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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 or
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-20882
STANDARD MANAGEMENT CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1773567
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
9100 Keystone Crossing, Indianapolis, Indiana 46240 (317) 574-6200
(Address of principal executive offices) (Telephone)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, No
Par Value
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X
No
Indicate 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 13,
1998 as reported on The Nasdaq Stock Market, was approximately $41.5 million.
Shares of Common Stock held by each executive officer and director and by each
person who owns 5% or more the outstanding Common Stock have been excluded in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 13, 1998, Registrant had outstanding 7,094,417 shares of Common
Stock.
Documents Incorporated by Reference:
Portions of the Registrant's definitive Proxy Statement for the Annual Meeting
of Stockholders are incorporated by reference into Part III of this Form 10-K.
PART I
AS USED HEREIN, UNLESS THE CONTEXT OTHERWISE CLEARLY REQUIRES, "SMC", OR
THE "COMPANY" REFERS TO STANDARD MANAGEMENT CORPORATION AND ITS CONSOLIDATED
SUBSIDIARIES AND "STANDARD MANAGEMENT" REFERS TO STANDARD MANAGEMENT
CORPORATION ON AN UNCONSOLIDATED BASIS. ALL FINANCIAL INFORMATION CONTAINED
HEREIN IS PRESENTED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
("GAAP") UNLESS OTHERWISE SPECIFIED.
ITEM 1. BUSINESS OF SMC
INTRODUCTION
SMC is an international financial services holding company which directly
and through its subsidiaries acquires and manages in force life insurance and
annuity business and issues and distributes life insurance and annuity
products. SMC offers unit-linked assurance products through its international
subsidiaries. SMC's active subsidiaries at December 31, 1997 include:
(i) Standard Life Insurance Company of Indiana ("Standard Life") and its
subsidiary, Dixie National Life Insurance Company ("Dixie National Life"),
(ii) Standard Management International S.A. ("Standard Management
International") and its subsidiaries, Premier Life (Luxembourg) S.A. ("Premier
Life (Luxembourg)") and Premier Life (Bermuda) Ltd. ("Premier Life (Bermuda)")
and (iii) Standard Marketing Corporation ("Standard Marketing").
Standard Life, SMC's principal insurance subsidiary, was organized in
1934 as an Indiana-domiciled life insurer. It is licensed to write new business
or service existing business in the District of Columbia and all states except
New York and New Jersey. Standard Life offers flexible premium deferred
annuities ("FPDAs") and whole and universal life insurance. Standard Life also
generates cash flow and income from closed blocks of in force life insurance
and annuities. At December 31, 1997, Standard Life's statutory assets were
$367,121,000 and the aggregate of its statutory capital and surplus, asset
valuation reserve ("AVR") and interest maintenance reserve ("IMR") (its
"adjusted statutory capital") was $37,634,000. The ratio of Standard Life's
adjusted statutory capital to its total statutory assets was 10.3% at December
31, 1997. Standard Life has a rating of "B+" ("Very Good, Secure") by A.M. Best
Company, Inc. ("A.M. Best"), a rating agency.
Standard Management International is a holding company organized under
Luxembourg law with its registered office in Luxembourg. At December 31, 1997,
Standard Management International and its subsidiaries had $160,516,000 in
assets with policies in force in over 80 countries. The majority of its
business is unit-linked assurance products with a range of policyholder
directed investment choices coupled with a small death benefit, sold through
its subsidiaries: Premier Life (Luxembourg) and Premier Life (Bermuda). At
December 31, 1997, Premier Life (Luxembourg) had statutory capital and surplus
of $7,288,000 and its minimum capital and surplus was $2,915,000 and Premier
Life (Bermuda) had statutory capital and surplus of $1,350,000 and its minimum
capital and surplus was $250,000.
Standard Life owns 99.4% of Dixie National Life. At December 31, 1997,
Dixie National Life's statutory assets were $35,240,000, the adjusted statutory
capital was $3,865,000 and the ratio of its adjusted statutory capital to its
statutory assets was 11.0%. Dixie National Life has a rating of B ("Adequate")
by A.M. Best. Dixie National Life markets a variety of life insurance products
throughout the Mid-South offering primarily "burial expense" policies.
Standard Marketing is a wholesale distributor of life insurance and
annuity products. Through its network of managing general agents and
independent agents, Standard Marketing distributes life insurance and annuity
products for Standard Life, Dixie National Life and Savers Life Insurance
Company and for a select group of unaffiliated insurance companies. Standard
Marketing earns override commission income from the sale of these products.
On November 8, 1996, Standard Life acquired through merger Shelby Life
Insurance Company ("Shelby Life") from Delta Life and Annuity Corporation
("DLAC"), a life insurance company located in Memphis, Tennessee (the "Shelby
Merger"). The purchase price was approximately $14,650,000, including
$13,000,000 in cash, 250,000 shares of restricted Common Stock (valued at
$1,250,000) and acquisition costs of $400,000. Financing for the Shelby Merger
was provided by senior debt of $10,000,000 and $4,000,000 in subordinated
convertible debt. SMC's intent at the time it purchased Shelby Life was to
cease writing new business as the new business premium volume did not justify
the costs of marketing support, and to continue to earn profits from the
existing business. Consistent with that intent, Shelby Life ceased writing new
business effective November 1, 1996, thus eliminating marketing and sales costs
and thereby reducing statutory surplus strain. Statutory accounting practices
require that acquisition costs associated with new business (primarily
commissions and policy issue costs) be fully expensed in the year the new
business is written. Surplus strain is created when acquisition costs incurred
in connection with new business reduces statutory surplus. Many states impose
minimum levels of surplus as a condition to writing new business. See "Business
of SMC--Regulation."
The acquisition of Shelby Life was accounted for using the purchase
method of accounting and SMC's consolidated financial statements include the
results of Shelby Life from November 1, 1996, the effective date of
acquisition. Under purchase accounting, Standard Life allocated the total
purchase price of Shelby Life to the assets and liabilities acquired, based on
a determination of their fair values and recorded the excess of acquisition
cost over net assets acquired as goodwill, which will be amortized on a
straight-line basis over 20 years.
On March 18, 1996, Standard Life completed the sale of a duplicate
charter associated with First International Life Insurance Company ("First
International") to The Guardian Insurance and Annuity Company, Inc. ("GIAC"), a
subsidiary of The Guardian Group, New York, NY. Standard Life received proceeds
of approximately $10,393,000, including $1,500,000 for the charter and licenses
associated with First International. Standard Life realized a net pretax gain
of $1,042,000 and a tax benefit of $1,420,000 on this sale, or $2,462,000. In
addition, First International, Standard Life and GIAC have entered into a
series of agreements that include provisions for Standard Life to administer
First International policies in force at the date of sale, and for Standard
Life to continue to receive the profit stream from certain First International
policies in force at the date of such sale. See "Business of SMC--Reinsurance."
SMC decided in February 1996 to terminate the reinsurance agreement
between Standard Reinsurance of North America Ltd. ("Standard Reinsurance") and
Salamandra Joint-Stock Insurance Company in Ukraine ("Salamandra"), and not to
renew the Barbados license of Standard Reinsurance due to an insignificant
amount of reinsurance premium volume (less than $100,000). This resulted in
the termination of Standard Reinsurance operations and the write-off of SMC's
investment in Standard Reinsurance and certain intangible assets of Standard
Reinsurance amounting to $156,000.
The combined effect of the gain on sale of First International and
related contracts, and the Standard Reinsurance write-offs, was a gain on
disposal of subsidiaries of $886,000 and a tax benefit of $1,420,000, for net
income effect of $2,305,836 for the year ended December 31, 1996.
In June 1988, Standard Life ceded a block of business to National Mutual
Life Insurance Company ("National Mutual"). Effective May 31, 1996, Standard
Life terminated by recapture the reinsurance agreement with National Mutual. As
a result of this recapture, Standard Life received assets of $4,826,000 and
liabilities of $4,826,000, primarily ordinary life policies. In connection with
this transaction, Standard Life agreed to pay National Mutual a recapture fee
of $1,200,000, and Standard Life collected administration fees of $375,000
related to services provided in prior years that had not been recorded
previously due to the uncertainty as to its collection. The net proceeds of
$825,000 were recorded as the present value of the future profits on this block
of business, which is being amortized in proportion to the emergence of profits
over 20 years. This premium income and corresponding increase in reserves of
$4,234,000, recorded in connection with the recapture of the reinsurance
agreement with National Mutual will not recur in the future.
On March 12, 1998, SMC acquired Savers Life Insurance Company ("Savers
Life"), with Savers Life surviving as a wholly-owned subsidiary of SMC. Each
of the 1,779,908 shares of Savers Life Common Stock outstanding was converted
into 1.2 shares of SMC Common Stock plus $1.50. Each holder of Savers Life
Common Stock could elect to receive the $1.50 per share portion of the merger
consideration in the form of additional shares of SMC Common Stock. SMC issued
approximately 2.2 million shares with a value of approximately $14.9 million
and paid $2.1 million in cash (excluding acquisition costs) to acquire Savers
Life. SMC increased the Amended and Restated Revolving Line of Credit
Agreement with a bank (the "Amended Credit Agreement") to an amount of
$20,000,000 to finance the acquisition of Savers Life. See "Liquidity and
Capital Resources".
Savers Life underwrites, markets and distributes annuities, life
insurance, and Medicare supplement health insurance through a sales force
consisting of approximately 4,000 independent brokers and is licensed to sell
products in North Carolina, South Carolina, Virginia and Florida. Savers Life
had total assets of $72,186,000 at December 31, 1997 and revenues of
$43,047,000 for the year ended December 31, 1997.
ACQUISITION STRATEGY
A principal component of SMC's strategy is to grow through the
acquisition of life insurance companies and blocks of in force life insurance
and annuities. SMC regularly investigates acquisition opportunities in the life
insurance industry that complement or are otherwise strategically consistent
with its existing business. Any decision to acquire a block of business or an
insurance company will depend on a favorable evaluation of various factors. SMC
believes that availability of blocks of business in the marketplace will
continue in response to ongoing industry consolidation and risk-based capital
requirements as well as other regulatory and rating agency concerns. In
addition, SMC plans to market annuity and life insurance products directly as
it has done in the past. SMC currently has no plans or commitments to acquire
any specific insurance business or other material assets besides Savers Life.
No assurance can be given that SMC will be successful in consummating any
future acquisition.
SMC has the information systems and administrative capabilities necessary
to add additional blocks of business without a proportional increase in
operating expenses. In addition, SMC has developed management techniques for
reducing or eliminating the expenses of the companies it acquires through the
consolidation of their operations with those of SMC, and for increasing
investment yields. Such techniques include reduction or elimination of
overhead, including the acquired company's management, staff and home office,
elimination of marketing expenses and, where appropriate, the substitution of
Standard Marketing's network for the acquired company's current distribution
system, and the conversion of the acquired company's data processing operations
to SMC's system.
SMC may effect its acquisitions through the purchase or exchange of
shares, if the acquisition candidate is an insurance company, or an assumption
reinsurance transaction, if the proposed acquisition concerns a block of
business. SMC's acquisitions may be subject to certain regulatory approvals,
policyholder consents and stockholder approval, when applicable.
MARKETING
DOMESTIC MARKETING. Standard Marketing was organized as a wholesale
distribution system to provide a lower cost alternative to the traditional
captive agency force. Standard Marketing has established a network of
approximately 20,000 independent general agents, including Savers Life. These
agents distribute a full line of life insurance and annuity products issued by
Standard Life, Dixie National Life and Savers Life and a select group of
unaffiliated insurance carriers that Standard Marketing represents. As part of
its normal recruiting, Standard Marketing selectively recruits new agents from
those formerly associated with companies acquired by SMC.
Crediting rates, commissions, the perceived quality of the issuer,
product features and services are generally the principal factors influencing
an agent's willingness and ability to sell particular life and annuity
products. SMC believes that both agents and policy owners value the service
provided by SMC. Standard Marketing assists its agents in submitting and
processing policy applications and helps ensure that issuing insurers pay
commissions on a timely basis. Standard Life issues an annuity and pays the
Standard Marketing agent's commission within 24 hours subsequent to receipt of
policyholder's deposit. Standard Marketing also assists its agents with
licensing applications and provides other administrative support. Standard
Marketing provides marketing support for its agents, including sales seminars
and other continuing education programs, point of sale materials, illustrated
proposal services, toll-free access for sales inquiries and access to senior
executives. In addition, Standard Marketing can introduce agents to lead
services who will provide such services at discounted rates that Standard
Marketing has negotiated.
Standard Marketing agents offer a full portfolio of life insurance,
annuity and health products that Standard Marketing has selected on the basis
of their competitive position and likely consumer acceptance. Such portfolio
includes FPDAs, whole and universal life insurance and critical illness
products issued by Standard Life and Dixie National Life, for which Standard
Marketing is the exclusive distributor, and life insurance products issued by
selected unaffiliated insurers. Standard Marketing receives, directly from the
insurance companies it serves, primarily affiliated insurance companies,
override commissions on sales by its agents, which are in addition to the
commissions paid to Standard Marketing's independent agents. The availability
of override commissions provides an economic incentive to Standard Marketing to
recruit agents who produce business. Standard Marketing's relationships with
these companies are non-exclusive and are terminable by either party upon 30
days notice. Standard Marketing regularly evaluates the products its agents
offer to determine whether products or insurers should be added to, or deleted
from, the Standard Marketing portfolio. SMC does not insure any of the
policies and contracts Standard Marketing's agents sell for unaffiliated
insurers.
Each general agent operates his own agency and is responsible for all
expenses of the agency. The general agents are compensated directly by the
issuing insurance companies, which perform all policy issuance, underwriting
and accounting functions. SMC is not dependent on any one agent or agency for
any substantial amount of its business. No single agent accounted for more
than 4% of Standard Life's annual sales in 1997, and the top twenty individual
agents accounted for approximately 37% of Standard Life's volume in 1997. At
December 31, 1997, approximately 25% of Standard Marketing's independent agents
were located in Indiana, Florida, Ohio, Georgia, California and Illinois, with
the balance distributed across the country. SMC is attempting to increase the
number and geographic diversity of its agents. In 1997, SMC began writing
significant amounts of business in Colorado and the Mid-South due to Standard
Marketing's expansion efforts.
SMC does not have exclusive agency agreements with its agents and
management believes most of these agents sell products similar to those sold by
SMC for other insurance companies. This could result in a sales decline if
SMC's products were to become relatively less competitive. Standard Life's 1997
FPDA sales increased partially due to an aggressive marketing campaign targeted
to high volume sales agents and marketing companies. Also contributing to the
increase in premiums was the continued development of Standard Life's
distribution system through marketing support from Standard Marketing along
with an aggressive program aimed at retention of key producers and expanding
geographical concentration into the Mid-South and California.
SAVERS LIFE MARKETING. Savers Life initially sold only annuity products
through its affiliations with a network of North Carolina-based Savings and
Loan institutions. In the late 1980s, the Savings and Loan industry
experienced financial crises which led to a large number of mergers in that
industry. Savers Life's distribution network among the Savings and Loan
institutions was threatened by this merger boom, so Savers Life expanded its
marketing efforts, gradually building up a network of independent brokers,
while still continuing to market through certain North Carolina and South
Carolina Savings and Loan institutions. Savers Life currently has approximately
4,000 active brokers. Savers Life is not dependent on any one broker or
agency for any substantial amount of its business. Savers Life employs three
Regional Managers, who are responsible for personally initiating and
maintaining direct communications with every broker appointed by Savers
Life. The Regional Managers are responsible for the recruitment and
training of all new brokers. Each broker operates independently
of Savers Life and is responsible for all of his or her expenses.
INTERNATIONAL MARKETING. The subsidiaries of Standard Management
International, Premier Life (Luxembourg) and Premier Life (Bermuda), produced
aggregate new premium deposits of approximately $22,000,000, $17,000,000 and
$32,000,000 during 1997, 1996 and 1995, respectively. The increase in 1997 is
due to renewed marketing efforts in certain European countries, particularly in
Sweden and Belgium. The decrease in 1996 is primarily due to an internal
reorganization of its operational facility as well as a renewed focus on target
markets which succeeded in 1997. The countries within the European Union
have been the main contributor to these sales. Although SMC expects this to be
the case in the future, it plans to increase marketing efforts in other parts
of the world as well.
Although Standard Management International anticipates as part of its
long term plan to grow significantly through internal sales, acquisitions of
other European insurance companies may be considered. It has designed and
launched new single and regular premium products in recent years. It is also in
discussions with a number of companies to form alliances to produce tailored
products for their markets. It is currently the intention that Premier Life
(Luxembourg) will write business within the European Union and Premier Life
(Bermuda) will write international business elsewhere in the world. The market
for Standard Management International's products is considered to be medium to
high net worth individuals who typically have in excess of $75,000 to invest in
a single premium policy and medium to high earners who have in excess of $3,000
per annum to invest in a regular premium savings product. The above individuals
would come from a combination of expatriates, residents of European Union
countries and from other targeted areas. The expatriate and European insurance
markets are well established and highly competitive with a large number of
domestic and international groups operating in, or going into, the same markets
as Standard Management International.
Standard Management International's products are distributed via
independent agents who have established connections with these targeted
individuals. Standard Management International is striving to develop into an
entrepreneurial intermediary oriented organization committed to building long
term relationships with high quality distributors, thereby creating a niche
position. Standard Management International places the same emphasis as SMC's
U.S. insurance companies on a high level of service to intermediaries and
policyholders while striving to achieve low overhead costs.
PRODUCTS
SMC primarily markets FPDAs, whole life and universal and
interest-sensitive life insurance policies and unit-linked policies. The
following table sets forth the amounts and percentages of net premiums received
by SMC from currently marketed products for the years ended December 31, 1997,
1996 and 1995, respectively (in thousands). Because GAAP generally excludes
annuity and unit-linked products deposits, and premiums from universal and
interest-sensitive life insurance from premium income, and thus does not fully
reflect SMC's cash flow from new business, the premium information contained in
the following table is reported using statutory accounting principles which
includes deposits on annuities and unit-linked policies, and premiums from
universal and interest-sensitive life insurance.
Year Ended December 31,
1997 1996 1995
Amount % Amount % Amount %
Currently marketed products:
FPDAs $41,066 55.5 $37,322 58.7 $12,417 25.8
Universal and 5,836 7.9 5,384 8.5 2,044 4.2
interest-sensitive life
Single premium immediate 2,704 3.7 1,423 2.2 1,257 2.6
annuities
Whole life 2,349 3.2 2,546 4.0 668 1.4
Unit-linked products 21,954 29.7 16,902 26.6 31,793 66.0
$73,909 100.0 63,577 100.0 48,179 100.0
FPDA sales increased in 1997 primarily due to the introduction of new
products and an increase in the agency base achieved through the recruitment of
high volume agents and larger managing general agencies and continued expansion
of geographical concentration into such areas as California. FPDA sales
increased in 1996 partially due to Standard Life decreasing the quota-share
portion of business ceded pursuant to a reinsurance agreement, under which 70%
of a portion of Standard Life's annuity business pursuant to the terms of the
agreement produced after December 31, 1994 was ceded, to 50% at September 1,
1995, which was further decreased to 25% effective April 1, 1996. This
reduction was possible since the surplus strain experienced by Standard Life
was not as great as originally anticipated as a result of lower than expected
sales in 1995 and the additional surplus resulting from the sale of First
International. Premium deposits ceded pursuant to this reinsurance agreement
reduced net premium by $8,707,000, $8,907,000 and $20,090,000 for 1997, 1996
and 1995, respectively.
The increase in universal and interest-sensitive life products in 1996 is
primarily due to the increase in interest-sensitive life products issued by
Dixie National Life, which is included in results after October 2, 1995, the
effective date of the acquisition.
The increase in deposits from unit linked products in 1997 is primarily
due to the renewed marketing efforts in certain European countries,
particularly in Sweden and Belgium.
The following table shows certain information for SMC as of the dates set
forth below (in thousands):
At December 31,
1997 1996 1995
Number of annuity contracts in force 14,013 13,221{ (3)} 8,637
Interest-sensitive annuity and other
financial $350,607 $333,633{ (3)} $212,500
product reserves, net of reinsurance
ceded
Number of life policies in force 68,571 76,219{ (4)} 63,038
Life insurance in force, net of reinsurance $ 1,178,171{ (1)} $ 1,367,675{ (4)} $826,296
ceded
Number of separate contracts
(primarily unit-linked products) 2,329 2,484 2,951
Total liabilities related to separate
accounts $ 148,064 $128,546 $122,705
(primarily unit-linked products) {(2)}
(1) The decrease in life insurance in force is due to the termination and
recapture of a reinsurance agreement effective January 1, 1997. See
"Business of SMC -- Reinsurance".
(2) The liabilities related to separate accounts increased in 1997 due to
increased new premium deposits and higher investment returns earned by
the policyholder on the separate accounts due to improved fund
performance.
(3) The number of annuity contracts in force and interest-sensitive annuity
and other financial product reserves increased in 1996 primarily due to
the increase in FPDA sales in 1996 and the Shelby merger.
(4) The number of life policies and insurance in force increased in 1996, as
a result of the Shelby merger. Shelby Life had 16,603 life policies and
$617,688,000 insurance in force as of November 1, 1996.
CURRENTLY MARKETED PRODUCTS
The individual annuity business is a growing segment of the savings and
retirement industry, which increased in sales from $1 billion in 1970 to more
than $54 billion in 1990. The individual annuity market, which is one of SMC's
primary target, comprises 42% of those sales. As the 76 million baby boomers
born from 1946 through 1964 grow older, demand for insurance products is
expected to grow. SMC believes that those seeking adequate retirement incomes
will depend less and less on Social Security and their employers' retirement
programs and more and more upon their own financial resources. Annuities
currently enjoy an advantage over certain other saving mechanisms because the
annuity buyer receives a tax-deferred accrual of interest on his investment
during the accumulation period.
Standard Life, Dixie National Life and Standard Management International
all currently issue new policies. Standard Life emphasizes the issuance of
FPDAs. Dixie National Life primarily sells "burial expense" life insurance
policies. Standard Management International markets unit-linked products. Over
31% of all net premiums and deposits collected in 1997 by SMC from its
currently marketed products, arise from the sale of unit-linked products by
Standard Management International. The balance is represented by the sales of
whole life and universal and interest-sensitive life insurance products by
Standard Life and Dixie National Life and Standard Life's FPDAs. The portfolio
of products is continuously reviewed by management, and product features and
terms are adjusted in response to market conditions in an effort to remain
competitive.
Standard Management International's products are sold primarily in
Western Europe. SMC's gross sales percentages by U.S. geographical region are
summarized as follows:
STATE 1997 1996 1995
Indiana 21% 18% 24%
California 11 11 3
Ohio 10 16 22
Florida 10 14 11
Texas 4 4 2
Louisiana 4 2 2
Virginia 4 2 --
Colorado 4 1 --
Michigan 2 6 4
All other states {(1)} 30 26 32
Total 100% 100% 100%
(1) No other state had gross sales greater than 4%.
STANDARD LIFE PRODUCTS
FLEXIBLE PREMIUM DEFERRED ANNUITIES. FPDAs provide for an initial
deposit by an annuitant and optional additional deposits, the time and amount
of which are at the discretion of the annuitant. Standard Life credits the
account of the annuitant with earnings at interest rates that are revised
periodically by Standard Life until the maturity date. This accumulated value
is tax deferred. Revisions to interest rates on FPDAs are restricted by an
initial crediting rate guaranteed for a specific period of time and a minimum
crediting rate guaranteed for the term of the FPDA. At maturity, the annuitant
can elect a lump sum cash payment of the accumulated value or one of the
various payout options available. Standard Life's FPDAs also provide for
penalty-free partial withdrawals of up to 10% annually of the accumulation
value after the annuitant has held the FPDA for more than 12 months. In
addition, the annuitant may surrender the FPDA at any time before the maturity
date and receive the accumulated value, less any surrender charge then in
effect for that contract. To protect holders of FPDAs from a sharp reduction in
the credited interest rate after a FPDA is issued, Standard Life permits the
FPDA holder of certain annuities to surrender the annuity during a specified
period without incurring a surrender charge if the renewal crediting rate is
below a stated level. This stated level of interest is referred to as the
"bail-out rate" and is typically below the original crediting rate, but above
the minimum guaranteed crediting rate.
As of January 1, 1998, the crediting rates available on Standard Life's
currently marketed FPDAs ranged from 6.8% to 12%, with new issues having an
interest rate with a one year guarantee period. After the initial period, the
crediting rate may be changed periodically, subject to minimum guaranteed rates
from 3% to 4%. As of January 1, 1998, interest crediting rates after the
initial guarantee period ranged from 5% to 6.6%. The surrender charge is
initially 13% or 15% of the contract value depending on the product and
decreases over the applicable penalty period of nine, ten or thirteen years. As
of January 1, 1998, the bail out rate for Standard Life's FPDAs was 4.5%; most
currently marketed products carry a bail out rate for only the first two years
after issue. As of December 31, 1997, Standard Life had 8,855 currently
marketed FPDA contracts in force.
WHOLE LIFE INSURANCE. Standard Life offers two types of
non-participating whole life policies: one in face amounts up to $10,000 (which
is only issued upon conversion of other policies) and the other in face amounts
up to $50,000. Whole life insurance products involve fixed premium payments
made over time, with the stated death benefit paid in full upon the death of
the insured. The whole life policy combines the death benefit with a forced
savings plan. Premiums remain level over the life of the policy, with the
policyholder prefunding during the early years of coverage when risk of death
is low. Over time, whole life policies begin to accrue a cash value which can
be made available to the policyholder net of taxes and withdrawal penalties. As
of December 31, 1997, Standard Life had 551 currently marketed whole life
policies in force.
SINGLE PREMIUM IMMEDIATE ANNUITIES. Standard Life offers a single
premium immediate annuity ("SPIA"), whereby an annuitant purchases an immediate
annuity with a one-time premium deposit at the time of issuance. Standard Life
begins a payout stream shortly after the time of issuance consisting of
principal value plus accumulated interest credited to such annuity. This
product credits interest based on an investment portfolio earned rate
assumption. As of December 31, 1997, Standard Life had 691 SPIA contracts in
force.
UNIVERSAL LIFE. SPULs provide for an initial deposit (flexible premium
universal life ("FPUL") for periodic deposits), credit interest to account
values and charge the account values for mortality and administrative costs. As
of January 1, 1998, the current interest rate on new sales of SPULs was 6.75%
with a guaranteed interest rate of 3.4%. As of December 31, 1997, Standard Life
had 88 and 286 SPUL and FPUL policies in force, respectively.
CRITICAL ILLNESS. During 1997, Standard Life introduced a new critical
illness product which is being offered in the United States for the first time.
A critical illness policy pays a 100% lump sum cash payment when the insured
survives 30 days or more after diagnosis of cancer, stroke, or heart attack.
In addition, the insurer would pay 25% of the benefit amount on heart bypass
surgery, Alzheimer's, deafness, or blindness. Although not intended to replace
existing insurance, this product gives policyholders access to sums of money to
help them through difficult situations. Included in the policy is a return of
premium benefit, which would return all paid premiums (without interest) if the
insured dies after 10 years, assuming the policy is still in force. This 14
year-old product has been extremely successful in South Africa, Australia, the
United Kingdom, and Japan. In 1993, $15.5 billion of face amount insurance in
critical illness policies was sold in the United Kingdom alone. In Japan,
500,000 policies were sold within the first 10 months of its inception, with
over $6 million in total sales to date.
DIXIE NATIONAL LIFE PRODUCTS
Life insurance policies sold by Dixie National Life in the final expense,
or burial, market include fixed premium interest sensitive policies that
provide for increasing death benefits, as well as traditional whole life
policies. These policies are designed to cover expenses such as funeral, last
illness, monument and cemetery lot. The policies provide for a death benefit,
generally not in excess of $10,000, and a level premium payment. The products
include a cash value which may be borrowed by the policyholder. Dixie National
Life's policies sold in other markets include interest sensitive and
traditional whole life policies and forms of term policies. The interest
sensitive whole life policies have a guaranteed interest rate of 5.50% on
products marketed as of January 1, 1998. The interest sensitive and whole life
policies include cash values which may be borrowed by the policyholder. Dixie
National Life issues policies on both a participating and non-participating
basis. As of December 31, 1997, Dixie National Life had 734 and 24,185
individual annuities and life policies in force, respectively.
STANDARD MANAGEMENT INTERNATIONAL PRODUCTS
UNIT-LINKED POLICIES. Standard Management International currently writes
unit-linked life products, which are similar to U.S. produced variable life
products. Separate account assets and liabilities are maintained primarily for
the exclusive benefits of universal life contracts and investment contracts of
which the majority represents unit-linked business where benefits on surrender
and maturity are not guaranteed. They generally represent funds held in
accounts to meet specific investment objectives of policyholders who bear the
investment risk. Investment income and investment gains and losses within the
separate accounts accrue directly to such policyholders. The fees received by
Standard Management International for administrative and contract holder
maintenance services performed for these separate accounts are included in
SMC's statement of operations.
In the past, Standard Management International also wrote investment
contracts and universal life policies and to a lesser extent, traditional life
policies. The investment contracts are mainly short-term single premium
endowments or temporary annuities under which fixed benefits are paid to the
policyholder. The terms of these contracts are such that SMC has relatively
small morbidity or mortality risk. The universal life contracts are mainly
regular premium and single premium endowment. The benefits payable to the
policyholders are directly linked to the investment performance of the
underlying assets.
CLOSED BLOCKS
SMC also generates cash flow and income from its closed blocks of in
force life insurance and annuities. Closed blocks are blocks of in force life
insurance and annuities that are not currently being marketed by SMC. The
closed block designation is for internal purposes only, it does not have any
legal or regulatory significance and there are no restrictions on the assets or
future profits of closed blocks. The premiums received on the closed blocks
were primarily from the ordinary and universal life business. This decline in
premium income is expected as a result of policy lapses, surrenders and
expiries from closed blocks of business.
ANNUITIES. SMC's closed blocks of deferred annuities consist primarily
of FPDAs and a small amount of single premium deferred annuities ("SPDAs")
which, unlike FPDAs, do not provide for additional deposits. As of January 1,
1998, these deferred annuities had crediting rates ranging from 5% to 5.5% and
guaranteed minimum crediting rates ranging from 3% to 5.5%. The crediting rate
may be changed periodically. The contract owner is permitted to withdraw all or
part of the accumulation value. SMC's closed blocks of annuities include payout
annuities. Payout annuities consist of those annuities the benefits of which
are being paid out over a specified time period. Payout annuities cannot be
terminated by surrender or withdrawal. SMC's crediting rates on payout
annuities range from 5.5% to 6.5% and cannot be changed. At December 31, 1997,
SMC had 3,688 annuity contracts in force for closed blocks.
ORDINARY LIFE. The ordinary life policies included in SMC's closed
blocks are composed primarily of fixed premium, cash value whole life products.
In addition, they include annually renewable term policies as well as five, ten
and fifteen year level premium term policies. At December 31, 1997, SMC had
35,937 ordinary life policies in force for closed blocks.
UNIVERSAL LIFE. Certain closed blocks include universal life business.
For this business, SMC credits deposits and interest to account values and
charges the account values for mortality and administrative costs. At December
31, 1997, SMC had 6,368 universal life policies in force for the Shelby Life
closed block of business.
REINSURANCE. In connection with financial reinsurance, Dixie National
Life terminated a reinsurance agreement with Crown Life Insurance Company and
received recaptured premium income of $18,186,000 and entered into a financial
reinsurance agreement with Cologne Life Reinsurance Company and ceded
$13,091,000 of premium income in 1996.
The policies subject to the recapture of the reinsurance agreement with
National Mutual were primarily ordinary life policies. See "Business of SMC --
Reinsurance."
SAVERS LIFE PRODUCTS
Savers Life issues and markets Medicare supplement health policies, term
and whole life policies, single premium deferred annuities and SPIAs.
MEDICARE SUPPLEMENT INSURANCE. Medicare supplement insurance is designed
to help Medicare recipients with the portion of their medical expenses that
Medicare does not cover. This product is regulated by the federal government.
Each insurance company's products are identical in benefits covered. Medicare
supplement plans are identified by the letters A through J. Savers Life sells
plans A through G. Each plan has different benefits to the insured as well as
different premium levels. Medicare supplement plans are available to anyone
who is eligible for Medicare Part B and within the ages of 65 and 85 at date of
issue. At the time a person initially becomes eligible for Medicare Part B
("open enrollment period"), Savers Life must offer a Medicare supplement policy
to that person regardless of potential health problems of the person. If a
person requests insurance coverage after the open enrollment period, Savers
Life is allowed to underwrite the policy and determine insurability based on
the health of the individual. Savers Life has a combination of products in its
in-force block of Medicare supplement business, including pre-standardization
plans and standardized plans A through G. Premiums on all of these policies can
be increased only with regulatory approval in the states in which the policies
were written. With the exception of South Carolina, premium rate increases can
occur no more frequently than annually. South Carolina allows premium rate
increases semiannually after the first policy anniversary.
In addition to sales of its own products, Savers Life markets products of
other companies, and for this effort, receives fee income.
KEYPORT ANNUITIES. Savers Life sells annuities on behalf of Keyport Life
Insurance Company ("Keyport"), a Rhode Island-based seller of annuities,
through its broker network. Savers Life sells Keyport fixed annuity products
that, due to their relatively high rate of interest, are very popular with
Savers Life's customer base. Savers Life remits the premiums collected to
Keyport and is compensated through commission agreements.
QUALCHOICE OF NORTH CAROLINA PRODUCT. Savers Life entered into a
two-year marketing and administrative contract with QualChoice of North
Carolina ("QualChoice") in 1996 whereby Savers Life is the distribution system
for the small group product offered by QualChoice. QualChoice is an HMO in a
twenty-county area in the northwestern part of North Carolina offering HMO
insurance coverage to both large and small groups. Small group coverage is
defined as any group of employees from one to fifty. Savers Life is
compensated for this effort with a marketing fee, administrative fee and
commission reimbursement for its brokers.
PRODUCT PROFITABILITY
The profitability of the life insurance and annuity products depend to a
significant degree on the maintenance of profit margins between investment
results from invested assets and interest credited on insurance and annuity
products. During 1997, such margins continued to be positive as a result of the
increase in investment portfolio yields, which offsets the effects of sales of
FPDAs in 1997 with higher and more competitive interest rates.
The long-term profitability of insurance products depends on the accuracy
of the actuarial assumptions that underlie the pricing of such products.
Actuarial calculations for such insurance products, and the ultimate
profitability of such products, are based on four major factors:
(i) persistency, (ii) mortality (iii) return on cash invested by the insurer
during the life of the policy and (iv) expenses of acquiring and administering
the policies.
The average expected remaining life of Standard Life's ordinary life
business in force at December 31, 1997 was 9.0 years. This calculation was
determined based upon SMC's actuarial models and assumptions as to expected
persistency and mortality. Persistency is the extent to which insurance
policies sold are maintained by the insured. The persistency of life insurance
and annuity products is a critical element of their profitability. However, a
surrender charge often applies in the early contract years and declines to zero
over time.
Policyholders sometimes do not pay premiums, thus causing their policies
to lapse. For the years 1997, 1996 and 1995 Standard Life experienced total
policy lapses of 6.5%, 6.3% and 5.1% of total policies in force at December 31
of each year, respectively. The American Council of Life Insurance 1997 Fact
Book reported industry life insurance voluntary termination rates in 1996 of
17.7% for policies in force less than two years, 5.1% for policies in force for
two years or more and 6.8% for all policies in force.
OPERATIONS
SMC emphasizes a high level of service to agents and policyholders and
strives to achieve low overhead costs. SMC's principal administrative
departments are its financial, policyholder services and management information
services ("MIS") departments. The financial department provides accounting,
budgeting, tax, investment, financial reporting and actuarial services and
establishes cost control systems for SMC. The policyholder services department
reviews policy applications, issues and administers policies and authorizes
disbursements related to claims and surrenders. The MIS department oversees and
administers SMC's information processing systems.
SMC's administrative departments in the United States use a common
integrated system that permits SMC to function more efficiently, control costs
and maintain low overhead. SMC's MIS system serviced approximately 150,000
active and inactive policies at December 31, 1997. SMC is continually improving
its MIS systems to provide for continued growth from acquisitions and sales.
SMC's 1998 capital budget for systems improvements is $150,000. Also, SMC
anticipates minimal expenditure to be required in the update of the MIS system
for the year 2000.
Standard Management International's administrative and MIS departments in
Luxembourg are an autonomous unit from the systems in the United States. SMC is
in the process of improving the MIS systems of Standard Management
International and integrating them with the U.S. systems.
INVESTMENTS
Investment activities are an integral part of SMC's business; investment
income of SMC's insurance subsidiaries is an important part of its total
revenues. Profitability is significantly affected by spreads between rates
credited on insurance liabilities and interest yield on invested assets.
Substantially all credited rates on FPDAs may be changed at least annually. For
the year ended December 31, 1997, the weighted average interest rate credited
on SMC's interest-sensitive liability portfolio, excluding liabilities related
to separate accounts, was approximately 5.58% per annum, and the weighted
average net yield of SMC's investment portfolio for the year ended December 31,
1997 was 7.68% for an average interest spread of 210 basis points at December
31, 1997, compared to 205 basis points at December 31, 1996. The consistency in
the average interest spread is primarily attributable to the increase in
investment portfolio yields, which offsets the effects of sales of FPDAs in
1997 with higher and more competitive interest rates. Increases or decreases in
interest rates could increase or decrease the average interest rate spread
between investment yields and interest rates credited on insurance liabilities,
which in turn could have a beneficial or adverse effect on the future
profitability of SMC. Sales of fixed maturity securities that result in
investment gains may also tend to decrease future average interest rate
spreads. State insurance laws and regulations prescribe the types of permitted
investments and limit their concentration in certain classes of investments.
The following table shows SMC's pre-tax investment performance for the
periods indicated (in thousands):
Year Ended December 31,
1997 1996 1995
Average invested assets{ (1)} $384,145 $285,186 $253,055
Net investment income 29,516 20,871 18,517
Weighted average annual yield{ (2)} 7.68% 7.32% 7.32%
Net realized investment gains $396 $1,302 $688
(1) Average invested assets are computed by dividing the total of the
amortized cost of invested assets at the beginning of the period plus the
individual quarter-end balances by the number of quarterly periods plus
one. The increase in average invested assets in 1997 is primarily due to
the acquisition of Shelby Life effective November 1, 1997.
(2) The weighted average annual yield on SMC's investment portfolio for each
period is computed by dividing net investment income (exclusive of
realized and unrealized gains and losses) by average invested assets for
such period.
The following table shows the amortized cost, gross unrealized gain
(loss) and estimated fair value of SMC's investment securities all of which are
available for sale (in thousands):
December 31, 1997
Gross Gross
Amortized Unrealized Gain Unrealized Fair
Cost (Loss) Value
Fixed maturity securities:
United States Treasury
securities and
obligations of United $27,613 $174 $(90) $27,697
States government agencies
Obligations of states and
political 3,790 204 (26) 3,968
subdivisions
Foreign government securities 30,558 497 (3,296) 27,759
Utilities 26,606 534 (109) 27,031
Corporate bonds 223,958 8,140 (1,609) 230,489
Mortgage-backed securities 51,266 657 (60) 51,863
Redeemable preferred stock 3,581 188 (60) 3,769
Total fixed maturity 367,372 10,394 (5,190) 372,576
securities
Equity securities 55 -- (3) 52
Total $367,427 $10,394 $(5,193) $372,628
December 31, 1996
Gross Gross
Amortized Unrealized Gain Unrealized Fair
Cost (Loss) Value
Fixed maturity securities:
United States Treasury
securities and
obligations of United $20,753 $51 $(420) $20,384
States government agencies
Obligations of states and
political 3,588 106 -- 3,694
subdivisions
Foreign government securities 10,042 51 (166) 9,927
Utilities 31,000 295 (675) 30,620
Corporate bonds 210,977 3,086 (3,539) 210,524
Mortgage-backed securities 72,264 247 (919) 71,592
Redeemable preferred stock 527 42 -- 569
Total fixed maturity 349,151 3,878 (5,719) 347,310
securities
Equity securities 58 4 -- 62
Total $349,209 $3,882 $(5,719) $347,372
The fair values for fixed maturity securities are based on quoted market
prices, where available. For fixed maturity securities not actively traded,
fair values are estimated using values obtained from independent pricing
services or by discounting expected future cash flows using a current market
rate applicable to the coupon rate, credit and maturity of the investments.
SMC balances the duration of its invested assets with the expected
duration of benefit payments arising from insurance liabilities. The "duration"
of a security is the time-weighted present value of the security's cash flows
and is used to measure a security's price sensitivity to changes in market
interest rates. At December 31, 1997, the adjusted modified duration of fixed
maturities and short-term investments for its U.S. insurance subsidiaries was
5.6 years compared to 5.5 years at December 31, 1996.
The amortized cost and estimated fair value of fixed maturity securities
at December 31, 1997 by contractual maturity are shown below (in thousands).
Actual maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties and because most mortgage-backed securities provide for periodic
payments throughout their lives.
Amortized Fair
Cost Value
Due in one year or less $4,560 $4,551
Due after one year through five years 31,597 32,048
Due after five years through ten years 141,805 140,972
Due after ten years 134,561 139,373
Subtotal 312,523 316,944
Redeemable preferred stock 3,581 3,769
Mortgage-backed securities 51,266 51,863
Total fixed maturity securities $367,370 $372,576
SMC's investment strategy is guided by strategic objectives established
by the Investment Committee of the Board of Directors of Standard Life. SMC's
major investment objectives are: (i) to ensure adequate safety of investments
and to protect and enhance capital; (ii) to maximize after-tax return on
investments; (iii) to match the anticipated duration of investments with the
anticipated duration of policy liabilities; and (iv) to provide sufficient
liquidity to meet cash requirements with minimum sacrifice of investment yield.
Consistent with its strategy, SMC invests primarily in securities of the U.S.
government and its agencies, investment grade utility and corporate debt
securities and collateralized mortgage obligations ("CMOs"). From time to time
when opportunities arise, however, below investment grade securities may be
purchased. Protection against default risk is a primary consideration. SMC has
determined it will not invest more than 7% of its bond portfolio in below
investment grade securities.
The following table sets forth the quality of SMC's fixed maturity
securities as of December 31, 1997, classified in accordance with the ratings
assigned by the National Association of Insurance Commissioners ("NAIC"):
Percent of Fixed
NAIC RATING (1) MATURITY SECURITIES
1 48%
2 47
Investment Grade 95
3-4 4
5-6 1
Below Investment Grade 5
Total fixed maturity securities 100%
(1) The NAIC assigns securities quality ratings and uniform book values
called "NAIC Designations," which are used by insurers when preparing
their annual statements. The NAIC assigns ratings to publicly traded as
well as privately-placed securities. The ratings assigned by the NAIC
range from Class 1 to Class 6, with a rating in Class 1 being of the
highest quality.
SMC engages Conseco Capital Management Inc. ("CCM"), a wholly owned
subsidiary of Conseco, Inc., to manage SMC's invested assets (other than
mortgage loans, policy loans, real estate and other invested assets), subject
to the direction of SMC's Investment Committee. A quarterly fee equal to .035%
of the total market value of the assets under management as of the end of each
quarter is paid to CCM for its investment advisory services.
Approximately 14% of SMC's fixed maturity securities at December 31, 1997
is comprised of mortgage-backed securities. Investments in mortgage-backed
securities include CMOs and mortgage-backed pass-through securities.
Approximately 96% of the book value of the mortgage-backed securities in SMC's
portfolio is backed by an agency of the U.S. government (although generally not
by the full faith and credit of the U.S. government) as to the full amount of
both principal and interest. Approximately 9% of the book value of
mortgage-backed securities in SMC's portfolio is backed by the full faith and
credit of the U.S. government as to the full amount of both principal and
interest. SMC closely monitors the market value of all investments within its
mortgage-backed portfolio.
The following table summarizes SMC's mortgage-backed securities at
December 31, 1997 (in thousands):
Estimated Avg.
% of % of Avg. Life Term
Amortized Fixed Fair Fixed of to Final
Cost Maturities Value Maturities Investment Maturity
(In Years) (In Years)
Agency CMOs:
Planned and target amortization $23,034 6.3% $23,142 6.2% 7.1 24.4
classes
Sequential and support classes 2,150 .6 2,116 .6 4.6 26.4
Total 25,184 6.9 25,258 6.8 6.8 26.4
Non-agency CMOs:
Sequential classes 1,591 .4 1,636 .4 2.8 20.6
Total CMOs 26,775 7.3 26,894 7.2 6.8 24.4
Agency mortgage-backed pass-through
securities 24,491 6.7 24,969 6.7 4.6 15.9
Total mortgage- $51,266 14.0% $51,863 13.9% 6.4 19.5
backed securities
The market values for SMC's mortgage-backed securities were determined
from broker-dealer market makers, internally developed methods and nationally
recognized statistical rating organizations.
Certain mortgage-backed securities are subject to significant prepayment
risk, since, in periods of declining interest rates, mortgages may be repaid
more rapidly than scheduled as individuals refinance higher rate mortgages to
take advantage of the lower current rates. As a result, holders of
mortgage-backed securities may receive large prepayments on their investment
which cannot be reinvested at an interest rate comparable to the rate on the
prepaying mortgages. SMC has addressed this risk of prepayment risk by
investing 45% of its mortgage-backed investment portfolio in planned and target
amortization classes. These investments are designed to amortize in a more
predictable manner by shifting the primary risk of prepayment of the underlying
collateral to investors in other tranches ("support classes"). Mortgage-backed
pass-through securities, "sequential" and support class CMOs, which comprised
approximately 55% of the book value of SMC's mortgage-backed securities at
December 31, 1997, are more sensitive to this prepayment risk.
SEPARATE ACCOUNTS
Separate account assets and liabilities are maintained primarily for
universal life contracts of which the majority represents unit-linked business
where benefits on surrender and maturity are not guaranteed. They generally
represent funds held in accounts to meet specific investment objectives of
policyholders who bear the investment risk. Investment income and investment
gains and losses accrue directly to such policyholders.
UNDERWRITING
Premiums charged on insurance products are based in part on assumptions
about the incidence and timing of insurance claims. SMC has adopted and follows
underwriting procedures for both its whole life and universal life insurance
policies. To implement these procedures, SMC employs a professional
underwriting staff. All underwriting decisions are made in SMC's home office.
To the extent that an applicant does not meet SMC's underwriting standards for
issuance of a policy at the standard risk classifications, SMC may rate or
decline the application. Underwriting with respect to FPDAs is minimal. No
underwriting procedures are applied to Standard Life's $10,000 conversion
policy or Standard Management International's unit-linked business.
Traditional underwriting procedures are not applied to policies acquired
in blocks. In these cases, SMC reviews the mortality experience for recent
years and compares actual experience to that assumed in the actuarial
projections for the acquired policies.
RESERVES
In accordance with applicable insurance laws, SMC's insurance
subsidiaries have established and carry as liabilities in their statutory
financial statements actuarially determined reserves to satisfy their
respective annuity contract and life insurance policy obligations. Reserves,
together with premiums to be received on outstanding policies and interest
thereon at certain assumed rates, are calculated to be sufficient to satisfy
policy and contract obligations. The actuarial factors used in determining such
reserves are based on statutorily prescribed mortality tables and interest
rates.
The reserves recorded in the consolidated financial statements included
elsewhere herein are calculated based on GAAP and differ from those specified
by the laws of the various states and recorded in the statutory financial
statements of SMC's insurance subsidiaries. These differences arise from the
use of different mortality tables and interest rate assumptions, the
introduction of lapse assumptions into the reserve calculation and the use of
the net level premium reserve method on all insurance business. See Note 1 of
the Notes to the Consolidated Financial Statements for certain additional
information regarding reserve assumptions under GAAP.
To determine policy benefit reserves for its life insurance and annuity
products, SMC performs periodic studies to compare current experience for
mortality, interest and lapse rates with projected experience used in
calculating the reserves. Differences are reflected currently in earnings for
each period. SMC historically has not experienced significant adverse
deviations from its assumptions.
REINSURANCE
Consistent with the general practice of the life insurance industry, SMC
has reinsured portions of the coverage provided by its insurance products with
other insurance companies under agreements of indemnity reinsurance. The
policy risk retention limit on the life of any one individual does not exceed
$150,000.
Indemnity reinsurance agreements are intended to limit a life insurer's
maximum loss on a particular risk or to obtain a greater diversification of
risk. Indemnity reinsurance does not discharge the primary liability of the
original insurer to the insured, but it is the practice of insurers for
statutory accounting purposes (subject to certain limitations of state
insurance statutes) to account for risks which have been reinsured with other
approved companies, to the extent of the reinsurance, as though they are not
risks for which the original insurer is liable. However, under Statement of
Financial Accounting Standards No. 113 ("SFAS 113"), "Accounting and Reporting
for Reinsurance of Short-Duration and Long-Duration Contracts" these amounts
are added back to policy reserves and recorded as amounts due from reinsurers.
Reinsurance ceded on life insurance policies to unaffiliated companies by
SMC in 1997, 1996 and 1995 represented 51.9%, 57.6% and 68.8%, respectively, of
gross combined individual life insurance in force at the end of such years.
Reinsurance assumed in the normal course from unaffiliated companies by SMC in
1997, 1996 and 1995 represented .02%, .02% and .03%, respectively, of net
combined individual life insurance in force excluding reinsurance from GIAC
described below. SMC cedes reinsurance to numerous reinsurers. At December 31,
1997, approximately $398,456,000 of the face value of life policies and
reinsurance recoverable of $2,648,000 had been ceded to The Lincoln National
Life Insurance Company ("Lincoln National"), $188,524,000 of the face value of
life policies and reinsurance recoverable of $1,021,000 ceded to Swiss Re Life
and Health ("Swiss Re") and $169,869,000 of the face value of life policies and
reinsurance recoverable of $1,179,000 had been ceded to Security Life of Denver
Insurance Company ("Security Life"). Lincoln National is the lead reinsurer
with a total of 31.3% of total reinsurance ceded with Swiss Re and Security
Life each accounting for 14.9% and 13.3%, respectively, of total reinsurance
ceded by SMC's life insurance subsidiaries at December 31, 1997. The amount of
life insurance business ceded to any other reinsurer is not material. Of SMC's
total life insurance in force at December 31, 1997 that is reinsured, 100.0% is
ceded to insurers rated "A" or better by A.M. Best. SMC historically has not
experienced any material losses in collection of reinsurance receivables.
Commencing January 1, 1995, SMC began to reinsure a portion of its
annuity business. The primary purposes of the reinsurance agreement were to
limit the net loss arising from large risks, maintain SMC's exposure to loss
within capital resources, and provide additional capacity for future growth.
Furthermore, these reinsurance agreements have allowed SMC to write volumes of
business that it would not otherwise have been able to write due to
restrictions based on its ratio of surplus to liabilities as determined by
regulatory authorities in the State of Florida. By reinsuring a portion of the
annuity business, the liability growth is slowed, thereby avoiding the erosion
of surplus that can occur in periods of increasing sales. If SMC's ratio of
surplus to liabilities falls below 4%, the State of Florida could prohibit SMC
from writing new business in Florida. SMC's largest annuity reinsurer at
December 31, 1997, Winterthur Life Re Insurance Company ("Winterthur"),
represented $32,194,000, or 52.3% of total reinsurance recoverable, $8,707,000
of premium deposits ceded in 1997 and is rated "A" ("Excellent") by A.M. Best.
From January 1, 1995 to August 31, 1995 approximately 70% of certain of
Standard Life's annuity business produced was ceded. SMC decreased the
quota-share portion of business ceded to 50% at September 1, 1995 and further
reduced it to 25% effective April 1, 1996. This reduction was possible since
the surplus strain experienced by Standard Life was not as great as originally
anticipated as a result of lower than expected sales in 1995 and the increase
in surplus resulting from the sale of First International. Winterthur limits
dividends and other transfers by Standard Life to SMC or affiliated companies
if adjusted surplus is less than 5.5% of admitted assets, $20,192,000 at
December 31, 1997.
On March 18, 1996, Standard Life completed the sale of First
International to GIAC. Standard Life received sale proceeds of approximately
$10,393,000 including $1,500,000 for the charter and licenses associated with
First International. Standard Life realized a net pretax gain of $1,042,000 and
a tax benefit of $1,420,000 on the sale. First International, Standard Life and
GIAC have entered into a series of reinsurance and other agreements that
include provisions for Standard Life to administer First International policies
in force at the date of sale, and for Standard Life to continue to receive the
profit stream from certain First International policies in force effective
January 1, 1996.
All the in force business of First International effective January 1,
1996 was ceded to GIAC through a coinsurance indemnity reinsurance agreement.
Under the terms of the agreement, approximately $18,841,000 of First
International's reserves and assets of $18,841,000 were ceded to GIAC as of
January 1, 1996. The assets transferred included cash of $17,046,000, policy
loans of $1,371,000, and net due and deferred premiums of $424,000. The in
force business related to this automatic coinsurance indemnity reinsurance
agreement is comprised of the following two blocks: ("Block I") -- ordinary
life policies (issued in New York and New Jersey), universal life, immediate
and deferred annuities (issued in New York, New Jersey and Vermont),
supplemental contracts and group waivers, and ("Block II") -- ordinary life
policies (not issued in New York and New Jersey) issued prior to 1989, and term
life policies (issued in New York, New Jersey and Vermont) issued after 1988.
Effective January 1, 1996, GIAC entered into a modified coinsurance
indemnity reinsurance agreement with Standard Life with respect to Blocks I and
II. Pursuant to this agreement, Standard Life administers the policies in both
Block I and Block II. Under the terms of the agreement, Standard Life assumed
approximately $18,841,000 of reserves for Block I and Block II from GIAC as of
January 1, 1996. During 1996, Standard Life incurred and paid experience rating
refunds to GIAC on Block I for profits earned in excess of specified amounts.
These refunds were calculated and paid on a quarterly basis. As a result, the
economic risks and benefits associated with Block I remained with GIAC.
Effective January 1, 1997, GIAC and Standard Life executed Amendment I to the
modified coinsurance indemnity reinsurance agreement. Under the terms of
Amendment I, GIAC and Standard Life agreed to terminate effective January 1,
1997 the modified coinsurance indemnity reinsurance agreement with regard to
Block I, and Block I reverted completely to GIAC. In accordance with the
provisions of SFAS 60, SFAS 97, and SFAS 113 for a reinsurance assuming
enterprise, in accordance with deposit accounting, Standard Life has not
recorded revenue or expense during 1996 for the Block I reinsurance. A ceding
commission of $1,100,000 received by First International in connection with the
sale was deferred by First International in accordance with FAS 113. When First
International was sold, the amount was paid to SMC by GIAC as part of First
International's statutory capital and surplus. There is no experience rating
refund on Block II and, accordingly, the economic risks and benefits associated
with Block II remain with Standard Life. Under the terms of the reinsurance
agreement, Standard Life is permitted to appoint an investment advisor subject
to approval from GIAC for the Block II assets. Standard Life has appointed
Gibraltar Investments as such investment advisor for Block II assets.
Investment advisory fees are paid from the Block II assets and reduce Block II
profits. The Block II contract was determined to be a risk transfer assumption
reinsurance contract by Standard Life in accordance with SFAS 113.
As part of the acquisition of First International by SMC in 1992,
Standard Life entered into an indemnity reinsurance agreement with First
International effective July 1, 1992. This business was subsequently assumed by
Standard Life effective January 1, 1993. At the date of the sale of First
International to GIAC, Standard Life ceded this block of business with policy
reserves of $12,514,000 and related assets to GIAC. Consideration of $700,000
paid in connection with the purchase agreement represented additional sales
proceeds. All risks and rewards related to the $700,000 have occurred and have
therefore been recognized. This block of business ("Block III") consisted of
term life policies (not issued in New York, New Jersey or Vermont) issued after
1988 and immediate and deferred annuities (not issued in New York, New Jersey
and Vermont) and lottery annuities. Standard Life will continue to receive
profits from Block III through experience rating refunds from GIAC on
Block III. These experience rating refund calculations are prepared and paid on
a quarterly basis for profits in excess of specified amounts. The experience
rating refund payments will continue so long as any of the underlying policies
remain in force. Under the terms of the reinsurance agreement, Standard Life is
permitted to appoint an investment advisor subject to approval from GIAC for
the Block III assets. Standard Life has appointed Gibraltar Investments as such
investment advisor for Block III assets. Investment advisory fees are paid from
the Block III assets and reduce the experience rating refunds. For GAAP
accounting purposes, Standard Life concluded that this contract did not involve
the transfer of risk to GIAC in accordance with SFAS 113.
SMC decided in February 1996 to terminate the reinsurance agreement
between Standard Reinsurance and Salamandra, and to not renew the Barbados
license of Standard Reinsurance. This resulted in the termination of Standard
Reinsurance's operations and the write-off of SMC's investment in Standard
Reinsurance and certain intangible assets of Standard Reinsurance amounting to
$156,000.
Standard Life terminated by recapture in May 1996 the reinsurance
agreement with National Mutual. Standard Life received assets of $4,826,000 and
liabilities of $4,826,000, primarily ordinary life policies. In connection with
this transaction, Standard Life agreed to pay National Mutual a recapture fee
of $1,200,000, and Standard Life collected administration fees of $375,000
related to services provided in prior years that had not been recorded
previously due to the uncertainty as to its collection. The net proceeds of
$825,000 were recorded as the present value of the future profits on this block
of business, which is being amortized in proportion to the emergence of profits
over 20 years. The premium income, and corresponding increase in reserves, of
$4,234,000, recorded in connection with the recapture of the reinsurance
agreement with National Mutual will not recur in the future.
In order to write an increasing amount of new business while continuing
to meet the statutory requirements of the states in which it conducts its
insurance operations, it has been necessary for Dixie National Life to utilize
various forms of surplus relief. The principal source of surplus relief has
been financial reinsurance agreements, which for GAAP purposes are treated as
financing arrangements, but for statutory accounting purposes provide reserve
credits that, in equal amount, increase statutory surplus. Dixie National Life
has a financial reinsurance agreement that entitles it to a credit to its
statutory reserves of $1,250,000 at December 31, 1997, with the amount of the
credit decreasing each quarter by the amount of profit generated to Dixie
National Life by the underlying block of business.
COMPETITION
The life insurance industry is highly competitive and consists of a large
number of both stock and mutual insurance companies, many of which have
substantially greater financial resources, broader and more diversified product
lines and larger staffs than those possessed by SMC. There are approximately
2,000 life insurance companies in the United States which may offer insurance
products similar to those marketed by SMC. Competition within the life
insurance industry occurs on the basis of, among other things, product features
such as price and interest rates, perceived financial stability of the insurer,
policyholder service, name recognition and ratings assigned by insurance rating
organizations. Additionally, when SMC bids on companies it wishes to acquire,
it typically is in competition with other entities.
SMC must also compete with other insurers to attract and retain the
allegiance of agents. SMC believes it has been successful in attracting and
retaining agents because it has been able to offer a competitive package of
innovative products, competitive commission structures, prompt policy issuance
and responsive policyholder service. Because most annuity business written by
life companies is through agents, management believes that competition centers
more on the strength of the agent relationship rather than on the identity of
the insurer.
Competition also is encountered from the expanding number of banks,
securities brokerage firms and other financial intermediaries which are
marketing insurance products and which offer competing products such as savings
accounts and securities. In the case of banks, these insurance products are
sold for non-affiliate insurance companies in return for a sales fee. A change
in legislation may increase interest on the part of banks to begin selling
annuities or to expand their existing efforts to sell annuities. The decision
could result in a partial shift in the distribution of annuities from insurance
agents to national banks, which, in turn, could result in a decrease in sales
for SMC, or it could result in an increase in the number of annuities sold
because of distribution through national banks (or securities firms), which
could result in new distribution opportunities for SMC. SMC has not been
involved in distribution of annuities through national banks but anticipates
expansion into financial institutions with the acquisition of Savers Life.
The unit-linked life insurance market in Europe is highly competitive and
consists of many companies domiciled in the United Kingdom and its offshore
centers, as well as many companies in Luxembourg and Ireland which sell
products similar to those of Standard Management International. Standard
Management International is able to develop its share of a competitive market
by developing strong relationships with high-quality independent intermediaries
and by continual innovation in the design of niche market products.
Financial institutions, school districts, marketing companies, agents who
market insurance products and policyholders use the ratings of an insurer as
one factor in determining which insurer's annuity to market or purchase.
Standard Life and Dixie National Life have a rating of "B+" and "B",
respectively by A.M. Best. Savers Life is not rated by A.M. Best. A rating of
"B+" is assigned by A.M. Best to companies which, in their opinion, have
achieved very good overall performance when compared to the standards
established by A.M. Best, and have a good ability to meet their obligations to
policyholders over a long period of time. A rating of "B" is assigned by A.M.
Best to companies which, in their opinion, have achieved good overall
performance when compared to the standards established by A.M. Best. According
to A.M. Best, these companies generally have an adequate ability to meet their
obligations to policyholders, but their financial strength is vulnerable to
unfavorable changes in underwriting or economic conditions. In evaluating a
company's financial and operating performance, A.M. Best reviews the company's
profitability, leverage and liquidity as well as the company's book of
business, the adequacy and soundness of its reinsurance, the quality and
estimated market value of its assets, the adequacy of its reserves and the
experience and competence of its management. A.M. Best's ratings are based upon
factors relevant to policyholders, agents, insurance brokers and intermediaries
and are not directed to the protection of investors. Generally, rating agencies
base their ratings on information furnished to them by the issuer and on
investigations, studies and assumptions by the rating agencies. There is no
assurance that any particular rating will continue for any given period of time
or that it will not be changed or withdrawn entirely if, in the judgment of the
rating agency, circumstances so warrant. Although a higher rating by A.M. Best
or another insurance rating organization could have a favorable effect on
Standard Life and Dixie National Life's business, management believes that
Standard Life and Dixie National Life are able to compete on the basis of their
competitive crediting rates, asset quality, strong relations with their
independent agents and the quality of service to their policyholders.
FEDERAL INCOME TAXATION
The life insurance and annuity products marketed and issued by Standard
Life and Dixie National Life generally provide the policyholder with an income
tax advantage, as compared to other saving investments such as certificates of
deposit and bonds, in that income taxation on the increase in value of the
product is deferred until receipt by the policyholder. With other savings
investments, the increase in value is taxed as earned. Life insurance benefits
which accrue prior to the death of the policyholder and annuity benefits are
generally not taxable until paid and life insurance death benefits are
generally exempt from income tax. The tax advantage for life insurance and
annuity products is provided in the Internal Revenue Code ("IRC"), and is
generally followed in all states and other United States taxing jurisdictions.
Accordingly, it is subject to change by Congress and the legislatures of the
respective taxing jurisdictions.
SMC, Standard Marketing and other U.S. non-insurance subsidiaries file a
consolidated return for federal income tax purposes. Standard Life and Dixie
National Life, as life insurance companies, filed separate federal income tax
returns for 1996 and prior years. For 1997 and subsequent years, Standard Life
and Dixie National Life are eligible to file a life/life consolidated return.
As of December 31, 1997, SMC, Standard Marketing and other U.S. non-insurance
subsidiaries had consolidated net operating loss carryforwards of approximately
$9,320,000 for tax return purposes which expire from 2005 to 2012.
At December 31, 1997, the Standard Life consolidated return had tax
return net operating loss carryforwards of approximately $4,100,000, which
expire in 2010 and 2012. These carryforwards will be available to reduce the
taxable income of the Standard Life consolidated return. The change in
ownership of Savers Life will not result in additional limitations on the use
of the loss carryforwards available to Standard Life.
Standard Management International is a Luxembourg holding company which
is currently exempt from Luxembourg income tax. Premier Life (Bermuda) is
exempt from income tax until March 2016 pursuant to a decree from the Minister
of Finance. Premier Life (Luxembourg) is subject to Luxembourg income taxation
(statutory corporate rate of 39.39%) and a capital tax of approximately 1% of
its net equity. At December 31, 1997, Premier Life (Luxembourg) had accumulated
corporate income tax loss carryforwards of approximately $3,960,000, all of
which may be carried forward indefinitely. To the extent that such income is
taxable under U.S. law, such income will be included in SMC's consolidated
return.
INFLATION
The primary direct effect on SMC of inflation is the increase in
operating expenses. A large portion of SMC's operating expenses consists of
salaries which are subject to wage increases at least partly affected by the
rate of inflation. SMC attempts to minimize the impact of inflation on
operating expenses through programs to improve productivity.
The rate of inflation also has an indirect effect on SMC. To the extent
that the government's economic policy to control the level of inflation results
in changes in interest rates, SMC's new sales of insurance products and
investment income are affected. Changes in the level of interest rates also
have an effect on interest spreads, as investment earnings are reinvested.
FOREIGN OPERATIONS AND CURRENCY RISK
SMC's foreign operations represent the Standard Management International
group which consists of a Luxembourg holding company and two life insurance
subsidiaries: Premier Life (Luxembourg) and Premier Life (Bermuda). Standard
Management International policyholders invest in assets denominated in a broad
range of currencies. Policyholders effectively bear the currency risk, if any,
as these investments are matched by policyholder separate account liabilities.
Therefore, their investment and currency risk is limited to premiums they have
paid. Policyholders are not permitted to invest directly into options, futures
and derivatives.
Standard Management International could be exposed to currency
fluctuations if currencies within the conventional investment portfolio or
certain actuarial reserves are mismatched. The assets and liabilities of this
portfolio and the reserves are continually matched by the company and at
regular intervals by the independent actuary. In addition, Premier Life
(Luxembourg)'s stockholder's equity is denominated in Luxembourg francs.
Premier Life (Luxembourg) does not hedge it's translation risk because its
stockholder's equity will remain in Luxembourg francs for the foreseeable
future and no significant realized foreign exchange gains or losses are
anticipated. At December 31, 1997, there is an unrealized loss from foreign
currency translation adjustment of $473,000.
Due to the nature of unit-linked products issued by Standard Management
International, which represent over 94% of the Standard Management
International portfolio, the investment risk rests with the policyholder.
Investment risk for Standard Management International exists where Standard
Management International makes investment decisions with respect to the
remaining traditional business and for the assets backing certain actuarial and
regulatory reserves. The investments underlying these liabilities mostly
represent short term investments and fixed maturity securities. These
short-term investments and fixed maturity securities are normally bought and/or
disposed of only on the advice of independent consulting actuaries who perform
an annual exercise comparing anticipated cash flows on the insurance portfolio
with the cash flows from the fixed maturity securities. Any resulting material
foreign currency mismatches are then covered by buying and/or selling the
securities as appropriate.
REGULATORY FACTORS
SMC's insurance subsidiaries are subject to regulation by the insurance
regulatory authorities in the jurisdictions in which they are domiciled and the
insurance regulatory bodies in the other jurisdictions in which they are
licensed to sell insurance. The purpose of such regulation is primarily to
ensure the financial stability of insurance companies and to provide safeguards
for policyholders rather than to protect the interest of stockholders. The
insurance laws of various jurisdictions establish regulatory agencies with
broad administrative powers relating to the licensing of insurers and their
agents, the regulation of trade practices, management agreements, the types of
permitted investments and maximum concentration, deposits of securities, the
form and content of financial statements, rates charged by insurance companies,
sales literature and insurance policies, accounting practices and the
maintenance of specified reserves, capital and surplus. Each of SMC's insurance
subsidiaries is required to file detailed periodic financial reports with
supervisory agencies in certain of the jurisdictions in which it does business.
Most states have enacted legislation regulating insurance holding
companies. The insurance holding company laws and regulations vary by state,
but generally require an insurance holding company and its insurance company
subsidiaries licensed to do business in the state to register and file certain
reports with the regulatory authorities, including information concerning
capital structure, ownership, financial condition, certain intercompany
transactions and general business operations. State holding company laws also
require prior notice or regulatory agency approval of certain material
intercompany transfers of assets within the holding company structure.
As a holding company, Standard Management's ability to pay operating
expenses and meet debt service obligations if any, depends on the receipt of
sufficient funds, primarily through management fees, rental income, dividends
and interest payments on its Surplus Debentures from its subsidiaries. Subject
to the restrictions described below, Standard Management may receive dividends
from its direct subsidiaries, Standard Life, Standard Management International
and Standard Marketing. Dixie National Life is a subsidiary of Standard Life.
Accordingly, any dividends paid by Dixie National Life to Standard Life may be
paid to Standard Management only if Standard Life is entitled to pay dividends
to Standard Management.
Under Indiana insurance law, Standard Life may not enter into certain
transactions, including management agreements and service contracts, with
members of its insurance holding company system, including Standard Management,
unless Standard Life has notified the Indiana Department of Insurance of its
intention to enter into such transactions and the Indiana Department of
Insurance has not disapproved of them within the period specified by Indiana
law. Among other things, such transactions are subject to the requirement that
their terms be fair and reasonable and that the charges or fees for services
performed be reasonable.
Pursuant to the management services agreement with Standard Management,
Standard Life paid Standard Management a monthly fee of $166,667 (annual fee of
$2,000,000) during 1997 for certain management services related to the
production of business, investment of assets and evaluation of acquisitions.
Pursuant to the management service agreements with Standard Life, Dixie
National Life paid monthly payments of $83,333 (annual fee of $1,000,000) to
Standard Life in 1997. Both of these agreements provide that they may be
modified or terminated by the Indiana and Mississippi departments of insurance
in the event of financial hardship of Standard Life or Dixie National Life.
A management services agreement between SMC and Savers Life was approved
by the North Carolina Department of Insurance on March 11, 1998. The
management services agreement calls for the payment of $83,333 per month
by Savers Life to SMC for financial and regulatory reporting, investment of
assets and the production of business. SMC has agreed to receive no fee, nor
shall Savers Life have an obligation to pay, unless the capital and surplus
of Savers Life is $7,000,000 after the acquisition of Savers Life. The
amount of capital and surplus of Savers Life at December 31, 1997 was
$7,134,000.
In addition, as a condition of the acquisition of Savers Life, SMC
entered into an agreement with the North Carolina Department of Insurance to
maintain statutory capital and surplus of Savers Life of at least $6,000,000.
Dividends from Standard Life to Standard Management are limited by laws
applicable to insurance companies. As an Indiana domiciled insurance company,
Standard Life may pay a dividend or distribution from its surplus profits,
without the prior approval of the Commissioner of the Indiana Department of
Insurance, if the dividend or distribution, together with all other dividends
and distributions paid within the preceding twelve months, does not exceed the
greater of (i) net gain from operations or (ii) 10% of surplus, in each case as
shown in its preceding annual statutory financial statements. Also, regulatory
approval is required when dividends to be paid exceed unassigned surplus. For
the year ended December 31, 1997, Standard Life reported statutory net gain
from operations before net realized capital losses of $2,374,000 and statutory
surplus of $25,923,000 which includes unassigned surplus of $1,693,000.
During 1998, Standard Life can pay dividends of approximately $2,500,000
without regulatory approval.
The Indiana insurance laws and regulations require that the statutory
surplus of Standard Life following any dividend or distribution be reasonable
in relation to its outstanding liabilities and adequate to its financial needs.
The Indiana Department of Insurance may bring an action to enjoin or rescind
the payment of a dividend or distribution by Standard Life that would cause its
statutory surplus to be unreasonable or inadequate under this standard.
Standard Management International dividends are limited to its
accumulated earnings without regulatory approval. Standard Management
International and Premier Life (Luxembourg) were not permitted to pay dividends
in 1997 and 1996 due to accumulated losses. Premier Life (Bermuda) did not pay
dividends in 1997 and 1996. SMC does not anticipate any dividends from these
companies in 1998. Pursuant to the management services agreement with Standard
Management, Premier Life (Luxembourg) paid Standard Management a management fee
of $100,000 per year during 1997 and 1996 for certain management and
administrative services. The agreement provides that it may be modified or
terminated by either Standard Management or Premier Life (Luxembourg).
As a North Carolina domiciled insurance company, Savers Life may pay a
dividend or distribution from its capital and surplus, without the prior
approval of the North Carolina Commissioner of Insurance, if the dividend or
distribution together with all other dividends and distributions paid within
the preceding twelve months, does not exceed the lesser of (i) net gain from
operations or (ii) 10% of capital and surplus, in each case as shown in its
preceding annual statutory financial statements. Savers Life was not allowed
to pay a dividend in 1996 or 1997 without prior North Carolina Department of
Insurance approval due to its statutory net losses in 1995 and 1996. Savers
Life will not be permitted to pay dividends in 1998 without such approval.
Most states, including Indiana, require administrative approval of the
acquisition of 10% or more of the outstanding shares of an insurance company
incorporated in the state or the acquisition of 10% or more of the outstanding
shares of an insurance holding company whose insurance subsidiary is
incorporated in the state. The request for approval must be accompanied by
detailed information concerning the acquiring parties and the plan of
acquisition. The acquisition of 10% of such shares is generally deemed to be
the acquisition of "control" for the purpose of the holding company statutes.
However, in many states the insurance authorities may find that "control" in
fact does or does not exist in circumstances in which a person owns or controls
either a lesser or a greater amount of securities.
In some instances many state regulatory authorities require deposits of
assets for the protection of policyholders either in those states or for all
policyholders. At December 31, 1997, securities representing approximately 4%
of the book value of SMC's U.S. insurance subsidiaries' invested assets were on
deposit with various state treasurers or custodians. Such deposits must consist
of securities that comply with the standards that the particular state has
established. Assets of Standard Management International of $4,441,000 at
December 31, 1997 were held by a custodian bank approved by the Luxembourg
regulatory authorities to comply with local insurance laws.
In recent years, the NAIC and state insurance regulators have reexamined
existing laws and regulations and their application to insurance companies.
This reexamination has focused on insurance company investment and solvency
issues, risk-based capital guidelines, assumption reinsurance, interpretations
of existing laws, the development of new laws, the interpretation of
nonstatutory guidelines, the standardization of statutory accounting rules and
the circumstances under which dividends may be paid. The NAIC has encouraged
states to adopt model NAIC laws on specific topics such as holding company
regulations and the definition of extraordinary dividends. It is not possible
to predict the future impact of changing state regulation on the operations of
SMC.
The NAIC, as well as Indiana, Mississippi and North Carolina, has adopted
RBC requirements for U.S. life/health insurance companies to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks such as asset quality, mortality and morbidity, asset and
liability matching, benefit and loss reserve adequacy, and other business
factors. The RBC formula is used by state insurance regulators as an early
warning tool to identify, for the purpose of initiating regulatory action,
insurance companies that potentially are inadequately capitalized. The RBC
guidelines are intended to be a regulatory tool only, and are not intended as a
means to rank insurers generally. In addition, the formula defines minimum
capital standards that supplement the previously existing system of low fixed
minimum capital and surplus requirements on a state-by-state basis. Regulatory
compliance is determined by a ratio of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level RBC,
as defined by the NAIC. Enterprises below specific trigger points or ratios are
classified within certain levels, each of which requires specific corrective
action. If a company's RBC ratio is in the Company Action Level range defined
as an RBC ratio of 1.5-2, the company must submit a plan to improve its RBC
ratio. The Regulatory Action Level range defined as an RBC ratio of 1-1.5
provides that regulators will order corrective actions. At the Authorized
Control Level range defined as an RBC ratio of 0.7-1, regulators are authorized
to take control of the company. Finally, at the Mandatory Control Level defined
as ratios below 0.7, regulators must take over the company. The RBC ratios of
Standard Life and Dixie National Life are all in excess of 4 at December 31,
1997. The RBC ratio of Savers Life is in excess of 3 at December 31, 1997.
However, should the insurance subsidiaries' RBC position decline in the future,
the insurance subsidiaries' continued ability to pay dividends and the degree
of regulatory supervision or control to which they are subjected could be
affected.
The NAIC calculates twelve financial ratios based on statutory financial
statements ("IRIS ratios") to assist state regulators in monitoring the
financial condition of insurance companies. A "usual range" of results for each
ratio is used as a benchmark for analysis, and a company's variation from this
range may be either favorable or unfavorable. State insurance departments may
make inquiries of SMC when at least four IRIS ratios are outside the usual
range. These inquiries could lead to restrictions on the amount of business
that may be written in an individual state. The following table presents the
IRIS ratios as determined by the NAIC for SMC's insurance subsidiaries which
varied from the "usual range" for 1997.
Reported
COMPANY RATIO NAME USUAL RANGE VALUE
Standard Life..........Change in Product Mix........... . - to 5.0 ... 7.4
Dixie National Life....Net Change in Capital and Surplus.. -10 to 50 .......-11
.........Gross Change in Capital and Surplus -10 to 50 ...... -11
.........Adequacy of Investment Income...... 125 to 900.......121
.........Surplus Relief..................... -10 to 10 ........28
.........Change in Premium.................. -10 to 50 .......-82
Savers Life............Net Income to Total Income.......... .- to 0 .........0
...............Change in Premium.................. -10 to 50 .......-23
...............Change in Reserving Ratio.......... -20 to 20 .......-79
Explanation of Ratios:
CHANGE IN PRODUCT MIX. This ratio represents the average change in the
percentage of total premium from each product line during the year. The
unusual ratio is due to the sale of First International and related reinsurance
agreements in 1996.
CHANGE IN CAPITAL AND SURPLUS. This ratio, calculated on a gross and net
basis, are a measure of improvement or deterioration in the company's financial
position during the year. The negative value for Dixie National Life is
primarily due to continuation of reserve strengthening recorded by direct
charges to surplus of approximately $600,000 in 1997.
ADEQUACY OF INVESTMENT INCOME. This ratio indicates whether an insurer's
investment income is adequate to meet the interest requirements of its
reserves. The ratio may indicate that Dixie National Life's net investment
yield is not "adequate" to meet its interest required on reserves.
SURPLUS RELIEF. The positive ratio for Dixie National Life results from a
financial reinsurance agreement at December 31, 1997. See "Business of SMC --
Reinsurance."
CHANGE IN PREMIUM. This ratio represents the percentage change in premium
from prior to current years. The negative values for Dixie National Life in
1997 relate to the surplus relief reinsurance agreement transaction in 1996
increasing premium income in 1996. The negative value for Savers Life is due to
the sale of the major medical business effective July 1, 1997.
NET INCOME TO TOTAL INCOME. This ratio is a measure of a company's
profitability. The unusual value for Savers Life was primarily due to the
statutory loss from operations recorded in 1997.
CHANGE IN RESERVING RATIO. The change in reserving ratio represents the
number of percentage points of difference between the reserving ratio for
current and prior years. The negative value for Savers Life was due to the
reserve strengthening within the life product line in the prior year. The
majority of the life reserves consist of whole life policies which have higher
reserve requirements than term policies.
SMC attempts to manage its assets and liabilities so that income and
principal payments received from investments are adequate to meet the cash flow
requirements of its policyholder liabilities. The cash flows of SMC's
liabilities are affected by actual maturities, surrender experience and
credited interest rates. SMC periodically performs cash flow studies under
various interest rate scenarios to evaluate the adequacy of expected cash flows
from its assets to meet the expected cash requirements of its liabilities. SMC
utilizes these studies to determine if it is necessary to lengthen or shorten
the average life and duration of its investment portfolio. Because of the
significant uncertainties involved in the estimation of asset and liability
cash flows, there can be no assurance that SMC will be able to effectively
manage the relationship between its asset and liability cash flows.
In December 1995, the NAIC passed a model law for disclosure in life
insurance policy illustrations which became effective on January 1, 1997. This
law did not have a significant effect on SMC. New rules adopted by the NAIC are
effective only to the extent adopted by the states in which SMC operates, and
it is not possible to predict the future impact of changing state and federal
regulation on the operations of SMC.
The statutory filings of SMC's insurance subsidiaries require
classifications of investments and the establishment of an AVR, an account
designed to stabilize a company's statutory surplus against fluctuations in the
market value of stocks and bonds, according to regulations prescribed by the
NAIC. The AVR account consists of two main components: a "default component" to
provide for future credit-related losses on fixed income investments and an
"equity component" to provide for losses on all types of equity investments,
including real estate. The NAIC requires an additional reserve, called the IMR,
which consists of the portion of realized capital gains and losses from the
sale of fixed income securities attributable to changes in interest rates. The
IMR is required to be amortized against earnings on a basis reflecting the
remaining period to maturity of the fixed income securities sold. These
regulations affect the ability of SMC's insurance subsidiaries to reflect
future investment gains and losses in current period statutory earnings and
surplus.
The amounts related to AVR and IMR for the insurance subsidiaries at
December 31, 1997 are summarized as follows (in thousands):
Maximum
AVR AVR IMR
Standard Life...........$3,236 $3,856 $8,474
Dixie National Life........214 317 149
The annual addition to the AVR for 1997 is 20% of the maximum reserve
over the accumulated balance. If the calculated reserve with current year
additions exceeds the maximum reserve amount, the reserve is reduced to the
maximum amount. For the year ended December 31, 1997, SMC's U.S. subsidiaries
each made the required contribution to the AVR.
Most jurisdictions require insurance companies to participate in guaranty
funds designed to cover claims against insolvent insurers. Insurers authorized
to transact business in these jurisdictions are generally subject to
assessments based on annual direct premiums written in that jurisdiction to pay
such claims, if any. These assessments may be deferred or forgiven under most
guaranty laws if they would threaten an insurer's financial strength and, in
certain instances, may be offset against future state premium taxes. The
incurrence and amount of such assessments have increased in recent years and
may increase further in future years. The likelihood and amount of all future
assessments cannot be reasonably estimated and are beyond the control of SMC.
As part of their routine regulatory oversight process, approximately once
every three to five years state insurance departments conduct periodic detailed
examinations ("Examinations") of the books, records and accounts of insurance
companies domiciled in their states. Standard Life underwent an Examination
during 1996 for the five-year period ended December 31, 1995. The final report
on such examination has been issued by the Indiana Department of Insurance and
did not raise any significant issues.
Although the federal government generally does not directly regulate the
insurance industry, federal initiatives often have an impact on the business.
Congress and certain federal agencies are investigating the current condition
of the insurance industry (encompassing both life and health and property and
casualty insurance) in the United States in order to decide whether some form
of federal role in the regulation of insurance companies would be appropriate.
Congress is currently conducting a variety of hearings relating in general to
insurers. It is not possible to predict the outcome of any such congressional
activity nor the potential effects thereof on SMC.
Congressional initiatives have been introduced which are directed at
repeal of the McCarran-Ferguson Act (which exempts the "business of insurance"
from most federal laws to the extent it is subject to state regulation), and
judicial decisions have been issued which narrow the definition of "business of
insurance" for McCarran-Ferguson Act purposes. Current and proposed federal
measures may also significantly affect the insurance industry including removal
of barriers preventing banks from engaging in the insurance business.
EMPLOYEES
As of March 13, 1998, SMC had 139 employees: Standard Life had 58
employees, Savers Life had 47 employees, Standard Management International had
16 employees (9 of whom are covered by a collective bargaining agreement),
Standard Marketing had 10 employees, and Standard Management had 8 employees.
SMC believes that its future success will depend, in part, on its ability to
continue to attract and retain highly-skilled technical, marketing, support and
management personnel. Management believes that it has excellent relations with
its employees.
ITEM 2. PROPERTIES
SMC leases approximately 31,000 square feet in an office building located
at 9100 Keystone Crossing, Indianapolis, Indiana, under the terms of a lease
which expires on June 1, 2001. SMC entered into a lease on March 31, 1997, for
approximately 16,000 square feet in a warehouse located at 2525 North
Shadeland, Indianapolis, Indiana, under the terms of a lease which expires on
September 30, 1999.
Standard Management International entered into a lease on November 17,
1997 for approximately 4,500 square feet in an office building located at 13A,
rue de Bitbourg, L-1273 Luxembourg, Grand Duchy of Luxembourg, under the terms
of a lease which expires on November 16, 2003.
Dixie National Life leases approximately 1,000 square feet in an office
complex located at 855 South Pear Orchard Road, Suite 305, Ridgeland,
Mississippi, under the terms of a lease which expires on December 31, 1998.
Savers Life owns its Home Office building containing approximately 27,000
square feet at 8064 North Point Boulevard, Winston-Salem, North Carolina.
Savers Life occupies the top floor of its two story building and leases most of
the first floor.
ITEM 3. LEGAL PROCEEDINGS
John J. Quinn resigned as an officer and director of SMC effective as of
April 15, 1997. On June 19, 1997, Mr. Quinn commenced an action in the
Superior Court of Marion County, Indiana, against SMC claiming that his
employment agreement contained a provision to the effect that, following a
termination of his employment with SMC under certain circumstances, Mr. Quinn
would be entitled to receive a lump sum payment equal to the amount determined
by multiplying the number of shares of SMC Common Stock subject to unexercised
stock options previously granted by SMC to Mr. Quinn on the date of
termination, whether or not such options were then exercisable, by the highest
per share fair market value of the SMC Common Stock on any day during the
six-month period ending on the date of termination. Upon payment of such
amount, such unexercised stock options would be deemed to have been surrendered
and canceled. Mr. Quinn further claims that his employment agreement contained
an additional provision that he would be entitled to receive a lump sum payment
equal to two years of annual salary, following termination of employment.
Mr. Quinn has asserted to SMC that he is entitled to a lump sum termination
payment of $1,654,000, and liquidated damages not exceeding $3,308,000, by
virtue of his voluntarily leaving SMC's employment.
SMC disputes Mr. Quinn's claims. SMC filed its Answer and Counterclaim
against Mr. Quinn on September 11, 1997. SMC's investigation since the action
was filed revealed a basis for the termination of Mr. Quinn's employment for
cause relative to after-acquired evidence. On October 14, 1997, the Board of
Directors of SMC terminated Mr. Quinn for cause effective as of March 15, 1997.
Such termination will also be argued by SMC as a complete defense to all claims
asserted by Mr. Quinn. The ultimate outcome of the action cannot presently be
determined. Accordingly, no provision for any liability that may result has
been made in the consolidated financial statements. Management believes that
the conclusion of such litigation will not have a material adverse effect on
SMC's consolidated financial condition.
In addition, SMC is involved in various legal proceedings in the normal
course of business. In most cases, such proceedings involve claims under
insurance policies or other contracts of SMC. The outcomes of these legal
proceedings are not expected to have a material adverse effect on the
consolidated financial position, liquidity, or future results of operations of
SMC based on SMC's current understanding of the relevant facts and law.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
At the Company's Annual Meeting of Stockholders held on October 22, 1997,
the following individuals were elected to the Board of Directors:
Shares For Shares Withheld
Stephen M. Coons 4,154,740 343,709
Martial R. Knieser 4,154,845 343,604
Paul ("Pete") B. Pheffer 4,158,515 339,934
The following proposals were approved at the Company's Annual Meeting of
Stockholders:
Shares Shares
Shares For Against Abstaining
Approve the issuance of SMC Common Stock in
connection with the acquisition by SMC of
Savers Life Insurance Company 2,990,817 107,128 11,329
Approve an amendment to SMC's Amended and
Restated 1992 Stock Option Plan to increase
the number of shares of SMC Common Stock
available for issuance pursuant thereto
from 1,500,000 to 2,500,000 and to allow
the Board of Directors of SMC to vary, from
year to year, the number of shares subject 2,303,213 739,488 65,733
to options granted to Outside Directors
Ratify the appointment of Ernst and Young
LLP as principal independent auditors for
the year ending December 31, 1997. 4,473,009 17,155 8,285
A total of 4,498,449 shares were present in person or by proxy at the
Annual Meeting of Stockholders.
EXECUTIVE OFFICERS
The following table sets forth information concerning each of SMC's
executive officers:
NAME AGE POSITION
Ronald D. Hunter 46 Chairman of the Board, Chief Executive Officer and President
Stephen M. Coons 56 Executive Vice President, General Counsel and Secretary
Raymond J. Ohlson 47 Executive Vice President and Chief Marketing Officer
Paul B. Pheffer 46 Executive Vice President, Chief Financial Officer and Treasurer
Edward T. Stahl 51 Executive Vice President and Director of Corporate Development
RONALD D. HUNTER Mr. Hunter has been the Chairman of the Board, Chief
Executive Officer and President of SMC since its formation in June 1989 and the
Chairman of the Board and Chief Executive Officer of Standard Life since
December 1987. Previously, Mr. Hunter held several management and sales
positions in the life insurance industry with a number of companies including
Conseco, Inc. (1981-1986), Aetna Life & Casualty Company (1978-1981), United
Home Life Insurance Company (1975-1977) and Prudential Life Insurance Company
(1972-1975).
STEPHEN M. COONS Mr. Coons has been a director of SMC since August 1989.
Mr. Coons has been General Counsel and Executive Vice President of SMC since
March 1993 and has been Secretary of SMC since March 1994. He was of counsel to
the law firm of Coons, Maddox & Koeller from March 1993 to December 31, 1996.
Prior to March 1993, Mr. Coons was a partner with the law firm of Coons &
Saint. He has been practicing law for 27 years. Mr. Coons served as Indiana
Securities Commissioner from 1978 to 1983.
RAYMOND J. OHLSON Mr. Ohlson has served as Executive Vice President and
director of SMC since December 1993. He has served as President and director of
Standard Marketing since August 1991. Since June 1993, Mr. Ohlson has served as
President of Standard Life. Mr. Ohlson entered the life insurance business in
1971. While still in college, Mr. Ohlson qualified for the Million Dollar Round
Table and is now a life member. He earned his CLU designation in 1980.
Mr. Ohlson owned and operated Ohlson & Associates, an independent insurance
marketing organization, from 1984 to April 1, 1994, when the assets of Ohlson &
Associates were acquired by Standard Marketing.
PAUL ("PETE") B. PHEFFER Mr. Pheffer has been Executive Vice President,
Chief Financial Officer and Treasurer of SMC since May 1, 1997 and director of
SMC since June 27, 1997. Prior to joining SMC, Mr. Pheffer was Senior Vice
President -- Chief Financial Officer and Treasurer of Jackson National Life
Insurance Company from 1994 to 1996 and prior to that was Senior Vice
President -- Chief Financial Officer at Kemper Life Insurance Companies from
1992 to 1994. Mr. Pheffer, a CPA, received his MBA from the University of
Chicago in 1988.
EDWARD T. STAHL Mr. Stahl has been an Executive Vice President of SMC
since its formation, has been a director of SMC from July 1989 (except for the
period from January 12, 1990 to May 21, 1990) and has served as Director of
Corporate Development since June 1993. Mr. Stahl was Secretary of SMC from June
1989 to March 1994. Mr. Stahl was President and Chief Operations Officer of
Standard Life from May 1988 to June 1993. He has been a director of Standard
Life since December 1987, and Executive Vice President and Secretary since June
1993. Mr. Stahl has served in various capacities in the insurance industry
since 1966. He earned his FLMI designation in 1981, and is a member of several
insurance associations.
PART II
ITEM 5. MARKET FOR SMC COMMON STOCK AND RELATED STOCKHOLDER MATTERS
SMC Common Stock trades on Nasdaq under the symbol "SMAN." The following
table sets forth, for the periods indicated, the range of the high and low
sales prices of SMC Common Stock as reported by Nasdaq (after adjustment for
the May 17, 1996 5% stock dividend). SMC has never paid dividends on its Common
Stock. At the close of business on March 13, 1998 there were approximately
3,133 holders of record of the outstanding shares of SMC Common Stock. Although
SMC Common Stock is traded on Nasdaq, no assurance can be given as to the
future price of or the markets for SMC Common Stock.
SMC
COMMON STOCK
HIGH LOW
1996
Quarter ended March 31, 1996 $4.524 $3.571
Quarter ended June 30, 1996 5.250 3.690
Quarter ended September 30, 1996 5.500 4.000
Quarter ended December 31, 1996 5.375 4.000
1997
Quarter ended March 31, 1997 6.250 4.875
Quarter ended June 30, 1997 6.000 4.625
Quarter ended September 30, 1997 7.875 5.688
Quarter ended December 31, 1997 8.375 6.500
ITEM 6. SMC SELECTED HISTORICAL FINANCIAL DATA (A)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The selected historical financial data of SMC set forth below at and for the
years ended December 31, 1997, 1996, 1995, 1994 and 1993 were derived from
audited consolidated financial statements of SMC. The selected historical
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the SMC
Consolidated Financial Statements and related notes thereto, each included
elsewhere herein.
Year Ended December 31,
1997 1996 1995 1994 1993
STATEMENT OF OPERATIONS DATA:
Premium income $7,100 $10,468 (e) $5,504 $4,565 $5,511
Investment Activity:
Net investment income 29,516 20,871 18,517 16,057 12,171
Net realized investment gains 396 1,302 688 558 6,980
Total revenues 46,869 40,307 30,238 26,518 26,542
Interest expense and financing 2,381 805 118 47 519
costs
Total benefits and expenses 43,607 36,772 (e) 28,682 30,032 22,099
Income (loss) before income taxes,
extraordinary gain (charge) and
cumulative effect of change in 3,262 3,535 1,556 (3,514) 4,443 (i)
accounting principle
Income (loss) before extraordinary
gain
(charge) and cumulative effect 2,645 4,265 (f) 1,313 (3,436) 2,984 (i)
of change in accounting
principle
Net income (loss) 2,645 4,767 (g) 1,313 (3,436) 2,132
Operating income (loss) (b) 2,384 1,174 461 293 (1,936)
PER SHARE DATA: (C)
Income (loss) per share before
extraordinary
gain (charge) and cumulative
effect of change in accounting $.54 $.88 (f) $.25 $(.62) $.80 (i)
principle
Net income (loss) .54 (g) .98 (g) .25 (.62) .57
Net income (loss), assuming
dilution .48 .91 .25 (.61) .53
Operating income (loss) (b) .48 .24 .09 .05 (.52)
Operating income (loss), assuming
dilution (b) .43 .21 .09 .05 (.48)
Weighted average common shares
outstanding, assuming dilution 5,591,217 5,549,057 5,345,937 5,663,187 4,013,893
Book value per common share $8.88 $7.95 $7.73 $4.27 $7.82
Book value per common share
excluding
unrealized gain (loss) on $ 8.44 (h) $ 8.09 (h) $ 7.23 (h) $6.81 (h) $7.82
securities available for sale
Common shares outstanding 4,876,490 5,024,270 5,205,425 5,291,455 4,954,676
BALANCE SHEET DATA (at year end):
Invested assets $398,782 $370,138 $280,597 $224,926 $199,413
Assets held in separate accounts 148,064 128,546 122,705 94,301 107,173
Total assets 668,992 628,413 479,598 373,524 354,431
Long-term debt, notes payable and
capital 26,141 20,697 4,191 695 --
lease obligations
Class S Preferred Stock -- 1,757 -- -- --
Shareholders' equity 43,313 39,919 40,242 22,610 36,914
Shareholders' equity, excluding
unrealized gain 41,142 40,665 37,660 36,021 36,918
(loss) on securities available
for sale
Ratio of debt to total 38% 36% 9% 3% --
capitalization (d)
NOTES TO SMC SELECTED HISTORICAL FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(a)Comparison of consolidated financial information is significantly affected
by the acquisitions of Standard Management International effective
December 31, 1993, Dixie National Life on October 2, 1995 and Shelby Life
effective November 1, 1996 and disposal of First International effective
March 1, 1996. Refer to the notes to the consolidated financial statements
included in SMC's Audited Consolidated Financial Statements, included
elsewhere herein, for a description of business combinations.
(b)Operating income represents income before extraordinary gains (charge),
excluding net realized investment gains (less income taxes relating to such
gains), gain on disposal of subsidiary and class action litigation and
settlements.
(c)All applicable shares and per share amounts have been adjusted to reflect
the adoption of Statement of Financial Accounting Standards ("SFAS") No.
128, "Earning Per Share" on December 31, 1997. Refer to the notes to the
consolidated financial statements included in SMC's Audited Consolidated
Financial Statements, included elsewhere herein, for a description of
earnings per share.
(d)Total capitalization is the sum of SMC's debt (long term debt, notes
payable, capital lease obligations and redeemable preferred stock) and
shareholders' equity.
(e)Includes recapture of premiums ceded and an increase in benefits due to an
increase in reserves of $4,234 due to the termination and recapture of a
reinsurance agreement with National Mutual Life Insurance Company. See
"Business of SMC -- Reinsurance."
(f)Does not reflect extraordinary gain of $502 ($.10 per share) on early
redemption of Class S Preferred Stock for 1996.
(g)Does not reflect preferred stock dividends of $97 ($.01 per share) and $208
($.04 per share) for 1997 and 1996, respectively, on Class S Preferred
Stock.
(h)Excludes the effect of reporting securities available for sale at fair value
and recording the unrealized gain or loss on such securities as a component
of shareholders' equity, net of tax and other adjustments, which SMC began
to do in 1994. Such adjustments are in accordance with SFAS No. 115
"Accounting for Certain Investments in Debt and Equity Securities", as
described in the notes to the consolidated financial statements included in
SMC's Consolidated Financial Statements, included elsewhere herein.
(i)Before deduction of extraordinary charge of $1,301 ($.32 per share) on early
extinguishment of long-term debt and cumulative effect of change in
accounting principle of $449 ($.11 per share) from applying the new method
of accounting for income taxes.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion highlights the principal factors affecting the
results of operations and the significant changes in balance sheet items of SMC
on a consolidated basis for the periods listed as well as SMC's liquidity and
capital resources. This discussion should be read in conjunction with the SMC
Consolidated Financial Statements and the Notes thereto appearing elsewhere
herein.
INTRODUCTION
SMC acquired Standard Management International on December 15, 1993, Dixie
National Life on October 2, 1995, Shelby Life on November 8, 1996 and Savers
Life on March 12, 1998. These acquisitions are accounted for using the purchase
method of accounting (effective December 31, 1993 for the Standard Management
International acquisition, October 2, 1995 for the Dixie National Life
acquisition, November 1, 1996 for the Shelby Life acquisition, and March 1,
1998 for the Savers Life acquisition). Therefore, these subsidiaries are
included in the SMC Consolidated Financial Statements commencing with their
respective acquisition effective dates. SMC disposed of First International on
March 18, 1996 (effective March 1, 1996) and terminated the operations of
Standard Reinsurance on March 1, 1996.
PRODUCT PROFITABILITY. Margins on life insurance and annuity products are
affected by interest rate fluctuations. Rising interest rates would result in a
decline in the market value of assets. However, as there are positive cash
flows from renewal premiums, investment income and maturities of existing
assets, the need for early disposition of investment assets to meet operating
cash flow requirements would be unlikely. Rising interest rates would also
result in available cash flows from maturities being invested at higher
interest rates, which would help support a gradual increase in new business and
renewal interest rates on interest-sensitive products. A sharp, sudden rise in
the interest rate environment without a concurrent increase in crediting rates
could result in higher surrenders, particularly for annuities. The effect of
surrenders would be to reduce earnings over the long term. Earnings in the
period of the surrender could increase or decrease depending on whether
surrender charges were applicable and whether such changes differed from the
write-off of related deferred acquisition costs or present value of future
profits.
When interest rates fall, SMC generally attempts to adjust the credited
interest rates subject to competitive pressures. Although SMC believes that
such strategies will continue to permit it to achieve a positive spread, a
significant decline in the yield on SMC's investments could adversely affect
the results of operations and financial condition of SMC.
PURCHASED INSURANCE BUSINESS. In accordance with industry practice, when
SMC purchases additional insurance businesses it assigns a portion of the
purchase price, called the present value of future profits, to the right to
receive future cash flows arising from existing insurance policies. This asset
is recorded when the business is purchased at the value of projected future
cash flows on existing policies, less a discount to present value. As future
cash flows emerge, they are treated as a recovery of this asset. Therefore, if
cash flows emerging from the purchased or recaptured business during a period
exactly equal the projections, they are offset by that period's amortization of
the cost of the policies purchased. In that event, the only income statement
effect from the purchased business is the realization of the discount that was
initially deducted from the asset to reflect its present value. Changes in the
future annual amortization of this asset are not expected to have a significant
effect on the results of operations, because the amount of amortization is
expected to be equal to the profits emerging from the purchased policies, net
of interest on the unrecovered present value of future profits balance. This
asset is amortized over the expected life of the related policies purchased.
Present value of future profits is increased for the estimated effect of
realizing unrealized investment losses and decreased for the estimated effect
of realizing unrealized investment gains.
In selecting the interest rate to calculate the discounted present value of
the projected future profits, SMC used the risk rate of return it needs to earn
in order to invest in the business being acquired or recaptured.
In determining this required rate of return, SMC considers the following
factors:
The magnitude of the risks associated with each of the actuarial
assumptions used in determining expected future cash flows (as
described above).
Our cost of the capital required to fund the acquisition or
recapture.
The likelihood of changes in projected future cash flows that might
occur if there are changes in insurance regulations and tax laws.
The acquired company's compatibility with other SMC activities that
may favorably affect future cash flows.
The complexity of the acquired company or recaptured business.
Recent prices (i.e., discount rates used in determining valuations)
paid by others to acquire or recapture similar blocks of business.
The discount rate used to determine the present value of the projected
future profits is used to determine the subsequent amortization of the cost of
the purchased policies for acquisitions prior to November 19, 1992. For
acquisitions subsequent to November 19, 1992, the discount rate used to
amortize the unamortized balance of the present value of future profits is the
crediting rate of the underlying policies.
The discount rate selected may affect subsequent earnings in those instances
where the purchase price of the policies exceeds the value of net assets
acquired (including the value of future profits discounted at the selected
interest rate). Selection of a lower (or higher) discount rate will increase
(or decrease) the portion of the purchase price assigned to the present value
of future cash flows and will result in an offsetting decrease (or increase) in
the amount of the purchase price assigned to goodwill. The effect on subsequent
earnings caused by this variation in purchase price allocation will depend on
the characteristics of the policies purchased. For products where the profits
emerge at relatively constant levels over an extended period of time (for
example, most of SMC's immediate and deferred annuities), use of a lower rate
may result in an increase in reported earnings in the early years after an
acquisition followed by a decrease in earnings in later years. For products
where profits emerge over a shorter period of time or in amounts that decrease
over the life of the product (for example, ordinary and term life products),
selection of a lower rate will generally result in a decrease in reported
earnings in the early years after an acquisition followed by an increase in
reported earnings in later years. For SMC, the majority of the cost of policies
purchased relates to ordinary life products and the balance to deferred annuity
products.
The activity related to the present value of future profits of the business
acquired or recaptured is summarized as follows (in thousands):
YEAR ENDED DECEMBER 31,
1997 1996 1995
Balance, beginning of year $23,806 $ 15,246 $ 8,299
Amounts related to acquisitions and disposals (1,374) 9,615 7,901
Net amortization during the year (1,666) (1,249) (780)
Adjustments relating to net unrealized (gain)
losses on securities available for sale (229) 194 (174)
Balance, end of year........................... $20,537 $ 23,806 $15,246
The percentage of future expected net amortization of the beginning balance
of the present value of future profits before the effect of net unrealized
gains and losses, based on the present value of future profits at December 31,
1997 and current assumptions as to future events on all policies in force, will
be between 6% and 8% in each of the years 1998 through 2002.
The discount rate used to calculate the present value of future profits for
business acquired prior to November 19, 1992, reflected in SMC's December 31,
1997 consolidated balance sheet ranged from 7.5% to 18%. SMC used a 15%
discount rate to calculate the present value of future profits on the business
of the Dixie National Life acquisition, which is being amortized over 30 years
as the majority of the present value of future profits related primarily to the
ordinary life business. SMC used a 15% discount rate to calculate the present
value of future profits on the business of the Shelby Life acquisition, which
is being amortized over 20 years based on the mix of annuity and life business
in Shelby Life.
PRODUCED INSURANCE BUSINESS. Insurance products generate two types of
profit streams: (i) from the excess of investment income earned over that
credited to the policyholder and (ii) from the excess of premiums received over
costs incurred for policy issuance, administration and mortality. Costs
incurred in issuing new policies are deferred and recorded as deferred
acquisition costs ("DAC"), which are amortized using present value techniques
so that profits are realized in proportion to premium revenue for certain
products and estimated gross profits for certain other products. Profits from
all of these elements are recognized over the lives of the policies; no profits
are recorded at the time the policies are issued.
Amortization of DAC was $1,456,000, $1,221,000 and $1,142,000 for the years
ended December 31, 1997, 1996 and 1995, respectively. The increase in current
year amortization expense resulted primarily from increased amortization of DAC
as gross profits from business sold in recent years began to emerge. DAC of
$18,309,000 at December 31, 1996 and additions to policy acquisition costs of
$7,005,000 for business produced during the year ended December 31, 1997 are
generally being amortized over the expected lives of the policies, a period of
approximately 20 years, in a constant relationship to the present value of
estimated future gross profits. Interest is being accreted at 7% during year
one and 5% thereafter, the projected crediting rate on the policies. DAC is
increased for the estimated effect of realizing unrealized investment losses
and decreased for the estimated effect of realizing unrealized investment
gains. The offset to these amounts is recorded directly to shareholders'
equity, net of taxes. Future expected amortization of DAC for the next five
years before the effect of net realized and unrealized gains and losses, based
on DAC at December 31, 1997 and current assumptions, is as follows (in
thousands):
1998 1999 2000 2001 2002
Gross amortization $2,945 $2,976 $3,068 $2,858 $2,597
Interest accreted 1,079 906 736 604 483
Net amortization $1,866 $2,070 $2,332 $2,254 $2,114
The amounts included in the foregoing table do not include any
amortization of DAC resulting from the sale of new products after December 31,
1997. Any changes in future annual amortization of this asset are not expected
to have a significant effect on results of operations because the amount of
amortization is expected to be proportionate to the profits from the produced
policies, net of interest on DAC.
VARIANCES BETWEEN ACTUAL AND EXPECTED PROFITS. Actual experience on
purchased and produced insurance may vary from projections due to differences
in renewal premiums collected, investment spreads, mortality costs, surrender
benefits, persistency, administrative costs and other factors. Variances from
original projections, whether positive or negative, are included in net income
as they occur. To the extent that these variances indicate that future
experience will differ from the estimated profits reflected in the
capitalization and amortization of the cost of policies purchased or the cost
of policies produced, current and future amortization rates may be adjusted.
ACCOUNTING FOR ANNUITIES AND UNIVERSAL AND INTEREST-SENSITIVE LIFE
PRODUCTS. The Company primarily accounts for its annuity and universal and
interest-sensitive life policy deposits in accordance with Statement of
Financial Accounting Standards No. 97 ("SFAS No. 97"). "Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses on the Sale of Investments". Under SFAS No. 97, a
benefit reserve is established at the time of policy issuance in an amount
equal to the deposits received. Thereafter, the benefit reserve is adjusted for
any additional deposits, interest credited and partial or complete withdrawals.
Revenues for annuities and universal and interest-sensitive life policies,
other than certain non-interest sensitive annuities, consist of policy charges
for surrenders and partial withdrawals, mortality and administration, and
investment income earned. Such revenues do not include the annuity and
universal and interest-sensitive life policy deposits. Expenses related to
these products include interest credited to policyowner account balances,
operating costs for policy administration, amortization of DAC and mortality
costs in excess of account balances.
Costs relating to the acquisition of new business, primarily commissions
paid to agents, which vary with and are directly related to the production of
new business, are deferred to the extent that such costs are recoverable from
future profit margins. At the time of issuance, the acquisition expenses,
approximately 13% of initial annuity premium deposits and 50% of premiums from
universal and interest-sensitive life products for SMC, are capitalized as DAC.
In accordance with SFAS No. 97, DAC with interest is amortized over the lives
of the policies in a constant relationship to the present value of estimated
future gross profits.
UNIT-LINKED PRODUCT ACCOUNTING. Separate account assets and liabilities
are maintained primarily for contracts of which the majority represents
unit-linked products where benefits on surrender and maturity are not
guaranteed. They generally represent funds held in accounts to meet specific
investment objectives of policyholders who bear the investment risk. Investment
income and investment gains and losses accrue directly to such policyholders.
SMC earns income from the investment management fee it charges on such
unit-linked contracts, which range from .8% to 1.2% of the value of the
underlying separate accounts.
DISCUSSION OF CHANGES IN THE CONSOLIDATED STATEMENT OF OPERATIONS FROM YEAR
ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996
OPERATING INCOME. The income from operations (before net realized
investment gains and gain on disposal of subsidiaries) was $2,384,000 in 1997,
or $.48 per share, compared to $1,174,000 for 1996, or $.24 per share. The
increase resulted primarily from operations in the United States producing
income from operations of $664,000 for 1997 compared to a loss of $44,000 for
1996. The increase is primarily due to an increase in interest spreads on an
increasing asset base. The income from international operations also increased
to $1,720,000 for 1997 compared to $1,218,000 for 1996. The international
operating income resulted primarily from increased fees from an increase in
value of assets under separate accounts and deceased operating expenses,
primarily due to the strengthening of the U.S. dollar.
PREMIUM INCOME. GAAP premium income for 1997 was $7,100,000, a decrease
of $3,368,000 or 32% from 10,468,000 for 1996. This decrease is attributable to
the recapture of premiums ceded of $4,234,000 in 1996 due to the termination
and recapture of a reinsurance agreement with National Mutual which offset the
increase in premium income for the inclusion of Shelby Life in the results of
operations for periods after November 1, 1996. The Shelby Life block of
business recorded net premium income of $1,685,000 in 1997.
Net premiums received from the sales of interest-sensitive annuities and
other financial products (which are not recorded as revenues) were $49,362,000
compared to $42,347,000 for 1997 and 1996, respectively. The increase in
premium deposits is partially due to an increase in gross domestic premium
deposits. Gross domestic premium deposits received from interest-sensitive
annuities and financial products were $58,069,000 for 1997 compared to
$51,254,000 for 1996. The increase in gross domestic premium is the result of
an aggressive marketing campaign targeted to high volume marketing companies.
Also contributing to the increase in premiums is the continued development of
SMC's distribution system through marketing support from Standard Marketing, an
aggressive program aimed at retaining key producers, and an increase in the
agency base achieved by expanding geographical concentration into the Mid-South
and California. Since SMC's operating income is primarily a function of its
investment spreads, persistency of annuity in force business mortality
experience and operating expenses, a change in premium deposits in a single
period does not directly cause operating income to change, although continued
increases or decreases in premiums may affect the growth rate of total assets
on which investment spreads are earned.
NET INVESTMENT INCOME. Net investment income increased $8,645,000 or 41%
to $29,516,000 for 1997 from $20,871,000 for 1996. The increase resulted from
an increase in total invested assets (amortized cost) of approximately 42% from
December 31, 1995 to December 31, 1997, most of which occurred in the fourth
quarter of 1996 due to the acquisition of Shelby Life, and an increase in the
weighted average net yield of SMC's investment portfolio (exclusive of realized
and unrealized gains) to 7.68% from 7.32% for 1997 and 1996, respectively. The
continued growth in SMC's total invested assets reflects increased sales of
FPDAs and the inclusion of the invested assets of Shelby Life of approximately
$100,000,000 in the consolidated balance sheet effective November 1, 1996.
NET REALIZED INVESTMENT GAINS. Net realized investment gains decreased
$906,000 or 70% to $396,000 from $1,302,000 for 1997 and 1996, respectively.
Net realized investment gains fluctuate from period to period and arise when
securities are sold in response to changes in the investment environment which
provide opportunities to maximize return on the investment portfolio without
adversely affecting the quality and overall yield of the investment portfolio.
The pretax net unrealized gain on the Company's fixed maturity portfolio
was $5,201,000 at December 31, 1997, compared to a pretax net unrealized (loss)
of $(1,837,000) at December 31, 1996. In the absence of continued decreases in
interest rates the Company may be unable to realize gains on its investment
portfolio at the levels of prior years or could recognize losses from sales of
securities prior to maturity. The Company's future earnings could be adversely
affected to the extent it is unable to realize gains on its investment
portfolio.
GAIN ON DISPOSAL OF SUBSIDIARIES. On March 18, 1996, SMC completed the
sale of a duplicate charter associated with First International to GIAC. SMC
received sale proceeds of $10,393,000, including $1,500,000 for the charter and
licenses associated with First International. Standard Life realized a net
pre-tax gain of $1,042,000 on this sale. In addition, First International,
Standard Life and GIAC have entered into a series of agreements that include
provisions for Standard Life to retain the economic interest in certain First
International policies and administer First International policies in force at
the date of such sale.
In an unrelated matter, SMC decided in February 1996 to terminate the
reinsurance agreement between Standard Reinsurance and Salamandra, and not to
renew the Barbados license of Standard Reinsurance. This resulted in a 1996
write-off of SMC's investment in Standard Reinsurance and certain intangible
assets of Standard Reinsurance amounting to $156,000.
The combined effect of the pre-tax gain on the sale of First
International and related contracts, and the Standard Reinsurance write-offs,
was $886,000 pre-tax and $2,306,000 after tax in 1996.
POLICY CHARGES. Policy charges, which represent the amounts assessed
against policyholder account balances for the cost of insurance, policy
administration and surrenders, increased $2,961,000 or 116% to $5,512,000 for
1997 compared to $2,551,000 for 1996. The increase in policy charges resulted
from an increase in policy charges for Standard Life's universal life insurance
products of $1,790,000 due to the inclusion of Shelby Life in the results of
operations for periods after November 1, 1996, and an increase in policy
surrender charges on FPDAs of $693,000. The increase in annuity policy
withdrawals and surrender charges on flexible premium deferred annuities
generally corresponds to the aging and growth of SMC's annuity business in
force.
FEES FROM SEPARATE ACCOUNTS. Fees from separate accounts increased
$215,000 or 14% to $1,779,000 for 1997 from $1,564,000 for 1996. This increase
is due primarily to an increase in the value of assets held in separate
accounts from $122,705,000 at December 31, 1995 to $148,064,000 at December 31,
1997. Net deposits from sales of unit-linked products by Standard Management
International were $21,954,000 and $16,902,000 for 1997 and 1996, respectively.
Such income fluctuates in relationship to total separate account assets and the
return earned on such assets.
BENEFITS AND CLAIMS. Benefits and claims decreased $821,000 or 8% to
$9,098,000 for 1997 from $9,919,000 for 1996. The decrease in benefits and
claims in 1997 resulted primarily from an increase in change in policy reserves
of $4,234,000 in 1996 related to the termination and recapture of the
reinsurance agreement with National Mutual. This decrease offset the increase
in benefits and claims from adverse mortality experience and the inclusion of
Shelby Life (approximately $1,152,000 in 1997) in the results of operations for
periods after November 1, 1996. Throughout SMC's history, it has experienced
both periods of higher and lower benefits and claims. Such volatility is not
uncommon in the life insurance industry and, over extended periods of time,
periods of higher claims experience tend to be offset by periods of lower
claims experience.
INTEREST CREDITED ON INTEREST SENSITIVE ANNUITIES AND OTHER FINANCIAL
PRODUCTS. Interest credited on interest sensitive annuities and other
financial products was $16,281,000 for 1997, an increase of $5,189,000 or 47%
from $11,092,000 for 1996. The increase resulted from the inclusion of interest
credited of $3,740,000 from Shelby Life products, increases in interest
credited rates on new annuity sales and the increases in the growth in policy
reserves for FPDAs from sales. At December 31, 1997, the weighted average
interest credited rate for Standard Life's currently marketed annuities and
other financial product liabilities was 5.58% compared to 5.27% at December 31,
1996.
SALARIES AND WAGES. Salaries and wages were $5,608,000 for 1997, an
increase of $555,000 or 11% from $5,053,000 for 1996. This increase was caused
primarily by an increase in the average wages per employee in 1997 and an
increase in the number of employees from 84 at January 1, 1996 to 92 at
December 31, 1997.
AMORTIZATION. Amortization expense increased $656,000 or 25% to
$3,248,000 for 1997 from $2,592,000 for 1996. The increase in current year
amortization expense resulted primarily from the amortization of present value
of future profits of $555,000 in 1997 for the acquisition of Shelby Life.
OTHER OPERATING EXPENSES. Other operating expenses decreased $320,000 or
4% to $6,991,000 for 1997 from $7,311,000 for 1996. The decrease in other
operating expenses resulted primarily from eliminating in 1997 the additional
cost to convert the operations and expand the marketing effort in Dixie
National Life incurred in 1996 and a reduction in international operating
expenses due to the strengthening of the U.S. dollar.
INTEREST EXPENSE AND FINANCING COSTS. Interest expense and financing
costs increased $1,576,000 or 196% to $2,381,000 for 1997 from $805,000 for
1996. The increase in interest expense and financing costs during 1997 resulted
primarily from increased borrowing of $10,100,000 in November 1996 on the
Amended Credit Agreement and borrowings of $4,000,000 from an unaffiliated
insurance company in connection with the acquisition of Shelby Life and
additional borrowings of $5,600,000 in connection with funding capital
contributions to an insurance subsidiary and redemption of Class S Preferred
Stock in 1997.
FEDERAL INCOME TAXES. Federal income tax expense (credit) was $617,000
for 1997, compared to $(730,000) for 1996. The large credit in 1996 is
primarily due to tax benefits of $1,420,000 related to the sale of First
International.
EXTRAORDINARY GAIN ON EARLY REDEMPTION OF REDEEMABLE PREFERRED STOCK.
Extraordinary gains were recorded on the early redemption of the Class S
Preferred Stock for the amounts by which the repurchase price for the Class S
Preferred Stock was below its book value plus accrued and unpaid dividends.
SMC recorded no extraordinary gain for 1997 compared to a $502,000 gain for
1996. Effective August 1, 1997, SMC redeemed all of its issued and outstanding
Class S Preferred Stock at redemption value of $10.00 per share plus
accumulated and unpaid dividends.
DISCUSSION OF CHANGES IN THE CONSOLIDATED STATEMENT OF OPERATIONS FROM
YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995
OPERATING INCOME. The income from operations (before net realized
investment gains and gain on disposal of subsidiaries), was $1,174,000 in 1996,
or $.24 per share, compared to $461,000 for 1995, or $.09 per share. The change
resulted primarily from international operations producing income from
operations of $1,218,000 compared a loss of to $(22,000) for 1996 and 1995,
respectively. The international operating gains resulted primarily from
increased management fees on an increasing separate account base due to
portfolio sales in 1996 and 1995, and increased value of assets under
management, coupled with a decrease in marketing costs in 1996 when compared to
1995. The income (loss) from operations in the United States decreased to
$(44,000) in 1996 compared to $483,000 in 1995. The decline was attributable to
an increase in interest expense from borrowings to repurchase Common Stock,
Class S Preferred Stock and the purchase of Shelby Life and additional costs to
convert the operations and expand the marketing effort in Dixie National Life.
PREMIUM INCOME. GAAP premium income for the 1996 was $10,468,000, an
increase of $4,964,000 or 90% from $5,504,000 for 1995. This increase is mainly
attributable to recapture of premiums ceded of $4,234,000 due to the
termination and recapture of a reinsurance agreement with National Mutual and
the inclusion of Dixie National Life and Shelby Life in the results of
operations for periods after October 2, 1995 and November 1, 1996,
respectively. These amounts offset the decline in premiums from the cession of
a portion of First International's life insurance business and the regular
policy lapses, surrenders and expiries in SMC's closed blocks of business.
Net premiums received from the sales of interest-sensitive annuities and
other financial products (which are not recorded as revenues) were $42,347,000
compared to $17,524,000 for 1996 and 1995, respectively. The increase in
premium deposits is partially due to an increase in gross domestic premium
deposits. Gross domestic premium deposits received from interest-sensitive
annuities and financial products were $51,254,000 for 1996 compared to
$37,614,000 for 1995. The increase is the result of an aggressive marketing
campaign implemented by Standard Life with increased crediting interest rates.
First year interest crediting rates were increased approximately 1% on certain
FPDAs sold after April 1, 1995. Also contributing to the increase in premiums
is the continued development of SMC's distribution system through marketing
support from Standard Marketing and an increase in the agency base achieved
through the recruitment of larger managing general agencies and expanding
geographical concentration into the Mid-South and California.
SMC also decreased the quota-share portion of business ceded pursuant to
a reinsurance agreement from 70% to 50% at September 1, 1995, which was further
decreased to 25% effective April 1, 1995. Premium deposits ceded pursuant to
this reinsurance agreement reduced net premium deposits by $8,907,000 in 1996
compared to $20,090,000 in 1995.
NET INVESTMENT INCOME. Net investment income increased $2,354,000 or 13%
to $20,871,000 for 1996 from $18,517,000 for 1995. The increase primarily
resulted from an increase in total invested assets (amortized cost) of
approximately 32% from 1995 to 1996, most of which occurred in the fourth
quarter due to the acquisition of Shelby Life. The weighted average net yield
on SMC's invested assets was 7.32% for both 1996 and 1995. The continued growth
in SMC's total invested assets reflects increased sales of FPDAs and the
inclusion of the invested assets of Dixie National Life of approximately
$26,400,000 and Shelby Life of approximately $100,000,000 in the consolidated
balance sheet effective October 2, 1995 and November 1, 1996, respectively,
which was offset by the invested assets ceded in the GIAC reinsurance
transaction of approximately $18,000,000.
NET REALIZED INVESTMENT GAINS. Net realized investment gains increased
$614,000 or 89% to $1,302,000 from $688,000 for 1996 and 1995, respectively.
The increase primarily resulted from active portfolio management by SMC. Net
realized investment gains fluctuate from period to period and arise when
securities are sold in response to changes in the investment environment which
provide opportunities to maximize return on the investment portfolio without
adversely affecting the quality and overall yield of the investment portfolio.
POLICY CHARGES. Policy charges increased $84,000 or 3% to $2,551,000 for
1996 compared to $2,467,000 for 1995. The increase in policy charges resulted
from an increase in policy surrender charges on FPDAs of $254,000 and the
inclusion of Dixie National Life and Shelby Life in operating results for
periods after October 2, 1995 and November 1, 1996, respectively, for an
increase of $1,359,000 which offset a decrease of $1,502,000 for the absence of
policy charges from SMC's closed blocks of universal life business which were
sold to GIAC through a reinsurance contract effective January 1, 1995.
FEES FROM SEPARATE ACCOUNTS. Fees from separate accounts increased
$270,000 or 21% to $1,564,000 for 1996 from $1,294,000 for 1995. This increase
is due primarily to an increase in the value of assets held in separate
accounts from $94,301,000 at December 31, 1994 to $128,546,000 at December 31,
1996 and to higher service fees being levied on certain transactions. Net
deposits from sales of unit-linked products by Standard Management
International were $16,902,000 and $31,793,000 for 1996 and 1995, respectively.
Such income fluctuates in relationship to total separate account assets and the
return earned on such assets.
OTHER INCOME. Other income increased $897,000 or 236% to $1,277,000 for
1996 compared to $380,000 for 1995. The increase resulted primarily from
administration fees of $316,000 and the reserve and experience refund
adjustments in connection with the agreements with GIAC and increased
commissions received by Standard Marketing from the sale of unaffiliated
products.
BENEFITS AND CLAIMS. Benefits and claims increased $4,128,000 or 71% to
$9,919,000 for 1996 from $5,791,000 for 1995. The increase resulted primarily
from an increase in reserves of $4,234,000 related to the termination and
recapture of a reinsurance agreement with National Mutual. Throughout SMC's
history, it has experienced both periods of higher and lower benefit claims.
Such volatility is not uncommon in the life insurance industry and, over
extended periods of time, periods of higher claims experience tend to be offset
by periods of lower claims experience.
INTEREST CREDITED ON INTEREST SENSITIVE ANNUITIES AND OTHER FINANCIAL
PRODUCTS. Interest credited on interest sensitive annuities and other
financial products was $11,092,000 for 1996, an increase of $1,083,000 or 11%
from $10,009,000 for 1995. The increase resulted primarily from SMC's increase
of credited interest rates on new annuity sales and the increases in the growth
in policy reserves for FPDAs from sales and the inclusion of Shelby Life in the
operations results effective November 1, 1996. At December 31, 1996, the
weighted average interest credited rate for Standard Life's annuities and other
financial product liabilities was 5.27% compared to 5.35% at December 31, 1995.
SALARIES AND WAGES. Salaries and wages were $5,053,000 for 1996, an
increase of $352,000 or 7% from $4,701,000 for 1995. This increase was caused
primarily by an increase in incentive compensation expense of $315,000.
AMORTIZATION. Amortization expense increased $548,000 or 27% to
$2,592,000 for 1996 from $2,044,000 for 1995. The increase in current year
amortization expense resulted primarily from increased amortization of deferred
acquisition costs as gross profits from business sold in recent years began to
emerge and increased surrenders and their corresponding increase in the
amortization of deferred acquisition costs, and from an increase of $602,000
for the amortization of present value of future profits for the acquisitions of
Dixie National Life, Shelby Life and National Mutual. These items more than
offset reduced amortization of excess of cost over net assets acquired of
$46,000 and present value of future profits of $120,000 due to the sale of
First International.
OTHER OPERATING EXPENSES. Other operating expenses increased $1,292,000
or 21% to $7,311,000 for 1996 from $6,019,000 for 1995. The increase in other
operating expenses resulted primarily from the expenses of Dixie National Life
and Shelby Life included in the results for the periods after October 2, 1995
and November 1, 1996, respectively and the increased expenses related to
potential acquisitions and advisory fees.
INTEREST EXPENSE AND FINANCING COSTS. Interest expense and financing
costs increased $687,000 or 582% to $805,000 for 1996 from $118,000 for 1995.
The increase in interest expense and financing costs during 1996 resulted
primarily from the borrowing on the Amended Credit Agreement. The borrowing
under the Amended Credit Agreement and the original credit agreement primarily
occurred after December 31, 1995 in connection with the acquisition of Shelby
Life and the repurchase of Common Stock and Class S Preferred Stock.
LIQUIDITY AND CAPITAL RESOURCES
Standard Management is a financial services holding company. The
liquidity requirements of Standard Management are met primarily from management
fees, equipment rental fees and payments for other charges and dividends and
interest on Surplus Debentures received from Standard Management's subsidiaries
as well as Standard Management's working capital. These are Standard
Management's primary source of funds to pay operating expenses and meet debt
service obligations. The payment of dividends and interest on Surplus
Debentures and management and other fees by Standard Life to Standard
Management is subject to restrictions under the insurance laws of Indiana,
Standard Life's jurisdiction of domicile. These internal sources of liquidity
have been supplemented in the past by external sources such as lines of credit
and revolving credit agreements and long-term debt and equity financing in the
capital markets.
SMC reported on a consolidated GAAP basis net cash provided by operations
of $7,764,000 and $1,726,000 for 1997 and 1996, respectively. Although deposits
received on SMC's interest-sensitive annuities and other financial products are
not included in cash flow from operations under GAAP, such funds are available
for use by SMC. Cash provided by operations plus net deposits received, less
net account balances returned to policyholders on interest sensitive annuities
and other financial products, resulted in positive cash flow of $19,649,000 and
$26,717,000 for 1997 and 1996, respectively. Cash generated on a consolidated
basis is available to Standard Management only to the extent that it is
generated at Standard Management level or is available to Standard Management
through dividends, interest, management fees or other payments from
subsidiaries.
In April 1993, Standard Management instituted a program to repurchase SMC
Common Stock from time to time. The purpose of the stock repurchase program is
to enhance shareholder value. Standard Management had repurchased 1,134,356
shares of SMC Common Stock for $5,826,000 as of January 1, 1998. Of the
repurchases, 419,026 shares were paid for through additional borrowings under
the Amended Credit Agreement, 39,016 shares from the proceeds of the additional
borrowings of the subordinated convertible notes, and the remainder were paid
from working capital. At January 1, 1998, Standard Management was authorized to
purchase an additional 365,644 shares under this program.
At February 28, 1998, Standard Management had "parent company only" cash
and short-term investments of $558,000. These funds are available to Standard
Management for general corporate purposes. Standard Management's "parent
company only" operating expenses (not including interest expense) were
$3,420,000 and $3,470,000 for 1997 and 1996, respectively.
Pursuant to the management services agreement with Standard Management,
Standard Life paid Standard Management a monthly fee of $166,667 (annual fee of
$2,000,000) during 1997 for certain management services related to the
production of business, investment of assets and evaluation of acquisitions.
Pursuant to the management service agreements with Standard Life, Dixie
National Life paid monthly payments of $83,333 (annual fee of $1,000,000) to
Standard Life in 1997. Both of these agreements provide that they may be
modified or terminated by the Indiana and Mississippi departments of insurance
in the event of financial hardship of Standard Life or Dixie National Life.
A management services agreement between SMC and Savers Life was approved
by the North Carolina Department of Insurance on March 11, 1998. The
management services agreement calls for the payment of $83,333 per month by
Savers Life to SMC for financial and regulatory reporting, investment of
assets and the production of business. SMC has agreed to receive no fee, nor
shall Savers life have an obligation to pay, unless the capital and surplus of
Savers Life is $7,000,000 after the acquisition of Savers Life. The amount
of capital and surplus of Savers Life at December 31, 1997 was $7,134,00.
In addition, as a condition of the acquisition of Savers Life, SMC
entered into an agreement with the North Carolina Department of Insurance to
maintain statutory capital and surplus of Savers Life of at least $6,000,000.
Pursuant to the management services agreement with Standard Management,
Premier Life (Luxembourg) paid Standard Management a management fee of $25,000
per quarter during 1997 and 1996 for certain management and administrative
services. The agreement provides that it may be modified or terminated by
either Standard Management or Premier Life (Luxembourg).
At April 1, 1995, Standard Management sold its property and equipment to
an unaffiliated leasing/financing company for $1,396,000 and subsequently
entered into a capital lease obligation whereby Standard Management pays a
monthly rental amount of $45,000. Standard Management charges a monthly
equipment rental fee to its subsidiaries for this equipment and additional
equipment purchased after April 1, 1995. The amount of the rental fee income
received from Standard Management's subsidiaries was $1,145,000 and $853,000
for 1997 and 1996, respectively.
On November 8, 1996, Standard Life acquired through merger Shelby Life
from DLAC for approximately $14,650,000, including $13,000,000 in cash, 250,000
shares of restricted SMC Common Stock (valued at $1,250,000) and $400,000 of
acquisition costs. Financing for the Shelby Life transaction was provided by
senior debt of $10,000,000 under the Amended Credit Agreement and $4,000,000 in
subordinated convertible debt described below.
The Amended Credit Agreement permits Standard Management to borrow up to
$20,000,000 in the form of a seven-year reducing revolving loan arrangement.
Standard Management has agreed to pay a non-use fee of .50% per annum on the
unused portion of the commitment. In connection with the original and Amended
Credit Agreement, Standard Management issued warrants to the bank to purchase
77,500 shares of SMC Common Stock. Borrowing under the Amended Credit Agreement
may be used for contributions to surplus of insurance subsidiaries, acquisition
financing, and repurchases of Class S Preferred and SMC Common Stock. The debt
is secured by a Pledge Agreement of all of the issued and outstanding shares of
common stock of Standard Life and Standard Marketing. Interest on the borrowing
under the Amended Credit Agreement is determined, at the option of Standard
Management, to be: (i) a fluctuating rate of interest based on corporate base
rate announced by the bank from time to time plus 1% per annum, or (ii) a rate
at LIBOR plus 3.25%. Annual principal repayments of $3,333,000 begin in March
2000 and conclude in March 2005. Indebtedness incurred under the Amended Credit
Agreement is subject to certain restrictions and covenants including, among
other things, certain minimum financial ratios, minimum statutory surplus
requirements for the insurance subsidiaries, minimum consolidated equity
requirements for Standard Management and certain investment and indebtedness
limitations. At December 31, 1997, Standard Management had borrowed $16,000,000
under the Amended Credit Agreement at a weighted average interest rate of
9.062%.
In connection with the acquisition of Shelby Life, Standard Management
borrowed $4,000,000 from an insurance company pursuant to a subordinated
convertible debt agreement which is due in December, 2003. At June 30, 1997,
this subordinated convertible debt agreement was amended to the principal
amount of $4,372,000 which is due July 2004 unless previously converted, and
requires interest payments in cash on January 1 and July 1 of each year at 10%
per annum. At June 30, 1997, SMC borrowed an additional $5,628,000 from an
insurance company pursuant to another subordinated convertible debt agreement
(collectively, the "Notes") which is due July 2004 unless previously converted,
and requires interest payments in cash on January 1 and July 1 of each year at
10% per annum. Proceeds from the additional borrowings were used for
contributions to surplus of insurance subsidiaries of $2,400,000, redemption of
Class S Preferred Stock of approximately $1,840,000 and other general corporate
purposes. The Notes are convertible at any time at the option of the
noteholders into Common Stock at the rate of $5.747 per share. The Notes may
be prepaid in whole or in part at the option of SMC commencing on July 1, 2000
at redemption prices equal to 105% of the principal amount (plus accrued
interest) and declining to 102% of the principal amount (plus accrued
interest). The Notes may be prepaid prior to July 1, 2000 at a redemption
price equal to 101% of the principal amount plus accrued interest under certain
limited circumstances. The subordinated convertible debt agreements contains
terms and financial covenants substantially similar to those in the Amended
Credit Agreement.
Assuming the current level of debt under the Amended Credit Agreement and
current interest rates at December 31, 1997 (weighted average rate of 9.062%),
annual debt service in 1998 would be approximately $2,800,000 in interest paid.
In addition, Standard Management has 1998 obligations under a capital lease of
$151,000.
From the funds borrowed by Standard Management pursuant to the Amended
Credit Agreement and the subordinated convertible debt agreement, $13,000,000
was loaned to Standard Life pursuant to an Unsecured Surplus Debenture
Agreement ("Surplus Debenture") which requires Standard Life to make quarterly
interest payments to Standard Management at a variable corporate base rate plus
2% per annum, and annual principal payments of $1,000,000 per year beginning in
2007 and concluding in 2019. The interest and principal payments are subject to
quarterly approval by the Indiana Department of Insurance, depending upon
satisfaction of certain financial tests relating to levels of Standard Life's
capital and surplus and general approval of the Commissioner of the Indiana
Department of Insurance. Standard Management currently anticipates these
quarterly approvals will be granted. Assuming the approvals are granted and the
December 31, 1997 interest rate of 10.50% continues in 1998, Standard
Management will receive interest income of $1,365,000 from the Surplus
Debenture for 1998.
Dividends from Standard Life to Standard Management are limited by laws
applicable to insurance companies. As an Indiana domiciled insurance company,
Standard Life may pay a dividend or distribution from its surplus profits,
without the prior approval of the Commissioner of the Indiana Department of
Insurance, if the dividend or distribution, together with all other dividends
and distributions paid within the preceding twelve months, does not exceed the
greater of (i) net gain from operations or (ii) 10% of surplus, in each case as
shown in its preceding annual statutory financial statements. Also, regulatory
approval is required when dividends to be paid exceed unassigned statutory
surplus. For the year ended December 31, 1997, Standard Life reported statutory
net gain from operations before realized capital losses of $2,374,000 and
statutory surplus of $25,923,000 which includes unassigned surplus of
$1,693,000. During 1998, Standard Life can pay dividends of approximately
$2,500,000 without regulatory approval.
As a North Carolina domiciled insurance company, Savers Life may pay a
dividend or distribution from its capital and surplus, without the prior
approval of the North Carolina Commissioner of Insurance, if the dividend or
distribution together with all other dividends and distributions paid within
the preceding twelve months, does not exceed the lesser of (i) net gain from
operations or (ii) 10% of capital and surplus, in each case as shown in its
preceding annual statutory financial statements. Savers Life was not allowed
to pay a dividend in 1996 or 1997 without prior North Carolina Department of
Insurance approval due to its statutory net losses in 1995 and 1996. Savers
Life will not be permitted to pay dividends in 1998 without such approval.
Standard Management anticipates the available cash from its existing
working capital, plus anticipated 1998 dividends, management fees, rental
income and interest payments on its Surplus Debentures receivable will be more
than adequate to meet its anticipated "parent company only" cash requirements
for 1998.
Standard Management has a note receivable of $2,858,000 from an affiliate
and a note payable of $2,858,000 to a different affiliate. This note receivable
and note payable are eliminated in the consolidated financial statements.
U.S. INSURANCE OPERATIONS. The principal liquidity requirements of
Standard Life are its contractual obligations to policyholders, dividend, rent,
management fee and Surplus Debenture payments to Standard Management and other
operating expenses. The primary source of funding for these obligations has
been cash flow from premium income, net investment income, investment sales and
maturities and sales of FPDAs. These sources of liquidity for Standard Life
significantly exceed scheduled uses. Liquidity is also affected by unscheduled
benefit payments including death benefits and policy withdrawals and
surrenders. The amount of withdrawals and surrenders is affected by a variety
of factors such as renewal interest crediting rates, interest rates for
competing products, general economic conditions, Standard Life's A.M. Best
ratings (currently rated "B+") and events in the industry that affect
policyholders' confidence.
The policies and annuities issued by Standard Life contain provisions
that allow policyholders to withdraw or surrender their policies under defined
circumstances. These policies and annuities generally contain provisions which
apply penalties or otherwise restrict the ability of policyholders to make such
withdrawals or surrenders. Standard Life closely monitors the surrender and
policy loan activity of its insurance products and manages the composition of
its investment portfolios, including liquidity, in light of such activity.
Changes in interest rates may affect the incidence of policy surrenders
and other withdrawals. In addition to the potential effect on liquidity,
unanticipated withdrawals in a changing interest rate environment could
adversely affect earnings if SMC were required to sell investments at reduced
values to meet liquidity demands. SMC manages the asset and liability
portfolios in order to minimize the adverse earnings effect of changing market
interest rates. SMC seeks assets that have duration characteristics similar to
the liabilities that they support. SMC also prepares cash flow projections and
performs cash flow tests under various market interest rate scenarios to assist
in evaluating liquidity needs and adequacy. SMC's U.S. insurance subsidiaries
currently expect available liquidity sources and future cash flows to be
adequate to meet the demand for funds.
Statutory surplus is computed according to rules prescribed by the NAIC,
as modified by the Indiana Department of Insurance, or the state in which the
insurance subsidiaries do business. Statutory accounting rules are different
from GAAP and are intended to reflect a more conservative perspective. With
respect to new business, statutory accounting practices require that:
(i) acquisition costs (primarily commissions and policy issue costs) and
(ii) reserves for future guaranteed principal payments and interest in excess
of statutory rates, be expensed in the year the new business is written. These
items cause a reduction in statutory surplus ("surplus strain") in the year
written for many insurance products. SMC designs its products to minimize such
first-year losses, but certain products continue to cause a statutory loss in
the year written. For each product, SMC controls the amount of net new premiums
written to manage the effect of such surplus strain. SMC's long-term growth
goals contemplate continued growth in its insurance businesses. To achieve
these growth goals, SMC's U.S. insurance subsidiaries will need to increase
statutory surplus. Additional statutory surplus may be secured through various
sources such as internally generated statutory earnings, infusions by Standard
Management with funds generated through debt or equity offerings or mergers
with other life insurance companies. If additional capital is not available
from one or more of these sources, SMC believes that it could reduce surplus
strain through the use of reinsurance or through reduced writing of new
business.
During 1997, Standard Life produced a statutory net income of $1,776,000.
Standard Management contributed $2,400,000 to Standard Life in 1997 to
facilitate growth in premiums written. In March 1996, Standard Life sold its
subsidiary, First International, and realized an increase in statutory capital
and surplus of approximately $4,951,000 from the statutory gain on the sale and
related reinsurance transactions.
Commencing January 1, 1995, Standard Life began to reinsure a portion of
its annuity business. This reinsurance agreement has allowed SMC to write
volumes of business that it would not otherwise have been able to write due to
regulatory restrictions based on its ratio of surplus to liabilities as
determined by regulatory authorities in the State of Florida. By reinsuring a
portion of the annuity business, the liability growth is slowed, thereby
avoiding the erosion of surplus that occurs in periods of increasing sales. If
SMC's ratio of surplus to liabilities falls below 4%, the State of Florida
could prohibit SMC from writing new business in Florida. Standard Life's
largest annuity reinsurer at December 31, 1997, Winterthur, is rated "A"
("Excellent") by A.M. Best. From January 1, 1995 to August 31, 1995
approximately 70% of certain of Standard Life's annuity business produced was
ceded. Standard Life decreased the quota-share portion of business ceded to 50%
at September 1, 1995 and further reduced it to 25% effective April 1, 1996 to
reflect the reduced need for additional capital and increase current earnings
potential. This reduction was possible since the surplus strain experienced by
Standard Life was not as great as originally anticipated as a result of lower
than expected sales in 1995 and the increase in surplus resulting from the sale
of First International. In addition, Standard Life's ability to retain business
was further increased by contributions to surplus of insurance subsidiaries of
$2,400,000 in 1997. Winterthur limits dividends and other transfers by
Standard Life to Standard Management or affiliated companies in certain
circumstances.
Management believes that operational cash flow of Standard Life will be
sufficient to meet its anticipated needs for 1998. As of December 31, 1997,
Standard Life had statutory capital and surplus for regulatory purposes of
$25,923,000 compared to $22,970,000 at December 31, 1996. The increase is
primarily due to the capital contribution of $2,400,000 from Standard
Management in 1997. As the life insurance and annuity business produced by
Standard Life and Dixie National Life increases, Standard Life expects to
continue to satisfy statutory capital and surplus requirements through
statutory profits, through the continued reinsurance of a portion of its new
business, and through additional capital contributions by Standard Management.
Net cash flow from operations on a statutory basis of Standard Life, after
payment of benefits and operating expenses, was $19,588,000 and $17,921,000 for
1997 and 1996, respectively. If the need arises for cash which is not readily
available, additional liquidity could be obtained from the sale of invested
assets.
State insurance regulatory authorities impose minimum risk-based capital
requirements on insurance enterprises that were developed by the NAIC. The
formulas for determining the amount of RBC specify various weighting factors
that are applied to financial balances or various levels of activity based on
the perceived degree of risk. Regulatory compliance is determined by a ratio
(the "RBC Ratio") of the enterprise's regulatory total adjusted capital, as
defined by the NAIC, to its authorized control level RBC, as defined by the
NAIC. Enterprises below specific trigger points or ratios are classified within
certain levels, each of which requires specified corrective action. Each of
SMC's insurance subsidiaries has an RBC Ratio that is at least 400% of the
minimum RBC requirements; accordingly, the subsidiaries meet the RBC
requirements.
Standard Life's acquisition of Shelby Life, and merger of Shelby Life
into Standard Life, effective November 1, 1996 is anticipated to have a
positive effect on Standard Life's liquidity and cash flows. Shelby Life ceased
writing new business effective November 1, 1996, thus reducing the surplus
strain normally associated with the issuance of new policies. The anticipated
profits from Shelby Life's book of business are expected to exceed the related
interest expense connected with the $13,000,000 of Surplus Debentures issued by
Standard Life in connection with the acquisition of Shelby Life.
SMC's acquisition of Savers Life at March 12, 1998 is anticipated to have
a positive effect on SMC's liquidity and cash flows. SMC anticipates that
existing working capital, unused proceeds from borrowings under the Amended
Credit Agreement, and management fees by Savers Life will be adequate to cover
debt service on the additional borrowings under the Amended Credit Agreement
through 1998.
INTERNATIONAL OPERATIONS. The consolidated balance sheet of SMC at
December 31, 1997, includes a $1,388,000 credit representing negative goodwill
on the purchase of Standard Management International which will be amortized
into earnings during 1998. This amortization is a non-cash credit to SMC
statement of operations.
Standard Management International dividends are limited to its
accumulated earnings without regulatory approval. Standard Management
International and Premier Life (Luxembourg) were not permitted to pay dividends
in 1997 and 1996 due to accumulated losses. Premier Life (Bermuda) did not pay
dividends in 1997 and 1996. SMC does not anticipate any dividends from these
companies in 1998.
Due to the nature of unit-linked products issued by Standard Management
International, which represent over 90% of the Standard Management
International portfolio, the investment risk rests with the policyholder.
Investment risk for Standard Management International exists where Standard
Management International makes investment decisions with respect to the
remaining traditional business and for the assets backing certain actuarial and
regulatory reserves. The investments underlying these liabilities mostly
represent short-term investments and fixed maturity securities. These short
term investments and fixed maturity securities are normally bought and/or
disposed of only on the advice of independent consulting actuaries who perform
an annual analysis comparing anticipated cash flows on the insurance portfolio
with the cash flows from the fixed maturity securities. Any resulting material
mismatches are then covered by adjusting the securities in the investment
portfolio as appropriate.
FACTORS THAT MAY AFFECT FUTURE RESULTS
MERGERS, ACQUISITIONS AND CONSOLIDATIONS. The U.S. insurance industry
has experienced an increasing number of mergers, acquisitions, consolidations
and sales of certain business lines. These consolidations have been driven by a
need to reduce costs of distribution and overhead and maintain business in
force. Additionally, increased competition, regulatory capital requirements and
technology costs have also contributed to the level of consolidation in the
industry. These forces are expected to continue as is the level of industry
consolidation.
FOREIGN CURRENCY RISK. Standard Management International policyholders
invest in assets denominated in a wide range of currencies. Policyholders
effectively bear the currency risk, if any, as these investments are matched by
policyholder separate account liabilities. Therefore, their investment and
currency risk is limited to premiums they have paid. Policyholders are not
permitted to invest directly into options, futures and derivatives. Standard
Management International could be exposed to currency fluctuations if
currencies within the conventional investment portfolio or certain actuarial
reserves are mismatched. The assets and liabilities of this portfolio and the
reserves are continually matched by the company and at regular intervals by the
independent actuary. In addition, Premier Life (Luxembourg) shareholder's
equity is denominated in Luxembourg francs. Premier Life (Luxembourg) does not
hedge translation risk because its stockholder's equity will remain in
Luxembourg francs for the foreseeable future and no significant realized
foreign exchange gains or losses are anticipated. At December 31, 1997, there
was an unrealized loss from foreign currency translation adjustment of
$473,000.
UNCERTAINTIES REGARDING INTANGIBLE ASSETS. Included in SMC's financial
statements as of December 31, 1997 are certain assets that are valued for
financial statement purposes primarily on the basis of assumptions established
by SMC's management. These assets include deferred acquisition costs, present
value of future profits, costs in excess of net assets acquired and
organization and deferred debt issuance costs. The total value of these assets
reflected in the December 31, 1997 consolidated balance sheet aggregated
$43,492,000 or 6% of SMC's assets. SMC has established procedures to
periodically review the assumptions utilized to value these assets and
determine the need to make any adjustments in such values in SMC's consolidated
financial statements. SMC has determined that the assumptions utilized in the
initial valuation of these assets are consistent with the current operations of
SMC as of December 31, 1997.
REGULATORY ENVIRONMENT. Currently, prescribed or permitted statutory
accounting principles ("SAP") may vary between states and between companies.
The NAIC is in the process of codifying SAP to promote standardization of
methods utilized throughout the industry. Completion of this project might
result in changes in statutory accounting practices for SMC's insurance
subsidiaries; however, it is not expected that such changes would materially
affect SMC's insurance subsidiaries' statutory capital requirements.
FINANCIAL SERVICES DEREGULATION. The United States Congress is currently
considering a number of legislative proposals intended to reduce or eliminate
restrictions on affiliations among financial services organizations. Proposals
are extant which would allow banks to own or affiliate with insurers and
securities firms. An increased presence of banks in the life insurance and
annuity businesses may increase competition in these markets. The Company
cannot predict the impact of these proposals on the earnings of the Company.
IMPACT OF YEAR 2000. Some of the Company's older computer programs were
written using two digits rather than four to define the applicable year. As a
result, those computer programs have time-sensitive software that recognize a
date using "00" as the year 1900 rather than the year 2000. This could cause a
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send billing
notices, or engage in similar normal business activities.
The Company has completed an assessment and will have minimal
expenditures to modify or replace portions of its software so that its computer
systems will function properly with respect to dates in the year 2000 and
thereafter. Modifications and or replacements are estimated to be completed
not later than December 31, 1998, which is prior to any anticipated impact on
its operating systems. The Company believes that with modifications to
existing software and conversions to new software, the Year 2000 Issue will not
pose significant operational problems for its computer systems. Additionally,
management has concluded that the Year 2000 Issue will not materially affect
future financial results, or cause reported financial information not to be
indicative of future operating results or future financial condition.
SAFE HARBOR PROVISIONS. All statements, trend analyses, and other
information contained in this Annual Report on Form 10-K or any document
incorporated by reference herein relative to markets for the Company's products
and trends in the Company's operations or financial results, as well as other
statements including words such as "anticipate," "believe,"
"plan,""estimate,""expect,""intend," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation reform Act
of 1995. These forward-looking statements are subject to known and unknown
risks, uncertainties and other factors which may cause actual results to be
materially difference from those contemplated by the forward-looking
statements. Such factors include, among other things: (1) general economic
conditions and other factors, including prevailing interest rate levels, stock
market performance and health care inflation, which may affect the ability of
the Company to sell its products, the market value of the Company's investments
and the lapse rate and profitability of the Company's policies; (2) the
Company's ability to achieve anticipated levels of operational efficiencies at
recently acquired companies, as well as through other cost-saving initiatives;
(3) customer response to new products, distribution channels and marketing
initiatives; (4) mortality, morbidity, usage of health care services and other
factors which may affect the profitability of the Company's insurance products;
(5) changes in the Federal income tax laws and regulation which may affect the
relative tax advantages of some of the Company's products; (6) increasing
competition in the sale of the Company's products; (7) regulatory changes or
actions, including those relating to regulation of financial services affecting
(among other things) bank sales and underwriting of insurance products,
regulation of the sale, underwriting and pricing of insurance products, and
health care regulation affecting the Company's supplemental health insurance
products; (8) the availability and terms of future acquisitions; and (9) the
risk factors or uncertainties listed from time to time in any document
incorporated by reference herein.
ITEM 8.CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required with respect to
this Item 8 are listed in Item 14(a)(1) and included in a separate section of
this report.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The Registrant will file a definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
Company's 1998 Annual Meeting of Shareholders, (the "Proxy Statement") not
later than 120 days after the end of the fiscal year covered by this report,
and certain information included therein is incorporated herein by reference.
Only those sections of the Proxy Statements which specifically address the
items set forth herein are incorporated by reference. Such incorporation does
not include the Compensation Committee Report or the Performance Graph included
in the Proxy Statement.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning SMC's directors required by this item is
incorporated by reference to SMC's Proxy Statement.
The information concerning SMC's executive officers required by this Item
is incorporated by reference herein to the section in Part I, entitled
"Executive Officers."
The information regarding compliance with Section 16 of the Securities
and Exchange Act of 1934 is to be set forth in the Proxy Statement and is
hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
SMC's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
SMC's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
SMC's Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2) The response to this portion of Item 14 is submitted as a
separate section of this report.
(a)(3) List of Exhibits:
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
2.1 Amended and Restated Agreement and Plan of Merger dated as of
December 9, 1997 among SMC, SAC and Savers Life. (incorporated by
reference to SMC's Registration Statement on Form S-4 (Registration
No. 333-43023).
3.1 Amended and Restated Articles of Incorporation, as amended
(incorporated by reference to SMC's Annual Report on Form 10-K (File
No. 0-20882) for the year ended December 31, 1995).
3.2 Amended and Restated Bylaws of SMC as amended (incorporated by
reference to SMC's Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993 and to
Exhibit 3 of SMC's Quarterly Report on Form 10-Q (File No. 0-20882)
for the quarter ended September 30, 1994).
4.1 Form of Senior Note Agreement Warrant (incorporated by reference to
SMC's Registration Statement on Form S-1 (Registration No. 33-53370)).
4.2 Form of Oppbridge Partners Warrant (incorporated by reference to SMC's
Registration Statement on Form S-1 (Registration No. 33-53370)).
4.3 Registration Rights Agreement, dated as of May 3, 1990 among SMC,
Howard T. Cohn and Joseph J. Piazza and the first amendment thereto,
dated June 4, 1990 (incorporated by reference to SMC's Registration
Statement on Form S-1 (Registration No. 33-53370).
4.4 Amended and Restated Registration Rights Agreement dated as of April
15, 1997 by and between SMC and Fleet National Bank.
4.5 Form of Fleet National Bank Warrant.
4.6 Form of President's Club Warrant (incorporated by reference to SMC's
Annual Report on Form 10-K (File No. 0-20882)).
4.7 Registration Rights Agreement dated as of November 8, 1996 by and
between SMC and Great American Reserve Insurance Company ("Great
American Reserve") (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
September 30, 1996).
4.8 Form of Sand Brothers & Company, Ltd. Warrant (incorporated by
reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for
the year ended December 31, 1997).
9 Voting Trust Agreement dated as of November 8, 1996 among Delta Life
and Annuity Company, Messrs. Ronald D. Hunter and Allen O. Jones, Jr.,
as Voting Trustees, and SMC (incorporated by reference to SMC's
Registration Statement on Form S-4 (Registration No. 333-35447)).
10.1 Amended Advisory Agreement, dated as of August 1, 1991, between
SMC and Conseco Capital Management, Inc., as amended, April 17,
1995 (incorporated by reference to SMC's Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31,
1996).
10.2 Second Amended and Restated Employment Contract by and between
SMC and Ronald D. Hunter, dated and effective, as amended,
April 3, 1995 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1995).
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
10.3 Second Amended and Restated Employment Contract by and between
SMC and Edward T. Stahl, dated and effective, as amended,
April 3, 1995 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1995).
10.4 Second Amended and Restated Employment contract by and between
SMC and Raymond J. Ohlson, dated and effective, as amended,
April 3, 1995 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1995).
10.5 First Amended and Restated Employment Contract by and between
SMC and Stephen M. Coons dated and effective, April 3, 1995
(incorporated by reference to SMC's Quarterly Report on
Form 10-Q (File No. 0-20882) for the quarter ended June 30,
1995).
10.6 Indemnification Agreement between SMC and Stephen M. Coons and
Coons & Saint, dated August 1, 1991 (incorporated by reference
to SMC's Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993).
10.7 Standard Management Corporation Amended and Restated 1992 Stock
Option Plan (incorporated by reference to the Company's
Registration Statement on Form S-4 (Registration No. 333-35447)
as filed with the Commission on September 11, 1997.
10.8 Lease by and between Standard Life and WRC Properties, Inc.,
dated February 27, 1991 (incorporated by reference to SMC's
Registration Statement on Form S-1 (Registration No. 33-53370)
as filed with the Commission on January 27, 1993).
10.9 Management Service Agreement between Standard Life and SMC dated
August 1, 1992, as amended on January 1, 1997 (incorporated by
reference to SMC's Annual Report on Form 10-K (File No. 0-20882)
for the year ended December 31, 1996).
10.10 Agreement for Assumption Reinsurance between the National
Organization Of Life and Health Insurance Guaranty Associations
and Standard Life, concerning, The Midwest Life Insurance
Company In Liquidation effective June 1, 1992 (incorporated by
reference to SMC's Registration Statement on Form S-1
(Registration No. 33-53370) as filed with the Commission on
January 27, 1993).
10.11 Reinsurance Agreement between Standard Life and Swiss Re Life
and Health effective May 1, 1975 (incorporated by reference to
SMC's Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993).
10.12 Reinsurance Agreement between Firstmark Standard Life Insurance
Company and Swiss Re Life and Health effective February 1, 1984
(incorporated by reference to SMC's Registration Statement on
Form S-1 (Registration No. 33-53370) as filed with the
Commission on January 27, 1993).
10.13 Reinsurance Contract between First International and Standard
Life dated July 10, 1992 (incorporated by reference to SMC's
Registration Statement on Form S-1 (Registration No. 33-53370)
as filed with the Commission on January 27, 1993).
10.14 Amended Reinsurance Agreement between Standard Life and
Winterthur Life Re Insurance Company effective January 1, 1995
(incorporated by reference to SMC's Annual Report on Form 10-K
(File No. 0-20882) for the year ended December 31, 1996).
10.15 Management Service Agreement between Premier Life (Luxembourg)
and SMC dated September 30, 1994 (incorporated by reference to
SMC's Annual Report on Form 10-K (File No. 0-20882) for the year
ended December 31, 1994).
10.16 Assignment of Management Contract dated October 2, 1995 of
Management Contract dated January 1, 1987 between DNC and Dixie
National Life to Standard Life (incorporated by reference to
SMC's Annual Report on Form 10-K (File No. 0-20882) for the year
ended December 31, 1996).
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
10.17 Automatic Indemnity Reinsurance Agreement between the First
International and The Guardian Insurance & Annuity Company, Inc.
dated and effective January 1, 1996 (incorporated by reference
to SMC's Annual Report on Form 10-K (File No. 0-20882) for the
year ended December 31, 1996).
10.18 Indemnity Retrocession Agreement between The Guardian
Insurance & Annuity Company, Inc. and the Standard Life dated
and effective January 1, 1996 (incorporated by reference to
SMC's Annual Report on Form 10-K (File No. 0-20882) for the year
ended December 31, 1996).
10.19 Automatic Indemnity Reinsurance Agreement between The Guardian
Insurance & Annuity Company, Inc. and the Standard Life dated
and effective January 1, 1996 (incorporated by reference to
SMC's Annual Report on Form 10-K (File No. 0-20882) for the year
ended December 31, 1996).
10.20 Administrative Services Agreement between First International
and Standard Life dated and effective March 18, 1996
(incorporated by reference to SMC's Annual Report on Form 10-K
(File No. 0-20882) for the year ended December 31, 1996).
10.21 Amendment No. 1 to Amended and Restated Revolving Line of Credit
Agreement dated as of March 10, 1998 between SMC and Fleet
National Bank.
10.22 Amended and Restated Note Agreement dated as of March 10, 1998
between SMC and Fleet National Bank in the amount of
$20,000,000.
10.23 Amended and Restated Pledge Agreement dated as of March 10, 1998
between SMC and Fleet National Bank.
10.24 Revised Service Contract Agreement dated as of October 16, 1995
and effective January 1, 1995 between Standard Life and Standard
Marketing (incorporated by reference to SMC's Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31,
1996).
10.25 Note Agreement dated as of November 8, 1996, as amended and
restated on June 30, 1997, by and between SMC and Great
American Reserve in the amount of $4,371,573 (incorporated by
reference to SMC's Quarterly Report on Form 10-Q (File
No. 0-20882) for the quarter ended June 30, 1997).
10.26 Surplus Debenture dated as of November 8, 1996 by and between
SMC and Standard Life in the amount of $13,000,000 (incorporated
by reference to SMC's Quarterly Report on Form 10-Q (File
No. 0-20882) for the quarter ended September 30, 1996).
10.27 Portfolio Indemnify Reinsurance Agreement between Dixie National
Life and Cologne Life Reinsurance Company dated and effective
December 31, 1996 (incorporated by reference to SMC's Annual
Report on Form 10-K (File No. 0-20882) for the year ended
December 31, 1996).
10.28 Note Agreement dated as of June 30, 1997 between SMC, Capitol
American Life Insurance Company and Transport Life Insurance
Company in the amount of $5,628,427 (incorporated by reference
to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for
the quarter ended June 30, 1997).
10.29 Senior Subordinated Convertible Note dated as of June 30, 1997
between SMC and Capitol American Life Insurance Company in the
amount of $3,628,427 (incorporated by reference to SMC's
Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter
ended June 30, 1997).
10.30 Senior Subordinated Convertible Note dated as of June 30, 1997
between SMC and Transport Life Insurance Company in the amount
of $2,000,000 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1997).
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
10.31 Coinsurance Agreement effective as of July 1, 1997 by and
between Savers Life and World Insurance Company (incorporated by
reference to SMC's Registration Statement on Form S-4
(Registration No. 333-35447)).
10.32 Amendment I to the Guardian Indemnity Retrocession Agreement
effective as of January 1, 1996 by and between The Guardian
Insurance and Annuity Company and Standard Life (incorporated by
reference to SMC's Registration Statement on Form S-4
(Registration No. 333-35447)).
10.33 Promissory Note from Ronald D. Hunter to SMC in the amount of
$775,500 executed October 28, 1997 (incorporated by reference to
SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the
quarter ended September 30, 1997).
10.34 Reinsurance Agreement between Standard Life and Life Reassurance
Corporation of America effective September 1, 1997.
10.35 Reinsurance Agreement between Standard Life and Business Men's
Assurance Company of America effective September 1, 1997.
21 List of Subsidiaries of SMC
23.1 Consent of Ernst & Young LLP
23.2 Consent of KPMG Audit
24 Powers of Attorney
27 Financial Data Schedule, which is submitted electronically pursuant to
Regulation S-K to the Securities and Exchange Commission for
information only and not filed.
The following is a list of each management contract or compensatory plan or
arrangement required to be filed as an exhibit to this report.
EXHIBIT
NUMBER
10.2
10.3
10.4
10.5
10.7
10.33
(b) Reports on Form 8-K filed during the fourth quarter of 1997.
The Company filed a Current Report on Form 8-K on October 8, 1997 relating
to the signing of a letter of intent with a proposed acquisition. The Company
subsequently filed a Current Report on Form 8-K on October 29, 1997 to announce
the termination of negotiations regarding the proposed acquisition. The
Company filed a Current Report on Form 8-K on December 23, 1997 to announce the
signing of the Amended and Restated Agreement and Plan of Merger with Savers
Life.
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.
Date: March 26, 1998
STANDARD MANAGEMENT CORPORATION
RONALD D. HUNTER
Ronald D. Hunter
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 26, 1998 by the following persons on
behalf of the Registrant and in the capacities indicated.
RONALD D. HUNTER
Ronald D. Hunter Chairman, President and Chief Executive Officer
(Principal Executive Officer)
*
Paul B. Pheffer Director, Executive Vice President,
Treasurer and Chief Financial Officer
(Principal Financial Officer)
*
Gerald R. Hochgesang Senior Vice President -- Finance
(Principal Accounting Officer)
*
Raymond J. Ohlson Director
*
Edward T. Stahl Director
*
Stephen M. Coons Director
*
Martial R. Knieser Director
*
Ramesh H. Bhat Director
*
James C. Lanshe Director
*
Robert A. Borns Director
John J. Dillon Director
*
Jerry E. Francis Director
*By: /s/ RONALD D. HUNTER
Ronald D. Hunter
Attorney-in-Fact
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) AND (2),(c) AND (d)
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
LIST OF FINANCIAL STATEMENTS
and
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
FINANCIAL STATEMENT SCHEDULES
Year Ended December 31, 1997
STANDARD MANAGEMENT CORPORATION
INDIANAPOLIS, INDIANA
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
PAGE
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-4
Consolidated Statements of Income for the Years Ended
December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995 F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements F-8
FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedules are included herein
and should be read in
conjunction with the Audited Consolidated Financial Statements.
Schedule II -- Condensed Financial Information of Registrant (Parent Company)
for the Years Ended December 31, 1997, 1996 and 1995 F-27
Schedule IV -- Reinsurance for the Years Ended December 31, 1997,
1996 and 1995 F-31
Schedules not listed above have been omitted because they are not applicable or
are not required, or because the required information is included in the
Audited Consolidated Financial Statements or Notes thereto.
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Standard Management Corporation
We have audited the accompanying consolidated balance sheets of Standard
Management Corporation and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of income, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. Our
audits also included the financial statement schedules listed in the Index.
These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits. We did not audit the
consolidated balance sheets at September 30, 1997 and 1996 or the consolidated
statements of operations, shareholder's equity and cash flows for the three
years ended September 30, 1997 of Standard Management International S.A. and
subsidiaries, a wholly owned subsidiary group, which financial statements
reflect assets totaling approximately 24% and 23% of the Company's consolidated
assets at December 31, 1997 and 1996 and revenues totaling approximately 9%, 9%
and 12% of consolidated revenues for each of the three years in the period
ended December 31, 1997. Those financial statements, which as explained in Note
1 are included in the Company's consolidated balance sheets at December 31,
1997 and 1996, and the Company's consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997, were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the data included
for Standard Management International S.A., is based solely on the report of
other auditors.
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
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Standard Management
Corporation and subsidiaries at December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles. Also in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
Ernst & Young LLP
Indianapolis, Indiana
February 11, 1998
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Standard Management International S.A.
We have audited the consolidated balance sheets of Standard Management
International S.A. and subsidiaries as at September 30, 1997 and 1996 and the
related consolidated statements of operations, shareholder's equity and cash
flows for each of the three years in the period ended September 30, 1997 (none
of which aforementioned financial statements are separately presented herein).
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 in the United States of America. 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 accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in
all material aspects, the consolidated financial position of Standard
Management International S.A. and subsidiaries as at September 30, 1997 and
1996, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended September 30, 1997 in conformity
with generally accepted accounting principles in the United States of America.
Luxembourg City, Luxembourg
February 11, 1998
KPMG Audit
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31,
1997 1996
ASSETS
Investments:
Securities available for sale:
Fixed maturity securities, at fair value (amortized cost: 1997 - $372,576 $347,310
$367,372; 1996 - $349,151)
Equity securities, at fair value (cost: 1997 - $55; 1996 - $58) 52 62
Mortgage loans on real estate 375 3,035
Policy loans 9,495 9,903
Real estate 2,163 546
Other invested assets 779 865
Short-term investments 13,342 8,417
Total investments 398,782 370,138
Cash 4,165 5,113
Accrued investment income 6,512 6,198
Amounts due and recoverable from reinsurers 61,596 68,811
Deferred policy acquisition costs 21,435 18,309
Present value of future profits 20,537 23,806
Excess of acquisition cost over net assets acquired 2,445 2,260
Federal income tax recoverable 1,854 2,397
Other assets 3,602 2,835
Assets held in separate accounts 148,064 128,546
Total assets $668,992 $628,413
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Insurance policy liabilities $439,390 $425,324
Accounts payable and accrued expenses 6,208 6,249
Obligations under capital lease 141 637
Notes payable 26,000 20,000
Deferred federal income taxes 4,488 3,206
Excess of net assets acquired over acquisition cost 1,388 2,775
Liabilities related to separate accounts 148,064 128,546
Total liabilities 625,679 586,737
Class S Cumulative Convertible Redeemable Preferred Stock, par value $10 per
share:
Authorized 300,000 shares; issued and outstanding 159,889 shares in 1996 -- 1,757
Shareholders' Equity:
Preferred Stock, no par value:
Authorized 700,000 shares; none issued and outstanding -- --
Common Stock, no par value:
Authorized 20,000,000 shares 40,646 40,481
Treasury stock (4,572) (3,528)
Unrealized gain (loss) on securities available for sale 2,171 (746)
Foreign currency translation adjustment (473) 691
Retained earnings 5,541 3,021
Total shareholders' equity 43,313 39,919
Total liabilities and shareholders' equity $668,992 $628,413
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31,
1997 1996 1995
Revenues:
Premium income $7,100 $10,468 $5,504
Net investment income 29,516 20,871 18,517
Net realized investment gains 396 1,302 688
Gain on disposal of subsidiaries -- 886 --
Policy charges 5,512 2,551 2,467
Amortization of excess of net assets acquired over 1,388 1,388 1,388
acquisition cost
Fees from separate accounts 1,779 1,564 1,294
Other income 1,178 1,277 380
Total revenues 46,869 40,307 30,238
Benefits and expenses:
Benefits and claims 9,098 9,919 5,791
Interest credited on interest-sensitive annuities and
other 16,281 11,092 10,009
financial products
Salaries and wages 5,608 5,053 4,701
Amortization 3,248 2,592 2,044
Other operating expenses 6,991 7,311 6,019
Interest expense and financing costs 2,381 805 118
Total benefits and expenses 43,607 36,772 28,682
Income before federal income taxes, extraordinary gain and
preferred stock 3,262 3,535 1,556
dividends
Federal income tax expense (credit) 617 (730) 243
Income before extraordinary gain and preferred stock 2,645 4,265 1,313
dividends
Extraordinary gain on early redemption of redeemable
preferred stock, -- 502 --
net of $-- federal income tax
Net income 2,645 4,767 1,313
Preferred stock dividends 97 208 --
Earnings available to common shareholders $2,548 $4,559 $1,313
Earnings per common share:
Income before extraordinary gain and preferred stock $ .54 $ .88 $ .25
dividends
Extraordinary gain -- .10 --
Net income .54 .98 .25
Preferred stock dividends .02 .04 --
Earnings available to common shareholders $ .52 $ .94 $ .25
Earnings per common share - assuming dilutions:
Income before extraordinary gain and preferred stock $ .48 $ .82 $ .25
dividends
Extraordinary gain -- .09 --
Net income .48 .91 .25
Preferred stock dividends .01 .04 --
Earnings available to common shareholders - assuming $ .47 $ .87 $ .25
dilutions
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31,
Amounts Number of Shares
1997 1996 1995 1997 1996 1995
Common Stock:
Balance, beginning of year $40,481 $39,808 $39,695 5,752,499 5,459,573 5,457,906
Issuance of common stock -- 100 -- -- 20,000 --
5% common stock dividend -- 850 -- -- 272,926 --
Issuance of common stock warrants 165 285 107 -- -- --
Repurchase of common stock warrants -- (600) -- -- -- --
Gain on reissuance of treasury stock
in connection -- 38 -- -- -- --
with purchase of Shelby Life
Issuance of common stock in
connection with -- -- 6 -- -- 1,667
exercise of stock options
Balance, end of year 40,646 40,481 39,808 5,752,499 5,752,499 5,459,573
Treasury stock, at cost:
Balance, beginning of year (3,528) (2,621) (2,221) (728,229) (502,025) (418,425)
Treasury stock acquired (1,079) (2,126) (400) (154,903) (431,026) (83,600)
5% common stock dividend -- -- -- -- (46,402) --
Reissuance of treasury stock in
connection with 35 6 -- 7,123 1,224 --
exercise of stock options
Reissuance of treasury stock in
connection with -- 1,213 -- -- 250,000 --
purchase of Shelby Life
Balance, end of year (4,572) (3,528) (2,621) (876,009) (728,229) (502,025)
Unrealized gain (loss) on securities:
Balance, beginning of year (746) 2,582 (13,411)
Change in unrealized gain (loss) on
securities 2,917 (3,328) 15,993
available for sale, net
Balance, end of year 2,171 (746) 2,582
Foreign currency translation adjustments:
Balance, beginning of year 691 1,159 546
Translation adjustments for the year (1,164) (468) 613
Balance, end of year (473) 691 1,159
Retained earnings (deficit):
Balance, beginning of year 3,021 (686) (1,999)
Net income 2,645 4,767 1,313
5% common stock dividend, plus cash
in lieu of -- (850) --
fractional shares
Loss on reissuance of treasury stock (28) (2) --
Preferred stock dividend (97) (208) --
Balance, end of year 5,541 3,021 (686)
Total shareholders' equity and common shares $43,313 $39,919 $40,242 4,876,490 5,024,270 4,957,548
outstanding
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
Year Ended December 31,
1997 1996 1995
OPERATING ACTIVITIES
Net income $2,645 $4,767 $1,313
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred policy acquisition costs 1,456 1,221 1,142
Policy acquisition costs deferred (7,005) (6,400) (1,863)
Deferred federal income taxes 1,187 158 353
Depreciation and amortization 1,085 544 78
Insurance policy liabilities 9,441 4,785 6,273
Net realized investment gains (396) (1,302) (688)
Accrued investment income (314) (770) 347
Extraordinary gain on early redemption of redeemable -- (502) --
preferred stock
Other (335) (775) (624)
Net cash provided by operating activities 7,764 1,726 6,331
FINANCING ACTIVITIES
Issuance of Common Stock, net -- -- 6
Borrowings, net of debt issuance costs of $70 in 1997, $208 in 5,558 16,792 2,923
1996 and $81 in 1995
Repayments on long-term debt and obligations under capital (543) (491) (353)
lease
Short-term borrowings, net -- -- (550)
Premiums received on interest-sensitive annuities and other
financial products credited 49,362 42,347 17,524
to policyholder account balances, net of premiums ceded
Return of policyholder account balances on interest-sensitive
annuities and other (37,477) (17,356) (17,852)
financial products, net of premiums ceded
Redemption of redeemable preferred stock (1,855) (949) --
Repurchase of Common Stock warrants -- (600) --
Proceeds from common and treasury stock sales 138 100 --
Purchase of Common Stock for treasury (1,079) (2,126) (400)
Net cash provided by financing activities 14,104 37,717 1,298
INVESTING ACTIVITIES
Fixed maturity securities available for sale:
Purchases (205,976) (249,638) (183,183)
Sales 161,891 194,244 191,477
Maturities, calls and redemptions 28,380 10,254 7,812
Short-term investments, net (4,925) 11,890 (21,662)
Other investments, net (2,186) (551) 4,082
Proceeds from sale of property and equipment under capital -- -- 1,396
lease
Purchase of Shelby Life Insurance Company, less cash acquired -- (14,618) --
of $32
Dividends paid by Shelby Life Insurance Company to former -- (3,000) --
parent
Purchase of Dixie National Life Insurance Company, less cash -- -- (3,393)
acquired of $4,626
Proceeds from sale of First International Life Insurance
Company, less cash transferred -- 11,327 --
to seller of $265
Net cash used by investing activities (22,816) (40,092) (3,471)
Net increase (decrease) in cash (948) (649) 4,158
Cash at beginning of year 5,113 5,762 1,604
Cash at end of year $4,165 $5,113 $5,762
See accompanying notes to consolidated financial
statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Standard Management Corporation ("SMC") is an international financial
services holding company, which directly and through its subsidiaries acquires
and manages in force life insurance and annuity business and issues and
distributes life insurance and annuity products. SMC offers unit-linked
assurance products through its international subsidiaries.
SMC's active subsidiaries at December 31, 1997 include: (i) Standard Life
Insurance Company of Indiana ("Standard Life") and its subsidiary, Dixie
National Life Insurance Company ("Dixie National Life"), (ii) Standard
Management International S.A. ("Standard Management International") and its
subsidiaries, Premier Life (Luxembourg) S.A. ("Premier Life (Luxembourg)") and
Premier Life (Bermuda) Ltd. ("Premier Life (Bermuda)") and (iii) Standard
Marketing Corporation ("Standard Marketing").
BASIS OF PRESENTATION
The accompanying consolidated financial statements of SMC and its
subsidiaries (the "Company") have been prepared in conformity with generally
accepted accounting principles ("GAAP") and include the accounts of SMC and its
majority-owned subsidiaries since acquisition or organization. All significant
intercompany balances and transactions have been eliminated.
The fiscal year end for Standard Management International is September 30.
To facilitate reporting on the consolidated level, the fiscal year end for
Standard Management International was not changed and the consolidated balance
sheets and statements of operations for Standard Management International at
September 30, 1997 and 1996 and for each of the three years in the period ended
September 30, 1997, are included in the Company's consolidated balance sheets
at December 31, 1997 and 1996 and for each of the three years in the period
ended December 31, 1997.
USE OF ESTIMATES
The nature of the Company's insurance businesses requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known, which could
impact the amounts reported and disclosed herein.
INVESTMENTS
The Company classifies its fixed maturity and equity securities as available
for sale and, accordingly, such securities are carried at fair value. Fixed
maturity securities include bonds and redeemable preferred stocks. Changes in
fair values of securities available for sale, after adjustment for deferred
policy acquisition costs, present value of future profits and deferred income
taxes, are reported as unrealized gains or losses directly in shareholders'
equity and, accordingly, have no effect on net income. The deferred policy
acquisition costs and present value of future profits adjustments to the
unrealized gains or losses represent valuation adjustments or reinstatements of
these assets that would have been required as a charge or credit to operations
had such unrealized amounts been realized.
The cost of fixed maturity securities is adjusted for amortization of
premiums and discounts. The amortization is provided on a constant effective
yield method over the life of the securities and is included in net investment
income.
Mortgage-backed and other collateralized securities, classified as fixed
maturity securities in the balance sheet, are comprised principally of
obligations backed by an agency of the United States government (although
generally not by the full faith and credit of the United States government).
The Company has reduced the risk normally associated with these investments by
primarily investing in highly rated securities and in those that provide more
predictable prepayment patterns. The income from these securities is recognized
using a constant effective yield based on anticipated prepayments and the
estimated economic life of the securities. When actual prepayments differ
significantly from anticipated prepayments, the income recognized is adjusted
currently to match that which would have been recorded had the effective yield
been applied since the acquisition of the security. This adjustment is included
in net investment income.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Mortgage loans on real estate and policy loans are carried at unpaid
principal balances and are generally collateralized. Real estate investments,
which the Company has the intent to hold for the production of income, are
carried at cost, less accumulated depreciation. Short-term investments are
carried at amortized cost, which approximates fair value.
NET REALIZED INVESTMENT GAINS OR LOSSES
Net realized investment gains and losses are calculated using the specific
identification method and included in the consolidated statements of income.
If the values of investments decline below their amortized cost and this
decline is considered to be other than temporary, the amortized cost of these
investments is reduced to net realizable value and the reduction is recorded as
a realized loss.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits for deferred annuities and universal
life policies are equal to full account value that accrues to the policyholder
(cumulative premiums less certain charges, plus interest credited) with rates
ranging from 4.5% to 12% in 1997 and 4.5% to 9% in 1996.
Future policy benefits for traditional life insurance contracts are computed
using the net level premium method on the basis of assumed investment yields,
mortality and withdrawals which were appropriate at the time the policies were
issued. Assumed investment yields are based on interest rates ranging from 6.5%
to 7.5%. Mortality is based upon various actuarial tables, principally the
1965-1970 Select and Ultimate Table. Withdrawals are based upon Company
experience and vary by issue age, type of coverage, and duration.
RECOGNITION OF INSURANCE POLICY REVENUE AND RELATED BENEFITS AND EXPENSES
Revenue for interest-sensitive annuity contracts consists of policy charges
for surrenders and investment income earned. Premiums received for these
annuity contracts are reflected as premium deposits and are not recorded as
revenues. Expenses related to these annuities include interest credited to
policyholder account balances. Revenue for universal life insurance policies
consists of policy charges for the cost of insurance, policy administration
charges, surrender charges and investment income earned during the period.
Expenses related to universal life policies include interest credited to
policyholder account balances and death benefits incurred in excess of
policyholder account balances.
Traditional life insurance and immediate annuity premiums are recognized as
premium revenue when due over the premium paying period of the policies.
Benefits are charged to expense in the period when claims are incurred and are
associated with related premiums through changes in reserves for future policy
benefits which results in the recognition of profit over the premium paying
period of the policies.
REINSURANCE
Premiums, annuity policy charges, benefits and claims, interest credited and
amortization expense are reported net of reinsurance ceded. Reinsurance
premiums, annuity policy charges, benefits and claims, interest credited and
amortization expense are accounted for on bases consistent with those used in
accounting for the original policies issued and the terms of the reinsurance
contracts.
SEPARATE ACCOUNTS
Separate accounts are maintained primarily for universal life contracts
written by Standard Management International of which the majority represent
unit-linked business where benefits on surrender and maturity are not
guaranteed and investment contracts under which fixed benefits are paid to the
policyholder and the terms of which are such that there is little or no
mortality risk. Separate accounts generally represent funds maintained in
accounts to meet specific investment objectives of policyholders who bear the
investment risk. The Company records the related liabilities at amounts equal
to the underlying assets. Investment income and investment gains and losses
accrue directly to such policyholders. The assets of each account are
segregated and are not subject to claims that arise out of any other business
of the Company. Deposits, net investment income and realized gains and losses
on separate accounts assets are not reflected in the consolidated statements of
income.
FOREIGN CURRENCY TRANSLATION
The Company's foreign subsidiaries' balance sheets and statements of income
are translated at the year end exchange rates and average exchange rates for
the year, respectively. The resulting unrealized gain or loss adjustment from
the translation to U.S. dollars is recorded in the foreign currency translation
adjustment as a separate component of shareholders' equity. Other translation
adjustments for foreign exchange gains or losses have been reflected in the
consolidated statements of income. Foreign exchange gains or losses relating to
policyholders' funds in separate accounts are allocated to the relevant
separate account.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period in which the change
is enacted.
Standard Life and Dixie National Life filed separate federal income tax
returns for 1996 and prior years and were taxed as separate life insurance
companies. For 1997 and subsequent years, Standard Life and Dixie National Life
plan to file a life/life consolidated return. SMC, Standard Marketing and
other U.S. non-insurance subsidiaries are taxed as regular corporations and
file a consolidated return. SMC and its U.S. non-insurance subsidiaries were
eligible to consolidate with Standard Life for income tax purposes beginning in
1996, but do not currently plan to do so.
Standard Management International is incorporated as a holding company in
the Grand Duchy of Luxembourg and, accordingly, is not currently subject to
taxation on income or capital gains. Standard Management International is
subject to an annual capital tax which is calculated on the nominal value of
the statutory shareholder's equity at an annual rate of .20%. Premier Life
(Luxembourg) is a normal commercial taxable company and is subject to income
tax at regular corporate rates (statutory corporate rate of 39.39%), and annual
capital taxes amounting to approximately 1% of its net equity. Premier Life
(Bermuda) is exempt from taxation on income until March 2016 pursuant to a
decree from the Minister of Finance in Bermuda. To the extent that such income
is taxable under U.S. law, such income will be included in SMC's consolidated
return.
PRESENT VALUE OF FUTURE PROFITS
Present value of future profits is recorded in connection with acquisitions
of insurance companies or a block of policies. The initial value is based on
the actuarially determined present value of the projected future gross profits
from the in-force business acquired. In selecting the interest rate to
calculate the discounted present value of the projected future gross profits,
the Company uses the risk rate of return believed to best reflect the
characteristics of the purchased policies, taking into account the relative
risks of such policies, the cost of funds to acquire the business and other
factors. The value of insurance in force purchased is amortized on a constant
yield basis over the estimated life of the insurance in force at the date of
acquisition in proportion to the emergence of profits over a period of
approximately 20 years. For acquisitions the Company made on or before
November 19, 1992, the Company amortizes the asset with interest at the same
discount rate used to determine the present value of future profits at date of
purchase. For acquisitions after November 19, 1992, including the acquisitions
of Dixie National Life and Shelby Life, the Company amortizes the asset using
the interest rate credited to the underlying policies.
DEFERRED POLICY ACQUISITION COSTS
Costs relating to the production of new business (primarily commissions and
certain costs of marketing, policy issuance and underwriting) are deferred and
included in the deferred policy acquisition cost asset to the extent that such
costs are recoverable from future related policy revenues. For
interest-sensitive annuities and other financial products, deferred policy
acquisition costs, with interest, are amortized over the lives of the policies
and products in a constant relationship to the present value of estimated
future gross profits, discounted using the interest rate credited to the
policy. Traditional life insurance deferred policy acquisition costs are being
amortized over the premium-paying period of the related policies using
assumptions consistent with those used in computing policy benefit reserves.
The Company reviews the recoverability of the carrying value of the deferred
policy acquisition costs each year. For interest-sensitive annuities and other
financial products, the Company considers estimated future gross profits in
determining whether the carrying value is appropriate; for other insurance
products, the Company considers estimated future premiums. In all cases, the
Company considers expected mortality, interest earned and crediting rates,
persistency and expenses. Amortization is adjusted retrospectively for
interest-sensitive annuities and other financial products when estimates of
future gross profits to be realized are revised.
EXCESS OF ACQUISITION COST OVER NET ASSETS ACQUIRED
The excess of the cost to acquire purchased companies over the fair value of
net assets acquired is being amortized on a straight-line basis over periods
that generally correspond with the benefits expected to be derived from the
acquisitions, usually 20 to 40 years. Accumulated amortization was $428,000 and
$314,000 at December 31, 1997 and 1996, respectively. The Company continually
monitors the value of excess of acquisition cost over net assets acquired
("goodwill") based on estimates of future earnings. If it determines that
goodwill has been impaired, the carrying value is reduced with a corresponding
charge to expense.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EXCESS OF NET ASSETS ACQUIRED OVER ACQUISITION COST
The excess of the net assets acquired over the cost to acquire purchased
companies ("negative goodwill"), after reducing the basis in property and
equipment and other noncurrent assets to zero, is being amortized into earnings
on a straight-line basis over a five year period. Accumulated amortization was
$5,227,000 and $3,839,000 at December 31, 1997 and 1996, respectively.
STOCK OPTIONS
The Company recognizes compensation expense for its stock option plan using
the intrinsic value method of accounting. Under the terms of the intrinsic
value method, compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date, or other measurement date, over the
amount an employee must pay to acquire the stock. Under the Company's stock
option plans, no expense is recognized since the exercise price equals or
exceeds the market price at the measurement date.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." The Company adopted SFAS No. 128 on December 31, 1997. All earnings
per share amounts for all periods presented have been restated to conform to
the SFAS No. 128 requirements. SFAS No. 128 eliminates the presentation of
primary earnings per share and replaces it with basic earnings per share.
Basic earnings per share differs from primary earnings per share because common
stock equivalents are not considered in computing basic earnings per share.
Fully diluted earnings per share are replaced with diluted earnings per share.
Diluted earnings per share is similar to fully diluted earnings per share,
except in determining the number of dilutive shares outstanding for options and
warrants, the proceeds that would be received upon the conversion of all
dilutive options and warrants are assumed to be used to repurchase the
Company's common shares at the average market price of such stock during the
period. For fully diluted earnings per share, the higher of the average market
price or ending market price was used.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 defines the financial statement presentation for all
changes in a company's equity during a period except those resulting from
investments by owners and distributions to owners. SFAS No. 130 is effective
for financial statements issued for fiscal years beginning after December 15,
1997 and will be adopted by the Company in the first quarter of 1998. Because
the statement is merely a change in presentation, the Company does not expect
the adoption of this statement to have any impact on the amount of net income,
earnings per share or total shareholders' equity.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14
"Financial Reporting for Segments of a Business Enterprise" and defines
financial and descriptive information about a company's operating segments that
is to be disclosed in financial statements. SFAS No. 131 is effective for
financial statements issued for fiscal years beginning after December 15, 1997
and will be adopted by the Company in 1998. Currently, the Company considers
its life insurance operations to be its only material operating segment. The
Company is in the process of defining additional business segments and
developing allocation methods to assess their performance. Once the process is
completed, additional disclosures will be provided in accordance with SFAS No.
131.
RECLASSIFICATIONS
Certain amounts in the 1996 and 1995 consolidated financial statements and
notes have been reclassified to conform with the 1997 presentation. These
reclassifications had no effect on previously reported shareholders' equity or
net income during the periods involved.
2. ACQUISITIONS AND DISPOSALS
On November 8, 1996, Standard Life acquired through merger Shelby Life
Insurance Company ("Shelby Life") from Delta Life and Annuity Corporation
("DLAC"), a life insurance company located in Memphis, Tennessee (the "Shelby
Merger"). The purchase price was approximately $14,650,000, including
$13,000,000 in cash, 250,000 shares of restricted Common Stock (valued at
$1,250,000) and acquisition costs of $400,000. Financing for the Shelby Merger
was provided by senior debt of $10,000,000 and $4,000,000 in subordinated
convertible debt.
The acquisition of Shelby Life was accounted for using the purchase method
of accounting and the consolidated financial statements include the results of
Shelby Life from November 1, 1996, the effective date of acquisition. Under
purchase accounting, Standard Life allocated the total purchase price of Shelby
Life to the assets and liabilities acquired, based on a determination of their
fair values and recorded the excess of acquisition cost over net assets
acquired as goodwill, which will be amortized on a straight-line basis over
20 years.
2. ACQUISITIONS AND DISPOSALS (CONTINUED)
The following schedule summarizes the assets acquired and the liabilities
assumed with the Shelby Life acquisition described above (in thousands):
Assets acquired:
Fixed maturity securities $ 93,376 Policy loans
2,430 Short term investments 4,725 Cash 32 Present
value of future profits 7,998 Other assets
2,880
Total assets acquired 111,441
Liabilities assumed:
Policy reserves 92,322
Deferred federal income taxes 376
Other liabilities 1,102
Dividends payable to DLAC 3,000
Total liabilities assumed 96,800
Net assets acquired 14,641
Excess of acquisition cost over net assets acquired 9
Total purchase price $ 14,650
The following are supplemental unaudited pro forma consolidated results
of operations of the Company for year ended December 31, 1996 as if the
acquisition for Shelby Life had occurred at January 1, 1996 presented at the
same purchase price, based on estimates and assumptions considered appropriate
(in thousands).
Revenues $49,344
Income before extraordinary gain 4,242
Net income 4,536
Earnings per share:
Income before extraordinary gain .83
Net income .89
Earnings per share, assuming dilution:
Income before extraordinary gain .73
Net income .82
The above amounts are based upon certain assumptions and estimates which the
Company believes are reasonable and do not reflect any benefit from savings
which might be achieved from combined operations. The unaudited pro forma
results do not necessarily represent results which would have occurred if the
acquisitions had taken place on the basis assumed above, nor are they
indicative of the results of future combined operations.
On October 2, 1995, Standard Life completed its acquisition of 99.3% of
Dixie National Life from Dixie National Corporation ("DNC"), a life insurance
holding company located in Jackson, Mississippi. Dixie National Life markets a
variety of life insurance products throughout the Mid-South offering primarily
"burial expense" policies. The purchase price was $8,019,000, including costs
of $684,000, the forgiveness of a $3,689,000 DNC note payable to Standard Life
and a $1,720,000 repayment of a DNC note payable. The remaining purchase price
of $1,926,000 was paid in cash from internally generated funds.
The acquisition was accounted for using the purchase method of accounting
and the consolidated financial statements include the results of Dixie National
Life from the date of acquisition. Under purchase accounting, Standard Life
allocated the total purchase price of Dixie National Life to the assets and
liabilities acquired, based on a determination of their fair values. Standard
Life recorded goodwill of $1,589,000 which will be amortized on a straight-line
basis over 40 years.
On March 18, 1996, Standard Life completed the sale of a duplicate charter
associated with First International Life Insurance Company ("First
International") to The Guardian Insurance and Annuity Company, Inc. ("GIAC"), a
subsidiary of The Guardian Group, New York, NY. Standard Life received proceeds
of approximately $10,393,000, including $1,500,000 for the charter and licenses
associated with First International. Standard Life realized a net pretax gain
of $1,042,000 and a tax benefit of $1,420,000 on this sale, or $2,462,000. In
addition, First International, Standard Life and GIAC have entered into a
series of reinsurance and other agreements that include provisions for Standard
Life to administer First International policies in force at the date of sale,
and for Standard Life to continue to receive the profit stream from certain
First International policies in force at the date of such sale (SEE NOTE 9).
2. ACQUISITIONS AND DISPOSALS (CONTINUED)
SMC decided in February 1996 to terminate the reinsurance agreement between
Standard Reinsurance of North America Ltd. ("Standard Reinsurance") and
Salamandra Joint-Stock Insurance Company in Ukraine ("Salamandra"), and to not
renew the Barbados license of Standard Reinsurance. This resulted in the
termination of Standard Reinsurance operations and the write-off of SMC's
investment in Standard Reinsurance and certain intangible assets of Standard
Reinsurance amounting to $156,000.
3. INVESTMENTS
The amortized cost, gross unrealized gain (loss) and estimated fair value of
securities available for sale are as follows (in thousands):
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain (Loss) Value
Securities available for sale:
Fixed maturity securities:
United States Treasury
securities and
obligations of United States $27,613 $174 $(90) $27,697
government agencies
Obligations of states and
political 3,790 204 (26) 3,968
subdivisions
Foreign government securities 30,558 497 (3,296) 27,759
Utilities 26,606 534 (109) 27,031
Corporate bonds 223,958 8,140 (1,609) 230,489
Mortgaged-backed securities 51,266 657 (60) 51,863
Redeemable preferred stock 3,581 188 -- 3,769
Total fixed maturity 367,372 10,394 (5,190) 372,576
securities
Equity securities 55 -- (3) 52
Total securities available for $367,427 $10,394 $(5,193) $372,628
sale
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain (Loss) Value
Securities available for sale:
Fixed maturity securities:
United States Treasury
securities and
obligations of United States $20,753 $51 $(420) $20,384
government agencies
Obligations of states and
political 3,588 106 -- 3,694
subdivisions
Foreign government securities 10,042 51 (166) 9,927
Utilities 31,000 295 (675) 30,620
Corporate bonds 210,977 3,086 (3,539) 210,524
Mortgaged-backed securities 72,264 247 (919) 71,592
Redeemable preferred stock 527 42 -- 569
Total fixed maturity 349,151 3,878 (5,719) 347,310
securities
Equity securities 58 4 -- 62
Total securities available for $349,209 $3,882 $(5,719) $347,372
sale
The estimated fair values for fixed maturity securities are based on quoted
market prices, where available. For fixed maturity securities not actively
traded, fair values are estimated using values obtained from independent
pricing services, or by discounting expected future cash flows using a current
market rate applicable to the coupon rate, credit, and maturity of the
investments.
3. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1997 by contractual maturity are shown below (in thousands).
Actual maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties and because most mortgage-backed securities provide for periodic
payments throughout their lives.
Amortized Fair
COST VALUE
Due in one year or less $ 4,560 $ 4,551
Due after one year through five years 31,597 32,048
Due after five years through ten years 141,806 140,972
Due after ten years 134,562 139,373
Subtotal 312,525 316,944
Redeemable preferred stock 3,581 3,769
Mortgage-backed securities 51,266 51,863
Total fixed maturity securities $ 367,372 $ 372,576
The Company maintains a highly-diversified investment portfolio with
limited concentration of financial instruments in any given region, industry or
economic characteristic. Investments in any entity in excess of 10% of
shareholders' equity at December 31, 1997, other than asset-backed securities
and investments issued or guaranteed by the U.S. government or a U.S.
government agency, all of which were classified as fixed maturity securities
available for sale, were as follows (in thousands):
Amortized Fair
INVESTMENT COST VALUE
Continental Cablevision $ 5,302 $ 5,509
AMERCO 4,994 5,042
Eastern Energy Limited 4,975 5,068
Republic of Indonesia 4,636 3,596
Net investment income was attributable to the following (in thousands):
Year Ended December 31,
1997 1996 1995
Fixed maturity securities $27,151 $19,865 $17,457
Mortgage loans on real estate 123 309 152
Policy loans 618 447 305
Real estate 58 65 120
Short-term investments and other 2,098 602 990
Gross investment income 30,048 21,288 19,024
Investment expenses 532 417 507
Net investment income $29,516 $20,871 $18,517
Net realized investment gains arose from the following (in thousands):
Year Ended December 31,
1997 1996 1995
Fixed maturity securities available for sale:
Gross realized gains $2,181 $2,012 $2,115
Gross realized losses 1,695 911 1,662
Net 486 1,101 453
Real estate 26 -- 124
Other gains (losses) (116) 201 111
Net realized investment gains $396 $1,302 $688
3. INVESTMENTS (CONTINUED)
Life insurance companies are required to maintain certain amounts of
assets with state or other regulatory authorities. At December 31, 1997 fixed
maturity securities of $12,658,000 and short-term investments of $1,498,000
were held on deposit by various state regulatory authorities in compliance with
statutory regulations. Additionally, fixed maturity securities of $851,000 and
short-term investments of $3,590,000 of Standard Management International were
held by a custodian bank approved by the Luxembourg regulatory authorities to
comply with local insurance laws.
4. DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
The activity related to the deferred policy acquisition costs of business
produced is summarized as follows (in thousands):
Year Ended December 31,
1997 1996 1995
Balance, beginning of year $18,309 $10,054 $12,206
Additions 7,005 6,400 1,863
Amortization (1,456) (1,221) (1,142)
Adjustment relating to net unrealized (gain)
loss on (2,423) 3,076 (2,873)
securities available for sale
Balance, end of year $21,435 $18,309 $10,054
The activity
related to the present value of future profits of the business acquired is
summarized as follows (in thousands):
Year Ended December 31,
1997 1996 1995
Balance, beginning of year $23,806 $15,246 $8,299
Amounts related to acquisitions and disposals (1,374) 9,615 7,901
Interest accreted on unamortized balance 3,178 2,563 1,566
Gross amortization during the year (4,844) (3,812) (2,346)
Adjustments relating to net unrealized (gain)
loss on securities available for sale (229) 194 (174)
Balance, end of year $20,537 $23,806 $15,246
The percentages of future expected net amortization of the beginning
balance of the present value of future profits before the effect of net
unrealized gains and losses, based on the present value of future profits at
December 31, 1997 and current assumptions as to future events on all policies
in force, will be between 6% and 8% in each of the years 1998 through 2002.
The discount rate used to calculate the present value of future profits
reflected in the Company's consolidated balance sheets at December 31, 1997,
ranged from 7.5% to 18%. The Company used a 15% discount rate to calculate the
present value of future profits on the Shelby Life and Dixie National Life
acquisitions.
5. NOTES PAYABLE
SMC has outstanding borrowings at December 31, 1997 pursuant to an
Amended Revolving Line of Credit Agreement with a bank (the "Amended Credit
Agreement") that provides for it to borrow up to $16,000,000 in the form of a
seven-year reducing revolving loan arrangement. SMC has agreed to pay a non-use
fee of .50% per annum on the unused portion of the commitment. In connection
with the original and Amended Credit Agreement, SMC issued warrants to the bank
to purchase 61,500 shares of Common Stock. Borrowings under the Amended Credit
Agreement may be used for contributions to surplus of insurance subsidiaries,
acquisition financing, and repurchases of Class S Cumulative Convertible
Redeemable Preferred Stock ("Class S Preferred Stock") and Common Stock. The
debt is secured by a Pledge Agreement of all of the issued and outstanding
shares of common stock of Standard Life and Standard Marketing. Interest on the
borrowings under the Amended Credit Agreement is determined, at the option of
SMC, to be: (i) a fluctuating rate of interest to the corporate base rate
announced by the bank from time to time plus 1% per annum, or (ii) a rate at
LIBOR plus 3.25%. Annual principal repayments of $2,667,000 begin in November
1998 and conclude in November 2003. Indebtedness incurred under the Amended
Credit Agreement is subject to certain restrictions and covenants including,
among other things, certain minimum financial ratios, minimum consolidated
5. NOTES PAYABLE (CONTINUED)
equity requirements for SMC, positive net income, minimum statutory surplus
requirements for the Company's insurance subsidiaries and certain limitations
on acquisitions, additional indebtedness, investments, mergers, consolidations
and sales of assets. At December 31, 1997, SMC had borrowed $16,000,000 under
this Amended Credit Agreement at a weighted average interest rate of 9.069%.
In connection with the acquisition of Shelby Life, SMC borrowed
$4,000,000 from an insurance company pursuant to a subordinated convertible
debt agreement which was due in December 2003. At June 30, 1997, this
subordinated convertible debt agreement was amended to the principal amount of
$4,372,000 which is due July 2004 unless previously converted, and requires
interest payments in cash on January 1 and July 1 of each year at 10% per
annum. At June 30, 1997, SMC borrowed an additional $5,628,000 from an
insurance company pursuant to another subordinated convertible debt agreement
(collectively, the "Notes") which is due July 2004 unless previously converted,
and requires interest payments in cash on January 1 and July 1 of each year at
10% per annum. Proceeds from the additional borrowings were used for
contributions to surplus of insurance subsidiaries of $2,400,000, redemption of
Class S Preferred Stock of approximately $1,840,000 (SEE NOTE 7), and other
general corporate purposes. The Notes are convertible at any time at the
option of the noteholders into SMC Common Stock at the rate of $5.747 per
share. The Notes may be prepaid in whole or in part at the option of SMC
commencing on July 1, 2000 at redemption prices equal to 105% of the principal
amount (plus accrued interest) and declining to 102% of the principal amount
plus accrued interest. The Notes may be prepaid prior to July 1, 2000 at a
redemption price equal to 101% of the principal amount (plus accrued interest)
under certain limited circumstances. The Notes are subject to certain
restrictions and covenants substantially similar to those in the Amended Credit
Agreement.
Standard Management International has an unused line of credit of
$1,615,000, with no borrowings in connection with this line of credit in 1997
or 1996.
Interest expense on debt during 1997, 1996 and 1995 was $2,310,000,
$773,000 and $116,000, respectively. Cash paid for interest was $1,464,000,
$356,000 and $100,000 in 1997, 1996 and 1995, respectively.
6. INCOME TAXES
The components of the federal income tax expense (credit), applicable to
pre-tax income before extraordinary gains, were as follows (in thousands):
Year Ended December 31,
1997 1996 1995
Current taxes (credit) $(570) $(888) $(110)
Deferred taxes 1,187 158 353
$617 $(730) $243
The effective tax rate on pre-tax income before extraordinary gain is lower
than the statutory corporate federal income tax rate as follows (in thousands):
Year Ended December 31,
1997 1996 1995
Federal income tax expense at statutory rates (34%) $1,109 $1,202 $529
Small insurance company deduction -- -- (128)
Nonrecognition of losses in SMC consolidated return and in
foreign 314 543 372
subsidiaries
Amortization of excess of net assets acquired over (472) (472) (472)
acquisition cost
Tax benefit from disposal of subsidiary -- (1,420) --
Tax benefits from capital loss carryforwards not (200) -- --
previously recognized
Release of reserve for tax adjustments (100) (325) --
Other items, net (34) (258) (58)
Federal income tax expense (credit) $617 $(730) $243
Effective tax rate 19% (21)% 16%
6. INCOME TAXES (CONTINUED)
The Company recovered $1,313,000, $130,000 and $280,000 in federal income
taxes in 1997, 1996 and 1995, respectively and paid federal income taxes of
$200,000 and $900,000 in 1997 and 1996, respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for tax return purposes. Significant temporary
differences included in the Company's deferred tax assets (liabilities) are as
follows (in thousands):
December 31,
1997 1996
Deferred income tax assets:
Unrealized loss on securities available for sale $ -- $355
Future policy benefits 9,368 8,267
Capital and net operating loss carryforwards 6,123 7,719
Other-net 1,126 1,385
Gross deferred tax assets 16,617 17,726
Valuation allowance for deferred tax assets (6,962) (8,750)
Deferred income tax assets, net of valuation allowance 9,655 8,976
Deferred income tax liabilities:
Unrealized gain on securities available for sale (1,820) --
Present value of future profits (6,983) (8,093)
Deferred policy acquisition costs (5,340) (4,089)
Total deferred income tax liabilities (14,143) (12,182)
Net deferred income tax liabilities $(4,488) $(3,206)
The Company is required to establish a "valuation allowance" for any portion
of its deferred tax assets which are unlikely to be realized. The valuation
allowance for deferred tax assets includes $1,560,000 at December 31, 1997 with
respect to corporate income tax loss carryforwards of Standard Management
International which, if recognized in the future, will result in an addition to
negative goodwill and be amortized into income over its remaining life. The
valuation allowance for deferred tax assets includes $1,770,000 at December 31,
1997 with respect to deferred tax assets at the date of acquisition and net tax
operating loss carryforwards of Dixie National Life and Shelby Life which, if
recognized in the future, will result in a reduction to goodwill and be
amortized into income over its remaining life by reducing goodwill amortization
expense.
As of December 31, 1997, SMC and its noninsurance subsidiaries had
consolidated net operating loss carryforwards of approximately $9,320,000 for
tax return purposes which expire from 2005 through 2012. These carryforwards
will only be available to reduce the taxable income of SMC. At December 31,
1997, the Standard Life consolidated return had tax return net operating loss
carryforwards of approximately $4,100,000 which expire in 2010 and 2012. These
carryforwards will only be available to reduce the taxable income of the
Standard Life consolidated return. At December 31, 1997, Premier Life
(Luxembourg) had accumulated corporate income tax loss carryforwards of
approximately $3,960,000, all of which may be carried forward indefinitely.
The Internal Revenue Service has completed its examination of the Company
for years through 1993 in 1996. All adjustments to taxable income determined by
completed examinations, which were not material, have reduced the net operating
loss carryforwards. Upon completion of the examination, a tax reserve for
adjustments of $325,000 was released and recorded in income in 1996. In 1997,
the Internal Revenue Service completed its examination of Standard Life through
1995. All adjustments including a tax benefit from previously expired capital
loss carryforwards were settled during 1997 resulting in a net tax benefit of
approximately $200,000 during 1997 and upon completion of the examination, a
tax reserve for adjustments of $100,000 was released into income in 1997.
7. SHAREHOLDERS' EQUITY
REDEEMABLE PREFERRED STOCK
Shareholders have authorized 1,000,000 shares of Preferred Stock. Other
terms, including preferences, voting and conversion rights, may be established
by the Board of Directors. In March 1995, 300,000 of these shares designated as
Class S Preferred Stock, $10.00 per share par value, were issued February 8,
1996. In February 1996, SMC instituted a program to repurchase from time to
time up to 300,000 shares of its Class S Preferred Stock in the open market or
privately negotiated
7. SHAREHOLDERS' EQUITY (CONTINUED)
transactions. Through December 31, 1996, SMC had repurchased and retired
140,111 shares of its Class S Preferred Stock on the open market at a cost of
$949,000. These repurchases resulted in an extraordinary gain of $502,000 in
1996. Effective as of August 1, 1997, SMC redeemed all of the issued and
outstanding Class S Preferred Stock at an aggregate redemption value of
$1,840,000 ($10.00 per share plus accumulated and unpaid dividends).
COMMON STOCK
The Company has a stock repurchase program and repurchases its Common Stock
from time to time. The Company repurchased 154,903, 431,026 and 83,600 shares
of Common Stock for $1,079,000, $2,126,000 and $400,000 in 1997, 1996 and 1995,
respectively. At December 31, 1997, the Company is authorized to purchase an
additional 365,644 shares under this program.
The following table represents outstanding warrants to purchase Common Stock
as of December 31, 1997:
Exercise Warrants
ISSUE DATE EXPIRATION DATE PRICE OUTSTANDING
June 1989 December 1999 $3.5216 236,858
July 1992 June 1998 3.5296 175,800
January 1994 January 1998 7.8571 42,000
September 1995 September 1998 5.2381 4,200
November 1995 November 2002 4.5238 31,500
July 1996 July 2003 4.3750 30,000
August 1996 August 1998 4.3125 100,000
September 1996 September 1998 5.0000 25,000
September 1996 September 1999 5.5000 17,000
July 1997 July 2000 5.7500 75,000
September 1997 September 2000 7.5000 15,000
752,358
UNREALIZED GAIN (LOSS) ON SECURITIES
The components of the balance sheet caption "Unrealized gain (loss) on
securities available for sale" in shareholders' equity are summarized as
follows (in thousands):
December 31,
1997 1996
Fair value of securities available for sale $372,628 $347,372
Amortized cost of securities available for sale 367,427 349,209
Gross unrealized gain (loss) on securities available for sale 5,201 (1,837)
Adjustments for:
Deferred policy acquisition costs (1,727) 696
Present value of future profits (209) 20
Deferred federal income tax recoverable (liability) (1,094) 375
Net unrealized gain (loss) on securities available for sale $2,171 $ (746)
8. STOCK OPTION PLAN
SMC has a non-qualified Stock Option Plan (the "Plan") under which
2,500,000 (increased by 1,000,000 shares effective October 29, 1997) shares of
Common Stock are reserved for grants of stock options to employees and
directors. The purchase price per share specified in any Plan option must be at
least equal to the fair market value of common stock at the grant date. Options
generally become exercisable over a three-year period and have a term of
10 years. The Plan is administered by the Board of Directors and officers of
SMC. The terms of the options, including the number of shares and the exercise
price, are subject to the sole discretion of the Board of Directors. A total
of 562,988 shares are available for future issuance for the Plan as of December
31, 1997.
8. STOCK OPTION PLAN (CONTINUED)
SFAS No. 123 entitled "Accounting for Stock-Based Compensation" issued in
October 1995, was adopted by the Company as of December 31, 1996. The
provisions of SFAS No. 123 allow companies to either expense the estimated fair
value of stock options or to continue their current practice but disclose the
pro forma effects on net income and earnings per share had the fair value of
the options been expensed. The Company has elected to continue its practice of
recognizing compensation expense for its Plan using the intrinsic value based
method of accounting and to provide the required pro forma information. Had
compensation cost for the Plan been determined based on the fair value at the
grant date for awards under the Plan consistent with the provisions of SFAS
No. 123, the Company's pro forma net income and pro forma earnings per share
would have been the following (in thousands):
Year Ended December 31,
1997 1996 1995
Net income $1,945 $3,847 $685
Earnings per share .37 .75 .13
Earnings per share, assuming .35 .71 .13
dilution
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-valuation model with the following
weighted-average assumptions :
1997 1996 1995
Risk-free interest rates 5.7% 5.9% 6.6%
Volatility factors .37 .49 .39
Weighted average expected life 7 years 7 years 7 years
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferrable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
subjective assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not provide a reliable single
measure of the fair value of its employee stock options. Because SFAS No. 123
is effective only for awards granted after January 1, 1995, the pro forma
disclosures provided may not be representative of the effects on reported net
income for future years.
A summary of the Company's stock option activity and related information
for the years ended December 31, 1997, 1996 and 1995 is as follows:
1997 1996 1995
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Price Price Price
Shares Shares Shares
Options outstanding, beginning 1,446,169 $5.98 1,164,720 $6.46 520,294 $7.73
of year
Exercised (17,300) 4.52 (1,224) 3.57 (1,667) 3.75
Granted 685,000 6.29 769,122 6.14 655,008 5.40
Expired or forfeited (197,049) 4.30 (486,449) 7.56 (8,915) 5.50
Options outstanding, end of 1,916,820 6.08 1,446,169 5.98 1,164,720 6.46
year
Options exercisable, end of 1,467,185 1,097,028 762,374
year
Weighted-average fair value of
options $3.10 $3.62 $2.90
granted during the year
8. STOCK OPTION PLAN (CONTINUED)
Information with respect to stock options outstanding at December 31,
1997 is as follows:
Options Outstanding Options Exercisable
Weighted- Weighted- Weighted-
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Price Exercisable Price
Life
(years)
$3-$5 367,650 9 Years $4.37 231,350 $4.31
$5-$7 1,036,949 9 Years 5.98 723,614 5.76
$7-$9 492,533 5 Years 7.41 492,533 7.41
$9-$11 19,688 6 Years 9.40 19,688 9.40
1,916,820 1,467,185
9. REINSURANCE
The Company's insurance subsidiaries have entered into reinsurance
agreements with non-affiliated companies to limit the net loss arising from
large risks, maintain their exposure to loss within capital resources, provide
additional capacity for future growth, and effect sharing arrangements. The
maximum amount of life insurance retained on any one life ranges from $30,000
to $150,000. Amounts of standard risk in excess of that limit are reinsured.
Reinsurance premiums ceded to other insurers were $4,821,000, $2,152,000
and $4,312,000 in 1997, 1996 and 1995, respectively. Reinsurance ceded has
reduced benefits and claims incurred by $5,383,000, $6,201,000 and $1,369,000
in 1997, 1996 and 1995, respectively. A contingent liability exists to the
extent any of the reinsuring companies are unable to meet their obligations
under the reinsurance agreements. To minimize exposure to significant losses
from reinsurance insolvencies, the Company evaluates the financial condition of
its reinsurers and monitors concentrations of credit risk arising from similar
geographic regions, activities, or economic characteristics of the reinsurers.
Based on its periodic reviews of these companies, the Company believes the
assuming companies are able to honor all contractual commitments under the
reinsurance agreements.
The Company's largest annuity reinsurer at December 31, 1997 represented
$32,194,000, or 52.3% of total reinsurance recoverable, $8,707,000 of premium
deposits ceded in 1997 and is rated "A" (Excellent) by A.M. Best. From January
1, 1995 to August 31, 1995, approximately 70% of Standard Life's annuity
business pursuant to the terms of the agreement produced after December 31,
1994 was ceded. Standard Life decreased the quota-share portion of business
ceded pursuant to this agreement to 50% at September 1, 1995, and further
reduced it to 25% effective April 1, 1996. This agreement limits dividends and
other transfers by Standard Life to SMC or affiliated companies in certain
circumstances.
All the inforce business of First International effective January 1, 1996
was ceded to GIAC through a coinsurance indemnity reinsurance agreement. Under
the terms of the agreement, approximately $18,841,000 of First International's
reserves and the related assets were ceded to GIAC as of January 1, 1996.
Effective at January 1, 1996, GIAC entered into a modified coinsurance
indemnity reinsurance agreement with Standard Life relating to this business.
Under the terms of the agreement, approximately $18,841,000 of Standard Life's
reserves were assumed from GIAC as of January 1, 1996. In addition, at the
date of the sale of First International to GIAC, Standard Life ceded a block of
business with policy reserves of $12,514,000 and related assets to GIAC.
In June 1988, Standard Life ceded a block of business to National Mutual
Life Insurance Company ("National Mutual"). Effective May 31, 1996, Standard
Life terminated by recapture the reinsurance agreement with National Mutual.
As a result of this recapture, Standard Life received premium income, and
corresponding increase in reserves, of $4,234,000 and agreed to pay National
Mutual a net recapture fee of $825,000.
10. RELATED PARTY TRANSACTIONS
SMC is a guarantor on a $70,000 loan to a director and officer. The
guaranty will be effective until the earlier of repayment of the loan or
June 25, 1999.
On October 28, 1997, SMC made an interest-free loan to an officer and
director of SMC, in the amount of $778,000, representing a new loan in the sum
of $438,000 and consolidation of an existing loan. The principal balance of
the loan was $778,000 and $338,000 at December 31, 1997 and 1996, respectively.
Repayment is due within 10 days of the officer's voluntary termination or
resignation as an officer of SMC. In the event of a termination of the
officer's employment with SMC following a change in control, the loan is deemed
to be forgiven.
10. RELATED PARTY TRANSACTIONS (CONTINUED)
SMC entered into a covenant not to compete agreement with a former
officer and director in February 1997, effective July 1, 1996, the date his
employment agreement terminated. In accordance with the covenant not to compete
agreement, the officer and director received payments of $275,000 in 1997, and
will receive $125,000 in 1998 and $100,000 in 1999.
11. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company rents office and storage space under noncancellable operating
leases. The Company incurred rent expense for operating leases of $932,000,
$1,037,000 and $1,092,000 in 1997, 1996 and 1995, respectively. Pursuant to the
terms of a lease agreement effective June 1, 1991, Standard Life has agreed to
lease office space for a ten year period. After the initial ten year lease
period, Standard Life may continue to lease the premises on a month to month
basis at a rental of 125% of the prevailing market rate for the leased premises
in effect at that time.
In April 1995, SMC sold its equipment and leased it back under a capital
lease. SMC has the option to renew or purchase the equipment at the end of the
lease term in April 1998. The cost of the equipment was $1,396,000 and
accumulated depreciation of $1,279,000 and $814,000 at December 31, 1997 and
1996, respectively.
Future required minimum rental payments, by year and in the aggregate,
under noncancellable capital leases and operating leases as of December 31,
1997, are as follows (in thousands):
Capital Operating
LEASES LEASES
1998 $144 $ 779
1999 -- 790
2000 -- 721
2001 -- 366
2002 -- 128
Thereafter -- 128
Total minimum lease payments 144 $2,912
Less amounts representing interest 3
Present value of net minimum lease
payments under capital lease $141
EMPLOYMENT AGREEMENTS
Certain officers are employed pursuant to executive employment agreements
that create certain liabilities in the event of the termination of the covered
executives following a change in control of the Company. The commitment under
these agreements is approximately three times their current annual salaries.
Additionally, following termination from the Company following a change in
control, each executive is entitled to receive a lump sum payment equal to all
unexercised stock options granted multiplied by the highest per share fair
market value during the six month period ending on the date of termination.
There were unexercised options outstanding to these executives to buy 1,177,880
shares at December 31, 1997.
12. LITIGATION
An officer and director of SMC resigned effective as of April 15, 1997.
On June 19, 1997, this former officer commenced an action in the Superior Court
of Marion County, Indiana, against SMC claiming that his employment agreement
contained a provision to the effect that, following a termination of his
employment with SMC under certain circumstances, he would be entitled to
receive certain benefits. This former officer has asserted to SMC that he is
entitled to a lump sum termination payment of $1,654,000 and liquidated damages
not exceeding $3,308,000 by virtue of his voluntarily leaving SMC's employment.
SMC disputes those claims. SMC filed its Answer and Counterclaim on September
11, 1997. SMC's investigation since the action was filed revealed a basis for
the termination of employment of the former officer for cause relative to
after-acquired evidence. On October 14, 1997, the Board of Directors of SMC
terminated the former officer for cause effective as of March 15, 1997. Such
termination will also be argued by SMC as a complete defense to all claims
asserted by the former officer. The ultimate outcome of the action cannot
presently be determined. Accordingly, no provision for any liability that may
result has been made in the consolidated financial statements. Management
believes that the conclusion of such litigation will not have a material
adverse effect on SMC's consolidated financial condition.
12. LITIGATION (CONTINUED)
In addition, the Company is involved in various legal proceedings in the
normal course of business. In most cases, such proceedings involve claims under
insurance policies or other contracts of the Company. The outcomes of these
legal proceedings are not expected to have a material adverse effect on the
consolidated financial position, liquidity, or future results of operations of
the Company based on the Company's current understanding of the relevant facts
and law.
13. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES
The Company's U.S. life insurance subsidiaries maintain their records in
conformity with statutory accounting practices prescribed or permitted by state
insurance regulatory authorities. Statutory accounting practices differ in
certain respects from GAAP. In consolidation, adjustments have been made to
conform the Company's domestic subsidiaries' accounts with GAAP.
The Company's U.S. life insurance subsidiaries had consolidated statutory
capital and surplus of $25,923,000 and $22,970,000 at December 31, 1997 and
1996, respectively, after appropriate eliminations of intercompany accounts
among such subsidiaries. Consolidated net income (loss) of the Company's life
insurance subsidiaries on a statutory basis, after appropriate eliminations of
intercompany accounts among such subsidiaries, was $1,776,000, $3,291,000 and
$(1,339,000) for the years ended December 31, 1997, 1996 and 1995,
respectively. Minimum statutory capital and surplus required by the Indiana
Insurance Code was $450,000 as of December 31, 1997.
"Prescribed" statutory accounting practices include a variety of
publications of the National Association of Insurance Commissioners ("NAIC"),
as well as state laws, regulations, and general administrative rules.
"Permitted" statutory accounting practices encompass all accounting practices
that are not prescribed; such practices may differ from state to state, may
differ from company to company within a state, and may change in the future.
The NAIC currently is in the process of codifying statutory accounting
practices, the result of which is expected to constitute the only source of
"prescribed" statutory accounting practices. Accordingly, that project, which
is expected to be completed in 1998, will likely change, to some extent,
prescribed statutory accounting practices, and may result in changes to the
accounting practices that insurance enterprises use to prepare their statutory
financial statements.
Policy reserves for Dixie National Life's fixed premium universal life
policies were calculated according to the Commissioners' Reserve Valuation
Method ("CRVM") for traditional whole life policies. This differs from
prescribed statutory accounting practices. Effective October 2, 1995, Dixie
National Life received permission from the Mississippi Insurance Department to
strengthen the reserves for these policies by using the CRVM methodology as
modified by the Universal Life Model Regulation. This reserve strengthening
will be recorded quarterly through September 30, 1998. This permitted
accounting practice increased statutory surplus by $451,000 and $1,053,000 as
of December 31, 1997 and 1996, respectively.
From the funds borrowed by SMC pursuant to the Amended Credit Agreement
and the subordinated convertible debt agreement, $13,000,000 was loaned to
Standard Life pursuant to an Unsecured Surplus Debenture Agreement ("Surplus
Debenture") which requires Standard Life to make quarterly interest payments to
SMC at a variable corporate base rate plus 2% per annum, and annual principal
payments of $1,000,000 per year beginning in 2007 and concluding in 2019. As
required by state regulatory authorities, the balance of the surplus debenture
at December 31, 1997 of $13,000,000 is classified as a part of capital and
surplus of Standard Life. The interest and principal payments are subject to
quarterly approval by the Indiana Department of Insurance, depending upon
satisfaction of certain financial tests relating to levels of Standard Life's
capital and surplus and general approval of the Commissioner of the Indiana
Department of Insurance.
SMC's ability to pay operating expenses and meet debt service obligations
is partially dependent upon the amount of dividends received from Standard
Life. Standard Life's ability to pay cash dividends to SMC is, in turn,
restricted by law or subject to approval by the insurance regulatory
authorities of Indiana. Dividends are permitted based on, among other things,
the level of preceding year statutory surplus and net income. In 1997 and
1996, Standard Life paid dividends of $1,600,000 and $1,000,000, respectively,
to SMC. In 1995, Standard Life paid no dividends to SMC. During 1998,
Standard Life can pay dividends of $2,592,000 without regulatory approval;
Standard Life must notify the Indiana regulatory authorities of the intent to
pay dividends at least thirty days prior to payment.
State insurance regulatory authorities impose minimum risk-based capital
requirements on insurance enterprises that were developed by the NAIC. The
formulas for determining the amount of risk-based capital ("RBC") specify
various weighting factors that are applied to financial balances or various
levels of activity based on the perceived degree of investment and insurance
risks. Regulatory compliance is determined by a ratio (the "Ratio") of the
enterprise's regulatory total adjusted capital, as defined by the NAIC, to its
authorized control level RBC, as defined by the NAIC. Enterprises below
specific trigger points or ratios are classified within certain levels, each of
which requires specified corrective action. Each of the Company's insurance
subsidiaries has a Ratio that is at least 400% of the minimum RBC requirements;
accordingly, the subsidiaries meet the RBC requirements.
13. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES (CONTINUED)
The statutory capital and surplus for Premier Life (Luxembourg) was
$7,288,000 and $8,243,000 at fiscal years ended 1997 and 1996, respectively,
and minimum capital and surplus under local insurance regulations was
$2,915,000 and $3,295,000 at fiscal years ended 1997 and 1996, respectively.
The statutory capital and surplus for Premier Life (Bermuda) was $1,357,000 and
$1,307,000 at fiscal years ended 1997 and 1996, respectively, and minimum
capital and surplus under local insurance regulations was $250,000 at fiscal
years ended 1997 and 1996. Standard Management International dividends are
limited to its accumulated earnings without regulatory approval. Standard
Management International and Premier Life (Luxembourg) were not permitted to
pay dividends under Luxembourg law in 1997 and 1996 due to accumulated losses.
14. OPERATIONS BY GEOGRAPHIC AREA
The Company operates exclusively in one business segment -- the sale and
administration of life insurance business (principally annuities and other
financial products).
The revenues, pre-tax income and assets by geographic segment for 1997
through 1995 are as follows (in thousands):
Year Ended December 31,
1997 1996 1995
Revenues:
United States $42,651 $36,524 $26,851
International 4,218 3,783 3,387
Total $46,869 $40,307 $30,238
Income before federal income taxes, extraordinary Year Ended
gain and December 31,
preferred stock dividends:
United States $1,541 $2,313 $1,224
International 1,721 1,222 332
Total $3,262 $3,535 $1,556
At December 31,
1997 1996 1995
Assets:
United States $508,476 $486,576 $343,040
International 160,516 141,837 136,558
Total $668,992 $628,413 $479,598
The states in the U.S. with the largest share of U.S. premiums collected
in 1997 were Indiana (21%), California (11%), Ohio (10%), and Florida (10%).
No other state accounted for more than 5% of total collected premiums.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following discussion outlines the methods and assumptions used by the
Company in estimating its fair value disclosures for its financial instrument
assets and liabilities. Because fair values for all balance sheet items are
not required to be disclosed pursuant to SFAS No. 107, "Disclosures about Fair
Values of Financial Instruments", the aggregate fair value amounts presented
herein do not necessarily represent the underlying value of the Company;
likewise, care should be exercised in deriving conclusions about the Company's
business or financial condition based on the fair value information presented
herein.
FIXED MATURITY SECURITIES: Fair values for fixed maturity securities are
based on quoted market prices from broker-dealers, where available. For fixed
maturity securities not actively traded, fair values are estimated using values
obtained from independent pricing services, or, in the case of private
placements, are estimated by discounting the expected future cash flows using
current market rates applicable to the coupon rate, credit, and maturity of the
investments.
EQUITY SECURITIES: The fair values for equity securities are based on
the quoted market prices.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
MORTGAGE LOANS AND POLICY LOANS: The estimated fair values for mortgage
loans and policy loans are estimated using discounted cash flow analyses and
interest rates currently being offered for similar loans to borrowers with
similar credit ratings.
ASSETS AND LIABILITIES HELD IN SEPARATE ACCOUNTS: Fair values for the
assets held in separate accounts are determined from broker-dealer market
makers, or valuations supplied by internationally recognized statistical rating
organizations. The separate account liability represents the Company's
obligations to policyholders and approximates fair value.
INSURANCE LIABILITIES FOR INVESTMENT CONTRACTS: Fair values for the
Company's liabilities under investment-type insurance contracts are estimated
using discounted cash flow calculations, based on interest rates currently
being offered for similar contracts with maturities consistent with those
remaining contracts being valued. The estimated fair value of the liabilities
for investment contracts was approximately equal to its carrying value at
December 31, 1997 and 1996, as credited rates on the vast majority of account
balances approximate current rates paid on similar investments and because
these rates are generally not guaranteed beyond one year.
INSURANCE LIABILITIES FOR NON-INVESTMENT CONTRACTS: Fair value
disclosures for the Company's reserves for insurance contracts other than
investment-type contracts are not required and have not been determined by the
Company. However, the Company closely monitors the level of its insurance
liabilities and the fair value of reserves under all insurance contracts are
taken into consideration in the Company's overall management of interest rate
risk.
NOTES PAYABLE: The Company believes the fair value of its variable rate
long-term debt was equal to its carrying value at December 31, 1997 and 1996.
The Company negotiated the terms of its Amended Credit Agreement with its
lenders in November 1996. Those negotiations were based on the financial
condition of the Company and market conditions at that time. The financial
condition of the Company has not changed significantly since the negotiations
and although market conditions have changed, the Company pays a variable rate
of interest on the debt which reflects the change in market conditions. The
fair value of the subordinated convertible debt is based on quoted market
prices for the amount of shares convertible at December 31, 1997.
The carrying amount for all other financial instruments approximates
their fair values.
The fair value of the Company's financial instruments is shown below
using a summarized version of the Company's assets and liabilities at December
31, 1997 and 1996 (in thousands). Refer to Note 3 for additional information
relating to the fair value for investments.
December 31,
1997 1996
Fair Carrying Fair Carrying
Value Amount Value Amount
Assets:
Investments:
Securities available for sale:
Fixed maturity securities $372,576 $372,576 $347,310 $347,310
Equity securities 52 52 62 62
Mortgage loans on real estate 377 375 3,041 3,035
Policy loans 8,978 9,495 7,767 9,903
Other invested assets 779 779 888 865
Short-term investments 13,342 13,342 8,417 8,417
Assets held in separate 148,064 148,064 128,546 128,546
accounts
Liabilities:
Insurance liabilities for 350,607 350,607 333,633 333,633
investment contracts
Obligations under capital lease 141 141 637 637
Notes payable 27,419 26,000 20,000 20,000
Liabilities related to separate 148,064 148,064 128,546 128,546
accounts
16. EARNINGS PER SHARE
A reconciliation of the numerator and denominator of the earnings per
share computation is as follows (dollars in thousands, except per share
amounts):
1997 1996 1995
Numerator:
Income before extraordinary gain and preferred stock $2,645 $4,265 $1,313
dividends
Extraordinary gain on early redemption of redeemable -- 502 --
preferred stock
Preferred stock dividends (97) (208) --
Numerator for basic earnings per share -
Income available to common shareholders 2,548 4,559 1,313
Effect of dilutive securities:
Preferred stock dividends 97 208 --
14% subordinated convertible debt -- 82 --
10% subordinated convertible debt -- -- --
97 290 1,313
Numerator for diluted earnings per share -
Income available to common sharehodlers after assumed $2,645 $4,849 $1,313
conversions
Denominator:
Denominator for basic earnings per share - weighted - 4,948,302 4,856,316 5,244,495
average shares
Effect of dilutive securities:
Stock options 182,615 24,311 5,240
Stock warrants 230,285 108,062 96,202
Convertible preferred stock 230,015 393,701 --
14% subordinated convertible debt -- 166,667 --
10% subordinated convertible debt -- -- --
Dilutive potential common shares 642,915 692,741 101,442
Denominator for diluted earnings per share - adjusted
weighted -average 5,591,217 5,549,057 5,345,937
shares and assumed conversions
Basic earnings per share $ .52 $ .94 $ .25
Diluted earnings per share $ .47 $ .87 $ .25
The Notes convertible in 1997 (SEE NOTE 5) were not included in the
computation of diluted earnings per share in 1997 because the effect would be
antidilutive.
17. PENDING ACQUISITION
On December 9, 1997, SMC and Savers Life Insurance Company ("Savers
Life") entered into an Amended and Restated Agreement and Plan of Merger (the
"Merger Agreement") with Savers Life surviving as a wholly-owned subsidiary of
SMC. Subject to the terms and conditions of the Merger Agreement, each share
of Savers Life Common Stock outstanding immediately prior to the Effective Time
(as defined in the Merger Agreement) of the Merger will be converted into 1.2
shares of SMC Common Stock plus $1.50. Each holder of Savers Life Common Stock
may elect to receive the $1.50 per share portion of the merger consideration in
the form of additional shares of SMC Common Stock. Assuming each holder of
Savers Life Common Stock elects to receive $1.50 per share cash consideration
in lieu of electing to receive shares of SMC Common Stock and a value per share
of $7.00 per share, SMC will issue 2.1 million shares with a value of
approximately $15 million to acquire the Savers Life Common Stock. SMC has
received a commitment to increase the Amended Credit Agreement to $20,000,000
to finance the acquisition of Savers Life. The acquisition is expected to
close in March 1998.
Savers Life underwrites, markets and distributes annuities, life
insurance, and Medicare supplement health insurance through a sales force
consisting of 4,000 independent brokers and is licensed to sell products in
North Carolina, South Carolina, Virginia and Florida. Savers Life had total
assets of $72,186,000 at December 31, 1997 and revenues of $43,047,000 for the
year ended December 31, 1997.
18. QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Earnings per common and common equivalent share for each quarter are
computed independently of earnings per share for the year. Due to the
transactions affecting the weighted average number of shares outstanding in
each quarter and due to the uneven distribution of earnings during the year,
the sum of the quarterly earnings per share may not equal the earnings per
share for the year. The 1996 and first three quarters of 1997 earnings per
share amounts have been restated to comply with SFAS No. 128.
1997 Quarters
First Second Third Fourth
Total revenues $12,019 $11,292 $11,599 $11,959
Components of net income:
Operating income $528 $661 $537 $658
Net realized investment gains 115 21 53 72
Net income $643 $682 $590 $730
Net income per common share $ .13 $ .14 $ .12 $ .15
Net income per common share, assuming
dilution $ .11 $ .12 $ .11 $ .13
1996 Quarters
First Second Third Fourth
Total revenues $8,856 $12,665 $7,969 $10,817
Components of net income:
Operating income $214 $(187) $342 $804
Net realized investment gains 145 125 129 387
Gain on disposal of subsidiaries 2,306 -- -- --
Extraordinary gain on early
redemption of 101 166 233 2
redeemable preferred stock
Net income $2,766 $104 $704 $1,193
Net income per common share $ .55 $ .02 $ .15 $ .24
Net income per common share, assuming
dilution $ .51 $ .02 $ .13 $ .21
Reporting the results of insurance operations on a quarterly basis
requires the use of numerous estimates throughout the year, primarily in the
computation of reserves, amortization of deferred policy acquisition costs and
present value of future profits, and the effective rate for income taxes. It
is the Company's practice to review estimates at the end of each quarter and,
if necessary, make appropriate adjustments, with the effect of such adjustments
being reported in current operations. Only at year-end is the Company able to
assess the accuracy of its previous quarterly estimates. The Company's fourth
quarter results include the effect of the difference between previous estimates
and actual year-end results. Therefore, the results of an interim period may
not be indicative of the results of the entire year.
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31,
1997 1996
ASSETS
Investments:
Investment in subsidiaries $52,005 $46,422
Surplus debenture due from Standard Life 13,000 13,000
Equity securities available for sale, at fair value (amortized 2 12
cost: 1997 - $5; 1996 -$8)
Real estate 130 139
Investment in joint venture -- 320
Notes receivable from officers and directors 778 338
Short-term investments, at cost, which approximates fair value 79 124
65,994 60,355
Cash 1,327 900
Property and equipment, less accumulated depreciation of $1,636 in 1997 879 1,087
and $989 in 1996
Note receivable from affiliate 2,858 2,858
Amounts receivable from subsidiaries 1,212 638
Other assets 1,892 829
Total assets $74,162 $66,667
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Obligations under capital lease $141 $637
Notes payable 26,000 20,000
Note payable to affiliate 2,858 2,858
Amounts due to subsidiaries 397 473
Other liabilities 1,453 1,023
Total liabilities 30,849 24,991
Class S Cumulative Convertible Redeemable Preferred Stock, par value $10
per share:
Authorized 300,000 shares; issued and outstanding 159,889 shares in -- 1,757
1996
Shareholders' Equity:
Preferred Stock, no par value:
Authorized 700,000 shares; none issued and outstanding -- --
Common Stock, no par value:
Authorized 20,000,000 shares; issued 5,752,499 shares 40,646 40,481
Treasury stock, at cost, 876,009 shares in 1997 and 728,229 shares in (4,572) (3,528)
1996
Unrealized gain (loss) on securities available for sale of subsidiaries 2,171 (746)
Foreign currency translation adjustment of subsidiaries (473) 691
Retained earnings 5,541 3,021
Total shareholders' equity 43,313 39,919
Total liabilities and shareholders' equity $74,162 $66,667
See accompanying notes to condensed financial statements.
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
Year Ended December 31,
1997 1996 1995
Revenues:
Net investment income $ -- $32 $112
Interest income from subsidiaries 1,519 357 172
Net realized investment gains -- -- 23
Loss on disposal of subsidiary -- (156) --
Other income 154 135 28
Rental income from subsidiaries 1,145 853 715
Management fees from subsidiaries 2,100 1,905 1,930
Total revenues 4,918 3,126 2,980
Expenses:
Other operating expenses 3,420 3,470 2,479
Interest expense and financing costs 2,367 799 110
Interest expense on note payable to affiliate 162 161 172
Total expenses 5,949 4,430 2,761
Income (loss) before federal income taxes, equity
in earnings
of consolidated subsidiaries, extraordinary gain (1,031) (1,304) 219
and preferred stock dividends
Federal income tax expense (credit) (76) -- (57)
Income (loss) before equity in earnings of
consolidated
subsidiaries, extraordinary gain and preferred (955) (1,304) 276
stock dividends
Equity in earnings of consolidated subsidiaries 3,600 5,569 1,037
Income before extraordinary gain and preferred 2,645 4,265 1,313
stock dividends
Extraordinary gain on early redemption of
redeemable -- 502 --
preferred stock, net of $-- federal income tax
Net income 2,645 4,767 1,313
Preferred stock dividends 97 208 --
Earnings available to common shareholders $2,548 $4,559 $1,313
See accompanying notes to condensed financial statements.
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
Year Ended December 31,
1997 1996 1995
OPERATING ACTIVITIES
Net income $2,645 $4,767 $1,313
Adjustments to reconcile net income to net cash
provided by
operating activities:
Amortization of deferred debt issuance costs 71 32 2
Depreciation and amortization 646 564 562
Equity in earnings of subsidiaries (3,600) (5,569) (1,037)
Accrued interest payable 435 320 --
Other liabilities 79 192 480
Net realized investment gain -- -- (23)
Dividend from Standard Life 1,600 1,000 --
Extraordinary gain -- (502) --
Other (370) 165 (905)
Net cash provided by operating activities 1,506 969 392
FINANCING ACTIVITIES
Issuance of Common Stock, net -- -- 6
Borrowings, net of debt issuance costs of $70 in 1997,
$208 in 1996 5,558 16,792 2,923
and $81 in 1995
Repayments on long-term debt and obligations under (543) (491) (312)
capital lease
Short-term borrowings, net -- -- (550)
Redemption of redeemable preferred stock (1,855) (949) --
Repurchase of stock warrants -- (600) --
Proceeds from common and treasury stock sales 138 100 --
Purchase of Common Stock for treasury (503) (2,126) (822)
Net cash provided by financing activities 2,795 12,726 1,245
INVESTING ACTIVITIES
Investments, net (1,035) 197 653
Proceeds from sale of property and equipment under -- -- 1,396
sales leaseback
Purchase of property and equipment, net (439) (246) (475)
Surplus debenture contributed to Standard Life -- (13,000) --
Capital contribution to Standard Life (2,400) -- (3,000)
Capital contribution to Standard Management -- -- (170)
International
Capital contribution to Standard Advertising, Inc. -- -- (173)
Capital contribution to Standard Reinsurance -- -- (6)
Net cash used by investing activities (3,874) (13,049) (1,775)
Net increase (decrease) in cash 427 646 (138)
Cash at beginning of year 900 254 392
Cash at end of year $1,327 $900 $254
See accompanying notes to condensed financial statements.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. BASIS OF PRESENTATION
For purposes of these condensed financial statements, Standard Management
Corporation ("SMC") carries its investments in subsidiaries at cost plus equity
in undistributed earnings of subsidiaries since date of acquisition. Net income
of its subsidiaries is included in income using the equity method. These
condensed financial statements should be read in conjunction with SMC's
consolidated financial statements included elsewhere in this document.
2. DIVIDENDS FROM SUBSIDIARIES
SMC received a cash dividend from subsidiaries of $1,600,000 and $1,000,000
in 1997 and 1996, respectively. There were no cash dividends paid to SMC from
its subsidiaries in 1995.
SCHEDULE IV -- REINSURANCE
STANDARD MANAGEMENT CORPORATION
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
Percentage
Ceded to Assumed of Amount
Gross Other from Other Assumed
Amount Companies Companies Net Amount to Net
YEAR ENDED DECEMBER 31, 1997
Life insurance in force $2,447,782 $1,269,848 $237 $1,178,171 .02%
Premiums
Life insurance and annuities $11,735 $4,821 $-- $6,914
Accident and health insurance 17 -- -- 17
Supplementary contract and other
funds 169 -- -- 169
on deposit
Total premiums $11,921 $4,821 $-- $7,100
YEAR ENDED DECEMBER 31, 1996
Life insurance in force $3,000,763 $1,633,340 $252 $1,367,675 .02%
Premiums
Life insurance and annuities $11,862 $2,152 $-- $9,710
Accident and health insurance 21 -- -- 21
Supplementary contract and other
funds 737 -- -- 737
on deposit
Total premiums $12,620 $2,152 $-- $10,468
YEAR ENDED DECEMBER 31, 1995
Life insurance in force $2,316,826 $1,490,812 $282 $826,296 .03%
Premiums
Life insurance and annuities $9,574 $4,312 $-- $5,262
Accident and health insurance 22 -- -- 22
Supplementary contract and other
funds 220 -- -- 220
on deposit
Total premiums $9,816 $4,312 $-- $5,504