuant to General Instruction I(2) of Form 10-K.
Item 13. Certain Relationships and Related Transactions.
Omitted pursuant to General Instruction I(2) of Form 10-K.
PART IV
Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on
Form 8-K.
(a) The following documents are filed as part of this report:
1. Financial statements. See Item 8 on Page 27.
2. Financial statement schedules. See Index to Consolidated Financial
Statement Schedules on Page 64.
3. Exhibits:
3(i)(a) Certificate of Incorporation
Incorporated herein by reference to post-effective amendment
No. 1 to Registration Statement on Form S-1 (File No. 33-60477)
as filed on April 15, 1996.
3(i)(b) Amendment of Certificate of Incorporation of Aetna Life Insurance
and Annuity Company Incorporated herein by reference to
Post-Effective Amendment No. 12 to Registration Statement on
Form N-4 (File No. 33-75964) as filed on February 11, 1997.
3(ii) By-Laws, as amended September 17, 1997.
Incorporated herein by reference to post-effective amendment
No. 12 to Registration Statement on Form N-4 (File No. 33-91846)
as filed on October 30, 1997.
59
Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on
Form 8-K. (continued)
4. Instruments Defining the Rights of Security Holders, Including
Indentures (Annuity Contracts)
Incorporated by reference to Post-Effective Amendment No. 14 to
Registration Statement on Form N-4 (File No. 33-75964), as filed on
July 29, 1997.
Incorporated by reference to Post-Effective Amendment No. 6 to
Registration Statement on Form N-4 (File No. 33-75980), as filed on
February 12, 1997.
Incorporated by reference to Post-Effective Amendment No. 12 to
Registration Statement on Form N-4 (File No. 33-75964), as filed on
February 11, 1997.
Incorporated by reference to Post-Effective Amendment No. 5 to
Registration Statement on Form N-4 (File No. 33-75986), as filed on
April 12, 1996.
Incorporated by reference to Post-Effective Amendment No. 12 to
Registration Statement on Form N-4 (File No. 333-01107), as filed on
February 4, 1999.
Incorporated by reference to Post-Effective Amendment No. 4 to
Registration Statement on Form N-4 (File No. 33-75988), as filed on
April 15, 1996.
Incorporated by reference to Post-Effective Amendment No. 3 to
Registration Statement on Form N-4 (File No. 33-81216), as filed on
April 7, 1996.
Incorporated by reference to Post-Effective Amendment No. 3 to
Registration Statement on Form N-4 (File No. 33-91846), as filed on
April 15, 1996.
Incorporated by reference to Post-Effective Amendment No. 6 to
Registration Statement on Form N-4 (File No. 33-91846), as filed on
August 6, 1996.
Incorporated by reference to Registration Statement on Form N-4 (File
No. 333-01107), as filed on February 21, 1996.
Incorporated by reference to Post-Effective Amendment No. 12 to
Registration Statement on Form N-4 (File No. 33-75982), as filed on
February 20, 1997.
Incorporated by reference to Post-Effective Amendment No. 7 to
Registration Statement on Form N-4 (File No. 33-75992), as filed on
February 13, 1997.
Incorporated by reference to Post-Effective Amendment No. 6 to
Registration Statement on Form N-4 (File No. 33-75974), as filed on
February 28, 1997.
Incorporated by reference to Post-Effective Amendment No. 15 to
Registration Statement on Form N-4 (File No. 33-75962), as filed on
April 17, 1996.
60
Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on
Form 8-K. (continued)
Incorporated by reference to Post-Effective Amendment No. 14 to
Registration Statement on Form N-4 (File No. 33-75962), as filed on
April 17, 1998.
Incorporated by reference to Post-Effective Amendment No. 6 to
Registration Statement on Form N-4 (File No. 33-75982), as filed on
April 22, 1996.
Incorporated by reference to Post-Effective Amendment No. 8 to
Registration Statement on Form N-4 (File No. 33-75980), as filed on
August 19, 1997.
Incorporated by reference to Registration Statement on Form N-4 (File
No. 333-56297), as filed on June 8, 1998.
Incorporated by reference to Post-Effective Amendment No. 3 to
Registration Statement on Form N-4 (File No. 33-79122), as filed on
August 16, 1995.
Incorporated by reference to Post-Effective Amendment No. 32 to
Registration Statement on Form N-4 (File No. 33-34370), as filed on
December 16, 1997.
Incorporated by reference to Post-Effective Amendment No. 30 to
Registration Statement on Form N-4 (File No. 33-34370), as filed on
September 29, 1997.
Incorporated by reference to Post-Effective Amendment No. 26 to
Registration Statement on Form N-4 (File No. 33-34370), as filed on
February 21, 1997.
Incorporated by reference to Post-Effective Amendment No. 35 to
Registration Statement on Form N-4 (File No. 33-34370), as filed on
April 17, 1998.
Incorporated by reference to Post-Effective Amendment No. 1 to
Registration Statement on Form N-4 (File No. 33-87932), as filed on
September 15, 1995.
Incorporated by reference to Post-Effective Amendment No. 8 to
Registration Statement on Form N-4 (File No. 33-79122), as filed on
April 17, 1998.
Incorporated by reference to Post-Effective Amendment No. 7 to
Registration Statement on Form N-4 (File No. 33-79122), as filed on
April 22, 1997.
10 Material Contracts (Management contracts / compensatory plans or
arrangements)
The Aetna Inc. Annual Incentive Plan, incorporated by reference to
Aetna Inc.'s Registration Statement on Form S-4 (Registration No.
333-5791) filed on June 12, 1996.*
The Supplemental Pension Benefit Plan for Certain Employees of Aetna
Services, Inc., incorporated herein by reference to Aetna Inc.'s Form
10-Q filed on October 25, 1996.*
61
Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on
Form 8-K. (continued)
Amendment No. 1 dated as of December 31, 1996 to the Supplemental
Pension Benefit Plan for Certain Employees of Aetna Services,
Inc.--Incorporated herein by reference to Aetna Inc.'s Form 10-Q as
filed on May 6, 1997.*
Amendment No. 2 dated as of February 28, 1997 to the Supplemental
Pension Benefit Plan of Certain Employees of Aetna Services,
Inc.--Incorporated herein by reference to Aetna Inc.'s Form 10-Q as
filed on May 6, 1997.*
The Aetna Inc. 1996 Stock Incentive Plan, incorporated herein by
reference to Aetna Inc.'s Registration Statement on Form S-4
(Registration Statement No. 333-5791) filed on June 12, 1996.*
Amendment dated as of February 27, 1998 to the Aetna Inc. 1996 Stock
Incentive Plan, incorporated by reference to Aetna Inc.'s Form 10-Q,
as filed on May 6, 1998.
Employment Agreement, dated as of December 19, 1995 between Aetna
Services, Inc. and Daniel P. Kearney, incorporated herein by reference
to Aetna Services, Inc.'s 1995 Form 10-K*
Amendment dated as of July 22, 1996 to Employment Agreement dated as
of December 19, 1995 between Aetna Services, Inc. and Daniel P.
Kearney, incorporated herein by reference to Aetna Inc.'s Form 10-Q
filed on May 6, 1997*
Amendment dated as of September 8, 1997 to Employment Agreement dated
as of December 19, 1995 between Aetna Services, Inc. and Daniel P.
Kearney--Incorporated herein by reference to Aetna Inc.'s Form 10-Q
filed on November 4, 1997*
Employment Agreement, dated as of December 21, 1995, by and between
Aetna Services, Inc. and Thomas McInerney, as amended--Incorporated
herein by reference to Aetna Inc.'s Form 10-K filed on March 3, 1998.*
Amended and Restated Asset Purchase Agreement by and among Aetna Life
Insurance Company, Aetna Life Insurance and Annuity Company, The
Lincoln National Life Insurance Company and Lincoln Life & Annuity
Company of New York, dated May 21, 1998, incorporated herein by
reference to the Company's Form 10-Q filed on August 8, 1998. (The
Company will provide to the Securities and Exchange Commission a copy
of omitted schedules or similar attachments upon request.)
* Management contract or compensatory plan or arrangement
62
Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on
Form 8-K. (continued)
21 Subsidiaries of the Registrant
Incorporated by reference to Exhibit Item 26 of Post-Effective
Amendment No. 2 to Registration Statement on Form N-4 (File Number
333-56297) as filed on December 14, 1998.
24 Power of Attorney
(Filed herein immediately after Signature page.)
27 Financial Data Schedules
Exhibits other than these listed are omitted because they are not
required or not applicable.
(b) Reports on Form 8-K.
None.
63
Index to Consolidated Financial Statement Schedules
Page
----
Independent Auditors' Report .......................................... 65
I. Summary of Investments--Other than Investments in Affiliates as
of December 31, 1998 ............................................. 66
III. Supplementary Insurance Information as of and for the years
ended December 31, 1998, 1997, 1996 .............................. 67
IV. Reinsurance for the years ended December 31, 1998, 1997, 1996 ...... 69
Schedules other than those listed above are omitted because they are not
required or are not applicable.
64
Independent Auditors' Report
The Shareholder and Board of Directors
Aetna Life Insurance and Annuity Company:
Under date of February 3, 1999, we reported on the consolidated balance sheets
of Aetna Life Insurance and Annuity Company and Subsidiary as of December 31,
1998 and 1997, and the related consolidated statements of income, changes in
shareholder's equity and cash flows for each of the years in the three-year
period ended December 31, 1998, as included herein. In connection with our
audits of the aforementioned consolidated financial statements, we also audited
the related consolidated financial statement schedules as listed in the
accompanying index. These consolidated financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statement schedules based on our
audits.
In our opinion, such consolidated financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as
a whole, present fairly, in all material respects, the information set forth
therein.
/s/ KPMG LLP
Hartford, Connecticut
February 3, 1999
65
Schedule I
Summary of Investments--Other than Investments in Affiliates
As of December 31, 1998
(in millions)
Amount at
Which Shown
in the
Type of Investment Cost Value* Balance Sheet
------------------ ----- ------ -------------
Debt Securities:
U.S. government and government
agencies and authorities $ 718.9 $ 779.1 $ 779.1
States, municipalities and political
subdivisions .3 .3 .3
U.S. corporate securities 5,299.6 5,514.2 5,514.2
Foreign securities (1) 1,165.8 1,208.8 1,208.8
Residential mortgage-backed securities 2,551.5 2,696.3 2,696.3
Commercial/Multifamily mortgage-
backed securities 1,114.9 1,136.0 1,136.0
Other asset-backed securities 719.3 732.5 732.5
--------- --------- ---------
Total debt securities 11,570.3 12,067.2 12,067.2
Equity securities:
Non-redeemable preferred stock 202.6 203.3 203.3
Investment in affiliated mutual funds 96.8 100.1 100.1
Common stock 1.0 2.0 2.0
--------- --------- ---------
Total equity securities 300.4 305.4 305.4
Short-term investments 47.9 47.9 47.9
Mortgage loans 12.7 12.3 12.7
Policy loans 292.2 292.2 292.2
--------- --------- ---------
Total investments $12,223.5 $12,725.0 $12,725.4
========= ========= =========
*See Notes 1 and 3 to the Consolidated Financial Statements.
(1) The term "foreign" includes foreign governments, foreign political
subdivisions, foreign public utilities and all other bonds of foreign
issuers. All of the Company's foreign securities are denominated in U.S.
dollars.
66
Schedule III
Supplementary Insurance Information
As of and for the years ended December 31, 1998, 1997 and 1996
(in millions)
Policy-
Deferred Unpaid holders'
policy Future claims funds left
acquisition policy and claim Unearned with the
Segment costs benefits expenses premiums (1) Company
- -----------------------------------------------------------------------------------------------
1998
- ----
Financial Services $ 864.0 $ 878.0 $ 0.3 $ -- $11,295.1
Discontinued
Operations (2) -- 2,936.8 $ 18.5 1.1 10.5
--------------------------------------------------------------------
Total $ 864.0 $ 3,814.8 $ 18.8 $ 1.1 $11,305.6
====================================================================
1997
- ----
Financial Services $ 799.6 $ 948.0 $ 0.8 $ -- $11,116.8
Discontinued
Operations (2) 855.0 2,814.6 37.2 1.1 26.7
--------------------------------------------------------------------
Total $1,654.6 $ 3,762.6 $ 38.0 $ 1.1 $11,143.5
====================================================================
1996
- ----
Financial Services $ 715.2 $ 960.0 $ 0.5 $ -- $10,648.5
Discontinued
Operations (2) 800.1 2,655.8 28.4 1.2 15.2
--------------------------------------------------------------------
Total $1,515.3 $ 3,615.8 $ 28.9 $ 1.2 $10,663.7
====================================================================
Notes to Schedule III:
(1) Included in future policy benefits on the Company's Consolidated Balance
Sheets.
(2) Domestic individual life insurance business.
67
Schedule III (continued)
Supplementary Insurance Information
As of and for the years ended December 31, 1998, 1997 and 1996
(in millions)
Amortization
of deferred
Net Current policy Other
Premium investment Other and future acquisition operating
Segment revenue income (3) income (4) benefits costs expenses (5)
- -------------------------------------------------------------------------------------------------
1998
- ----
Financial Services $ 79.4 $877.6 $364.3 $714.4 $106.7 $281.2
============================================================================
Discontinued
Operations (2) $342.0 $146.1 $164.1 $482.4 $ 34.7 $ 41.3
============================================================================
1997
- ----
Financial Services $ 69.1 $878.8 $330.0 $720.4 $ 82.8 $286.5
============================================================================
Discontinued
Operations (2) $198.0 $201.7 $220.7 $407.4 $ 45.6 $ 60.9
============================================================================
1996
- ----
Financial Services $ 84.9 $852.6 $257.6 $728.3 $ 28.0 $308.9
============================================================================
Discontinued
Operations (2) $ 48.7 $193.0 $204.0 $240.3 $ 41.8 $ 80.6
============================================================================
Notes to Schedule III (continued):
(2) Domestic individual life insurance business.
(3) The allocation of net investment income is based upon the investment year
method or specific identification of certain portfolios within specific
segments.
(4) Includes net realized capital gains.
(5) Includes operating expenses and severance and facilities charges. Excludes
Year 2000 costs and any effect of the corporate facilities and severance
charge recorded in 1996 which is not directly allocable to the Financial
Services and Individual Life Insurance segments.
68
Schedule IV
Reinsurance
For the years ended December 31, 1998, 1997 and 1996
(Millions)
Percentage
Ceded to Assumed of Amount
Direct Other from Other Net Assumed
Amount Companies Companies Amount to Net
----------------------------------------------------------------------
1998
- ----
Life insurance in force --
Discontinued Operations (1) $42,882.9 $45,381.4 $2,505.4 $ 6.9 --
======================================================
Premiums:
Discontinued Operations (1) $ 166.8 $ 165.4 $ 340.6 $ 342.0 99.6%
Accident and Health Insurance 16.3 16.3 -- -- --
Annuities 80.8 2.9 1.5 79.4 1.9%
------------------------------------------------------
Total earned premiums $ 263.9 $ 184.6 $ 342.1 $ 421.4 81.2%
======================================================
1997
- ----
Life insurance in force --
Discontinued Operations (1) $42,133.4 $ 3,547.4 $2,006.2 $40,592.2 4.9%
======================================================
Premiums:
Discontinued Operations (1) $ 35.7 $ 15.1 $ 177.4 $ 198.0 89.6%
Accident and Health Insurance 5.6 5.6 -- -- --
Annuities 67.9 -- 1.2 69.1 1.7%
------------------------------------------------------
Total earned premiums $ 109.2 $ 20.7 $ 178.6 $ 267.1 66.9%
======================================================
1996
- ----
Life insurance in force --
Discontinued Operations (1) $40,276.3 $ 2,416.0 $2,076.3 $39,936.6 5.2%
======================================================
Premiums:
Discontinued Operations (1) $ 34.6 $ 11.2 $ 25.3 $ 48.7 52.0%
Accident and Health Insurance 6.3 6.3 -- -- --
Annuities 84.3 -- 0.6 84.9 0.7%
------------------------------------------------------
Total earned premiums $ 125.2 $ 17.5 $ 25.9 $ 133.6 19.4%
======================================================
(1) The Company's domestic individual life insurance business was sold to
Lincoln on October 1, 1998. See "Overview" in Management's Analysis of the
Results of Operations and Note 2 of Notes to Consolidated Financial
Statements for additional information on the sale.
69
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
AETNA LIFE INSURANCE AND ANNUITY COMPANY
(Registrant)
Date March 25, 1999 By /s/ Deborah Koltenuk
-------------- --------------------
Deborah Koltenuk
Vice President, Treasurer and
Corporate Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 25, 1999.
Signature Title
*
- ----------------------------------- President and Director
Thomas J. McInerney (Principal Executive Officer)
*
- ----------------------------------- Senior Vice President, Chief Financial Officer,
Catherine H. Smith and Director (Principal Financial Officer)
*
- -----------------------------------
Shaun P. Mathews Senior Vice President and Director
/s/ Deborah Koltenuk Vice President, Treasurer and Corporate
- -----------------------------------
Deborah Koltenuk Controller (Principal Accounting Officer)
* By: /s/ Kirk P. Wickman
--------------------
Kirk P. Wickman
Vice President, General Counsel and Corporate Secretary
70
POWER OF ATTORNEY
We, the undersigned directors and officers of Aetna Life Insurance and Annuity
Company, hereby severally constitute and appoint Kirk P. Wickman and Deborah
Koltenuk and each of them individually, our true and lawful attorneys, with
full power to them and each of them to sign for us, and in our names and in the
capacities indicated below, the 1998 Form 10-K and any and all amendments
thereto to be filed with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, hereby ratifying and confirming our signatures
as they may be signed by our said attorney to the Form 10-K and any and all
amendments thereto.
WITNESS our hands and common seal on this 25th day of March, 1999.
Signature Title
/s/ Thomas J. McInerney President and Director
- ----------------------------------- (Principal Executive Officer)
Thomas J. McInerney
/s/ Catherine H. Smith Senior Vice President, Chief Financial Officer,
- ----------------------------------- and Director (Principal Financial Officer)
Catherine H. Smith
/s/ Shaun P. Mathews
- -----------------------------------
Shaun P. Mathews Senior Vice President and Director
/s/ Deborah Koltenuk Vice President, Treasurer and Corporate
- ----------------------------------- Controller (Principal Accounting Officer)
Deborah Koltenuk
71
SECRETARY CERTIFICATE
I, Rose-Marie DeRensis, the duly appointed Assistant Corporate Secretary of
Aetna Life Insurance and Annuity Company (the "Company"), hereby certify that
the attached resolutions titled "Company Name, Authority to Sign (Duplicate
Corporate Seals)" adopted by the Board of Directors on June 22, 1995, are
currently in full force and effect, and have not been amended, restated, or
superseded.
IN WITNESS WHEREOF, I have affixed my name as Assistant Corporate Secretary and
have caused the corporate seal of said Company to be hereunto affixed this 25th
day of March, 1999.
s/ Rose-Marie DeRensis
--------------------------------------------
(corporate seal) Rose-Marie DeRensis
Assistant Corporate Secretary
Aetna Life Insurance and Annuity Company
72
AETNA LIFE INSURANCE AND ANNUITY COMPANY
COMPANY NAME, AUTHORITY TO
SIGN (DUPLICATE CORPORATE SEALS)
June 22, 1995
- -------------
RESOLVED: That the following officers:
President
Senior Vice President
Vice President
General Counsel
Corporate Secretary
Treasurer
Assistant Corporate Secretary
(1) are hereby severally authorized to sign in the Company's name:
(a) insurance contracts of every type and description which the Company
is authorized to write;
(b) agreements relating to the purchase, sale, or exchange of securities
including any consents and modifications given or made under such
agreements;
(c) conveyances and leases of real estate or any interest therein
including any modifications thereof;
(d) assignments and releases of mortgages and other liens, claims or
demands;
(e) any other written instrument which they are authorized to approve in
the normal course of Company business; and
(f) any other written instrument when specifically authorized by the
Board of Directors or the President;
and are further severally authorized (i) to delegate all or any part of
the foregoing authority to one or more officers, employees or agents of
this Company, provided that each such delegation is in writing and a copy
thereof is filed in the Office of the Corporate Secretary, or (ii) to
designate any attorney at law representing this Company on a matter under
their direction, to so sign this Company's name;
(2) are hereby severally authorized to possess the Company's duplicate seals
and to affix the same to items (a) through (f) above;
and are further severally authorized to designate any Company officer
under their direction to possess and to so affix the Company's duplicate
seals; and
that the Senior Vice President, Investments is hereby authorized to
designate any officer, employee or agent of this Company under his
direction to sign the Company's name and to affix the Company's seal to
any and all documents required in connection with any investment
transaction in which the Company has an interest.
73