ITEM 1. BUSINESS
GENERAL DESCRIPTION
Anchor National Life Insurance Company (the "Company"), is an indirect wholly owned subsidiary of SunAmerica Inc. (the "Parent"), a diversified financial services company specializing in retirement savings and investment products and services. The Company ranks among the largest U.S. issuers of variable annuities. Complementing these annuity operations are the Company's asset management operations and broker-dealer operations. At September 30, 1996, the Company held $11.34 billion of assets, consisting of $9.20 billion of assets owned by the Company and $2.14 billion of assets managed in mutual funds.
The Company believes that demographic trends have produced strong consumer demand for long-term, investment-oriented products. According to U.S. Census Bureau projections, the number of individuals ages 45 to 64 will grow from 46 million to 60 million during the 1990s, making this age group the fastest-growing segment of the U.S. population. Between 1985 and 1995, annual industry premiums from annuities and fund deposits increased from $53 billion to $159 billion. During the same period, annual industry sales of mutual funds, excluding money market accounts, rose from $114 billion to $477 billion.
Focusing its operations on this expanding market, the Company specializes in the sale of tax-deferred long-term savings products and investments through its life insurance operations and its asset management and broker-dealer subsidiaries. The Company markets fee-generating variable annuities, guaranteed investment contracts ("GICs") and mutual funds. Its annuity products are distributed through a broad spectrum of financial services distribution channels, including independent registered representatives of the Company's broker-dealer subsidiary, affiliated and unaffiliated broker-dealers and banks and financial institutions.
The Company maintains its principal executive offices at 1 SunAmerica Center, Los Angeles, California 90067-6022, telephone (310) 772-6000. The Company has no employees; however, employees of the Parent and its other subsidiaries perform various services for the Company. The Parent has approximately 1,600 employees, approximately 880 of whom perform services for the Company as well as for certain of its affiliates.
As consumer demand for investment-oriented products has grown, the Company has broadened the array of fee income producing products and services it offers and has in recent years significantly increased its fee income. Over the last several years, the Company has enhanced its marketing of variable annuities and mutual funds. Fee income has also expanded through the receipt of broker-dealer net retained commissions. The Company's fee-generating businesses entail no portfolio credit risk and require significantly less capital support than its fixed-rate business, which generates net investment income.
For the year ended September 30, 1996, the Company's net investment income (including net realized investment losses) and fee income by primary product line or service are as follows:
NET INVESTMENT AND FEE INCOME
Primary product or Amount Percent service --------- --------- ------------------------- (In thousands)
Net investment income (including net realized investment losses) $ 43,488 21.3% Fixed-rate products --------- ----- Fee income: Variable annuity fees 103,970 50.9 Variable annuities Net retained commissions 31,548 15.4 Broker-dealer sales Asset management fees 25,413 12.4 Mutual funds --------- ----- Total fee income 160,931 78.7 --------- ----- Total $ 204,419 100.0% ========= ===== For financial information on the Company's business segments, see Part IV - "Notes to Consolidated Financial Statements - Note 10 - Business Segments."
LIFE INSURANCE OPERATIONS
Founded in 1965, the Company is an Arizona-chartered company licensed in 49 states and the District of Columbia, the Company specializes in the sale of flexible premium variable annuities and GICs. It has a "AA-" (Excellent) claims-paying ability rating from Standard & Poor's Corporation ("S&P"), a "AA" (Very High) rating from Duff & Phelps, Inc. ("D&P") and an "A2" (Good) rating from Moody's Investors Service ("Moody's"). It also has an "A+" (Superior) rating from industry analyst A.M. Best Company. The Company specializes in the sale of flexible premium variable annuities, including Polaris, the Company's flagship variable annuity, which offers investors nine money management groups, 22 variable annuity portfolios and five fixed-rate account options. The Company ranks among the largest issuers of variable annuities in the nation, according to the latest published industry data.
Benefitting from continued strong demographic growth of the retirement savings market, industry sales of tax-deferred savings products have represented, for a number of years, a significantly larger source of new premiums for the U.S. life insurance industry than have traditional life insurance products. Recognizing the growth potential of this market, the Company focuses its life insurance operations on the sale of annuities and GICs.
Because of its focus on annuity products, which generally have more contractholder transactions than traditional life insurance products, the Company utilizes computer-driven systems that employ optical disk imaging and artificial intelligence, in lieu of paper-intensive life insurance processing
procedures. The Company believes its service support and associated cost structure to be among the most competitive in the industry.
The Company markets its variable annuities through the following distribution channels: (i) independent registered representatives of SunAmerica Securities, Inc. and Advantage Capital Corp., which are indirect wholly owned subsidiaries of the Parent, and Royal Alliance Associates, Inc. ("Royal Alliance"), which is an indirect wholly owned subsidiary of the Company; and (ii) approximately 600 other securities firms and financial institutions. Approximately 30,000 independent sales representatives nationally are licensed to sell the Company's variable annuity products.
The Company markets its GICs principally through direct marketing to banks, municipalities, asset management firms and direct plan sponsors or through intermediaries, such as managers or consultants servicing these groups.
FIXED ANNUITIES AND GICs
The Company services a number of fixed-rate products, including fixed- rate annuities issued in prior years and fixed-rate account options of its variable annuity contracts. Although the Company's contracts remain in force an average of seven to ten years, a majority (approximately 81% at September 30, 1996) reprice annually at discretionary rates determined by the Company. In repricing, the Company takes into account yield characteristics of its investment portfolio, annuity surrender assumptions and competitive industry pricing.
During 1995 the Company began augmenting its retail annuity sales effort with the marketing of institutional products. At September 30, 1996, the Company had $410.2 million of fixed-maturity, variable-rate GIC obligations that reprice periodically based upon certain defined indexes. Of the total GIC portfolio at September 30, 1996, approximately 83% was sold to asset management firms, including bank trust departments, and 17% was sold to banks. The one new GIC contract sold by the Company in 1996 amounted to $75.0 million, compared to an average new GIC contract size of $34.4 million in 1995.
The Company designs its fixed-rate products and conducts its investment operations in order to closely match the duration of the assets in its investment portfolio to its annuity and GIC obligations. The Company seeks to achieve a predictable spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed-rate securities. The Company's fixed-rate products incorporate surrender charges or other limitations on when contracts can be surrendered for cash to encourage persistency. Approximately 63% of the Company's fixed annuity and GIC reserves had surrender penalties or other restrictions at September 30, 1996.
VARIABLE ANNUITIES
The variable annuity products of the Company offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as guaranteed fixed-rate account options. The Company earns fee income through the sale, administration and management of the variable account options of its variable annuity products. The Company also earns investment income on monies allocated to the fixed-rate account options of these products. Variable
annuities offer retirement planning features and surrender charges similar to those offered by fixed annuities, but differ in that the annuity holder's rate of return is generally dependent upon the investment performance of the particular equity, fixed-income, money market or asset allocation funds selected by the contractholder. Because the investment risk is borne by the customer in all but the fixed-rate account options, these products require significantly less capital support than fixed annuities. The average new variable annuity contract sold by the Company amounted to approximately $37,000 in 1996.
INVESTMENT OPERATIONS
The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed maturities that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed maturities are priced over the yield curve and general competitive conditions within the industry. The Company manages most of its invested assets internally. Its portfolio strategy is designed to achieve adequate risk- adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety.
As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-maturity assets and liabilities under commonly used stress-test interest rate scenarios. Based on the results of these computer simulations, the investment portfolio has been constructed with a view to maintaining a desired investment spread between the yield on portfolio assets and the rate paid on its reserves under a variety of possible future interest rate scenarios.
For the years ended September 30, 1996, 1995 and 1994, the Company's yields on average invested assets were 7.50%, 7.62% and 8.20%, respectively, before net realized investment losses, and it realized net investment spreads of 2.59%, 2.95% and 3.78%, respectively, on average invested assets. At September 30, 1996, the weighted average life of the Company's investments was approximately five years and the duration was approximately three. Weighted average life is the average time to receipt of all principal, incorporating the effects of scheduled amortization and expected prepayments, weighted by book value. Duration is a common option-adjusted measure for the price sensitivity of a fixed-income portfolio to changes in interest rates. It is the calculation of the relative percentage change in market value resulting from shifts in interest rates, and recognizes the changes in portfolio cashflows resulting from embedded options such as prepayments and bond calls.
The Company's general investment philosophy is to hold fixed maturity assets for long-term investment. Thus, it does not have a trading portfolio. Effective December 1, 1995, pursuant to guidelines issued by the Financial Accounting Standards Board, the Company determined that all of its portfolio of bonds, notes and redeemable preferred stocks (the "Bond Portfolio") is available to be sold in response to changes in market interest rates, changes in prepayment risk, the Company's need for liquidity and other similar factors. Accordingly, the Company no longer classifies a portion of its Bond Portfolio as held for investment.
The following table summarizes the Company's investment portfolio at September 30, 1996:
SUMMARY OF INVESTMENTS
Amortized Percent of cost portfolio --------------- ---------- (In thousands) Fixed maturities: Cash and short-term investments $ 122,058 5.2% U.S. Government securities 311,458 13.3 Mortgage-backed securities 747,653 32.0 Other bonds, notes and redeemable preferred stocks 941,913 40.2 Mortgage loans 98,284 4.2 --------------- ---------- Total 2,221,366 94.9
Real estate 39,724 1.7 Equity securities 2,911 0.1 Other invested assets 77,925 3.3 --------------- ---------- Total investments $ 2,341,926 100.0% =============== ==========
All of the Bond Portfolio (at amortized cost, excluding $9.1 million of redeemable preferred stock) at September 30, 1996 was rated by S&P, Moody's, D&P, Fitch Investor Service, Inc. ("Fitch") or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners ("NAIC") and implemented by either the NAIC or the Company. At September 30, 1996, approximately $1.83 billion (at amortized cost) of the Bond Portfolio was rated investment grade by one or more of these agencies or by the Company or the NAIC, pursuant to applicable NAIC guidelines, including $1.05 billion of U.S. government/agency securities and mortgage-backed securities ("MBSs").
At September 30, 1996, the Bond Portfolio included $160.8 million (fair value, $160.2 million) of bonds not rated investment grade by S&P, Moody's, D&P, Fitch or the NAIC. Based on their September 30, 1996 amortized cost, these non-investment-grade bonds accounted for 1.8% of the Company's total assets and 6.9% of its invested assets.
Senior secured loans ("Secured Loans") are included in the Bond Portfolio and their amortized cost aggregated $200.8 million at September 30, 1996. Secured Loans are senior to subordinated debt and equity, and are secured by assets of the issuer. At September 30, 1996, Secured Loans consisted of loans to 52 borrowers spanning 20 industries.
Mortgage loans aggregated $98.3 million at September 30, 1996 and consisted of 17 first mortgage loans with an average loan balance of approximately $5.8 million, collateralized by properties located in 11 states.
At September 30, 1996, the amortized cost of all investments in default as to the payment of principal or interest totaled $3.1 million (fair value, $2.9 million), which constituted 0.1% of total invested assets at amortized cost.
For more information concerning the Company's investments, including the risks inherent in such investments, see Item 7, "Management Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition and Liquidity".
MUTUAL FUNDS AND INVESTMENT SERVICES
Through its registered investment advisor, SunAmerica Asset Management Corp. ("SunAmerica Asset Management") and its related mutual fund distributor, the Company earns fee income by distributing and managing a diversified family of mutual funds and by providing professional management of individual, corporate and pension plan portfolios. These mutual funds offer investors an array of equity, fixed-income, money market and tax-exempt portfolios. In November 1996, SunAmerica Asset Management introduced its new "Style Select Series," which combines the expertise of three well-respected advisors with similar investment styles in each available portfolio. Founded in 1983 and acquired by the Company in January 1990, SunAmerica Asset Management managed approximately $2.43 billion of assets at September 30, 1996, including mutual fund assets and certain of the variable annuity assets of the Company and its affiliates.
The SunAmerica mutual funds are distributed nationally through a network of approximately 350 financial institutions and affiliated and unaffiliated broker-dealers, as well as by the Company's broker-dealer subsidiary.
BROKER-DEALER
The Company owns a broker-dealer, Royal Alliance, acquired by the Company in January 1990. As a result of the Company's ongoing active recruitment of independent registered representatives, the Company has increased its network of representatives from approximately 2,800 at September 30, 1995 to approximately 3,000 at September 30, 1996. The Company believes that, through its ownership of Royal Alliance and marketing arrangements with two affiliated broker-dealers, SunAmerica Securities, Inc. and Advantage Capital Corp., it has the largest network of independent registered representatives in the nation, based on industry data.
REGULATION
The Company is subject to regulation and supervision by the states in which it is authorized to transact business. State insurance laws establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, regulating marketing and other trade practices, operating guaranty associations, licensing agents, approving policy forms, regulating certain premium rates, regulating insurance holding company systems, establishing reserve requirements, prescribing the form and content of required financial statements and reports, performing financial and other examinations, determining the reasonableness and adequacy of statutory capital and surplus, regulating the type, valuation and amount of
investments permitted, limiting the amount of dividends that can be paid and the size of transactions that can be consummated without first obtaining regulatory approval and other related matters.
During the last decade, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government and the NAIC. Various states have considered or enacted legislation that changes, and in many cases increases, the states' authority to regulate insurance companies. Legislation has been introduced from time to time in Congress that could result in the federal government assuming some role in the regulation of insurance companies. In recent years, the NAIC has approved and recommended to the states for adoption and implementation several regulatory initiatives designed to reduce the risk of insurance company insolvencies and market conduct violations. These initiatives include investment reserve requirements, risk-based capital standards and restrictions on an insurance company's ability to pay dividends to its stockholders. The NAIC is also currently developing model laws relating to product design and illustrations for annuity products. Current proposals are still being debated and the Company is monitoring developments in this area and the effects any changes would have on the Company.
SunAmerica Asset Management is registered with the Securities and Exchange Commission (the "Commission") as a registered investment adviser under the Investment Advisers Act of 1940. The mutual funds that it markets are subject to regulation under the Investment Company Act of 1940. SunAmerica Asset Management and the mutual funds are subject to regulation and examination by the Commission. In addition, variable annuities and the related separate accounts of the Company are subject to regulation by the Commission under the Securities Act of 1933 and the Investment Company Act of 1940.
The Company's broker-dealer subsidiary is subject to regulation and supervision by the states in which it transacts business, as well as by the National Association of Securities Dealers, Inc. (the "NASD"). The NASD has broad administrative and supervisory powers relative to all aspects of business and may examine the subsidiary's business and accounts at any time.
COMPETITION
The businesses conducted by the Company are highly competitive. The Company's life insurance operations compete with other life insurers, and also compete for customers' funds with a variety of investment products offered by financial services companies other than life insurance companies, such as banks, investment advisors, mutual fund companies and other financial institutions. Within the U.S. life insurance industry, the 100 largest writers of individual and group annuities account for approximately 97% of total net premiums written. Net annuity premiums written among the top 100 companies range from less than $200 million to more than $9 billion annually. The Company ranks in the top quartile of this group. Certain of these companies and other life insurers with which the Company competes are significantly larger and have available to them much greater financial and other resources. The Company believes the primary competitive factors among life insurance companies for investment-oriented insurance products, such as annuities and GICs, include product flexibility, product pricing, innovation in product design, the claims-paying ability rating and the name recognition of the issuing company, the availability of distribution channels and service rendered to the customer before and after a contract is issued. Other factors affecting
the annuity business include the benefits (including before-tax and after-tax investment returns) and guarantees provided to the customer and the commissions paid.
Competitors of SunAmerica Asset Management include a large number of mutual fund organizations, both independent and affiliated with other financial services companies, including banks and insurance companies. Competition in mutual fund sales is based on investment performance, service to clients and product design.
The Company's broker-dealer faces competition from regional firms and large, national full service and discount brokerage firms.
ITEM 2.

ITEM 2. PROPERTIES
The Company's principal office is in leased premises at 1 SunAmerica Center, Los Angeles, California. The Company, through an affiliate, also leases office space in Torrance, California which is utilized for certain recordkeeping and data processing functions. The Company's broker-dealer and asset management subsidiaries lease offices in New York, New York.
The Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its businesses.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various kinds of litigation common to its businesses. These cases are in various stages of development and, based on reports of counsel, management believes that provisions made for potential losses are adequate and any further liabilities and costs will not have a material adverse impact upon the Company's financial position or results of operations.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted during the fourth quarter 1996 to a vote of security-holders, through the solicitation of proxies or otherwise.
PART II Item 5.

Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of financial condition and results of operations of Anchor National Life Insurance Company (the "Company") for the three years in the period ended September 30, 1996 follows. In connection with, and because it desires to take advantage of, the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in the following discussion and elsewhere in this report and in any other statements made by or on behalf of the Company, whether or not in future filings with the Securities and Exchange Commission ("SEC"). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. In particular, statements using verbs such as "expect," "anticipate," "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements contained in this report which represent the Company's beliefs concerning future or projected levels of sales of the Company's products, investment spreads or yields, or the earnings or profitability of the Company's activities.
Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from the forward- looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as general economic conditions and interest rates, some of which may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation, and others of which may relate to the Company specifically, such as credit, volatility, and other risks associated with the Company's investment portfolio, and other factors. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the SEC. The Company disclaims any obligation to update forward-looking information.
RESULTS OF OPERATIONS
INCOME BEFORE CUMULATIVE EFFECTIVE OF CHANGE IN ACCOUNTING FOR INCOME TAXES totaled $45.1 million in 1996, compared with $39.3 million in 1995 and $44.6 million in 1994. The cumulative effect of the change in accounting for income taxes resulting from the 1994 implementation of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," amounted to a nonrecurring non-cash charge of $20.5 million. Accordingly, net income amounted to $24.1 million in 1994.
PRETAX INCOME totaled $69.3 million in 1996, $65.0 million in 1995, and $67.3 million in 1994. The $4.3 million improvement in 1996 over 1995 primarily resulted from increased net investment income and significantly increased fee income partially offset by increased net realized investment losses and additional general and administrative expenses. The $2.3 million decline in 1995 over 1994 primarily resulted from additional amortization of
deferred acquisition costs, increased general and administrative expenses and decreased net investment income, partially offset by decreased net realized investment losses.
NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest-bearing liabilities, totaled $56.8 million in 1996, $50.1 million in 1995 and $59.0 million in 1994. These amounts represent 2.59% on average invested assets (computed on a daily basis) of $2.19 billion in 1996, 2.95% on average invested assets of $1.70 billion in 1995 and 3.78% on average invested assets of $1.56 billion in 1994.
Net investment income also includes the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. This excess amounted to $142.9 million in 1996, $108.4 million in 1995 and $49.5 million in 1994. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities was 2.25% in 1996, 2.63% in 1995 and 3.64% in 1994.
Investment income and the related yields on average invested assets totaled $164.6 million or 7.50% in 1996, compared with $129.5 million or 7.62% in 1995 and $127.8 million or 8.20% in 1994.
Investment income rose during 1996 as a result of higher levels of average invested assets, partially offset by reduced investment yields. Investment yields were lower in 1996 because of a generally declining interest rate environment since early 1995 and lower contributions from the Company's investments in partnerships. Partnership income totaled $4.1 million in 1996, $5.1 million in 1995 and $9.5 million in 1994. This income represents a yield of 10.12% on average investments in partnerships of $40.2 million in 1996, compared with 10.60% on average investments in partnerships of $48.4 million in 1995 and 23.78% on average investments in partnerships of $39.9 million in 1994. Partnership income is based upon cash distributions received from limited partnerships, the operations of which the Company does not significantly influence. Consequently, such income is not predictable and there can be no assurance that the Company will realize comparable levels of such income in the future.
The decline in investment yield in 1995 compared with 1994 is primarily due to lower contributions from the Company's investments in partnerships and a significant decline from the $3.7 million of yield enhancement recorded in 1994 through the Company's use of dollar roll transactions ("Dollar Rolls"). Although the Company continues to use Dollar Rolls, their use did not have a significant impact on investment income in 1995 or 1996.
Total interest expense aggregated $107.8 million in 1996, $79.4 million in 1995 and $68.8 million in 1994. The average rate paid on all interest- bearing liabilities increased to 5.25% (5.11% on fixed annuity contracts and 5.87% on guaranteed investment contracts ("GICs")) in 1996, compared with 4.99% (4.90% on fixed annuity contracts and 6.14% on GICs) in 1995 and 4.56% (4.50% on fixed annuity contracts) in 1994. Interest-bearing liabilities averaged $2.05 billion during 1996, compared with $1.59 billion during 1995 and $1.51 billion during 1994.
The increase in the average rates paid on all interest-bearing liabilities during 1996 primarily resulted from the growth in average reserves for GICs, which credit at higher rates of interest than fixed annuity contracts. Average GIC reserves were $340.5 million in 1996 and $60.8 million
in 1995. The increase in average crediting rates in 1995 resulted from higher crediting rates on fixed annuity contracts as interest rates rose from the low levels experienced in 1994.
The growth in average invested assets since 1994 primarily reflects sales of the Company's fixed-rate products, consisting of both fixed accounts of variable annuity products and GICs. Fixed annuity premiums totaled $741.8 million in 1996, compared with $284.4 million in 1995 and $140.7 million in 1994. These increased premiums resulted from greater inflows into the one-year fixed account of the Company's Polaris variable annuity product.
GIC premiums totaled $135.0 million in 1996 and $275.0 million in 1995. In 1995, the Company began to issue GICs, which guarantee the payment of principal and interest at fixed or variable rates for a term of one year. The Company's GICs that are purchased by asset management firms permit withdrawals with notice of 90 days. Contracts that are purchased by banks or state and local governmental authorities may permit scheduled book value withdrawals subject to terms of the underlying indenture or agreement. In pricing GICs, the Company analyzes cash flow information and prices accordingly so that it is compensated for possible withdrawals prior to maturity (see "Financial Condition and Liquidity").
NET REALIZED INVESTMENT LOSSES totaled $13.4 million in 1996, $4.4 million in 1995 and $33.7 million in 1994 and represent 0.61%, 0.26% and 2.16%, respectively, of average invested assets. Net realized investment losses include impairment writedowns of $16.0 million in 1996, $4.8 million in 1995 and $14.2 million in 1994. Therefore, net gains from sales of investments totaled $2.6 million in 1996 and $0.4 million in 1995. In 1994, the Company incurred $19.5 million of net losses from sales of investments.
Net gains from sales of investments in 1996 include $4.1 million of net gains realized on $1.27 billion of sales of bonds and $288.6 million of redemptions of bonds. Net gains from sales of investments in 1995 include a $4.4 million gain on sales of real estate, common stock and other invested assets offset by $4.0 million of net losses realized on $1.11 billion of sales of bonds. Net losses from sales of investments in 1994 include $17.3 million of net losses realized on $673.6 million of sales of bonds. These bond sales include approximately $289.3 million of sales of MBSs made primarily to acquire other MBSs that were then used in dollar roll transactions ("Dollar Rolls"). Sales of investments are generally made to maximize total return.
Impairment writedowns in 1996 include $13.4 million of provisions applied to certain real estate owned in Arizona on December 31, 1995. Prior to that date, the statutory carrying value of this real estate had been guaranteed by the Company's ultimate parent, SunAmerica Inc. On December 31, 1995, the Parent made a $27.4 million capital contribution to the company through the company's direct parent in exchange for the termination of its guaranty with respect to this real estate. Accordingly, the Company reduced the carrying value of this real estate to estimated fair value to reflect the termination of the guaranty. The Parent continues to guarantee the statutory carrying value of the Company's other real estate owned in Arizona.
Impairment writedowns in 1995 include $2.0 million of additional provisions applied to defaulted bonds and $1.8 million of additional provisions applied to certain interest-only strips ("IOs"). IOs, a type of MBS used as an asset-liability matching tool to hedge against rising interest rates, are investment grade securities that give the holder the right to receive only the interest payments on a pool of underlying mortgage loans. At September 30,
1996, the amortized cost of the IOs held by the Company was $2.6 million and their fair value was $3.7 million. Impairment writedowns in 1994 of $14.2 million reflect additional provisions applied to bonds, primarily made in response to the adverse impact of declining interest rates on certain MBSs.
VARIABLE ANNUITY FEES are based on the market value of assets supporting variable annuity contracts in separate accounts. Such fees totaled $104.0 million in 1996, $84.2 million in 1995 and $79.1 million in 1994. Increases in variable annuity fees in 1996 and 1995 reflect growth in average variable annuity assets, principally due to increased market values and the receipt of variable annuity premiums, partially offset by surrenders. Variable annuity assets averaged $5.70 billion during 1996, $4.65 billion during 1995 and $4.40 billion during 1994. Variable annuity premiums, which exclude premiums allocated to the fixed accounts of variable annuity products, totaled $919.8 million in 1996, $577.2 million in 1995 and $769.6 million in 1994. The increase in premiums in 1996 may be attributed, in part, to a heightened demand for equity investments, principally as a result of generally improved market performance. The decline in premiums in 1995 may be attributed, in part, to a heightened demand for fixed-rate investment options, including the fixed accounts of variable annuities. The Company has encountered increased competition in the variable annuity marketplace during recent years and anticipates that the market will remain highly competitive for the foreseeable future.
ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1 distribution fees, are based on the market value of assets managed in mutual funds by SunAmerica Asset Management Corp. Such fees totaled $25.4 million on average assets managed of $2.14 billion in 1996, $26.9 million on average assets managed of $2.07 billion in 1995 and $31.3 million on average assets managed of $2.39 billion in 1994. Asset management fees decreased slightly in 1996, despite a modest increase in average assets managed, principally due to changes in product mix. The decrease in asset management fees during 1995 principally resulted from the decline in average assets managed, primarily due to an excess of redemptions over sales. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to $379.9 million in 1996, compared with $426.5 million in 1995 and $561.0 million in 1994. Sales of mutual funds, excluding sales of money market accounts, amounted to $223.4 million in 1996, compared with $140.2 million in 1995 and $342.6 million in 1994. Higher mutual fund sales and lower redemptions in 1996 both reflect the combined effects of additional advertising, the favorable performance records of certain of the Company's mutual funds and heightened demand for equity investments, principally as a result of improved market performance.
NET RETAINED COMMISSIONS are primarily derived from commissions on the sales of nonproprietary investment products by the Company's broker-dealer subsidiary, after deducting the substantial portion of such commissions that is passed on to registered representatives. Net retained commissions totaled $31.5 million in 1996, $24.1 million in 1995 and $20.8 million in 1994. Broker-dealer sales (mainly sales of general securities, mutual funds, and annuities) totaled $8.75 billion in 1996, $5.67 billion in 1995 and $5.21 billion in 1994. The significant increases in sales and net retained commissions during 1996 reflect a greater number of registered representatives and higher average production, combined with generally favorable market conditions. Increases in net retained commissions are not proportionate to increases in sales primarily due to differences in sales mix.
SURRENDER CHARGES on fixed and variable annuities totaled $5.2 million in 1996, $5.9 million in 1995 and $5.0 million in 1994. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first five to seven years of the contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $898.0 million in 1996, $908.9 million in 1995 and $723.9 million in 1994. These payments represent 12.4%, 15.1% and 12.5%, respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity payments from the separate accounts totaling $634.1 million in 1996, $646.4 million in 1995 and $459.1 million in 1994. Such variable annuity surrenders represent 11.2%, 14.0% and 10.5%, respectively, of average variable annuity liabilities in 1996, 1995 and 1994. Variable annuity surrender rates increased in 1995 primarily due to surrenders on a closed block of business, policies coming off surrender charge restrictions and increased competition in the marketplace. Fixed annuity surrenders have remained relatively constant, totaling $263.8 million in 1996, $262.4 million in 1995 and $264.8 million in 1994. Management anticipates that withdrawal rates will remain relatively stable for the foreseeable future.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $80.0 million in 1996, compared with $61.6 million in 1995 and $52.6 million in 1994. General and administrative expenses in 1996 include expenses related to a national advertising campaign, as well as additional administrative expenses related to a growing block of business. General and administrative expenses remain closely controlled through a company-wide cost containment program and represent approximately 1% of average total assets.
AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $57.5 million in 1996, $58.7 million in 1995 and $44.2 million in 1994. The decline in amortization for 1996 is due to lower redemptions of mutual funds from the rate experienced in 1995, partially offset by additional fixed and variable annuity and mutual fund sales in recent years and the subsequent amortization of related deferred commissions and other acquisition costs. The increase in amortization in 1995 was primarily caused by the substantial reduction in net realized capital losses from the level experienced in 1994.
ANNUAL COMMISSIONS represent renewal commissions paid quarterly in arrears to maintain the persistency of certain of the Company's variable annuity contracts. Substantially all of the Company's currently available variable annuity products allow for an annual commission payment option in return for a lower immediate commission. Annual commissions totaled $4.6 million in 1996, $2.7 million in 1995 and $1.2 million in 1994. The increase in annual commissions since 1994 reflects increased sales of annuities that offer this commission option. The company estimates that approximately 35% of the average balances of its variable annuity products are currently subject to such annual commissions. Based on current sales, this percentage is expected to increase in future periods.
INCOME TAX EXPENSE totaled $24.3 million in 1996, $25.7 million in 1995 and $22.7 million in 1994, representing effective tax rates of 35% in 1996, 40% in 1995 and 34% in 1994. The increase in the effective tax rate in 1995 was due to a prior year tax settlement. Without such payment, the effective tax rate would have been 33%.
FINANCIAL CONDITION AND LIQUIDITY
SHAREHOLDER'S EQUITY increased by $43.2 million to $485.3 million at September 30, 1996 from $442.1 million at September 30, 1995, primarily as a result of the $45.1 million of net income recorded in 1996 and a $0.2 million reduction of net unrealized losses on debt and equity securities available for sale charged directly to shareholder's equity. In addition, the Company received a contribution of capital of $27.4 million in December 1995 and paid a dividend of $29.4 million in March 1996.
TOTAL ASSETS increased by $1.42 billion to $9.20 billion at September 30, 1996 from $7.78 billion at September 30, 1995, principally due to a $1.08 billion increase in the separate accounts for variable annuities and a $214.3 million increase in invested assets.
INVESTED ASSETS at year end totaled $2.33 billion in 1996, compared with $2.11 billion in 1995. This $214.3 million increase primarily resulted from a $208.2 million increase in amounts receivable from brokers for sales of securities.
The Company manages most of its invested assets internally. The Company's general investment philosophy is to hold fixed maturity assets for long-term investment. Thus, it does not have a trading portfolio. Effective December 1, 1995, pursuant to guidelines issued by the Financial Accounting Standards Board, the Company determined that all of its portfolio of bonds, notes and redeemable preferred stocks (the "Bond Portfolio") is available to be sold in response to changes in market interest rates, changes in prepayment risk, the Company's need for liquidity and other similar factors. Accordingly, the Company no longer classifies a portion of its Bond Portfolio as held for investment.
THE BOND PORTFOLIO had an aggregate amortized cost that exceeded its fair value by $13.8 million at September 30, 1996, compared with $3.7 million at September 30, 1995 (including net unrealized losses of $10.8 million on the portion of the portfolio that was designated as available for sale at September 30, 1995). The increase in net unrealized losses on the Bond Portfolio since September 30, 1995, principally reflects the higher prevailing interest rates at September 30, 1996 and their corresponding effect on the fair value of the Bond Portfolio.
All of the Bond Portfolio ($1.99 billion at amortized cost, excluding $9.1 million of redeemable preferred stocks) at September 30, 1996 was rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service ("Moody's"), Duff and Phelps Credit Rating Co. ("D&P"), Fitch Investor Service, Inc. ("Fitch") or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners ("NAIC") and implemented by either the NAIC or the Company. At September 30, 1996, approximately $1.83 billion of the Bond Portfolio (at amortized cost) was rated investment grade by one or more of these agencies or by the Company or the NAIC, pursuant to applicable NAIC guidelines, including $1.05 billion of U.S. government/agency securities and MBSs.
At September 30, 1996, the Bond Portfolio included $160.8 million (fair value, $160.2 million) of bonds not rated investment grade by S&P, Moody's, D&P, Fitch or the NAIC. Based on their September 30, 1996 amortized cost, these non-investment-grade bonds accounted for 1.8% of the Company's total assets and 6.9% of its invested assets.
Non-investment-grade securities generally provide higher yields and involve greater risks than investment-grade securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment-grade issuers. In addition, the trading market for these securities is usually more limited than for investment-grade securities. The Company intends that the proportion of its portfolio in such securities not exceed current levels, but its policies may change from time to time, including in connection with any possible acquisition. The Company had no material concentrations of non-investment-grade securities at September 30, 1996.
The table on the following page summarizes the Company's rated bonds by rating classification as of September 30, 1996.
Footnotes to the table of Rated Bonds by Rating Classification --------------------------------------------------------------
(1) S&P and Fitch rate debt securities in rating categories ranging from AAA (the highest) to D (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Moody's rates debt securities in rating categories ranging from Aaa (the highest) to C (extremely poor prospects of ever attaining any real investment standing). The number 1, 2 or 3 (with 1 the highest and 3 the lowest) indicates the debt's relative standing within the rating category. A security rated Baa3 or higher is considered investment grade. D&P rates debt securities in rating categories ranging from AAA (the highest) to DD (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Issues are categorized based on the highest of the S&P, Moody's, D&P and Fitch ratings if rated by multiple agencies.
(2) Bonds and short-term promissory instruments are divided into six quality categories for NAIC rating purposes, ranging from 1 (highest) to 5 (lowest) for nondefaulted bonds plus one category, 6, for bonds in or near default. These six categories correspond with the S&P/Moody's/D&P/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. A substantial portion of the assets in the NAIC categories were rated by the Company pursuant to applicable of NAIC rating guidelines.
(3) At amortized cost.
SENIOR SECURED LOANS ("Secured Loans") are included in the Bond Portfolio and their amortized cost aggregated $200.8 million at September 30, 1996. Secured Loans are senior to subordinated debt and equity, and are secured by assets of the issuer. At September 30, 1996, Secured Loans consisted of loans to 52 borrowers spanning 20 industries, with 22% of these assets (at amortized cost) concentrated in the leisure industry. No other industry concentration constituted more than 9% of these assets.
While the trading market for Secured Loans is more limited than for publicly traded corporate debt issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. Although, as a result of restrictive financial covenants, Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities, management believes that the risk of loss upon default for its Secured Loans is mitigated by their financial covenants and senior secured positions. The Company's Secured Loans are rated by S&P, Moody's, D&P, Fitch or by the Company or the NAIC, pursuant to comparable statutory rating guidelines established by the NAIC.
MORTGAGE LOANS aggregated $98.3 million at September 30, 1996 and consisted of 17 first mortgage loans with an average loan balance of approximately $5.8 million, collateralized by properties located in 11 states. At September 30, 1996, the Company had no concentrations in any single state or in any single type of property that amounted to more than 23% of the mortgage loan portfolio. At September 30, 1996, there were four loans with outstanding balances of $10 million or more, the largest of which had a balance of approximately $21 million, which collectively aggregated approximately 61% of the portfolio. At September 30, 1996, approximately 33% of the mortgage loan portfolio consisted of loans with balloon payments due before October 1, 1999. At September 30, 1996, loans delinquent by more than 90 days totaled $1.5 million (1.6% of total mortgages). There were no loans foreclosed upon and transferred to real estate in the balance sheet during 1996. At September 30, 1996, mortgage loans having an aggregate carrying value of $21.3 million had been previously restructured. Of this amount, $16.5 million was restructured during 1995 and $4.8 million was restructured during 1992. No mortgage loans were restructured during 1996.
Approximately 62% of the mortgage loans in the portfolio at September 30, 1996 were seasoned loans underwritten to the Company's standards and purchased at or near par from another financial institution which was downsizing its portfolio. Such loans generally have higher average interest rates than loans that could be originated today. The balance of the mortgage loan portfolio has been originated by the Company under strict underwriting standards. Commercial mortgage loans on properties such as offices, hotels and shopping centers generally represent a higher level of risk than do mortgage loans secured by multifamily residences. This greater risk is due to several factors, including the larger size of such loans and the effects of general economic conditions on these commercial properties. However, due to the seasoned nature of the Company's mortgage loans and its strict underwriting standards, the Company believes that it has reduced the risk attributable to its mortgage loan portfolio while maintaining attractive yields.
REAL ESTATE aggregated $39.7 million at September 30, 1996 and consisted of non-income producing land in the Phoenix, Arizona metropolitan area. Of this amount, the Company has undertaken to dispose of $28.4 million during the next year, either to affiliated or nonaffiliated parties, and SunAmerica Inc., the ultimate parent, has guaranteed that the Company will receive its statutory carrying value of these assets.
OTHER INVESTED ASSETS aggregated $77.9 million at September 30, 1996, including $45.1 million of investments in limited partnerships and an aggregate of $32.8 million of miscellaneous investments, including collateralized bond obligations, CMO residuals, policy loans, separate account investments, and leveraged leases. The Company's limited partnership interests, accounted for by using the cost method of accounting, invest mainly in equity securities.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed maturities that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed maturities are priced over the yield curve and general competitive conditions within the industry. Its portfolio strategy is designed to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety.
The Company designs its fixed-rate products and conducts its investment operations in order to closely match the duration of the assets in its investment portfolio to its annuity and GIC obligations. The Company seeks to achieve a predictable spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed-rate securities. The Company's fixed-rate products incorporate surrender charges or other limitations on when contracts can be surrendered for cash to encourage persistency. Approximately 63% of the Company's fixed annuity and GIC reserves had surrender penalties or other restrictions at September 30, 1996.
As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-maturity assets and liabilities under commonly used stress-test interest rate scenarios. Based on the results of these computer simulations, the investment portfolio has been constructed with a view to maintaining a desired investment spread between the yield on portfolio assets and the rate paid on its reserves under a variety of possible future interest rate scenarios. At September 30, 1996 the weighted average life of the Company's investments was approximately 5 years and the duration was approximately 3.
The Company also seeks to provide liquidity from time to time by using reverse repurchase agreements ("Reverse Repos"), Dollar Rolls and by investing in MBSs. It also seeks to enhance its spread income by using Reverse Repos and Dollar Rolls. Reverse Repos involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed upon price and are generally over-collateralized. Dollar Rolls are similar to Reverse Repos except that the repurchase involves securities that are only substantially the same as the securities sold and the arrangement is not collateralized, nor is it governed by a repurchase agreement. MBSs are generally investment-grade securities collateralized by large pools of mortgage loans. MBSs generally pay principal and interest monthly. The amount of principal and interest payments may fluctuate as a result of prepayments of the underlying mortgage loans.
There are risks associated with some of the techniques the Company uses to provide liquidity, enhance its spread income and match its assets and liabilities. The primary risk associated with the Company's Dollar Rolls and Reverse Repos is counterparty risk. The Company believes, however, that the
counterparties to its Dollar Rolls and Reverse Repos are financially responsible and that the counterparty risk associated with those transactions is minimal. Counterparty risk associated with Dollar Rolls is further mitigated by the Company's participation in an MBS trading clearinghouse. The sell and buy transactions that are submitted to this clearinghouse are marked to market on a daily basis and each participant is required to over- collateralize its net loss position by 30% with either cash, letters of credit or government securities. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase.
INVESTED ASSETS EVALUATION routinely includes a review by the Company of its portfolio of debt securities. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying value of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of collateral (if any), compliance with contractual covenants, the borrower's recent financial performance, news reports and other externally generated information concerning the creditor's affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and, if available, the current fair value of the underlying collateral.
The carrying values of bonds that are determined to have declines in value that are other than temporary are reduced to net realizable value and no further accruals of interest are made. The valuation allowances on mortgage loans are based on losses expected by management to be realized on transfers of mortgage loans to real estate, on the disposition and settlement of mortgage loans and on mortgage loans that management believes may not be collectible in full. Accrual of interest is suspended when principal and interest payments on mortgage loans are past due more than 90 days.
DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of principal or interest, totaled $3.1 million at September 30, 1996 (at amortized cost, with a fair value of $2.9 million) including $1.6 million of bonds and notes and $1.5 million of mortgage loans. At September 30, 1996, defaulted investments constituted 0.1% of total invested assets. At September 30, 1995, defaulted investments totaled $5.0 million which constituted 0.2% of total invested assets.
SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company's existing portfolio of cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At September 30, 1996, approximately $936.8 million of the Company's Bond Portfolio had an aggregate unrealized gain of $20.1 million, while approximately $1.06 billion of the Bond Portfolio had an aggregate unrealized loss of $33.9 million. In addition, the Company's investment portfolio currently provides approximately $21.6 million of monthly cash flow from scheduled principal and interest payments.
Management is aware that prevailing market interest rates may shift significantly and has strategies in place to manage either an increase or decrease in prevailing rates. In a rising interest rate environment, the Company's average cost of funds would increase over time as it prices its new and renewing annuities and GICs to maintain a generally competitive market rate. Management would seek to place new funds in investments that were matched in duration to, and higher yielding than, the liabilities assumed. The Company believes that liquidity to fund withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or Reverse Repos on the Company's substantial MBS segment of the Bond Portfolio, thereby avoiding the sale of fixed-rate assets in an unfavorable bond market.
In a declining rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its fixed annuities and GICs. Should increased liquidity be required for withdrawals, the Company believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening that would be expected in the bond market.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements begin on page. Reference is made to the Index to Financial Statements on page herein.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
All of the executive officers of the Company also serve as employees of SunAmerica Inc. or its affiliates and receive no compensation directly from the Company. Some of the officers also serve as officers of other companies affiliated with the Company. Allocations have been made as to each individual's time devoted to his or her duties as an executive officer of the Company.
The following table shows the cash compensation paid or earned, based on these allocations, to the chief executive officer and top four executive officers of the Company whose allocated compensation exceeds $100,000 and to all executive officers of the Company as a group for services rendered in all capacities to the Company during 1996:
Name of Individual or Capacities In Allocated Cash Number in Group Which Served Compensation --------------------- ------------------------- -------------- Eli Broad Chairman, Chief Executive $1,444,146 Officer and President Joseph M. Tumbler Executive Vice President 834,708 Jay S. Wintrob Executive Vice President 836,327 James R. Belardi Senior Vice President 341,329 Jana Waring Greer Senior Vice President 420,171 All Executive Officers as a Group (12) $5,056,560 ===========
Directors of the Company who are also employees of SunAmerica Inc. or its affiliates receive no compensation in addition to their compensation as employees of SunAmerica Inc. or its affiliates.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
No shares of the Company are owned by any executive officer or director. The Company is an indirect wholly owned subsidiary of SunAmerica Inc. Except for Mr. Broad, the percentage of shares of SunAmerica Inc. beneficially owned by any director does not exceed one percent of the class outstanding. At November 30, 1996, Mr. Broad was the beneficial owner of 5,930,156 shares of Common Stock (approximately 5.3% of the class outstanding) and 9,160,294 shares of Class B Common Stock (approximately 84.4% of the class outstanding). Of the Common Stock, 715,872 shares represent restricted shares granted under the Company's employee stock plans as to which Mr. Broad has no investment power; and 3,605,700 shares represent employee stock options held by Mr. Broad which are or will become exercisable on or before February 28, 1997 and as to which he has no voting or investment power. Of the Class B Stock, 8,456,140 shares are held directly by Mr. Broad; and 704,154 shares are registered in the name of a corporation as to which Mr. Broad exercises sole voting and dispositive powers. At November 30, 1996, all directors and officers as a group beneficially owned 9,197,722 shares of Common Stock (approximately 8.1% of the class outstanding) and 9,160,294 shares of Class B Common Stock (approximately 84.4% of the class outstanding).
Item 13.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Reference is made to the index set forth on page of this report.
EXHIBITS
Exhibit No. Description - ------- ----------- 3(a) Amended and Restated Articles of Incorporation and Articles of Redomestication, filed with the Arizona Department of Insurance on December 22, 1995, is incorporated herein by reference to Exhibit 3(a) to the Company's quarterly report on Form 10-Q for quarter ended December 31, 1995, filed February 14, 1996. 3(b) Amended and Restated Bylaws, as adopted January 1, 1996, is incorporated herein by reference to Exhibit 3(b) to the Company's quarterly report on Form 10-Q for quarter ended December 31, 1995, filed February 14, 1996. 4(a) Amended and Restated Articles of Incorporation and Articles of Redomestication, filed with the Arizona Department of Insurance on December 12, 1996. See Exhibit 3(a). 4(b) Amended and Restated Bylaws as adopted January 1, 1996. See Exhibit 3(b). 10(a) Subordinated Loan Agreement for Equity Capital, dated as of August 23, 1993, between the Company's subsidiary, Royal Alliance, and SAI, defining SAI's rights with respect to the 7% notes due August 22, 1996, is incorporated herein by reference to Exhibit 10(b) to the Company's Form 10-K, filed December 21, 1993. 10(b) Subordinated Loan Agreement for Equity Capital, dated as of June 30, 1992, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 7% notes due June 29, 1996, is incorporated herein by reference to Exhibit 10(d) to the Company's Form 10-K, filed December 21, 1993. 10(c) Subordinated Loan Agreement for Equity Capital, dated as of May 29, 1992, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 7% notes due May 28, 1996, is incorporated herein by reference to Exhibit 10(e) to the Company's Form 10-K, filed December 21, 1993. 10(d) Subordinated Loan Agreement for Equity Capital, dated as of March 16, 1992, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 7% notes due March 15, 1996, is incorporated herein by reference to Exhibit 10(f) to the Company's Form 10-K, filed December 21, 1993. 10(e) Subordinated Loan Agreement for Equity Capital, dated as of January 14, 1992, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 7% notes due January 13, 1996, is incorporated herein by reference to Exhibit 10(g) to the Company's Form 10-K, filed December 21, 1993. 10(f) Amendment to the Subordinated Loan Agreement for Equity Capital, dated as of August 22, 1996, between the Company's subsidiary, SACS, and SAI, extending the maturity date to September 30, 1999, of a Subordinated Loan Agreement for Equity Capital, dated as of September 30, 1992, which defined SAI's rights of the 9% notes due September 29, 1996.
Exhibit No. Description - ------- ----------- 10(g) Subordinated Loan Agreement for Equity Capital, dated as of December 14, 1994, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 9% notes due January 13, 1998. 10(h) Subordinated Loan Agreement for Equity Capital, dated as of April 20, 1995, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 9% notes due May 27, 1998. 10(i) Subordinated Loan Agreement for Equity Capital, dated as of May 30, 1996, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 9% notes due June 29, 1998. 10(j) Subordinated Loan Agreement for Equity Capital, dated as of February 24, 1992, between the Company's subsidiary, SACS, and SAI, defining SAI's rights with respect to the 7% notes due March 15, 1997. 10(k) Subordinated Loan Agreement for Equity Capital, dated as of July 24, 1996, between the Company's subsidiary, Royal Alliance, and SAI, defining SAI's rights with respect to the 9% notes due August 23, 1999. 10(l) Amendment to the Subordinated Loan Agreement for Equity Capital, dated as of September 3, 1996, between the Company's subsidiary, SunAmerica Asset Management, and SAI, extending the maturity date to September 13, 1999 of a Subordinated Loan Agreement for Equity Capital, dated as of September 3, 1993, which defined SAI's rights of the 7% notes due September 13, 1996. 21 Subsidiaries of the Company. 27 Financial Data Schedule
REPORTS ON FORM 8-K
No Current Report on Form 8-K was filed during the three months ended September 30, 1996.
ANCHOR NATIONAL LIFE INSURANCE COMPANY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page(s) -------
Report of Independent Accountants
Consolidated Balance Sheet as of September 30, 1996 and 1995 through
Consolidated Income Statement for the years ended September 30, 1996, 1995 and 1994
Consolidated Statement of Cash Flows for the years ended September 30, 1996, 1995 and 1994 through
Notes to Consolidated Financial Statements through
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of Anchor National Life Insurance Company
In our opinion, the accompanying consolidated balance sheet and the related consolidated income statement and statement of cash flows present fairly, in all material respects, the financial position of Anchor National Life Insurance Company and its subsidiaries at September 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," in fiscal 1994.
Price Waterhouse LLP Los Angeles, California November 8, 1996
See accompanying notes
ANCHOR NATIONAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
Anchor National Life Insurance Company (the "Company") is a wholly owned indirect subsidiary of SunAmerica, Inc. (the "Parent"). The Company is an Arizona-domiciled life insurance company and, on a consolidated basis, conducts its business through three segments: annuity operations, asset management operations and broker-dealer operations. Annuity operations include the sale and administration of fixed and variable annuities and guaranteed investment contracts. Asset management operations, which include the sale and management of mutual funds, is conducted by SunAmerica Asset Management Corp. Broker-dealer operations include the sale of securities and financial services products, and is conducted by Royal Alliance Associates, Inc.
The operations of the Company are influenced by many factors, including general economic conditions, monetary and fiscal policies of the federal government, and policies of state and other regulatory authorities. The level of sales of the Company's financial products is influenced by many factors, including general market rates of interest; strength, weakness and volatility of equity market; and terms and conditions of competing financial products. The Company is exposed to the typical risks normally associated with a portfolio of fixed-income securities, namely interest rate, option, liquidity and credit risks. The Company controls its exposure to these risks by, among other things, closely monitoring and matching the duration of its assets and liabilities, monitoring and limiting prepayment and extension risk in its portfolio, maintaining a large percentage of its portfolio in highly liquid securities, and engaging in a disciplined process of underwriting, reviewing and monitoring credit risk. The Company also is exposed to market risk, as market volatility may result in reduced fee income in the case of assets managed in mutual funds and held in separate accounts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of the Company and all of its wholly owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Certain 1995 and 1994 amounts have been reclassified to conform with the 1996 presentation.
The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
ANCHOR NATIONAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
RECENTLY ISSUED ACCOUNTING STANDARDS: Effective October 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly, the cumulative effect of this change in accounting for income taxes was recorded on October 1, 1993 to increase the liability for Deferred Income Taxes by $20,463,000.
INVESTMENTS: Cash and short-term investments primarily include cash, commercial paper, money market investments, repurchase agreements and short-term bank participations. All such investments are carried at cost plus accrued interest, which approximates fair value, have maturities of three months or less and are considered cash equivalents for purposes of reporting cash flows.
Bonds, notes and redeemable preferred stocks available for sale and common stocks are carried at aggregate fair value and changes in unrealized gains or losses, net of tax, are credited or charged directly to shareholder's equity. Bonds, notes and redeemable preferred stocks held for investment (the "Held for Investment Portfolio") are carried at amortized cost. On December 1, 1995, the Company reassessed the appropriateness of classifying a portion of its portfolio of bonds, notes and redeemable preferred stocks as held for investment. This reassessment was made pursuant to the provisions of "Special Report: A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities," issued by the Financial Accounting Standards Board in November 1995. As a result of its reassessment, the Company reclassified all of its Held for Investment Portfolio as available for sale. At December 1, 1995, the amortized cost of the Held for Investment Portfolio aggregated $157,830,000 and its fair value was $166,215,000. Upon reclassification, the resulting net unrealized gain of $8,385,000 was credited to Net Unrealized Losses on Debt and Equity Securities Available for Sale in the shareholder's equity section of the balance sheet.
Bonds, notes and redeemable preferred stocks are reduced to estimated net realizable value when necessary for declines in value considered to be other than temporary. Estimates of net realizable value are subjective and actual realization will be dependent upon future events.
Mortgage loans are carried at amortized unpaid balances, net of provisions for estimated losses. Real estate is carried at the lower of cost or fair value. Other invested assets include investments in limited partnerships, which are accounted for by using the cost method of accounting; separate account investments; leveraged leases; policy loans, which are carried at unpaid balances; and collateralized mortgage obligation residuals.
Realized gains and losses on the sale of investments are recognized in operations at the date of sale and are determined using the specific cost identification method. Premiums and discounts on investments are amortized to investment income using the interest method over the contractual lives of the investments.
ANCHOR NATIONAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
DEFERRED ACQUISITION COSTS: Policy acquisition costs are deferred and amortized, with interest, over the estimated lives of the contracts in relation to the present value of estimated gross profits, which are composed of net interest income, net realized investment gains and losses, variable annuity fees, surrender charges and direct administrative expenses. Costs incurred to sell mutual funds are also deferred and amortized over the estimated lives of the funds obtained. Deferred acquisition costs consist of commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business.
As debt and equity securities available for sale are carried at aggregate fair value, an adjustment is made to deferred acquisition costs equal to the change in amortization that would have been recorded if such securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. The change in this adjustment, net of tax, is included with the change in net unrealized gains or losses on debt and equity securities available for sale that is credited or charged directly to shareholder's equity. Deferred Acquisition Costs have been increased by $4,200,000 at September 30, 1996, and by $4,600,000 at September 30, 1995 for this adjustment.
VARIABLE ANNUITY ASSETS AND LIABILITIES: The assets and liabilities resulting from the receipt of variable annuity premiums are segregated in separate accounts. The Company receives administrative fees for managing the funds and other fees for assuming mortality and certain expense risks. Such fees are included in Variable Annuity Fees in the income statement.
GOODWILL: Goodwill, amounting to $19,478,000 at September 30, 1996, is amortized by using the straight-line method over periods averaging 25 years and is included in Other Assets in the balance sheet.
CONTRACTHOLDER RESERVES: Contractholder reserves for fixed annuity contracts and guaranteed investment contracts are accounted for as investment-type contracts in accordance with Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," and are recorded at accumulated value (premiums received, plus accrued interest, less withdrawals and assessed fees).
FEE INCOME: Variable annuity fees and asset management fees are recorded in income as earned. Net retained commissions are recognized as income on a trade-date basis.
ANCHOR NATIONAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
INCOME TAXES: The Company is included in the consolidated federal income tax return of the Parent and files as a "life insurance company" under the provisions of the Internal Revenue Code of 1986. Income taxes have been calculated as if the Company filed a separate return. Deferred income tax assets and liabilities are recognized based on the difference between financial statement carrying amounts and income tax bases of assets and liabilities using enacted income tax rates and laws.
ANCHOR NATIONAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ANCHOR NATIONAL LIFE INSURANCE COMPANY AND CONSOLIDATED SUBSIDIARIES LIST OF EXHIBITS FILED
Exhibit No. Description - ------- -----------
10(f) Amendment to the Subordinated Loan Agreement for Equity Capital.
10(g) Subordinated Loan Agreement for Equity Capital.
10(h) Subordinated Loan Agreement for Equity Capital.
10(i) Subordinated Loan Agreement for Equity Capital.
10(j) Subordinated Loan Agreement for Equity Capital.
10(k) Subordinated Loan Agreement for Equity Capital.
10(l) Amendment to the Subordinated Loan Agreement for Equity Capital.
21 Subsidiaries of the Company.
27 Financial Data Schedule.