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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 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR
- ------
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
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 incorporation or (I.R.S. employer identification no.)
organization)
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
Class S Cumulative Convertible Redeemable Preferred Stock, $10 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 February
28, 1997 as reported on The Nasdaq Stock Market, was approximately $21.9
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 February 28, 1997, Registrant had outstanding 5,025,143 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.
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PART I
As used herein, unless the context otherwise clearly requires, "SMC" 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. All information contained herein with respect to SMC Common
Stock, including information presented on a per share basis, has been adjusted
to reflect a 5% stock dividend effected on June 21, 1996 for holders of record
on May 17, 1996.
ITEM 1. BUSINESS OF SMC
INTRODUCTION
SMC is an insurance holding company which directly and through subsidiaries
acquires and manages in force life insurance and annuity business and
distributes life insurance and annuity products issued by SMC's insurance
subsidiaries and a select group of unaffiliated insurers. SMC's active
subsidiaries at December 31, 1996 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, 1996, Standard Life's statutory assets were
$347,329,660 and the aggregate of its statutory capital and surplus, asset
valuation reserve ("AVR") and interest maintenance reserve ("IMR") (its
"adjusted statutory capital") was $34,940,556. The ratio of Standard Life's
adjusted statutory capital to its total statutory assets was 10.1% at December
31, 1996. Standard Life has a rating of "B" ("adequate") 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, 1996,
Standard Management International and its subsidiaries had $141,837,000 in
assets with policies in force in over 113 countries. The majority of its
business is "unit-linked" 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, 1996, Premier Life (Luxembourg) had statutory capital and surplus of
$8,243,000 and its minimum capital and surplus was $3,295,000 and Premier Life
(Bermuda) had statutory capital and surplus of $1,307,000 and its minimum
capital and surplus was $250,000.
Standard Life owns 99.3% of Dixie National Life. At December 31, 1996,
Dixie National Life's statutory assets were $34,473,049, the adjusted statutory
capital was $4,229,059 and the ratio of its adjusted statutory capital to its
statutory assets was 12.3%. 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 master general agents and independent agents,
Standard Marketing distributes life insurance and annuity products for Standard
Life and Dixie National Life 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 associated with the purchase of
Shelby Life. Financing for the Shelby Merger was provided by
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senior debt of $10,000,000 and $4,000,000 in subordinated convertible debt.
Shelby Life ceased writing new business effective November 1, 1996, thus
reducing the statutory surplus strain associated with the issuance of policies.
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 preliminary
determination of their fair values and recorded the excess of acquisition cost
over net assets acquired as goodwill. Standard Life recorded goodwill of $9,000
which will be amortized on a straight-line basis over 20 years. Standard Life
may adjust this allocation when a final determination of such values is made.
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 $11,493,000, including $1,500,000 for the charter and licenses
associated with First International and $1,800,000 of reinsurance ceding
commissions. Standard Life realized a net pretax gain of $1,041,692 and a tax
benefit of $1,420,000 on this sale or $2,461,692 ($.47 per share). 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 the majority of
First International's in force business at the date of sale. See Business of SMC
- -- Reinsurance.
In an unrelated matter, 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 $155,856 ($.03 per share).
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 $885,836 and a tax benefit of $1,420,000, for net income effect
of $2,305,836 or $.44 per share 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 $5,200,554 and
liabilities of $4,953,055, primarily ordinary life policies. In connection with
this transaction, 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. This administration fee
income and premium income recorded with recapture, will not recur in the future.
SMC has entered into an Agreement and Plan of Merger dated as of December
19, 1996, as amended February 17, 1997, with Savers Life Insurance Company
("Savers Life"). Savers Life offers retirement products, major medical insurance
and Medicare supplement insurance through 5,000 independent brokers, primarily
in North Carolina, South Carolina and Virginia. SMC will pay approximately
$14,200,000 plus acquisition costs for the approximately $80,000,000 asset
company, with shareholders of Savers Life initially receiving $8.00 for each
share of Savers Life Common Stock, consisting of Standard Management Common
Stock and an election of up to $1.50 per share in cash. The proposed acquisition
is subject to certain conditions including SMC and Savers Life shareholder
approval and approval by applicable regulatory authorities. The acquisition is
expected to close during the second quarter of 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
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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 4,000 independent general agents. These agents distribute a full
line of life insurance and annuity products issued by Standard Life and Dixie
National 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. SMC does not market its annuity products through
stockbrokers.
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 after the submission of the policy application.
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 and
annuity products that Standard Marketing has selected on the basis of their
competitive position and likely consumer acceptance. Such portfolio includes
FPDAs and whole and universal life insurance issued by Standard Life and Dixie
National Life, for which Standard Marketing is the exclusive distributor, and
deferred annuities, whole life, term and universal life insurance, and pension
and payroll deduction products issued primarily by the following unaffiliated
insurers: American National Life Insurance Company, Indianapolis Life Insurance
Company, Jefferson-Pilot Life Insurance Company, The Midland Life Insurance
Company, The Old Line Life Insurance Company of America, United Presidential
Life Insurance Company, U.S. Financial Life Insurance Company and others. Each
of these unaffiliated insurers is rated "A-" to "A++" by a nationally recognized
insurance company rating agency. 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
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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 1996, and the top twenty individual agents
accounted for approximately 36.6% of Standard Life's volume in 1996. At December
31, 1996, approximately 40% of Standard Marketing's independent agents were
located in Indiana, Florida, Ohio, Georgia and Illinois, with the balance
distributed across the country. SMC is attempting to increase the number and
geographic diversity of its agents.
SMC does not have exclusive agency agreements with its agents and
management believes most of these agents sell products similar to those sold by
the companies for other insurance companies. This could result in sales decline
if the companies' products were to become relatively less competitive. Standard
Life's 1996 FPDA sales increased partially due to an aggressive marketing
campaign implemented by Standard Life with increased crediting rates. Also
contributing to the increase in premiums was the continued development of
Standard Life's distribution system.
Standard Marketing receives, directly from the insurance companies it
serves, 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. The following table shows for
the periods indicated the aggregate override commissions and service fees
received by Standard Marketing:
YEARS ENDED DECEMBER 31,
------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
Standard Life and Dixie National Life(1).......... $ 988 $ 829 $867
Unaffiliated insurance companies.................. 397 252 55
------ ------ ----
Total........................................ $1,385 $1,081 $922
====== ====== ====
- -------------------------
(1) These amounts are eliminated in SMC's consolidated financial statements.
International Marketing. The subsidiaries of Standard Management
International, Premier Life (Luxembourg) and Premier Life (Bermuda), produced
aggregate new premium deposits of approximately $17,000,000, $32,000,000 and
$1,700,000 during 1996, 1995 and 1994, respectively. The decrease in 1996 is
primarily due to a decrease in marketing costs and to changes in tax planning
laws in certain countries in Western Europe, which made Standard Management
International products less attractive. 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 expected that these alliances will be consummated in 1997.
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
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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. SMC also
generates cash flow and income from its closed blocks of in force life insurance
and annuities. The following table sets forth the amounts and percentages of net
premiums received by SMC from currently marketed products and closed block
products for the years ended December 31, 1996, 1995 and 1994, respectively.
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,
--------------------------------------------------------
1996 1995 1994
---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
------ - ------ - ------ -
(DOLLARS IN THOUSANDS)
Currently marketed products:
FPDAs..................................... $37,322 47.7 $12,417 23.0 $50,421 85.7
Universal and interest-sensitive life..... 5,384 6.9 2,044 3.8 279 0.4
SPIAs..................................... 1,423 1.8 1,257 2.3 -- --
Whole life................................ 2,546 3.3 668 1.2 86 0.2
Unit-linked products...................... 16,902 21.6 31,793 58.8 1,715 2.9
------- ----- ------- ----- ------- -----
63,577 81.3 48,179 89.1 52,501 89.4
Closed blocks:
Annuities and life........................ 9,230 6.5 5,906 10.9 6,364 10.8
Net effect of financial reinsurance....... 5,182 6.6 -- -- -- --
Recapture of National Mutual.............. 4,373 5.6 -- -- -- --
------- ----- ------- ----- ------- -----
18,942 18.7 5,906 10.9 6,364 10.8
------- ----- ------- ----- ------- -----
$82,362 100.0 $54,085 100.0 $58,865 100.0
======= ===== ======= ===== ======= =====
FPDA sales declined in 1995 reflecting competitive pressures due to
Standard Life not matching other insurer's higher interest crediting and
commission rates. Additionally, in order to reduce surplus strain Standard Life
began ceding a portion of its new annuity business to an unaffiliated reinsurer
effective January 1, 1995, which further reduced FPDA sales revenues by
$20,089,762 in 1995. Deposits from unit-linked products increased in 1995 as a
result of the resumption by Standard Management International of the sale of new
policies in 1994.
FPDA sales increased in 1996 partially due to an aggressive marketing
campaign implemented by Standard Life with increased interest crediting rates.
Standard Life also decreased 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
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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 $8,907,460 in the year ended December 31, 1996.
The increase in closed blocks annuities and life products is primarily due
to reinsurance premium assumed from GIAC and the acquisition of Shelby Life
effective November 1, 1996.
The following table shows, on a GAAP basis, certain information for SMC as
of the dates set forth below.
AT DECEMBER 31,
------------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
Number of annuity contracts in force.................... 13,221(1) 8,637 7,480
Interest-sensitive annuity and other financial product
reserves, net of reinsurance ceded.................... $ 333,633(1) $212,500 $173,334
---------- -------- --------
Number of life policies in force........................ 76,219(2) 63,038(3) 40,317
Life insurance in force, net of reinsurance ceded....... $1,367,675(2) $826,296(3) $787,414
---------- -------- --------
Number of separate contracts (primarily unit-linked
products)............................................. 2,484 2,951 3,131
Total liabilities related to separate accounts
(primarily unit-linked products)...................... $ 128,546 $122,705 $ 94,301
- -------------------------
(1) 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.
(2) The number of life policies and insurance in force has 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.
(3) The number of life policies and insurance in force increased 26,522 and
$219,663,000 in 1995, respectively, as a result of Standard Life's
acquisition of Dixie National Life.
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 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
27% of all net premiums and deposits collected in 1996 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.
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SMC's gross sales percentages by U.S. geographical region are summarized as
follows:
YEAR ENDED DECEMBER 31,
---------------------------
STATE 1996 1995 1994
----- ---- ---- ----
Indiana................................................ 18% 24% 30%
Ohio................................................... 16 22 18
Florida................................................ 14 11 19
California............................................. 11 3 2
Michigan............................................... 6 4 5
All other states....................................... 35(1) 36 26
--- --- ---
Total.................................................. 100% 100% 100%
=== === ===
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(1) No other state had gross sales greater than 4% for 1996.
Standard Management International's products are sold primarily in Western
Europe.
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 which are revised periodically by
Standard Life until the maturity date. These interest earnings are 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 December 31, 1996, the crediting rates available on Standard Life's
currently marketed FPDAs ranged from 6.8% to 8.1% (5.1% + 3% first year bonus),
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 December 31, 1996, interest
crediting rates after the initial guarantee period ranged from 5% to 6.75%. 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 December 31, 1996, 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.
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.
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.
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Single Premium Universal Life. SPULs provide for an initial deposit, credit
interest to account values and charge the account values for mortality and
administrative costs. As of December 31, 1996, the current interest rate on new
sales of SPULs is 7% with a guaranteed interest rate of 3%.
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 5.5% on currently marketed products at
December 31, 1996. The interest sensitive and whole life policies include cash
values which may be borrowed by the policyholder. Dixie National Life issues
polices on both a participating and non-participating basis.
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 benefit 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.
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
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.
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.
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.
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. At December 31, 1996,
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 whose benefits are being
paid
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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.
Reinsurance.
In connection with financial reinsurance, Dixie National Life terminated a
reinsurance agreement with Crown Life Insurance Company and received redeemed
premium income of $18,186,377 and entered into a financial reinsurance agreement
with Cologne Life Reinsurance Company and added $13,091,290 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).
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 1996, such margins continued to be positive as a result of
reductions in crediting rates in spite of a fluctuating interest rate
environment.
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 and Dixie National
Life's ordinary life business in force at December 31, 1996 is 9 and 10.75
years, respectively. These calculations were 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 1996, 1995 and 1994 Standard Life experienced total policy
lapses of 6.3%, 5.1% and 6.3% of total policies in force at December 31 of each
year, respectively. The American Council of Life Insurance 1996 Fact Book
reported industry life insurance voluntary termination rates in 1996 of 17.1%
for policies in force less than two years, 5.4% for policies in force for two
years or more and 7.2% 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. 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 management information services system is now
servicing approximately 150,000 active and inactive policies. SMC is continually
improving its MIS systems to provide for continued growth from acquisitions and
sales. SMC's 1997 capital budget for systems improvements is $250,000. 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 management
information services departments in Luxembourg are an autonomous unit from the
systems in the United States. SMC is in the process of
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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. As
of December 31, 1996, the weighted average interest rate credited on SMC's
interest-sensitive liability portfolio, excluding liabilities related to
separate accounts, was approximately 5.35% per annum, and the average net yield
of SMC's investment portfolio for the year ended December 31, 1996 was 7.36% for
a spread of 2.01% at December 31, 1996, compared to 2.05% at December 31, 1995.
The decrease in the net spread in 1996 is primarily attributable to sales of
FPDAs in 1996 with higher and more competitive crediting interest rates.
Increases or decreases in interest rates could increase or decrease the 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 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.
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
Average invested assets(1)............................... $285,186 $253,055 $221,138
Net investment income.................................... 20,871 18,517 16,057
Weighted average annual yield(2)......................... 7.32% 7.32% 7.26%
Net realized investment gains............................ $ 1,302 $ 688 $ 558
- -------------------------
(1) Average invested assets are computed by dividing the total of the amortized
cost of investments at the beginning of the period plus the individual
quarter-end balances by the number of quarterly periods plus one.
(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.
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The following table shows the amortized cost, gross unrealized gain (loss)
and estimated fair value of SMC's securities available for sale:
DECEMBER 31, 1996
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----
(DOLLARS IN THOUSANDS)
Fixed maturity securities:
United States Treasury securities and obligations
of United States government agencies........... $ 20,753 $ 51 $ 420 $ 20,384
Obligations of states and political
subdivisions................................... 3,588 106 -- 3,694
Foreign government securities..................... 10,042 51 166 9,927
Mortgage-backed securities........................ 72,264 247 919 71,592
Utilities......................................... 31,000 295 675 30,620
Corporate bonds................................... 210,977 3,086 3,539 210,524
Redeemable preferred stock........................ 527 42 -- 569
-------- ------ ------ --------
Total fixed maturity securities................ 349,151 3,878 $5,719 347,310
Equity securities................................... 58 4 -- 62
-------- ------ ------ --------
Total.......................................... $349,209 $3,882 $5,719 $347,372
======== ====== ====== ========
DECEMBER 31, 1995
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----
(DOLLARS IN THOUSANDS)
Fixed maturity securities:
United States Treasury securities and obligations
of United States government agencies........... $ 19,331 $ 452 $ 19 $ 19,764
Obligations of states and political
subdivisions................................... 60 -- -- 60
Foreign government securities..................... 5,056 118 3 5,171
Mortgaged-backed securities....................... 45,161 417 416 45,162
Utilities......................................... 23,916 462 186 24,192
Corporate bonds................................... 132,119 7,281 1,657 137,743
-------- ------ ------ --------
Total fixed maturity securities................ 225,643 8,730 2,281 232,092
Equity securities................................... 52 -- -- 52
-------- ------ ------ --------
Total.......................................... $225,695 $8,730 $2,281 $232,144
======== ====== ====== ========
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, 1996, the adjusted modified duration of fixed maturities
and short-term investments for its U.S. insurance subsidiaries was 5.5 years
compared to 5.4 years at December 31, 1995.
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1996 by contractual maturity are shown below. Actual maturities
will differ from contractual maturities because
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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
--------- -----
(DOLLARS IN THOUSANDS)
Due in one year or less.................................. $ 7,418 $ 7,435
Due after one year through five years.................... 24,818 24,970
Due after five years through ten years................... 123,503 123,075
Due after ten years...................................... 120,621 119,669
-------- --------
Subtotal............................................ 276,360 275,149
Redeemable preferred stock............................... 527 569
Mortgage-backed securities............................... 72,264 71,592
-------- --------
Total fixed maturity securities..................... $349,151 $347,310
======== ========
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, 1996, classified in accordance with the ratings
assigned by the National Association of Insurance Commissioners ("NAIC"):
PERCENT OF FIXED
NAIC RATING (1) MATURITY SECURITIES
--------------- -------------------
1........................................................... 49%
2........................................................... 47
---
Investment Grade.......................................... 96
3-4......................................................... 4
5-6......................................................... --
---
Below Investment Grade.................................... 4
---
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 21% of SMC's fixed maturity securities at December 31, 1996
is comprised of mortgage-backed securities. Investments in mortgage-backed
securities include CMOs and mortgage-backed pass-through securities.
Approximately 79% of the book value of the mortgage-backed securities in SMC's
portfolio
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are 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. 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, 1996:
ESTIMATED
% OF % OF AVG. LIFE AVG. TERM
BOOK FIXED FAIR FIXED OF TO FINAL
VALUE MATURITIES VALUE MATURITIES INVESTMENT MATURITY
----- ---------- ----- ---------- ---------- ---------
(DOLLARS IN THOUSANDS)
(IN YEARS) (IN YEARS)
Agency CMOs:
Planned and target amortization
classes....................... $23,371 6.7 $22,827 6.6 6.7 25.2
Sequential and support classes... 1,417 .4 1,456 .4 7.3 22.1
------- ---- ------- ---- ---- ----
Total......................... 24,788 7.1 24,282 7.0 6.7 25.0
Non-agency CMOs:
Planned amortization classes..... 1,492 .4 1,448 .4 10.8 27.0
Sequential classes............... 13,673 3.9 13,550 3.9 8.2 22.2
------- ---- ------- ---- ---- ----
Total......................... 15,165 4.3 14,998 4.3 8.5 22.7
------- ---- ------- ---- ---- ----
Total CMOs......................... 39,953 11.4 39,280 11.3 7.4 24.1
Agency mortgage-backed pass-through
securities....................... 32,311 9.3 32,312 9.3 7.2 17.4
------- ---- ------- ---- ---- ----
Total mortgage-backed
securities.................. $72,264 20.7 $71,592 20.6 7.3 21.0
======= ==== ======= ==== ==== ====
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
34% 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, comprising
approximately 66% of the book value of SMC's mortgage-backed securities at
December 31, 1996, 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; also there are
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. 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
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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. Prior to
January 1, 1995, reinsurance was not maintained with respect to SMC's currently
marketed annuity products. 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 (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.
Reinsurance ceded on life insurance policies to unaffiliated companies by
SMC in 1996, 1995 and 1994 represented 57.6%, 68.8% and 75.4%, 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
(other than GIAC) in 1996, 1995 and 1994 represented .02%, .04% and .05% of net
combined individual life insurance in force, respectively. SMC cedes reinsurance
to numerous reinsurers. At December 31, 1996, approximately $477,980,000 of the
face value of life policies had been ceded to The Lincoln National Life
Insurance Company ("Lincoln National"), with $203,097,000 ceded to Security Life
of Denver Insurance Company ("Security Life") and $191,813,000 ceded to The
Mercantile and General Reinsurance Company ("Mercantile"). Lincoln National is
the lead reinsurer with a total of 29.3% of total reinsurance ceded with
Security Life and Mercantile each accounting for 12.4% and 11.7%, respectively
of total reinsurance ceded by SMC's life insurance subsidiaries at December 31,
1996. The amount of life insurance business ceded to any
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other reinsurer is not material. Of SMC's total life insurance in force at
December 31, 1996 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 regulatory
restrictions based on the amount of its statutory capital and surplus. SMC's
largest annuity reinsurer at December 31, 1996, Winterthur Life Re Insurance
Company ("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. 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 in certain circumstances. At
December 31, 1996, total annuity resources ceded to Winterthur amounted to
$26,138,000.
On March 18, 1996, Standard Life completed the sale of First International
to GIAC. Standard Life received sale proceeds of approximately $11,493,000
including $1,500,000 for the charter and licenses associated with First
International and $1,800,000 of reinsurance ceding commissions. Standard Life
realized a net pretax gain of $1,041,692 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 the majority of
First International's inforce business effective January 1, 1996.
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. The
inforce 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 at January 1, 1996, GIAC entered into a modified coinsurance
indemnity reinsurance agreement with Standard Life with respect to Blocks I and
II. Under the terms of the agreement, approximately $18,841,000 of Standard
Life's reserves were assumed from GIAC as of January 1, 1996. Standard Life
incurs experience rating refunds to GIAC on Block I. There is no experience
rating refund on Block II.
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, pursuant to an automatic coinsurance
indemnity reinsurance agreement. 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.
Standard Life received an administration fee of $316,000 for the year ended
December 31, 1996 from First International for the administration of the Block I
and Block II policies that were in force at the time of the sale of First
International.
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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 $155,856.
Standard Life terminated by recapture in May 1996 the reinsurance agreement
with National Mutual. Standard Life received assets of $5,200,554 and
liabilities of $4,953,055, primarily ordinary life policies. In connection with
this transaction, 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. This administration fee
income and premium income recorded in connection with the recapture 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 since 1989 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 $1,500,000 at December 31, 1996, 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 that are marketing
insurance products and that offer competing products such as savings accounts
and securities. 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.
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, an insurance rating organization. A rating of "B" or "B-" is assigned by
A.M. Best to companies which, in their opinion, have achieved adequate 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
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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 judgement 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, file separate federal income tax
returns. As of December 31, 1996, SMC, Standard Marketing and other U.S. non-
insurance subsidiaries had consolidated net operating loss carryforwards of
approximately $8,600,000 for tax return purposes which expire from 2005 to 2011.
At December 31, 1996, Standard Life had tax return net operating loss carry
forwards of approximately $1,400,000, which expire in 2004 and 2005. As a result
of changes in ownership of SMC and Standard Life, use of the loss carry forwards
of Standard Life are subject to annual limitations. The maximum tax return
operating loss carryforwards available for use by Standard Life in any one year
are approximately $300,000.
At December 31, 1996, Dixie National Life had tax return net operating loss
carryforwards of approximately $5,800,000, which expire in 2010 and 2011.
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, 1996, Premier Life (Luxembourg) had accumulated
corporate income tax loss carryforwards of approximately $5,900,000, 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.
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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 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)'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, 1996, there is an
unrealized gain from foreign currency translation adjustment of $691,000.
Due to the nature of unit-linked products issued by Standard Management
International, which represent over 91% 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 only bought and/or disposed of 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 they do 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,
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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 $150,000 during 1996 and
1995 for certain management services related to the production of business,
investment of assets and evaluation of acquisitions. Management service
agreements between Standard Life and Dixie National Life, which currently
require a monthly payment of $100,000 have been approved by the Mississippi
Department of Insurance. 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. The
management service agreement between Standard Management and Standard Life has
been renegotiated to increase the monthly fee to $166,667 (annual fee of
$2,000,000) in 1997. This amended management service agreement has been approved
by the Commissioner of the Indiana Department of Insurance.
Dividends by 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, 1996, Standard Life reported statutory net gain from
operations of $1,427,300, statutory surplus of $22,969,666 and unassigned
surplus of, $1,139,659. Standard Life anticipates paying dividends of
approximately $1,600,000 in 1997 and the approval of the Commissioner of the
Indiana Department of Insurance may be required. Standard Life has declared a
dividend of $1,000,000 to be paid in April 1997.
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.
Under Luxembourg law, 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 1996 and 1995 due to accumulated losses, and none are anticipated
in 1997. Premier Life (Bermuda) did not pay dividends in 1996 and 1995. Pursuant
to the management services agreement with Standard Management, Premier Life
(Luxembourg) paid Standard Management a management fee of $100,000 per year
during 1996 and 1995 for certain management and administrative services. The
agreement provides that it may be modified or terminated by either Standard
Management or Premier Life (Luxembourg).
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
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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, 1996, 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 $7,750,000 at
December 31, 1996 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 and Mississippi, 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 SMC's U.S. insurance subsidiaries are all in excess of 4 at
December 31, 1996. 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.
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 is not anticipated to 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,
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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, 1996 are summarized as follows:
MAXIMUM
AVR AVR IMR
--- ------- ---
(DOLLARS IN THOUSANDS)
Standard Life....................................... $3,553 $6,193 $8,418
Dixie National Life................................. 213 404 81
The annual addition to the AVR for 1996 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, 1996, 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. Standard Life and Dixie National Life were assessed,
and paid, $144,000 and $63,000 for the year ended December 31, 1996,
respectively. 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. The Mississippi Department of Insurance
concluded the Report of Examination of Dixie National Life for the period of
January 1, 1991 through December 31, 1994 on October 18, 1995 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
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McCarran-Ferguson Act purposes. Current and proposed federal measures which may
also significantly affect the insurance industry including removal of barriers
preventing banks from engaging in the insurance business.
EMPLOYEES
As of December 31, 1996, SMC had 87 employees: Standard Life had 55
employees, Standard Management International had 11 employees (3 of whom are
covered by a collective bargaining agreement), Standard Marketing had 11
employees, and Standard Management had 10 employees. Dixie National Life has no
current direct employees, which is consistent with SMC's management technique of
eliminating an acquired company's staff and replacing them with its own
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 March 15, 1996
for approximately 3,000 square feet in an office building located at 1, rue
Emile Bian, L-1235 Luxembourg, Luxembourg, under the terms of a lease which
expires on December 15, 1997.
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, 1997.
ITEM 3. LEGAL PROCEEDINGS
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
No matter was submitted to a vote of shareholders, through the solicitation
of proxies or otherwise, during the fourth quarter of 1996.
EXECUTIVE OFFICERS
The following table sets forth information concerning each of SMC's
executive officers:
NAME AGE POSITION
---- --- --------
Ronald D. Hunter..................... 45 Chairman of the Board, Chief Executive Officer and
President
Stephen M. Coons..................... 55 Executive Vice President, General Counsel and Secretary
Raymond J. Ohlson.................... 46 Executive Vice President and Chief Marketing Officer
John J. Quinn........................ 49 Executive Vice President, Chief Financial Officer and
Treasurer
Edward T. Stahl...................... 50 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),
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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 General Counsel and Executive Vice
President of SMC since March 1993 and has been Secretary of SMC since March
1994. Mr. Coons also has been a director of SMC since August 1989. He was of
counsel to the law firm of Coons, Maddox & Koeller from March 1993 to December
31, 1995. Prior to March 1993, Mr. Coons was a partner with the law firm of
Coons & Saint. He has been practicing law for 25 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.
JOHN J. QUINN: Mr. Quinn has served as Executive Vice President, Chief
Financial Officer and Treasurer of SMC since June 1993, and as a Director since
August 1993. For 24 years prior to June 1993, Mr. Quinn was employed by Ernst &
Young as an auditor specializing in the insurance industry. He was named Partner
in 1981 and was Chairman of Ernst & Young's Insurance Industry Practice in
Indiana from 1989 to 1993. Mr. Quinn is a CPA, a CLU and a Fellow of the Life
Management Institute ("FLMI"). Mr. Quinn has been appointed as the Commissioner
of the Indiana Department of Insurance. In connection with that appointment, he
gave notice in the first quarter of 1997 he will be terminating his employment
at SMC.
EDWARD T. STAHL: Mr. Stahl, has been an Executive Vice President of SMC
since its formation, has been a director of SMC since 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.
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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 28, 1997 there were approximately 3,200
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 trading
volume or the market price on SMC Common Stock.
SMC
COMMON STOCK
-------------------
HIGH LOW
---- ---
1995
Quarter ended March 31, 1995............................. $4.881 $2.857
Quarter ended June 30, 1995.............................. 4.881 3.571
Quarter ended September 30, 1995......................... 6.071 4.286
Quarter ended December 31, 1995.......................... 4.881 4.167
1996
Quarter ended March 31, 1996............................. 4.524 3.571
Quarter ended June 30, 1996.............................. 4.881 3.750
Quarter ended September 30, 1996......................... 5.500 4.000
Quarter ended December 31, 1996.......................... 5.375 4.000
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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, 1996, 1995, 1994, 1993 and 1992 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,
---------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
STATEMENT OF
OPERATIONS DATA:
Premium income............................ $10,468(d) $ 5,504 $ 4,565 $ 5,511 $ 4,140
Investment Activity:
Net investment income................... 20,871 18,517 16,057 12,171 9,406
Net realized investment gains........... 1,302 688 558 6,980 1,726
Total revenues............................ 40,682 30,238 26,518 26,542 15,873
Class action litigation and settlement
costs (credit).......................... -- (314) 4,018 47 --
Interest expense and financing costs...... 805 118 47 519 1,628
Total benefits and expenses............... 36,772(d) 28,682 30,032 22,099 17,228
Income (loss) before income taxes,
extraordinary gain (charge) and
cumulative effect of change in
accounting principle.................... 3,910 1,556 (3,514) 4,443(h) (1,354)(i)
Income (loss) before extraordinary gain
(charge) and cumulative effect of change
in accounting principle................. 4,512(e) 1,313 (3,436) 2,984(h) (1,289)(i)(j)
Net income (loss)......................... 5,014(f) 1,313 (3,436) 2,132 (1,400)(i)
PER SHARE DATA: (b)
Income (loss) per share before
extraordinary gain (charge) and
cumulative effect of change in
accounting principle.................... $0.88(e) $0.25 $(0.62) $0.74(h) $(0.74)(i)
Net income (loss)......................... $0.98(f) $0.25 $(0.62) $0.53(h) $(0.80)(i)
Weighted average number of common and
common equivalent shares outstanding.... 5,250,094 5,345,937 5,504,039 4,013,893 1,756,894
Book value per common share outstanding at
period end.............................. $7.99 $7.73 $4.27 $7.82 $3.22
Book value per common share outstanding,
excluding unrealized gain (loss) on
securities available for sale........... $8.14(g) $7.23(g) $6.81(g) $7.82 $3.22
Common shares outstanding at period end... 5,024,270 5,205,425 5,291,455 4,954,676 1,565,801
BALANCE SHEET DATA (AT PERIOD END):
Invested assets........................... $370,138 $280,597 $224,926 $199,413 $153,106
Assets held in separate accounts.......... 128,546 122,705 94,301 107,173 --
Total assets.............................. 628,788 479,598 373,524 354,431 197,860
Long-term debt, notes payable and capital
lease obligations....................... 20,697 4,191 695 -- 20,750
Class S Cumulative Convertible Redeemable
Preferred Stock......................... 1,757 -- -- -- --
Shareholders' equity...................... 40,166 40,242 22,610 36,914 4,807
Ratio of debt to total
capitalization(c)....................... 36% 9% 3% -- 81%
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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 First International at June 30, 1992, Standard
Management International effective December 31, 1993, Dixie National Life on
October 2, 1995 and Shelby Life effective November 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) All applicable shares and per share amounts have been restated to reflect
the May 17, 1996 5% stock dividend.
(c) Total capitalization is the sum of SMC's debt (long term debt, notes
payable, capital lease obligations and redeemable preferred stock) and
shareholders' equity.
(d) 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."
(e) Does not reflect extraordinary gain of $502 ($.10 per share) on early
redemption of Class S Preferred Stock.
(f) Does not reflect preferred stock dividends of $208 ($.03 per share) on Class
S Preferred Stock.
(g) 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 Statement of
Financial Accounting Standards 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.
(h) Before deduction of extraordinary charge of $1,301 ($.32 per share) on early
extinguishment on 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.
(i) Includes a $1,325 allowance for losses ($1,221 after taxes) to reflect the
fair value of property collateralizing a $3,200 mortgage loan which was
subsequently foreclosed.
(j) Before deduction of extraordinary charge of $110 ($.06 per share) to
write-off unamortized deferred debt issuance costs in connection with
retirement of previously outstanding debt.
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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 First International on July 10, 1992, Standard Management
International on December 15, 1993, Dixie National Life on October 2, 1995 and
Shelby Life on November 8, 1996. These acquisitions are accounted for using the
purchase method of accounting (effective June 30, 1992 for the First
International acquisition, December 31, 1993 for the Standard Management
International acquisition, October 2, 1995 for the Dixie National Life
acquisition and November 1, 1996 for the Shelby Life acquisition. Therefore,
these subsidiaries are included in the SMC Consolidated Financial Statements
commencing with their respective acquisition effective dates. SMC acquired a
block of insurance liabilities and assets from The Midwest Life Insurance
Company in Liquidation (the "Midwest Block") effective June 30, 1992, and it is
included in the SMC Consolidated Financial Statements commencing with that date.
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 but to increase or decrease earnings in
the period of the surrender to the extent surrender charges were applicable and
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 purchased First International, the Midwest Block, Dixie National Life and
Shelby Life, and recaptured a block of insurance from National Mutual on July
31, 1996, effective as of May 1, 1996 (the "National Mutual Block"), it assigned
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 was recorded when the business was 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.
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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, we consider 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 for SMC is summarized as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
Balance at beginning of year................................ $15,246 $ 8,299 $9,144
Additions during the year from acquisitions and
recaptures............................................. 10,723 7,901 --
Deletions during the year from disposal of subsidiaries... (733) -- --
Net amortization during the year.......................... (1,249) (780) (845)
Adjustments relating to net unrealized (gains) loss on
fixed maturities available for sale.................... 194 (174) --
------- ------- ------
Balance at end of year...................................... $24,181 $15,246 $8,299
======= ======= ======
The percentage of future expected net amortization 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, 1996 and
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current assumptions as to future events on all policies in force, will be
between 6% and 8% in each of the years 1997 through 2001.
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,
1996 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, Shelby Life and National Mutual acquisitions and
recaptures.
Acquisition of Blocks of Business. SMC's growth strategy includes the
acquisition of in force blocks of business through assumption reinsurance
agreements. The accounting recognition given these acquisitions is dependent
upon the type of business acquired. FPDAs and payout annuities are recorded at
full account value. Funds received are recorded as invested assets. The excess
of the liabilities assumed over assets received is recorded as the present value
of future profits and amortized in relation to expected gross profits.
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 $1,221,000, $1,142,000 and $262,000 for the years
ended December 31, 1996, 1995 and 1994, 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
$18,078,000 at December 31, 1996 and additions to policy acquisition costs of
$6,169,000 for business produced during the year ended December 31, 1996 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 1
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, 1996 and current assumptions, is as follows:
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Gross amortization................. $1,897 $1,938 $1,976 $1,932 $1,840
Interest accreted.................. (860) (750) (644) (551) (473)
------ ------ ------ ------ ------
Net amortization................... $1,037 $1,188 $1,332 $1,381 $1,367
====== ====== ====== ====== ======
The amounts included in the foregoing table do not include any amortization
of DAC resulting from the sale of new products after December 31, 1996. 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
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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 10.25% 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, 1996 TO YEAR ENDED DECEMBER 31, 1995
Operating Income. The income from operations (before net realized
investment gains, gain on disposal of subsidiaries and reduction in accruals of
certain legal expenses) was $1,421,000 in 1996, or $.29 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
to a loss of $(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 from operations in the United
States decreased to $203,000 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. Premium income is composed of premiums, including renewal
premiums, received on ordinary life insurance policies. As noted above, SMC's
new product sales are composed primarily of annuity products. Under GAAP,
deposits from interest-sensitive annuities and other financial products are not
recorded as revenues. 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 the years ended December 31, 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
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products were $51,254,000 for the year ended December 31, 1996 compared to
$37,614,000 for the year ended December 31, 1995. The increase is the result of
an aggressive marketing campaign implemented by Standard Life with increased
crediting interest rates. Also contributing to the increase in premiums is the
continued development of SMC's distribution system. Since SMC's operating income
is primarily a function of its investment spreads, 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.
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, 1996. Premium deposits ceded pursuant to
this reinsurance agreement reduced net premium deposits by $8,907,000 in the
year ended December 31, 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 the year ended December 31, 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 average net yield on
SMC's invested assets was 7.32% for both years ended December 31, 1996 and 1995.
The continued growth in SMC's total invested assets reflects increased sales of
FPDAs and the inclusion of Dixie National Life and Shelby Life in the results of
operations effective October 2, 1995 and November 1, 1996, respectively, which
was offset by the invested assets ceded in the GIAC reinsurance transaction.
Net Realized Investment Gains. Net realized investment gains increased
$614,000 or 89% to $1,302,000 from $688,000 for the years ended December 31,
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.
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 $11,493,000, including $1,500,000 for the charter and licenses
associated with First International and $1,800,000 of reinsurance ceding
commissions. 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 reinsurance and other agreements that include provisions for
Standard Life to administer First International policies in force at the date of
sale.
In an unrelated matter, 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
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 $2,306,000 after tax ($.44 per share) in the first quarter of 1996.
Policy Charges. Policy charges, which represent the amounts assessed
against policyholder account balances for the cost of insurance, policy
administration and surrenders, increased $84,000 or 3% to $2,551,000 for the
year ended December 31, 1996 compared to $2,467,000 for the year ended December
31, 1995. The increase in policy charges resulted from an increase in policy
surrender charges on FPDAs and the inclusion of Dixie National Life and Shelby
Life in operating results for periods after October 2, 1995 and November 1,
1996, respectively, which offset 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, 1996.
Amortization of Excess of Net Assets Acquired Over Acquisition
Cost. Amortization of excess of net assets acquired over acquisition cost
("negative goodwill") is recorded to amortize into earnings the negative
goodwill recorded in connection with the acquisition of Standard Management
International in 1993. The
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negative goodwill is being amortized on a straight-line basis over five years.
Amortization of negative goodwill was $1,388,000 for each of the years ended
December 31, 1996 and 1995.
Management Fees and Similar Income from Separate Accounts. Management fees
and similar income from separate accounts consists of the investment management
fees earned by Standard Management International on its separate account assets
and investment contracts. Management fees and similar income from separate
accounts increased $270,000 or 21% to $1,564,000 for the year ended December 31,
1996 from $1,294,000 for the year ended December 31, 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
fluctuations in 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 the years ended December 31, 1996 and 1995,
respectively.
Administration Fee Income. Administration fee income includes
administration fees of $316,000 and other income related to reinsurance and
administration agreements with GIAC and administration fees of $375,000
collected in connection with the terminated and recaptured reinsurance agreement
with National Mutual. The administration fee income from National Mutual
primarily related to services provided in prior years; the income was not
previously recorded due to uncertainty as to its collection. The National Mutual
fee income will not recur in the future. Administration fee income was $691,000
for the year ended December 31, 1996; there was no such income for 1995.
Other Income. Other income increased $581,000 or 153% to $961,000 for the
year ended December 31, 1996 compared to $380,000 for 1995. The increase
resulted primarily from the reserve and experience refund adjustments in
connection with the reinsurance agreements with GIAC and increased commissions
received by Standard Marketing from the sale of unaffiliated products.
Benefits and Claims. Benefits and claims include life insurance and payout
annuity benefits paid and changes in policy reserves. Benefits and claims
increased $4,128,000 or 71% to $9,919,000 for the year ended December 31, 1996
from $5,791,000 for the year ended December 31, 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 $11,281,000 for the year ended December 31, 1996, an increase of
$1,272,000 or 13% from $10,009,000 for the comparable prior year period. 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 acquisition of Shelby Life. At December 31, 1996, the
weighted average interest credited rate for Standard Life's annuities and other
financial product liabilities was 5.35% compared to 5.27% at December 31, 1995.
Salaries and Wages. Salaries and wages were $5,053,000 for the year ended
December 31, 1996, an increase of $352,000 or 7% from $4,701,000 for the
comparable prior year period. This increase was caused primarily by an increase
in the number and average wages of employees in the United States due to the
acquisitions of Dixie National Life and Shelby Life and the increase in
incentive compensation for the increase in income for the year ended December
31, 1996.
In the first quarter of 1997, the chief financial officer gave notice he
will be terminating his employment at SMC as he has been named Commissioner of
the Indiana Department of Insurance. The Company is currently discussing
benefits that may or may not be due to the officer. The amount of such benefits
cannot be determined at this time.
Amortization. Amortization expense includes charges to operations for the
amortization of deferred policy acquisition costs, the present value of future
profits, the excess of cost over net assets acquired and subsidiary organization
costs. Amortization expense increased $548,000 or 27% to $2,592,000 for the year
ended December 31, 1996 from $2,044,000 for the year ended December 31, 1995.
The increase in current
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34
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 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 and present value of future profits due to the
sale of First International.
Other Operating Expenses. Other operating expenses increased $789,000 or
12% to $7,122,000 for the year ended December 31, 1996 from $6,333,000 for the
year ended December 31, 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 the year ended December 31, 1996 from
$118,000 for the year ended December 31, 1995. The increase in interest expense
and financing costs during 1996 resulted primarily from the borrowing on an
Amended Revolving Line of Credit Agreement with a bank ("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 repurchase of Common Stock and Class S
Preferred Stock.
Class Action Litigation and Settlement Costs. Class action litigation and
settlement costs were recorded to reflect the estimated costs of litigation and
settlement of the shareholder class action lawsuit, based on the terms of the
settlement agreement and assumptions as to the future estimated legal and other
costs to settle the lawsuit, which was settled in March 1995, and to register
the Class S Preferred Stock which was distributed to the class participants in
February 1996. There were no class action litigation and settlement expenses in
the years ended December 31, 1996 and 1995. However, with the signing of the
Settlement Agreement with the 22 persons who previously excluded themselves from
the class and the reevaluation of the future estimated legal and other costs to
settle the lawsuit, SMC recorded a reduction of $314,000 in the second quarter
of 1995 in the estimated future costs to settle the lawsuit and register the
Class S Preferred Stock.
Federal Income Taxes. Federal income tax expense (credit) was $(602,000)
for the year ended December 31, 1996, compared to $243,000 for the year ended
December 31, 1995. The large credit in 1996 is primarily due to tax benefits of
$1,420,000 related to the sale of First International. Also, the effective rates
are less than the statutory rates primarily because the amortization of excess
of net assets acquired over acquisition cost resulting from the acquisition of
Standard Management International is not subject to United States income tax.
Extraordinary Gain on Early Redemption of Redeemable Preferred
Stock. Extraordinary gains are recorded on the early redemption of the Class S
Preferred Stock for the amount by which SMC is able to repurchase the Class S
Preferred Stock below its book value. SMC will continue to repurchase these
shares as long as holders of the Class S Preferred Stock are willing to sell at
a substantial discount to book value. The extraordinary gain was $502,000 for
the year ended December 31, 1996 compared to no gain for the prior comparable
period.
DISCUSSION OF CHANGES IN THE CONSOLIDATED STATEMENT OF OPERATIONS FROM YEAR
ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994
Operating Income. The income from operations (before net realized
investment gains and class action litigation and settlement costs) increased to
$461,000 or $.09 per share from $293,000 or $.06 per share for 1995 and 1994,
respectively. The increase resulted from U.S. operations producing income from
operations of $483,000 compared to a U.S. loss from operations of $(720,000) for
1995 and 1994, respectively. The U.S. operating gains resulted primarily from
increased interest spreads on an increasing asset base due to annuity sales in
1995 and 1994. The improvement in U.S. operations was offset by a decline in
international income
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from operations from $1,013,000 in 1994 to a loss of $(22,000) in 1995 as the
costs of resuming marketing were absorbed.
Premium Income. GAAP premium income for 1995 was $5,504,000, an increase of
21% from $4,565,000 for 1994. Increase in premium income resulted primarily from
the inclusion of Dixie National Life in the results of operations effective
October 2, 1995.
Net premiums received from the sales of interest-sensitive annuities and
other financial products (which are not recorded as revenues) were $17,524,000
for the year ended December 31, 1995 compared to $53,490,000 for the year ended
December 31, 1994. The decline is partially due to increased competitive
pressures. To protect its profit margins, SMC was not willing to match other
insurers' high interest crediting and commission rates which caused a decrease
in gross domestic premium deposits of $15,876,000 in 1995 when compared to 1994.
Additionally, Standard Life began ceding a portion of its new annuity business
to an unaffiliated reinsurer effective January 1, 1995. Premium deposits ceded
pursuant to the reinsurance agreement with the reinsurer reduced net premiums by
$20,090,000 for 1995. There was no such reinsurance in 1994.
Net Investment Income. Net investment income increased 15% to $18,517,000
in 1995 from $16,057,000 in 1994. This increase primarily resulted from growth
in SMC's total invested assets attributable to the increased sales of FPDAs in
1994 and the inclusion of Dixie National Life in the results of operations
effective October 2, 1995. The amortized cost of total invested assets increased
12% to $274,148,000 in 1995 from $245,619,000 in 1994. These increased assets
also benefited from a higher concentration of investments in fixed maturity
securities. The average annualized yield of SMC's investment portfolio for the
year ended December 31, 1995 increased to 7.32% from 7.26% for 1994.
Net Realized Investment Gains. Net realized investment gains increased 23%
to $688,000 in 1995 from $558,000 in 1994. 1995 results reflect increased gains
on sales of investments due to rising values of fixed maturity securities as
interest rate levels decreased, combined with active portfolio management. Net
realized 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 of the investment portfolio.
Policy Charges. Policy charges increased 21% to $2,467,000 for 1995
compared to $2,031,000 for 1994. The increase in universal life policy charges
resulted from increased surrender charges on interest-sensitive annuity products
and the inclusion of Dixie National Life in operating results for periods after
October 2, 1995.
Amortization of Excess of Net Assets Acquired Over Acquisition
Cost. Amortization of negative goodwill increased 31% to $1,388,000 for 1995
compared to $1,063,000 for 1994 due to a reallocation of the purchase price in
the fourth quarter of 1994 which increased negative goodwill.
Management Fees and Similar Income from Separate Accounts. Management fees
and similar income from separate accounts decreased 32% to $1,294,000 in 1995
from $1,888,000 in 1994. This decrease is due to a change in the mix of the
types of separate accounts whereby those earning higher investment management
fees represent a significantly smaller portion of the total in 1995 than in
1994. Most of the new policies sold in 1995 carried significantly smaller
investment management fees than the policies lapsed or surrendered in 1995. Net
deposits from sales of unit-linked products by Standard Management International
were $31,793,000 in 1995 and $1,715,000 in 1994.
Other Income. Other income includes primarily override commissions received
by Standard Marketing from unaffiliated companies and other income recorded by
Standard Management International. Other income increased 7% to $380,000 for
1995 from $356,000 in 1994. The increase primarily resulted from commissions
from the sale of unaffiliated products and to a lesser extent the inclusion of
Dixie National Life in the results of operations after October 2, 1995. These
increases more than offset any loss of fee income generated by Standard
Advertising which was sold in early 1995.
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Benefits and Claims. Benefits and claims increased 3% to $5,791,000 for
1995 from $5,603,000 for 1994. The increase in benefits and claims resulted
primarily from an increase in death benefits in 1995 when compared to the
favorable mortality experience in 1994. Mortality experience is volatile and
these trends are not predictable from period to period.
Interest Credited on Interest-Sensitive Annuities and Other Financial
Products. Interest credited on interest-sensitive annuities and other financial
products was $10,009,000 for 1995, an increase of $1,333,000 or 15% from
$8,676,000 for the prior year. The increase resulted primarily from increases in
interest credited from the growth in policy reserves for FPDAs. This more than
offsets any decreases from the decline in credited interest rates on
interest-sensitive annuities and other financial products. At December 31, 1995,
the weighted average interest credited rate for Standard Life's
interest-sensitive annuities and other financial product liabilities was 5.27%
compared to 5.82% at December 31, 1994.
Salaries and Wages. Salaries and wages were $4,701,000 for 1995, an
increase of 20% from $3,910,000 for the prior year. This increase was caused by
$185,000 of unusual charges due to the termination of certain international
marketing programs and the subsequent reduction of SMC's staff in Luxembourg in
1995, the capitalization of certain salaries of $203,000 associated with the
internal development of computer software in 1994, increased salaries for new
marketing efforts for Standard Management International in 1995 and the
inclusion of Dixie National Life in the results of operations for periods after
October 2, 1995. Additionally, the average wages per employee increased in 1995.
Amortization. Amortization expense for 1995 was $2,044,000, an increase of
$829,000, or 68%, from $1,215,000 for the prior year. 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 from the amortization of present value of future profits for
the acquisition of Dixie National Life, which more than offset reduced
amortization of present value of future profits on previous acquisitions as
persistency of the purchased business begins to improve.
Other Operating Expenses. Other operating expenses for the year ended
December 31, 1995 were $6,333,000, reflecting a decrease of 4%, compared to
$6,563,000 for the year ended December 31, 1994. The decrease in other operating
expenses resulted primarily from decreases in consulting, legal and other
expenses related to potential acquisitions and the sale of Standard Advertising
in early 1995, which more than offset the increased expenses of operating Dixie
National Life from October 2, 1995 to December 31, 1995.
Interest Expense and Financing Costs. Interest expense and financing costs
increased 151% to $118,000 in 1995 from $47,000 in 1994. The increase in
interest expense during 1995 resulted primarily from the payments on the capital
lease obligations.
Class Action Litigation and Settlement Costs. SMC recorded a reduction of
$314,000 in 1995 in the estimated future costs to settle the lawsuit and list
the Class S Preferred Stock.
Federal Income Taxes. Federal income tax expense was $243,000 for 1995,
compared to a credit of $(78,000) for 1994. The effective rate of 16% is less
than the statutory rate of 34% primarily because the amortization of excess of
net assets acquired over acquisition cost resulting from the acquisition of
Standard Management International is not subject to United States income tax.
SMC receives the benefits of a special deduction available to small life
insurance companies and the utilization of capital and operating loss carry
forwards in the life insurance subsidiaries. However, the losses incurred by
Standard Management and the foreign subsidiaries, primarily due to class action
litigation and settlement costs, and operating costs in excess of management
fees, provide no current tax benefit as Standard Management and the foreign
subsidiaries are in a net operating loss carryforward position. The benefits of
the special deduction available to small life insurance companies will no longer
be available when consolidated assets exceed $500,000,000.
LIQUIDITY AND CAPITAL RESOURCES
Standard Management is an insurance 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
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as Standard Management 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 $1,726,000 and $6,331,000 for the years ended December 31, 1996 and 1995,
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 $26,717,000 and $6,003,000 for the years ended December 31, 1996
and 1995, respectively. Cash generated on a consolidated basis is available to
the parent company only to the extent that it is generated at the parent company
level or is available to the parent company through dividends, 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 979,453 shares
of SMC Common Stock for $4,747,000 as of December 31, 1996. The repurchases in
1996 have been paid for through additional borrowing under the Amended Credit
Agreement. At December 31, 1996, Standard Management was authorized to purchase
an additional 771,771 shares under this program. Standard Management implemented
a policy to issue shares for the exercise of stock options from treasury stock.
Standard Management has reissued 1,224 shares in 1996 under this program at a
cost of $6,000.
In February 1996, Standard Management 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 transactions. As of December 31, 1996,
Standard Management had repurchased and retired 140,111 shares of its Class S
Preferred Stock for $949,000.
At December 31, 1996, Standard Management had "parent company only" cash
and short-term investments of $1,024,000. These funds are available to Standard
Management for general corporate purposes. Standard Management's "parent company
only" operating expenses (not including class action litigation and settlement
costs and interest expense) were $3,470,000 and $2,793,000 for the years ended
December 31, 1996 and 1995, respectively.
Pursuant to the management services agreement with Standard Management,
Standard Life paid Standard Management a monthly fee of $150,000 during 1996 and
1995 for certain management services related to the production of business,
investment of assets and evaluation of acquisitions. Management service
agreements between Standard Life and Dixie National Life have been approved by
the Mississippi Department of Insurance which currently requires a monthly
payment of $100,000 from Dixie National Life to Standard Life. Both of these
agreements provide that they may be modified or terminated by the department of
insurance in the event of financial hardship of Standard Life or Dixie National
Life. The management service agreement between Standard Management and Standard
Life for 1997 has been renegotiated to increase the monthly fee to $166,667
(annual fee of $2,000,000) in 1997. This amended management service agreement
has been approved by the Commissioner of the Indiana Department of Insurance.
Pursuant to the management services agreement with Standard Management,
Premier Life (Luxembourg) paid Standard Management a management fee of $25,000
per quarter during 1996 and 1995 for certain management and administrative
services. The agreement provides that it may be modified or terminated by either
Standard Management or Premier Life (Luxembourg). Standard Management does not
plan to modify this agreement in 1997.
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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 of $77,000 for this equipment and additional equipment
purchased after April 1, 1995.
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
$16,000,000 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
60,000 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 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 statutory surplus
requirements for the insurance subsidiaries, minimum consolidated equity
requirements for Standard Management and certain investment and indebtedness
limitations. At December 31, 1996, Standard Management had borrowed $16,000,000
under the Amended Credit Agreement at a weighted average interest rate of
8.849%. SMC anticipates increasing the Amended Credit Agreement to $20,000,000
to finance the acquisition of Savers Life.
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 and requires interest
payments in cash at 12% per annum, or, if Standard Management chooses, in
non-cash additional subordinated convertible debt notes at 14% per annum until
December 31, 2000. The subordinated convertible notes are convertible into SMC
Common Stock at the rate of $6.00 per share through November 1997, and $5.75 per
share thereafter. Standard Management may prepay the subordinated convertible
debt with not less than thirty days notice at any time. The subordinated
convertible debt agreement contains terms and financial covenants substantially
similar to those in the Amended Credit Agreement.
Assuming the continuation of current level of debt under the Amended Credit
Agreement ($16,000,000) and current interest rates at December 31, 1996
(weighted average rate of 8.849%) and assuming Standard Management elects the
non-cash interest payment option under the subordinated convertible debt, annual
debt service in 1997 would be approximately $1,416,000 in interest paid on the
Amended Credit Agreement. In addition, Standard Management has 1997 obligations
under a capital lease of $539,000.
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
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December 31, 1996 interest rate of 10.25% continues in 1997, Standard Management
will receive interest income of $1,332,500 from the Surplus Debenture for 1997.
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 Indiana 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 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, 1996, Standard Life reported statutory net gain from operations of
$1,427,000, statutory surplus of $22,969,666 and unassigned surplus of
$1,139,659. Standard Life anticipates paying dividends of approximately
$1,600,000 in 1997 and the approval of the Indiana Commissioner of Insurance may
be required. Standard Life has declared a dividend of $1,000,000 to be paid in
April 1997.
Standard Management anticipates the available cash from its existing
working capital, plus anticipated 1997 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
1997.
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 and
management fee 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 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 statutory loss ("surplus strain") from many
insurance products in the year they are issued. SMC designs its products to
minimize such first-year losses, but certain products
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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
statutory 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, equity sales, 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 issuance of new policies.
During 1996, Standard Life produced a statutory net income of $3,291,000.
As a result, Standard Management has not made cash capital contributions to
Standard Life during 1996 to maintain adequate levels of statutory capital and
surplus. 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.
In order to be able to write volumes of business that it would not
otherwise have been able to write due to regulatory restrictions based on the
amount of its statutory capital and surplus commencing January 1, 1995, Standard
Life began to reinsure a portion of its annuity business. Standard Life's
largest annuity reinsurer at December 31, 1996, 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. 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 1997. As of December 31, 1996,
Standard Life had statutory capital and surplus for regulatory purposes of
$22,969,666 compared to $12,876,960 at December 31, 1995. 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. During 1996, Standard Management did not
make any capital contributions to Standard Life, other than the Common Stock
associated with the Shelby Merger. Net cash flow from operations on a statutory
basis of Standard Life, after payment of benefits and operating expenses, was
$17,921,422 and $4,263,011 for the years ended December 31, 1996 and December
31, 1995, 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 "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 a 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 statutory 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. The statutory
net
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income of Shelby Life was $1,660,855 for the year ended December 31, 1995 and
$851,472 for the ten months ended October 31, 1996.
International Operations. The consolidated balance sheet of SMC at December
31, 1996, includes a $2,775,000 credit representing the excess of net assets
acquired over acquisition cost on the purchase of Standard Management
International which will be amortized into future earnings. 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 1996 and 1995
due to accumulated losses. Premier Life (Bermuda) did not pay dividends in 1996
and 1995. SMC does not anticipate any dividends from these companies in 1997.
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 only bought and/or disposed of 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 mis-matches are then covered
by adjusting the securities in the investment portfolio as appropriate.
Pending Acquisition. SMC's pending purchase of Savers Life will cost
approximately $14,200,000, of which approximately $4,000,000 is to be borrowed
in cash under the Amended Credit Agreement. The balance of the purchase price
will be paid in shares of Common Stock.
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)'s shareholder'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, 1996, there was an unrealized
gain from foreign currency translation adjustment of $691,000.
Uncertainties Regarding Intangible Assets. Included in SMC's financial
statements as of December 31, 1996 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, 1996 consolidated balance sheet aggregated $42,198,000 or 7% of
SMC's assets. SMC has established procedures to periodically review the
assumptions utilized to value these
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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, 1996.
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.
Accounting Pronouncements. Effective January 1, 1996, SMC adopted SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123 requires expanded
disclosures of stock-based compensation arrangements with employees and
encourages, but does not require, compensation cost to be measured based on the
fair value of the equity instruments awarded. Companies are permitted, however,
to continue to apply Accounting Principles Board (APB) Opinion No. 25, which
recognizes compensation cost based on the intrinsic value of the equity
instrument awarded. SMC will continue to apply APB Opinion No. 25 to its
stock-based compensation awards to employees and directors and will disclose the
required pro forma effect on net income and earnings per share in its
consolidated financial statements for the year ended December 31, 1996.
Safe Harbor Provisions. Forward-looking statements in this Annual Report on
Form 10-K are made pursuant to the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. There are certain important factors
that could cause results to differ materially from those anticipated by some of
the statements made above. Investors are cautioned that all forward-looking
statements involve risks and uncertainty. In addition to the factors discussed
above, among the other factors that could cause actual results to differ
materially are the following: economic environment, interest rate changes,
product development, regulatory changes, the results of financing efforts, SMC's
accounting policies, competition, the reinsurance agreement with GIAC and the
acquisitions of Shelby Life and Savers Life.
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 1997 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 Statement 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 of the Registrant."
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.
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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 RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to SMC's
Proxy Statement.
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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 31, 1997
STANDARD MANAGEMENT CORPORATION
/s/ 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 31, 1997 by the following persons on
behalf of the Registrant and in the capacities indicated.
/s/ RONALD D. HUNTER Chairman, President and Chief Executive Officer
- ------------------------------------------ (Principal executive officer)
Ronald D. Hunter
/s/ JOHN J. QUINN Director, Executive Vice President,
- ------------------------------------------ Treasurer and Chief Financial Officer
John J. Quinn (Principal financial officer)
/s/ RAYMOND J. OHLSON Director
- ------------------------------------------
Raymond J. Ohlson
/s/ EDWARD T. STAHL Director
- ------------------------------------------
Edward T. Stahl
/s/ STEPHEN M. COONS Director
- ------------------------------------------
Stephen M. Coons
/s/ MARTIAL R. KNIESER Director
- ------------------------------------------
Martial R. Knieser
/s/ RAMESH H. BHAT Director
- ------------------------------------------
Ramesh H. Bhat
/s/ JAMES C. LANSHE Director
- ------------------------------------------
James C. Lanshe
Director
- ------------------------------------------
Robert A. Borns
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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:
The exhibits set forth in the accompanying Exhibit Index are filed as a
part of this report.
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
10.8
10.9
10.19
(b) Reports on Form 8-K filed during the fourth quarter of 1996.
The Company did not file a Current Report on Form 8-K during the fourth
quarter of 1996.
44
46
STANDARD MANAGEMENT CORPORATION
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
PAGE
----
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Report of Management........................................ F-2
Report of Independent Auditors.............................. F-3
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... F-5
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994.......................... F-6
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1996, 1995 and 1994.............. F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994.......................... F-8
Notes to Consolidated Financial Statements.................. F-9
FINANCIAL STATEMENT SCHEDULES:
The following consolidated financial statement schedules are
included as part of this Report and should be used in
conjunction with the Audited Consolidated Financial
Statements.
Schedule II -- Condensed Financial Information of Registrant
(Parent Company) for the years ended December 31, 1996,
1995 and 1994............................................. F-34
Schedule IV -- Reinsurance for the years ended December 31,
1996, 1995 and 1994....................................... F-39
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.
F-1
47
REPORT OF MANAGEMENT
To Our Shareholders
The management of Standard Management Corporation is responsible for the
reliability of the financial information appearing in this Annual Report. The
consolidated financial statements are prepared by management in accordance with
generally accepted accounting principles and the other financial information in
this Annual Report is consistent with that in the consolidated financial
statements.
The integrity of the financial information relies in large part on
maintaining a system of internal control that is established by management to
provide reasonable assurance that assets are safeguarded and transactions are
properly authorized, recorded and reported. Reasonable assurance is based upon
the premise that the cost of controls should not exceed the benefits derived
from them.
Certain financial information presented depends upon management's estimates
and judgments regarding the ultimate outcome of transactions which are not yet
complete. Management believes these estimates and judgments are fair and
reasonable in view of present conditions and available information.
The Company engages independent auditors to audit its consolidated
financial statements and express their opinion thereon. They have full access to
each member of management in conducting their audits. Such audits are conducted
in accordance with generally accepted auditing standards and include a review of
internal controls, tests of the accounting records, and such other auditing
procedures as they consider necessary to express an opinion on the Company's
consolidated financial statements.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with management and the independent auditors to
review the system of internal control, audit activities and financial reporting
matters. The independent auditors have full and free access to the Audit
Committee to discuss the results of their audit work and their views on
accounting policies, the adequacy of internal accounting controls and the
quality of financial reporting.
Ronald D. Hunter
Chairman of the Board,
President and
Chief Executive Officer
John J. Quinn
Executive Vice President,
Chief Financial Officer
and Treasurer
F-2
48
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Standard Management Corporation
We have audited the accompanying consolidated balance sheets of Standard
Management Corporation as of December 31, 1996 and 1995, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1996. Our audits also
included the financial statement schedules listed in the Index at Item 14(a).
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, 1996 and 1995 or the consolidated statements of
operations, shareholder's equity and cash flows for the three years ended
September 30, 1996 of Standard Management International S.A. and subsidiaries, a
wholly owned subsidiary group, which financial statements reflect assets
totaling approximately 23% and 28% of the Company's consolidated assets at
December 31, 1996 and 1995 and revenues totaling approximately 9%, 12% and 14%
of consolidated revenues for each of the three years in the period ended
December 31, 1996. Those financial statements, which as explained in Note 1 are
included in the Company's consolidated balance sheets at December 31, 1996 and
1995, and the Company's consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1996, 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 at
December 31, 1996 and 1995, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31, 1996
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
March 18, 1997
F-3
49
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Standard Management International S.A.
We have audited the accompanying consolidated balance sheets of Standard
Management International S.A. and subsidiaries as at September 30, 1996 and 1995
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, 1996.
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 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, 1996 and
1995, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended September 30, 1996 in conformity
with generally accepted accounting principles in the United States of America.
Luxembourg City, Luxembourg
March 12, 1997
KPMG Audit
F-4
50
STANDARD MANAGEMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
--------------------
1996 1995
---- ----
ASSETS
Investments:
Securities available for sale:
Fixed maturity securities, at fair value
(amortized cost: $349,151 in 1996 and $225,643 in
1995).................................................. $347,310 $232,092
Equity securities, at fair value (cost: $58 in 1996 and
$52 in 1995)........................................... 62 52
Mortgage loans on real estate, at unpaid principal
balances................................................ 3,035 2,963
Policy loans, at unpaid principal balances................ 9,903 8,509
Real estate, at cost less accumulated depreciation of $91
in 1996 and $81 in 1995................................. 546 556
Other invested assets..................................... 865 1,367
Short-term investments, at cost, which approximates fair
value................................................... 8,417 35,058
-------- --------
Total investments..................................... 370,138 280,597
Cash........................................................ 5,113 5,762
Accrued investment income................................... 6,198 4,637
Amounts due and recoverable from reinsurers................. 68,811 33,419
Deferred policy acquisition costs........................... 18,078 10,054
Present value of future profits, less accumulated
amortization of $3,520 in 1996 and
$2,803 in 1995............................................ 24,181 15,246
Excess of acquisition cost over net assets acquired, less
accumulated amortization of
$314 in 1996 and $393 in 1995............................. 2,260 3,175
Other assets................................................ 5,463 4,003
Assets held in separate accounts............................ 128,546 122,705
-------- --------
Total assets.......................................... $628,788 $479,598
======== ========
LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Future policy benefits:
Interest-sensitive annuities and other financial
products............................................... $333,633 $212,500
Traditional life insurance.............................. 87,106 82,762
-------- --------
Total future policy benefits.......................... 420,739 295,262
Policy claims and other policyholders' benefits and
funds................................................... 4,585 2,572
-------- --------
425,324 297,834
Accounts payable and accrued expenses..................... 6,189 4,880
Class action litigation and settlement liability.......... -- 3,000
Obligations under capital lease........................... 637 1,084
Notes payable............................................. 20,060 3,107
Deferred federal income taxes............................. 3,334 2,583
Excess of net assets acquired over acquisition cost, less
accumulated amortization of
$3,839 in 1996 and $2,451 in 1995....................... 2,775 4,163
Liabilities related to separate accounts.................. 128,546 122,705
-------- --------
Total liabilities..................................... 586,865 439,356
Class S Cumulative Convertible Redeemable Preferred Stock,
par value $10 per share:
Authorized 300,000 shares; issued and outstanding
159,889 shares......................................... 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
Issued 5,752,499 shares in 1996 and 5,459,573 in 1995... 40,481 39,808
Treasury stock, at cost, 728,229 shares in 1996 and
502,025 shares in 1995 (deduction)...................... (3,528) (2,621)
Unrealized gain (loss) on securities available for sale... (746) 2,582
Foreign currency translation adjustment................... 691 1,159
Retained earnings (deficit)............................... 3,268 (686)
-------- --------
Total shareholders' equity............................ 40,166 40,242
-------- --------
Total liabilities, redeemable securities and
shareholders' equity................................. $628,788 $479,598
======== ========
See accompanying notes to consolidated financial statements.
F-5
51
STANDARD MANAGEMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
---- ---- ----
Revenues:
Premium income............................................ $10,468 $ 5,504 $ 4,565
Net investment income..................................... 20,871 18,517 16,057
Net realized investment gains............................. 1,302 688 558
Gain on disposal of subsidiaries.......................... 886 -- --
Policy charges............................................ 2,551 2,467 2,031
Amortization of excess of net assets acquired over
acquisition cost....................................... 1,388 1,388 1,063
Management fees and similar income from separate
accounts............................................... 1,564 1,294 1,888
Administration fee income................................. 691 -- --
Other income.............................................. 961 380 356
--------- --------- ---------
Total revenues....................................... 40,682 30,238 26,518
Benefits and expenses:
Benefits and claims....................................... 9,919 5,791 5,603
Interest credited on interest-sensitive annuities and
other
financial products..................................... 11,281 10,009 8,676
Salaries and wages........................................ 5,053 4,701 3,910
Amortization.............................................. 2,592 2,044 1,215
Other operating expenses.................................. 7,122 6,333 6,563
Interest expense and financing costs...................... 805 118 47
Class action litigation and settlement costs (credit)..... -- (314) 4,018
--------- --------- ---------
Total benefits and expenses.......................... 36,772 28,682 30,032
--------- --------- ---------
Income (loss) before federal income taxes, extraordinary
gain on early redemption of redeemable preferred stock and
preferred stock dividends................................. 3,910 1,556 (3,514)
Federal income tax expense (credit)......................... (602) 243 (78)
--------- --------- ---------
Income (loss) before extraordinary gain on early redemption
of redeemable preferred stock and preferred stock
dividends................................................. 4,512 1,313 (3,436)
Extraordinary gain on early redemption of redeemable
preferred stock, net of $-- federal income tax............ 502 -- --
--------- --------- ---------
NET INCOME (LOSS)........................................... 5,014 1,313 (3,436)
Preferred stock dividends................................... 208 -- --
--------- --------- ---------
Earnings available to common shareholders................... $ 4,806 $ 1,313 $(3,436)
========= ========= =========
Earnings per share:
Income (loss) before extraordinary gain on early
redemption of redeemable preferred stock and preferred
stock dividends........................................ $.88 $.25 $(.62)
Extraordinary gain........................................ .10 -- --
--------- --------- ---------
NET INCOME (LOSS)......................................... .98 .25 (.62)
Preferred stock dividends................................. .03 -- --
--------- --------- ---------
Earnings available to common shareholders................. $.95 $.25 $(.62)
========= ========= =========
Weighted average number of common and common equivalent
shares outstanding........................................ 5,250,094 5,345,937 5,504,039
========= ========= =========
See accompanying notes to consolidated financial statements.
F-6
52
STANDARD MANAGEMENT CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
AMOUNTS NUMBER OF SHARES
---------------------------- ---------------------------------
1996 1995 1994 1996 1995 1994
---- ---- ---- ---- ---- ----
Common Stock:
Balance, beginning of year.............. $39,808 $39,695 $ 36,348 5,459,573 5,457,906 4,820,739
Issuance of common stock.............. 100 -- -- 20,000 -- --
5% common stock dividend.............. 850 -- -- 272,926 -- --
Issuance of common stock warrants..... 285 107 -- -- -- --
Repurchase of common stock warrants... (600) -- -- -- -- --
Gain on reissuance of treasury stock
in connection with purchase of
Shelby Life........................ 38 -- -- -- -- --
Issuance of common stock in connection
with exercise of stock options..... -- 6 -- -- 1,667 --
Issued in connection with the offshore
offering at an average per share
price of $5.85 in 1994 less $382 in
1994 in related issuance costs..... -- -- 3,347 -- -- 637,167
------- ------- -------- --------- --------- ---------
Balance, end of year.................... 40,481 39,808 39,695 5,752,499 5,459,573 5,457,906
------- ------- -------- --------- --------- ---------
Treasury stock (at cost):
Balance, beginning of year.............. (2,621) (2,221) (867) (502,025) (418,425) (102,000)
Treasury stock acquired............... (2,126) (400) (1,354) (431,026) (83,600) (316,425)
5% common stock dividend.............. -- -- -- (46,402) -- --
Reissuance of treasury stock in
connection with exercise of stock
options............................ 6 -- -- 1,224 -- --
Reissuance of treasury stock in
connection with purchase of Shelby
Life............................... 1,213 -- -- 250,000 -- --
------- ------- -------- --------- --------- ---------
Balance, end of year.................... (3,528) (2,621) (2,221) (728,229) (502,025) (418,425)
------- ------- -------- --------- --------- ---------
Unrealized gain (loss) on securities:
Balance, beginning of year.............. 2,582 (13,411) (4)
Change in unrealized gain (loss) on
securities available for sale,
net................................ (3,328) 15,993 (14,538)
Cumulative effect of adoption of SFAS
No. 115 as of January 1, 1994 (net
of deferred federal income taxes of
$583).............................. -- -- 1,131
------- ------- --------
Balance, end of year.................... (746) 2,582 (13,411)
------- ------- --------
Foreign currency translation adjustments:
Balance, beginning of year.............. 1,159 546 --
Translation adjustments for the
year............................... (468) 613 546
------- ------- --------
Balance, end of year.................... 691 1,159 546
------- ------- --------
Retained earnings (deficit):
Balance, beginning of year.............. (686) (1,999) 1,437
Net income (loss)..................... 5,014 1,313 (3,436)
5% common stock dividend, plus cash in
lieu of fractional shares.......... (850) -- --
Loss on reissuance of treasury
stock.............................. (2) -- --
Preferred stock dividend.............. (208) -- --
------- ------- --------
Balance, end of year.................... 3,268 (686) (1,999)
------- ------- --------
Total shareholders' equity and common
shares outstanding...................... $40,166 $40,242 $ 22,610 5,024,270 4,957,548 5,039,481
======= ======= ======== ========= ========= =========
See accompanying notes to consolidated financial statements.
F-7
53
STANDARD MANAGEMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
---- ---- ----
OPERATING ACTIVITIES
Net income (loss)........................................... $ 5,014 $ 1,313 $ (3,436)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Amortization of deferred policy acquisition costs......... 1,221 1,142 262
Policy acquisition costs deferred......................... (6,169) (1,863) (5,462)
Class action litigation and settlement liability.......... -- (655) 3,655
Deferred federal income taxes............................. 286 353 (80)
Depreciation and amortization............................. 544 78 513
Future policy benefits and reinsurance recoverable........ 4,143 6,533 2,490
Policy claims and other policyholders' benefits and
funds................................................... 642 (260) (33)
Net realized investment gains............................. (1,302) (688) (558)
Accrued investment income................................. (770) 347 (1,226)
Extraordinary gain on early redemption of redeemable
preferred stock......................................... (502) -- --
Other..................................................... (1,381) 31 1,097
--------- --------- ---------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES...... 1,726 6,331 (2,778)
FINANCING ACTIVITIES
Issuance of Common Stock, net............................... -- 6 3,347
Borrowings, net of debt issuance costs of $208 in 1996 and
$81 and 1995.............................................. 16,792 2,923 --
Repayments on long-term debt and capital lease obligation... (491) (353) --
Short-term borrowings, net.................................. -- (550) 550
Premiums received on interest-sensitive annuities and other
financial products credited to policyholder account
balances, net of premiums ceded........................... 42,347 17,524 53,490
Return of policyholder account balances on
interest-sensitive annuities and other financial products,
net of premiums ceded..................................... (17,356) (17,852) (10,922)
Redemption of redeemable preferred stock.................... (949) -- --
Repurchase of Common Stock warrants......................... (600) -- --
Proceeds from common and treasury stock sales............... 100 -- --
Purchase of Common Stock for treasury....................... (2,126) (400) (1,353)
--------- --------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES............. 37,717 1,298 45,112
INVESTING ACTIVITIES
Fixed maturity securities available for sale:
Purchases................................................. (249,638) (183,183) (307,358)
Sales..................................................... 194,244 191,477 253,773
Maturities................................................ 10,254 7,812 3,768
Purchase of Shelby Life Insurance Company, less cash
acquired of $32........................................... (14,618) -- --
Dividends paid by Shelby Life Insurance Company to former
parent.................................................... (3,000) -- --
Purchase of Dixie National Life Insurance Company, less cash
acquired of $4,626........................................ -- (3,393) --
Purchase of Standard Management International, less cash
acquired of $314.......................................... -- -- (67)
Short-term investments, net................................. 11,890 (21,662) 2,104
Other investments, net...................................... (551) 4,082 763
Proceeds from sale of property and equipment under capital
lease..................................................... -- 1,396 --
Proceeds from sale of First International Life Insurance
Company, less cash transferred to seller of $265.......... 11,327 -- --
--------- --------- ---------
NET CASH USED BY INVESTING ACTIVITIES................. (40,092) (3,471) (47,017)
--------- --------- ---------
Net increase (decrease) in cash............................. (649) 4,158 (4,683)
Cash at beginning of year................................... 5,762 1,604 6,287
--------- --------- ---------
CASH AT END OF YEAR......................................... $ 5,113 $ 5,762 $ 1,604
========= ========= =========
See accompanying notes to consolidated financial statements.
F-8
54
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Standard Management Corporation ("SMC") is an international insurance
holding company, which directly and through its subsidiaries acquires and
manages in force life insurance and annuity business and distributes life
insurance and annuity products issued by its subsidiaries and a select group of
unaffiliated insurers.
SMC's active subsidiaries at December 31, 1996 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. Subsidiaries that
are not majority-owned are reported on the equity method. 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, 1996 and 1995 and for each of the three years in the period ended
December 31, 1996, are included in the Company's consolidated balance sheets at
December 31, 1996 and 1995 and for each of the three years in the period ended
December 31, 1996.
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.
F-9
55
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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.
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 operations.
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 9% in 1996 and 4% to 9.75% in 1995). The average credited
rate for deferred annuities and universal life policies is 5.35% at December 31,
1996. Liabilities for future policy benefits for immediate annuities are based
on the 1983 Basic Annuity Mortality Table with interest rates ranging from 6.5%
to 7.5%. Group annuities in payout status are recorded at discounted future cash
flows with interest rates ranging from 5.5% to 6.15% in 1996 and 5.5% to 6.5% in
1995.
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 range from 5% to 20% per year.
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 during the period in excess of
policyholder account balances.
F-10
56
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
Assets Held in Separate Accounts/Liabilities Related to Separate Accounts
Separate account assets and liabilities 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; also there are 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 account assets and liabilities
also generally represent funds maintained 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.
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 operations. Management fees received by Standard
Management International for administrative and policyholder maintenance
services performed for these separate accounts are included in management fees
and similar income from separate accounts in the consolidated statements of
operations.
Foreign Currency Translation
The Company's foreign subsidiaries' balance sheets and statements of
operations 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 operations. Foreign exchange gains
or losses relating to policyholders' funds in separate accounts are allocated to
the relevant separate account.
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 file separate federal income tax
returns and are taxed as separate life insurance companies. 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 able to consolidate with Standard Life for income tax purposes
beginning in 1996, but do not currently plan to do so.
F-11
57
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 acquisition of universal life insurance,
interest-sensitive annuities, and traditional life insurance (primarily
commissions and certain costs of marketing, policy issuance and underwriting)
which vary with and are directly related to the production of new business 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 periodically reviews the carrying value of the deferred policy
acquisition costs. 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. The Company continually monitors the value
of excess of
F-12
58
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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.
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.
Earnings Per Share
Earnings per share is computed by dividing earnings available to common
shareholders by the weighted average number of common and common equivalent
shares outstanding for the applicable period. The weighted average number of
common equivalent shares outstanding is determined by calculating the number of
shares issuable on exercise of common stock options and warrants, reduced by the
number of shares assumed to have been repurchased (at the average market price
per share of Common Stock) with the proceeds from their exercise; these shares
are then added to the number of average common shares outstanding during the
period.
Reclassifications
Certain amounts in the 1995 and 1994 consolidated financial statements and
notes have been reclassified to conform with the 1996 presentation. These
reclassifications had no effect on previously reported shareholders' equity or
net income during the periods involved.
2. CHANGES IN ACCOUNTING PRINCIPLES
In May 1993, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 115 ("SFAS No. 115"),
"Accounting for Certain Investments in Debt and Equity Securities." The Company
adopted the provisions of SFAS No. 115 as of January 1, 1994. Under SFAS No.
115, securities are classified as available for sale, held-to-maturity, or
trading. The Company recognizes that there may be circumstances where it may be
appropriate to sell a security prior to maturity in response to unforeseen
changes in circumstances. The Company classified all of its fixed maturity
portfolio as of January 1, 1994 as available for sale. Securities classified as
available for sale are carried at fair value and unrealized gains and losses on
such securities are reported as a separate component of shareholders' equity.
With the adoption of SFAS No. 115, the January 1, 1994 balance of
shareholders' equity was increased by $1,131 (net of deferred taxes of $583 that
would have been recorded if such securities had been sold at their fair value on
January 1, 1994) to reflect the net unrealized gains on securities classified as
available for sale that were previously carried at lower of amortized cost or
market.
F-13
59
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. 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, including $13,000 in
cash, 250,000 shares of restricted Common Stock (valued at $1,250) and
acquisition costs of $400 associated with the purchase of Shelby Life. Financing
for the Shelby Merger was provided by senior debt of $10,000 and $4,000 in
subordinated convertible debt.
The acquisition of Shelby Life was accounted for using the purchase method
of accounting and the consolidated financial statements will 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 preliminary
determination of their fair values and recorded the excess of acquisition cost
over net assets acquired as goodwill. Standard Life recorded goodwill of $9
which will be amortized on a straight-line basis over 20 years. Standard Life
may adjust this allocation when a final determination of such values is made.
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, including costs
associated with acquiring Dixie National Life of $684, the forgiveness of a
$3,689 DNC note payable to Standard Life and a $1,720 repayment of a DNC note
payable. The remaining purchase price of $1,926 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 which will be amortized on a straight-line
basis over 40 years.
F-14
60
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS AND DISPOSALS (CONTINUED)
The following schedule summarizes the assets acquired and the liabilities
assumed with the Shelby Life and Dixie National Life acquisitions described
above:
DIXIE
SHELBY NATIONAL
LIFE LIFE
------ --------
Assets acquired:
Fixed maturity securities............................... $ 93,376 $17,804
Policy loans............................................ 2,430 3,042
Guaranteed government student loans..................... -- 5,158
Short term investments.................................. 4,725 567
Cash.................................................... 32 4,626
Present value of future profits......................... 9,372 7,901
Other assets............................................ 2,880 1,599
-------- -------
Total assets acquired..................................... 112,815 40,697
Liabilities assumed:
Policy reserves......................................... 91,221 30,981
Policy claims and policyholder funds.................... 1,101 2,030
Deferred federal income taxes........................... 1,750 450
Other liabilities....................................... 1,102 761
Dividends payable to DLAC............................... 3,000 --
Minority interest....................................... -- 45
-------- -------
Total liabilities assumed................................. 98,174 34,267
-------- -------
Net assets acquired....................................... 14,641 6,430
Excess of acquisition cost over net assets acquired....... 9 1,589
-------- -------
Total purchase price...................................... $ 14,650 $ 8,019
======== =======
The following are supplemental unaudited pro forma consolidated results of
operations of the Company as if the acquisitions for Shelby Life and Dixie
National Life had occurred at the beginning of the period presented at the same
purchase price, based on estimates and assumptions considered appropriate.
YEAR ENDED
DECEMBER 31,
------------------
1996 1995
---- ----
Revenues................................................... $49,719 $45,097
Income (loss) before extraordinary gain.................... 4,942 (90)
Net income (loss).......................................... 5,444 (61)
Income (loss) per common share and common equivalent share
before extraordinary gain................................ .90 (.01)
Net income (loss) per common share......................... $ .99 $ (.01)
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 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
F-15
61
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS AND DISPOSALS (CONTINUED)
Company, Inc. ("GIAC"), a subsidiary of The Guardian Group, New York, NY.
Standard Life received proceeds of approximately $11,493, including $1,500 for
the charter and licenses associated with First International and $1,800 of
reinsurance ceding commissions. Standard Life realized a net pretax gain of
$1,042 and a tax benefit of $1,420 on this sale, or $2,462 ($.47 per share). 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 the majority of
First International's in force business at the date of sale (See Note 10).
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 $156 ($.03 per share).
4. INVESTMENTS
The amortized cost, gross unrealized gain (loss) and estimated fair value
of securities available for sale are as follows:
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 government
agencies..................................... $ 20,753 $ 51 $ 420 $ 20,384
Obligations of states and political
subdivisions................................. 3,588 106 -- 3,694
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 securities........... 349,151 3,878 5,719 347,310
Equity securities................................. 58 4 -- 62
-------- ------ ------ --------
Total securities available for sale............ $349,209 $3,882 $5,719 $347,372
======== ====== ====== ========
F-16
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS (CONTINUED)
DECEMBER 31, 1995
----------------------------------------------
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 government
agencies..................................... $ 19,331 $ 452 $ 19 $ 19,764
Obligations of states and political
subdivisions................................. 60 -- -- 60
Foreign government securities.................. 5,056 118 3 5,171
Utilities...................................... 23,916 462 186 24,192
Corporate bonds................................ 132,119 7,281 1,657 137,743
Mortgaged-backed securities.................... 45,161 417 416 45,162
-------- ------ ------ --------
Total fixed maturity securities........... 225,643 8,730 2,281 232,092
Equity securities................................. 52 -- -- 52
-------- ------ ------ --------
Total securities available for sale............ $225,695 $8,730 $2,281 $232,144
======== ====== ====== ========
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.
The change in net unrealized gains (losses) of securities available for
sale before effects of deferred acquisition costs, present value of future
profits and deferred federal income taxes are as follows:
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
---- ---- ----
Fixed maturity securities......................... $(8,290) $27,142 $(22,407)
Equity securities................................. 4 --..... --
------- ------- --------
$(8,286) $27,142 $(22,407)
======= ======= ========
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1996 by contractual maturity are shown below. 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.................................. $ 7,418 $ 7,435
Due after one year through five years.................... 24,818 24,970
Due after five years through ten years................... 123,503 123,075
Due after ten years...................................... 120,621 119,669
-------- --------
Subtotal............................................ 276,360 275,149
Redeemable preferred stock............................... 527 569
Mortgage-backed securities............................... 72,264 71,592
-------- --------
Total fixed maturity securities..................... $349,151 $347,310
======== ========
F-17
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS (CONTINUED)
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, 1996, 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 and are investment-grade securities, were as follows:
AMORTIZED FAIR
INVESTMENT COST VALUE
---------- --------- -----
Republic of Indonesia....................................... $5,676 $5,566
AMERCO...................................................... 5,080 5,161
Eastern Energy Limited...................................... 4,974 4,932
Delta Airlines.............................................. 4,590 4,767
Torchmark Corporation....................................... 4,362 4,259
Net investment income was attributable to the following:
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
---- ---- ----
Fixed maturity securities.......................... $19,865 $17,457 $15,350
Mortgage loans on real estate...................... 309 152 121
Policy loans....................................... 447 305 331
Real estate........................................ 65 120 290
Short-term investments and other................... 602 990 801
------- ------- -------
Gross investment income....................... 21,288 19,024 16,893
Investment expenses................................ 417 507 836
------- ------- -------
Net investment income......................... $20,871 $18,517 $16,057
======= ======= =======
The Company had no investments in fixed maturity securities available for
sale, mortgage loans or real estate that were non-income producing for the year
ended December 31, 1996.
Net realized investment gains arose from the following:
YEAR ENDED DECEMBER 31,
------------------------
1996 1995 1994
---- ---- ----
Fixed maturity securities available for sale:
Gross realized gains................................ $2,012 $2,115 $1,933
Gross realized losses............................... 911 1,662 1,240
------ ------ ------
Net.............................................. 1,101 453 693
Real estate........................................... -- 124 (504)
Other................................................. 201 111 204
Change in allowance for losses........................ -- -- 165
------ ------ ------
Net realized investment gains.................... $1,302 $ 688 $ 558
====== ====== ======
Life insurance companies are required to maintain certain amounts of assets
with state or other regulatory authorities. At December 31, 1996 fixed maturity
securities carried at $15,326 and short-term investments carried at $691 were
held on deposit by various state regulatory authorities in compliance with
statutory regulations. Additionally, fixed maturity securities carried at $2,539
and short-term investments carried at $5,211 of Standard Management
International were held by a custodian bank approved by the Luxembourg
regulatory authorities to comply with local insurance laws.
F-18
64
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. 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:
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
---- ---- ----
Balance at beginning of year....................... $10,054 $12,206 $ 6,513
Deferrals during the year........................ 6,169 1,863 5,462
Amortization during the year..................... (1,221) (1,142) (262)
Adjustment relating to net unrealized (gain) loss
on fixed maturity securities available for
sale.......................................... 3,076 (2,873) 493
------- ------- -------
Balance at end of year............................. $18,078 $10,054 $12,206
======= ======= =======
The activity related to the present value of future profits of the business
acquired for the Company is summarized as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
---- ---- ----
Balance at beginning of year....................... $15,246 $ 8,299 $ 9,144
Additions during the year from acquisitions...... 10,723 7,901 --
Deletions during the year from disposal of
subsidiaries.................................. (733) -- --
Interest accreted on unamortized balance......... 2,563 1,566 1,461
Amortization during the year..................... (3,812) (2,346) (2,306)
Adjustments relating to net unrealized (gain)
loss on fixed maturities available for sale... 194 (174) --
------- ------- -------
Balance at end of year............................. $24,181 $15,246 $ 8,299
======= ======= =======
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, 1996 and current assumptions as to future events on all policies in
force, will be between 6% and 8% in each of the years 1997 through 2001.
The discount rate used to calculate the present value of future profits
reflected in the Company's consolidated balance sheet at December 31, 1996,
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 and block of business from the recapture of the National Mutual
Life Insurance Company ("National Mutual") reinsurance agreement (See Note 10).
6. NOTES PAYABLE
SMC has outstanding borrowings at December 31, 1996 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 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
F-19
65
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. NOTES PAYABLE (CONTINUED)
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 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 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, 1996, SMC had borrowed $16,000 under this
Amended Credit Agreement at a weighted average interest rate of 8.849%.
In connection with the acquisition of Shelby Life, SMC borrowed $4,000 from
an insurance company pursuant to a subordinated convertible debt agreement which
is due in December 2003 and requires interest payments in cash at 12% per annum,
or, if SMC chooses, in non-cash additional subordinated convertible debt notes
at 14% per annum until December 31, 2000. The subordinated convertible notes are
convertible into Common Stock at the rate of $6.00 per share through November
1997, and $5.75 per share thereafter. SMC may prepay the subordinated
convertible debt with not less than thirty days notice at any time. The
subordinated convertible debt agreement contains terms and financial covenants
substantially similar to those in the Amended Credit Agreement.
Standard Management International has an unused line of credit of $1,583
which was renewed in February 1997. There were no borrowings in connection with
this line of credit in 1996.
Interest expense during 1996, 1995 and 1994 was $773, $116 and $47,
respectively. Cash paid for interest was $356, $100 and $105 in 1996, 1995 and
1994, respectively.
7. INCOME TAXES
The components of the federal income tax expense (credit), applicable to
earnings before extraordinary gains, was as follows:
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
---- ---- ----
Current tax provision (benefit).................... $(888) $(110) $ 2
Deferred tax provision (benefit)................... 286 353 (80)
----- ----- ----
$(602) $ 243 $(78)
===== ===== ====
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
The effective tax rate on pre-tax income before extraordinary gain is lower
than the statutory corporate federal income tax rate as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
---- ---- ----
Federal income tax statutory rate.................. 34% 34% 34%
======= ===== =======
Federal income tax expense (credit) at statutory
rates............................................ $ 1,329 $ 529 $(1,195)
Amortization of excess of acquisition cost over net
assets acquired.................................. 41 37 33
Small insurance company deduction.................. -- (128) (290)
Non recognition of losses in SMC consolidated
return and in foreign subsidiaries............... 543 372 290
Class action litigation and settlement costs....... -- (107) 1,366
Amortization of excess of net assets acquired over
acquisition cost................................. (472) (472) (361)
Tax benefit from disposal of subsidiary............ (1,420) -- --
Release of reserve for tax adjustments............. (325) -- --
Other items, net................................... (298) 12 79
------- ----- -------
Federal income tax expense (credit).............. $ (602) $ 243 $ (78)
======= ===== =======
Effective tax rate............................... (15)% 16% 2%
======= ===== =======
The Company recovered $130, $280 and $684 in federal income taxes in 1996,
1995 and 1994, respectively and paid federal income taxes of $900 in 1996.
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:
DECEMBER 31,
--------------------
1996 1995
---- ----
Deferred income tax assets:
Unrealized loss on securities available for sale........ $ 355 $ --
Future policy benefits.................................. 8,267 6,902
Capital and net operating loss carryforwards............ 7,719 7,230
Other-net............................................... 1,385 864
------- -------
Gross deferred tax assets............................ 17,726 14,996
Valuation allowance for deferred tax assets............. (8,750) (8,680)
------- -------
Deferred income tax assets, net of valuation
allowance.......................................... 8,976 6,316
Deferred income tax liabilities:
Unrealized gain on securities available for sale........ -- (1,961)
Present value of future profits......................... (8,221) (5,184)
Deferred policy acquisition costs....................... (4,089) (1,754)
------- -------
Total deferred income tax liabilities................ (12,310) (8,899)
------- -------
Net deferred income tax assets (liabilities)............ $(3,334) $(2,583)
======= =======
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 $2,308 at
F-21
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
December 31, 1996 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 $2,745
at December 31, 1996 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 in
goodwill and be amortized into income over its remaining life by reducing
goodwill amortization expense.
As of December 31, 1996, SMC and its noninsurance subsidiaries had
consolidated net operating loss carryforwards of approximately $8,600 for tax
return purposes which expire from 2005 through 2011. At December 31, 1996,
Standard Life had tax return net operating loss carryforwards of approximately
$1,400 which expire in 2004 and 2005. As a result of changes in ownership of SMC
and Standard Life, use of the loss carryforwards of Standard Life are subject to
annual limitations. The maximum tax return operating loss carryforwards
available for use by Standard Life in any one year are approximately $300. At
December 31, 1996, Dixie National Life had tax return net operating loss
carryforwards of approximately $5,800 which expire in 2010 and 2011. These
carryforwards will only be available to reduce the respective taxable income of
SMC, Standard Life and Dixie National Life. At December 31, 1996, Premier Life
(Luxembourg) had accumulated corporate income tax loss carryforwards of
approximately $5,900, 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 was released and recorded in income in 1996.
8. 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 connection with the class action lawsuit
settlement 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. The
Class S Preferred Stock is redeemable in February 2003, has an 11% annual
cumulative dividend payable in February 2003, and is convertible into SMC Common
Stock at $7.62 per share until February 1998 and $10.00 per share thereafter,
subject to adjustment under a formula intended to protect against dilution.
SMC may voluntarily redeem the Class S Preferred Stock prior to February
2003 at par value plus accumulated and unpaid dividends. 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 transactions.
As of December 31, 1996, SMC had repurchased and retired 140,111 shares of its
Class S Preferred Stock for $949, primarily paid through additional borrowings
under the Amended Credit Agreement. This repurchase resulted in an extraordinary
gain on early redemption of redeemable preferred stock of $502 for the year
ended December 31, 1996.
Common Stock
SMC declared a 5% stock dividend on shares of its Common Stock for
shareholders of record on May 17, 1996 which was distributed on June 21, 1996.
All applicable number of shares and per share amounts included in the
accompanying consolidated financial statements and notes have been retroactively
adjusted to reflect this stock dividend for all periods presented.
F-22
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. SHAREHOLDERS' EQUITY (CONTINUED)
The Company commenced an offshore offering of newly issued Common Stock
exclusively to foreign investors in December 1993. During December 1993 and
January 1994 the Company sold 1,666,667 shares of common stock at an average
offering price of $5.87 per share. Certain costs amounting to $852 and related
to the offering, including legal and underwriting fees, have been charged to
common stock and deducted from the proceeds of the offering. The Company
received total consideration of $9,783 from the offering, of which 637,167
shares with net proceeds of $3,347 were received during January 1994. A portion
of the proceeds was used to complete the acquisition of Standard Management
International, with the additional proceeds used to infuse capital into Standard
Life and provide working capital to SMC.
The Company has a stock repurchase program and repurchases its Common Stock
from time to time for the purpose of enhancing shareholder value. The Company
repurchased 431,026, 83,600 and 316,425, shares of Common Stock for $2,126, $400
and $1,354 in 1996, 1995 and 1994, respectively. At December 31, 1996, the
Company is authorized to purchase an additional 771,771 shares under this
program. The Company implemented a policy to issue shares for the exercise of
stock options from treasury stock. The Company reissued 1,224 shares at a cost
of $6 in 1996 under this program.
The following table represents the Company's warrants outstanding to
purchase Common Stock as of December 31, 1996:
ISSUE DATE EXPIRATION DATE EXERCISE PRICE WARRANTS 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 4.375 30,000
August 1996................................... August 1998 4.3125 100,000
September 1996................................ September 1998 5.00 25,000
September 1996................................ September 1999 5.50 17,000
-------
662,358
=======
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:
DECEMBER 31,
--------------------
1996 1995
---- ----
Fair value of securities available for sale.............. $347,372 $232,144
Amortized cost of securities available for sale.......... 349,209 225,695
-------- --------
Gross unrealized gain (loss) on securities available
for sale.......................................... (1,837) 6,449
Adjustments for:
Deferred policy acquisition costs...................... 696 (2,380)
Present value of future profits........................ 20 (174)
Deferred federal income tax recoverable (liability).... 375 (1,311)
Minority interest...................................... -- (2)
-------- --------
Net unrealized gain (loss) on securities available
for sale.......................................... $ (746) $ 2,582
======== ========
F-23
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTION PLAN
SMC has a Non-qualified Stock Option Plan (the "Plan") under which
1,500,000 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.
Statement of Financial Accounting Standard No. 123 entitled "Accounting for
Stock-Based Compensation" ("SFAS 123") issued in October 1995, was adopted by
the Company as of December 31, 1996. The provisions of SFAS 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 for stock options granted after December 31,
1994.
Had compensation cost for the Plan been determined based on the fair value
at the grant date for awards in 1995 and 1996 consistent with the provisions of
SFAS No. 123, the Company's net income and earnings per share would have been
reduced to the pro forma amounts indicated below:
YEAR ENDED
DECEMBER 31,
----------------
1996 1995
---- ----
Net income -- as reported................................... $5,014 $1,313
Net income -- pro forma..................................... 4,094 685
Earnings per share -- as reported........................... .98 .25
Earnings per share -- pro forma............................. $ .78 $ .13
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1995 and 1996, respectively: expected volatility
of .3882% and .4980%; risk-free interest rate of 6.62% and 5.88%; and expected
lives of 7 years.
Information regarding the Plan for 1996, 1995 and 1994 is as follows:
1996 1995 1994
---------------------------- --------------- ---------------
WEIGHTED-
AVERAGE
EXERCISE
SHARES PRICE SHARES SHARES
------ --------- ------ ------
Options outstanding, beginning of
year............................... 1,164,720 $6.464 520,294 523,194
Exercised............................ (1,224) $3.571 (1,667) --
Granted.............................. 769,122 $6.140 655,008 2,600
Expired or forfeited................. (486,449) $7.564 (8,915) (5,500)
--------------- ------ --------------- ---------------
Options outstanding, end of year..... 1,446,169 $5.984 1,164,720 520,294
=============== =============== ===============
Option price range at end of year.... $3.571 - $9.405 $3.571 - $9.405 $4.286 - $9.405
Option price range for exercised
shares............................. $ 3.571 $ 3.571 --
Options available for grant at end of
year............................... 50,939 333,613 979,706
=============== =============== ===============
Weighted-average fair value of
options granted during the year.... $ 3.623 $ 2.906
=============== ===============
F-24
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTION PLAN (CONTINUED)
Shares under options that were exercisable at year-end are as follows:
DECEMBER 31, 1996 1995 1994
------------ ---- ---- ----
Options exercisable......................................... 1,097,028 762,374 363,179
Information with respect to stock options outstanding at December 31, 1996 is as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------------- ----------------------------------
WEIGHTED-AVERAGE
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE OUTSTANDING AT CONTRACTUAL EXERCISE EXERCISABLE AT EXERCISE
PRICES DEC. 31, 1996 LIFE (YEARS) PRICE DEC. 31, 1996 PRICE
-------- -------------- ---------------- ---------------- -------------- ----------------
$3 - $5............... 337,224 8 Years $4.25 145,775 $4.20
$5 - $7............... 517,975 8 Years $5.27 360,283 $5.29
$7 - $9............... 571,282 9 Years $7.38 571,282 $7.38
$9 - $11.............. 19,688 6 Years $9.41 19,688 $9.41
--------- ---------
1,446,169 1,097,028
========= =========
Effective May 1, 1996, the Board of Directors cancelled 480,480 options
that had previously been granted to certain executive officers with exercise
prices ranging from $8.00 to $13.00 per share (representing the market price of
the Common Stock on the date such options were initially granted), and granted
an identical number of new options with identical terms and vesting periods (the
"Replacement Options") to these persons with an exercise price of $7.60, the
book value per share of Common Stock on September 30, 1995. On May 1, 1996, the
last reported sale price per share of the Common Stock was $4.375. The per share
exercise price relating to each Replacement Option was reduced to $7.238 in
connection with the 5% stock dividend effected on June 21, 1996 for holders of
record of Common Stock on May 17, 1996.
10. 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 to
$150. Amounts of standard risk in excess of that limit are reinsured.
Reinsurance premiums ceded to other insurers were $2,152, $4,312 and $5,534
in 1996, 1995 and 1994, respectively. Reinsurance ceded has reduced benefits and
claims incurred by $6,201, $1,369 and $4,664 in 1996, 1995 and 1994,
respectively. A contingent liability exists to the extent any of the reinsuring
companies are unable to meet their obligations under reinsurance agreements. To
minimize its 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. The Company believes
the assuming companies are able to honor all contractual commitments under the
reinsurance agreements, based on its periodic reviews of these companies.
The Company's largest annuity reinsurer at December 31, 1996 represented
$26,138, or 38% of total reinsurance recoverable, $8,907 of premium deposits
ceded in 1996 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,
F-25
71
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. REINSURANCE (CONTINUED)
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 of First International's
reserves and the related assets were ceded to GIAC as of January 1, 1996. The
inforce 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 at January 1, 1996, GIAC entered into a modified coinsurance
indemnity reinsurance agreement with Standard Life with respect to Blocks I and
II. Under the terms of the agreement, approximately $18,841 of Standard Life's
reserves were assumed from GIAC as of January 1, 1996. Standard Life incurs
experience rating refunds to GIAC on Block I. There is no experience rating
refund on Block II.
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
and related assets to GIAC, pursuant to an automatic coinsurance indemnity
reinsurance agreement. 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.
Standard Life received an administration fee of $316 for the year ended
December 31, 1996 from First International for the administration of the Block I
and Block II policies that were in force at the time of the sale of First
International.
In June 1988, Standard Life ceded a block of business to 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 $5,201 and liabilities of $4,953, primarily ordinary life
policies. In connection with this transaction, Standard Life collected
administration fees of $375 related to services provided in prior years that had
not been recorded previously due to uncertainty as to collection. This
administration fee income and premium income recorded with recapture will not
recur in the future.
11. RELATED PARTY TRANSACTIONS
The Company paid legal fees of $23 and $114 in 1995 and 1994, respectively,
to a law firm of which a partner is a director and officer of SMC. This director
and officer resigned from the law firm effective January 1, 1996. In April 1994,
the Company made a loan to this director and officer in the amount of $70, due
May 1, 1995, at an annual interest rate of 7%. This loan was renewed in May 1995
and was due in two installments of $40 on May 1, 1996 and $30 on August 1, 1997.
This loan was collateralized by 10,000 shares of Common Stock owned by the
director and officer. The outstanding principal balance at December 31, 1995 was
$70. This note was repaid in 1996, with SMC becoming a guarantor supporting a
$70 loan to this director and officer on June 25, 1996. The guaranty will be
effective until the earlier of repayment of the loan or June 25, 1999.
A director and officer of SMC was the sole owner of an independent
insurance marketing organization. On April 1, 1994, the assets of this marketing
organization were sold to Standard Marketing for $174 payable
F-26
72
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RELATED PARTY TRANSACTIONS (CONTINUED)
on an installment basis over a four year period. The outstanding principal
balance due on this installment note was $60 and $104 on December 31, 1996 and
1995, respectively. Until the consummation of this transaction, this marketing
organization was a master general agent for Standard Marketing and received
commissions from Standard Life for sales made on its behalf. These commissions,
which amounted to approximately $128 in 1994, were paid at rates comparable to
commissions received by non-affiliated master general agents. As a result of the
purchase of the marketing organization assets, Standard Marketing receives those
commissions previously received by the marketing organization.
In December 1994, SMC consolidated two loans to an officer and director of
SMC, in the amount of $325 with an annual interest rate of 6.5%, repayable at $2
per month (principal and interest) with a final payment due on December 31,
1996. This loan was refinanced December 29, 1995, and again at December 31,
1996, at an annual interest rate of 5%, payable at $1 per month, with additional
annual payments ranging from $50 to $84 through December 31, 2001. The
outstanding principal balance was $338 and $333 at December 31, 1996 and 1995,
respectively.
A director of SMC received $197 in fees for services rendered in connection
with the offshore offering of common stock in December 1993 and January 1994.
In December 1993, the Company entered into a consulting agreement with a
director. The consulting agreement was effective December 1, 1993 and expired on
November 30, 1996. Under the terms of the agreement the Company agreed to pay
the director $30, $35 and $40 during the first, second and third year of the
agreement, respectively. In July 1994, SMC made two loans to this director of
SMC in the amounts of $100 and $80. Both notes were at an annual interest rate
of prime plus 1%, require quarterly principal repayments and were due in 1996.
The outstanding principal balances on these notes were $127 at December 31,
1995. Both notes were repaid in 1996.
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 a lump sum payment of $150 in February 1997,
and will receive $125 in each of July 1997 and 1998, and $100 in July 1999.
12. 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 $1,037, $1,092
and $916 in 1996, 1995 and 1994, 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 and accumulated depreciation of the equipment
was $1,396 and $814, respectively at December 31, 1996.
F-27
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STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future required minimum rental payments, by year and in the aggregate,
under noncancellable capital leases and operating leases as of December 31,
1996, are as follows:
CAPITAL OPERATING
LEASES LEASES
------- ---------
1997........................................................ $539 $ 958
1998........................................................ 144 717
1999........................................................ -- 558
2000........................................................ -- 558
2001........................................................ -- 232
Thereafter.................................................. -- --
---- ------
Total minimum lease payments................................ 683 $3,023
======
Less amounts representing interest.......................... 46
----
Present value of net minimum lease payments under capital
lease..................................................... $637
====
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 of 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 1,081,080
shares at December 31, 1996.
In the first quarter of 1997, the chief financial officer gave notice that
he will be terminating his employment at the Company as he has been named
Commissioner of the Indiana Department of Insurance. The Company is currently
discussing benefits that may or may not be due to the officer. The amount of
such benefits can not be determined at this time.
13. EMPLOYEE BENEFIT PLAN
The Company has an employee savings plan, available to substantially all
salaried employees, containing a matched savings provision that permits both
pretax and after-tax employee contributions pursuant to Section 401(k) of the
Internal Revenue Code. Participants can contribute from 1% to 15% of their
annual compensation and receive a matching employer contribution not to exceed
4% of their annual compensation. The matching contribution is at the discretion
of the Company pursuant to the savings plan contract. The contributions may be
invested in several investment funds including Common Stock. The Company's total
expense for the plan was $104, $43 and $38 in 1996, 1995 and 1994, respectively.
14. LITIGATION
SMC and certain of its officers, directors and underwriters were named as
defendants in a class action lawsuit originally filed in March 1993 related to
allegations surrounding SMC's initial public offering ("IPO") of 2.3 million
shares of Common Stock in February 1993.
On November 9, 1994, SMC signed a Stipulation of Settlement in the class
action suit. The settlement was approved by the United States District Court on
March 2, 1995 after notice and hearing. On April 28, 1995, SMC signed a
Settlement Agreement with the 22 persons who previously excluded themselves from
the
F-28
74
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. LITIGATION (CONTINUED)
class of plaintiffs in the November 9, 1994 settlement. The settlement was
approved by the United States District Court on April 28, 1995.
Although SMC firmly believes the lawsuit was without merit, management
decided it was in the best interest of shareholders and policyholders to settle
the suit, thereby decreasing legal costs and enhancing the Company's ability to
make acquisitions and obtain related financing. SMC charged the estimated future
costs of the settlement of $3,700 to earnings in 1994. The $3,700 charge
includes $3,000 of Class S Preferred Stock (see Note 8), $263 in cash which was
distributed to the class participants, and $437 of estimated future legal and
other costs to settle the lawsuit and register the Class S Preferred Stock. The
$263 cash settlement was part of a $650 cash settlement fund, the remainder of
which was paid by the underwriters of the IPO. When aggregated with the class
action lawsuit litigation costs already incurred prior to the settlement, the
total class action lawsuit litigation and settlement costs were $4,018 ($.73 per
share) for 1994.
With the signing of the Settlement Agreement with the 22 persons who
previously excluded themselves from the class and a reevaluation of the
estimated future legal and other costs to settle the lawsuit, SMC recorded a
reduction in the estimated future costs to settle the lawsuit and list the Class
S Preferred Stock of $314 in 1995. The Class S Preferred Stock was issued on
February 8, 1996.
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.
15. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES
The Company's domestic 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 $22,970 and $12,877 at December 31, 1996 and 1995,
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 $3,291, $(1,339) and $68 for
the years ended December 31, 1996, 1995 and 1994, respectively. Minimum capital
and surplus required by the Indiana Insurance Code as of December 31, 1996 was
$450 on a statutory basis.
"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
F-29
75
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES (CONTINUED)
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 as of December 31, 1996 by $1,053.
From the funds borrowed by SMC pursuant to the Amended Credit Agreement and
the subordinated convertible debt agreement, $13,000 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
per year beginning in 2007 and concluding in 2019. As required by state
regulatory authorities, the balance of the surplus debenture at December 31,
1996 of $13,000 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 1994 and 1995, Standard Life paid no
dividends to SMC. In 1996, Standard Life paid a dividend of $1,000 to SMC.
During 1997, Standard Life can pay dividends of $2,297 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.
The statutory capital and surplus for Premier Life (Luxembourg) was $8,243
and $6,857 at fiscal years ended 1996 and 1995, respectively, and minimum
capital and surplus under local insurance regulations was $3,295 and $2,736 at
fiscal years ended 1996 and 1995, respectively. The statutory capital and
surplus for Premier Life (Bermuda) was $1,307 and $1,245 at fiscal years ended
1996 and 1995, respectively, and minimum capital and surplus under local
insurance regulations was $250 at fiscal years ended 1996 and 1995. 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 1996
and 1995 due to accumulated losses.
16. 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).
F-30
76
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. OPERATIONS BY GEOGRAPHIC AREA (CONTINUED)
The revenues, pre-tax income and assets by geographic area for 1994 through
1996 are as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
---- ---- ----
Revenues:
United States................................. $36,899 $26,851 $22,514
Europe........................................ 3,783 3,379 3,911
Caribbean..................................... -- 8 93
------- ------- -------
Total.................................... $40,682 $30,238 $26,518
======= ======= =======
Income (loss) before federal income taxes,
extraordinary gain on early redemption of
redeemable preferred stock and preferred stock
dividends: YEAR ENDED DECEMBER 31,
-------------------------------
United States................................. $ 2,688 $ 1,224 $(4,710)
Europe........................................ 1,243 411 1,259
Caribbean..................................... (21) (79) (63)
------- ------- -------
Total.................................... $ 3,910 $ 1,556 $(3,514)
======= ======= =======
AT DECEMBER 31,
------------------------------
1996 1995 1994
---- ---- ----
Assets:
United States................................. $486,951 $343,040 $264,906
Europe........................................ 141,837 136,318 108,237
Caribbean..................................... -- 240 381
-------- -------- --------
Total.................................... $628,788 $479,598 $373,524
======== ======== ========
The states in the U.S. with the largest share of U.S. premiums collected in
1996 were Indiana (18%), Ohio (16%), Florida (14%), California (11%) and
Michigan (6%). No other state accounted for more than 4% of total collected
premiums.
17. 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 as of December 31, 1996 and 1995. 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.
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.
F-31
77
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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, 1996 and 1995, 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, 1996 and 1995.
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 changed market conditions.
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,
1996 and 1995. Refer to Note 4 for additional information relating to the fair
value for investments.
DECEMBER 31,
--------------------------------------------
1996 1995
-------------------- --------------------
FAIR CARRYING FAIR CARRYING
VALUE AMOUNT VALUE AMOUNT
----- -------- ----- --------
Assets:
Investments:
Securities available for sale:
Fixed maturity securities.................... $347,310 $347,310 $232,092 $232,092
Equity securities............................ 62 62 52 52
Mortgage loans on real estate.................. 3,041 3,035 2,990 2,963
Policy loans................................... 7,767 9,903 6,674 8,509
Other invested assets.......................... 888 865 1,401 1,367
Short-term investments......................... 8,417 8,417 35,058 35,058
Assets held in separate accounts............... 128,546 128,546 122,705 122,705
Liabilities:
Insurance liabilities for investment
contracts.................................... 333,633 333,633 212,500 212,500
Class action litigation and settlement
liability.................................... -- -- 3,000 3,000
Capital lease obligation....................... 637 637 1,084 1,084
Notes payable.................................. 20,060 20,060 3,107 3,107
Liabilities related to separate accounts....... 128,546 128,546 122,705 122,705
F-32
78
STANDARD MANAGEMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. PENDING ACQUISITION
SMC has entered into an Agreement and Plan of Merger dated as of December
19, 1996, as amended February 17, 1997, with Savers Life Insurance Company
("Savers Life"). Savers Life offers retirement products, major medical insurance
and Medicare supplement insurance through 5,000 independent brokers, primarily
in North Carolina, South Carolina and Virginia. SMC will pay approximately
$14,200 plus acquisition costs for the approximately $80,000 asset company, with
shareholders of Savers Life initially receiving $8.00 for each share of Savers
Life Common Stock, consisting of Common Stock and an election of up to $1.50 per
share in cash. The proposed acquisition is subject to certain conditions
including SMC and Savers Life shareholder approval and approval by applicable
regulatory authorities. The acquisition is expected to close during the second
quarter of 1997.
19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
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. All applicable per share amounts have been retroactively adjusted to
reflect the 5% stock dividend.
1996 QUARTERS
--------------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
Total revenues............................................ $8,856 $13,040 $7,969 $10,817
====== ======= ====== =======
Components of net income:
Operating income........................................ $ 214 $ 60 $ 342 $ 804
Net realized investment gains........................... 145 125 129 387
Gain on disposal of subsidiaries........................ 2,306 -- -- --
Extraordinary gain on early redemption of redeemable
preferred stock...................................... 101 166 233 2
------ ------- ------ -------
Net income.............................................. $2,766 $ 351 $ 704 $ 1,193
====== ======= ====== =======
Net income per common and common equivalent share......... $ .48 $ .07 $ .14 $ .24
====== ======= ====== =======
1995 QUARTERS
------------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
Total revenues.............................................. $7,379 $6,910 $7,104 $8,846
====== ====== ====== ======
Components of net income:
Operating income (loss)................................... $ 250 $ (279) $ 323 $ 167
Net realized investment gains............................. 36 213 122 167
Class action litigation and settlement credit............. -- 314 -- --
------ ------ ------ ------
Net income................................................ $ 286 $ 248 $ 445 $ 334
====== ====== ====== ======
Net income per common and common equivalent share........... $ .05 $ .05 $ .08 $ .06
====== ====== ====== ======
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 and the effective rate for federal 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.
F-33
79
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
-----------------------
1996 1995
---- ----
ASSETS
Investments:
Investment in subsidiaries................................ $46,669 $44,452
Surplus debenture due from Standard Life.................. 13,000 --
Equity securities available for sale, at fair value
(amortized cost: $8)................................... 12 --
Real estate, at cost less accumulated depreciation of $23
in 1996 and $15 in 1995................................ 139 147
Investment in joint venture............................... 320 --
Notes receivable from officers and directors.............. 338 534
Short-term investments, at cost, which approximates fair
value.................................................. 124 714
------- -------
60,602 45,847
Cash........................................................ 900 254
Property and equipment, less accumulated depreciation of
$989 in 1996 and $399 in 1995............................. 1,087 1,431
Note receivable from affiliate.............................. 2,858 2,858
Amounts receivable from subsidiaries........................ 638 505
Other assets................................................ 829 484
------- -------
Total assets......................................... $66,914 $51,379
======= =======
LIABILITIES
Obligations under capital lease............................. 637 1,084
Class action litigation and settlement liability............ -- 3,000
Notes payable............................................... 20,000 3,000
Note payable to affiliate................................... 2,858 2,858
Amounts due to subsidiaries................................. 473 677
Other liabilities........................................... 1,023 518
------- -------
Total liabilities.................................... 24,991 11,137
Class S Cumulative Convertible Redeemable Preferred Stock,
par value $10 per share:
Authorized 300,000 shares; issued and outstanding 159,889
shares................................................. 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
Issued 5,752,499 shares in 1996 and 5,459,573 in 1995..... 40,481 39,808
Treasury stock, at cost, 728,229 shares in 1996 and 502,025
shares in 1995 (deduction)................................ (3,528) (2,621)
Unrealized gain (loss) on securities available for sale of
subsidiaries.............................................. (746) 2,582
Foreign currency translation adjustment of subsidiaries..... 691 1,159
Retained earnings (deficit)................................. 3,268 (686)
------- -------
Total shareholders' equity........................... 40,166 40,242
------- -------
Total liabilities, redeemable securities and
shareholders' equity................................ $66,914 $51,379
======= =======
See accompanying notes to condensed financial statements.
F-34
80
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
---- ---- ----
Revenues:
Net investment income..................................... $ 32 $ 112 $ 130
Interest income from subsidiaries......................... 357 172 90
Net realized investment gains (losses).................... -- 23 (276)
Loss on disposal of subsidiary............................ (156) -- --
Other income.............................................. 135 28 --
Rental income from subsidiaries........................... 853 715 525
Management fees from subsidiaries......................... 1,905 1,930 1,630
------- ------ -------
Total revenues......................................... 3,126 2,980 2,099
Expenses:
Other operating expenses.................................. 3,470 2,793 2,772
Interest expense and financing costs...................... 799 110 38
Interest expense on note payable to affiliate............. 161 172 90
Class action litigation and settlement costs (credit)..... -- (314) 4,018
------- ------ -------
Total expenses......................................... 4,430 2,761 6,918
------- ------ -------
Income (loss) before federal income taxes, equity in
earnings of consolidated subsidiaries, extraordinary gain
on early redemption of redeemable preferred stock and
preferred stock dividends................................. (1,304) 219 (4,819)
Federal income tax expense (credit)......................... -- (57) (67)
------- ------ -------
Income (loss) before equity in earnings of consolidated
subsidiaries, extraordinary gain on early redemption of
redeemable preferred stock and preferred stock
dividends................................................. (1,304) 276 (4,752)
Equity in earnings of consolidated subsidiaries............. 5,816 1,037 1,316
------- ------ -------
Income (loss) before extraordinary gain on early redemption
of redeemable preferred stock and preferred stock
dividends................................................. 4,512 1,313 (3,436)
Extraordinary gain on early redemption of redeemable
preferred stock, net of $-- federal income tax............ 502 -- --
------- ------ -------
NET INCOME (LOSS)........................................... 5,014 1,313 (3,436)
Preferred stock dividends................................... 208 -- --
------- ------ -------
Earnings available to common shareholders................... $ 4,806 $1,313 $(3,436)
======= ====== =======
See accompanying notes to condensed financial statements.
F-35
81
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
---- ---- ----
OPERATING ACTIVITIES
Net income (loss)........................................... $ 5,014 $ 1,313 $(3,436)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Extraordinary gain on early redemption of redeemable
preferred stock........................................ (502) -- --
Amortization of deferred debt issuance costs.............. 32 2 --
Class action litigation and settlement liability.......... -- (655) 3,655
Depreciation and amortization............................. 564 562 470
Equity in earnings of subsidiaries........................ (5,816) (1,037) (1,316)
Accrued interest payable.................................. 320 -- --
Other liabilities......................................... 192 480 495
Net realized investment gain (loss)....................... -- (23) 276
Dividend from Standard Life............................... 1,000 -- --
Other..................................................... 165 (250) 179
-------- ------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES.............. 969 392 323
FINANCING ACTIVITIES
Issuance of Common Stock, net............................... -- 6 3,347
Borrowings, net of debt issuance costs of $208 in 1996 and
$81 in 1995............................................... 16,792 2,923 --
Repayments on long-term debt and capital lease obligation... (491) (312) --
Short-term borrowings, net.................................. -- (550) 550
Redemption of redeemable preferred stock.................... (949) -- --
Repurchase of stock warrants................................ (600) -- --
Proceeds from common and treasury stock sales............... 100 -- --
Purchase of Common Stock for treasury....................... (2,126) (822) (931)
-------- ------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES.............. 12,726 1,245 2,966
INVESTING ACTIVITIES
Investments, net............................................ 197 653 (1,309)
Surplus debenture contributed to Standard Life.............. (13,000) -- --
Capital contribution to Standard Life....................... -- (3,000) (1,225)
Capital contribution to Standard Management International... -- (170) (90)
Capital contribution to Standard Advertising, Inc........... -- (173) --
Capital contribution to Standard Reinsurance................ -- (6) --
Purchase of Standard Management International............... -- -- (67)
Proceeds from sale of property and equipment under sales
leaseback................................................. -- 1,396 --
Purchase of property and equipment, net..................... (246) (475) (1,448)
-------- ------- -------
NET CASH USED BY INVESTING ACTIVITIES.................. (13,049) (1,775) (4,139)
-------- ------- -------
Net increase (decrease) in cash............................. 646 (138) (850)
Cash at beginning of year................................... 254 392 1,242
-------- ------- -------
Cash at end of year......................................... $ 900 $ 254 $ 392
======== ======= =======
See accompanying notes to condensed financial statements.
F-36
82
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31, 1996
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 $1,000 in 1996. There
were no cash dividends paid to SMC from its subsidiaries in 1995 and 1994.
3. NOTES PAYABLE
SMC has outstanding borrowings at December 31, 1996 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 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 60,000 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 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 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, 1996, SMC had borrowed $16,000 under this
Amended Credit Agreement at a weighted average interest rate of 8.849%.
In connection with the acquisition of Shelby Life, SMC borrowed $4,000 from
an insurance company pursuant to a subordinated convertible debt agreement which
is due in December 2003 and requires interest payments in cash at 12% per annum,
or, if SMC chooses, in non-cash additional subordinated convertible debt notes
at 14% per annum until December 31, 2000. The subordinated convertible notes are
convertible into Common Stock at the rate of $6.00 per share through November
1997, and $5.75 per share thereafter. SMC may prepay the subordinated
convertible debt with not less than thirty days notice at any time. The
subordinated convertible debt agreement contains terms and financial covenants
substantially similar to those in the Amended Credit Agreement.
4. SURPLUS DEBENTURE
From the funds borrowed by SMC pursuant to the Amended Credit Agreement and
the subordinated convertible debt agreement, $13,000 was loaned to Standard Life
pursuant to an Unsecured Surplus Debenture Agreement ("Surplus Debenture") which
requires Standard Life to make quarterly interest
F-37
83
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
4. SURPLUS DEBENTURE (CONTINUED)
payments to SMC at a variable corporate base rate plus 2% per annum, and annual
principal payments of $1,000 per year beginning in 2007 and concluding in 2019.
As required by state regulatory authorities, the balance of the surplus
debenture at December 31, 1996 of $13,000 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.
5. REDEEMABLE PREFERRED STOCK
In connection with the class action lawsuit settlement 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. The Class S Preferred Stock is
redeemable in February 2003, has an 11% annual cumulative dividend payable in
February 2003, and is convertible into Common Stock at $7.62 per share until
February 1998 and $10.00 per share thereafter, subject to adjustment under a
formula intended to protect against dilution.
SMC may voluntarily redeem the Class S Preferred Stock prior to February
2003 at par value plus accumulated and unpaid dividends. 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 transactions.
As of December 31, 1996, SMC had repurchased and retired 140,111 shares of its
Class S Preferred Stock for $949, primarily paid through additional borrowings
under the Amended Credit Agreement. This repurchase resulted in an extraordinary
gain on early redemption of redeemable preferred stock of $502 for the year
ended December 31, 1996.
6. STOCK DIVIDEND
SMC declared a 5% stock dividend on shares of its common stock for
shareholders of record on May 17, 1996 which was distributed on June 21, 1996.
All applicable number of shares and per share amounts included in the
accompanying condensed financial statements and notes have been retroactively
adjusted to reflect this stock dividend for all periods presented.
F-38
84
SCHEDULE IV -- REINSURANCE
STANDARD MANAGEMENT CORPORATION
YEARS ENDED DECEMBER 31, 1996, 1994 AND 1993
(DOLLARS IN THOUSANDS)
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
------ --------- ---------- ------ ----------
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 on deposit................. 737 -- -- 737
---------- ---------- ---- ----------
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 on deposit................. 220 -- -- 220
---------- ---------- ---- ----------
Total premiums................... $ 9,816 $ 4,312 $ -- $ 5,504
========== ========== ==== ==========
YEAR ENDED DECEMBER 31, 1994:
Life insurance in force............... $2,561,412 $1,774,308 $310 $ 787,414 .04%
========== ========== ==== ========== ===
Premiums
Life insurance and annuities........ $ 9,670 $ 5,534 $ -- $ 4,136
Accident and health insurance....... 27 -- -- 27
Supplementary contracts and other
funds on deposit................. 402 -- -- 402
---------- ---------- ---- ----------
Total premiums................... $ 10,099 $ 5,534 $ -- $ 4,565
========== ========== ==== ==========
F-39
85
EXHIBIT INDEX
SEQUENTIAL
EXHIBIT PAGE
NUMBER DESCRIPTION OF DOCUMENT NUMBER
- ------- ----------------------- ----------
2.1 Agreement and Plan of Merger dated as of December 19, 1996
by and among SMC and Savers Life. (incorporated by reference
to SMC's Form 8-K (File No. 0-20882) as filed with the
Commission on January 24, 1997.
2.2 Amendment to Agreement and Plan of Merger dated as of
February 17, 1997 by and among SMC and Savers Life
(incorporated by reference to SMC's Form 8-K (File No.
0-20882) as filed with the Commission on February 19, 1997).
3(i) Amended and Restated Articles of Incorporation, as amended
(incorporated by reference to SMC's Annual Report on Form
10-K (File No. 2-20882) for the year ended December 31,
1995).
3(ii) 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) as filed with the Commission on
January 27, 1993).
4.2 Form of Oppbridge Partners Warrant (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).
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) as filed with the Commission on
January 27, 1993).
4.4 Amended and Restated Registration Rights Agreement dated as
of November 8, 1996 by and between SMC and Fleet National
Bank (incorporated by reference to SMC's Quarterly Report on
Form 10-Q (File No. 0-20882) for the quarter ended September
30, 1996).
4.5 Form of Fleet National Bank Warrant (incorporated by
reference to SMC's Quarterly Report on Form 10-Q (File No.
0-20882) for the quarter ended September 30, 1996).
4.6 Form of President's Club Warrant (incorporated by reference
to SMC's Annual Report on Form 10-K (File No. 2-20882) for
the year ended December 31, 1995).
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
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. 2-20882) for the year
ended December 31, 1995).
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).
86
SEQUENTIAL
EXHIBIT PAGE
NUMBER DESCRIPTION OF DOCUMENT NUMBER
- ------- ----------------------- ----------
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).
10.8 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).
10.9 Second Amended and Restated 1992 Stock Option Plan, as
amended (incorporated by reference to SMC's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1993 and as
amended by SMC's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1994).
10.10 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).
10.11 Management Service Agreement between Standard Life and SMC
dated August 1, 1992, as amended on January 1, 1997.
10.12 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).
10.13 Reinsurance Agreement between Standard Life and The
Mercantile and General Reinsurance Company Limited 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).
10.14 Reinsurance Agreement between Firstmark Standard Life
Insurance Company and The Mercantile and General Reinsurance
Company of America 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).
10.15 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).
10.19 Renewal Promissory Note from Ronald D. Hunter to SMC in the
amount of $337,854 executed December 31, 1996 and due
December 31, 2001.
10.20 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. 2-20882) for the year ended December 31,
1995).
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10.21 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).
10.22 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.
2-20882) for the year ended December 31, 1995).
10.23 Indemnity Reinsurance Agreement between Dixie National Life
and Crown Life Insurance Company dated and effective
September 30, 1992, and Amendment No. 1 as amended October
29, 1992; Amendment No. 2 as amended December 9, 1992;
Amendment No. 3 as amended February 11, 1993; Amendment No.
4 as amended June 29, 1993; Amendment No. 5 as amended
November 17, 1994; Amendment No. 6 as amended December 31,
1996.
10.24 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.
2-20882) for the year ended December 31, 1995).
10.25 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.
2-20882) for the year ended December 31, 1995).
10.26 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.
2-20882) for the year ended December 31, 1995).
10.27 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. 2-20882) for the year ended December
31, 1995).
10.28 Amended and Restated Revolving Line of Credit Agreement
dated as of November 8, 1996 between SMC and Fleet National
Bank (incorporated by reference to SMC's Quarterly Report on
Form 10-Q (File No. 0-20882) for the quarter ended September
30, 1996).
10.29 Note Agreement dated as of November 8, 1996 between SMC and
Fleet National Bank in the amount of $16,000,000
(incorporated by reference to SMC's Quarterly Report on Form
10-Q (File No. 0-20882) for the quarter ended September 30,
1996).
10.30 Amended and Restated Pledge Agreement dated as of November
8, 1996 between SMC and Fleet National Bank (incorporated by
reference to SMC's Quarterly Report on Form 10-Q (File No.
0-20882) for the quarter ended September 30, 1996).
10.31 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. 2-20882) for the year
ended December 31, 1995).
10.32 Note Agreement dated as of November 8, 1996 by and between
SMC and Great American Reserve in the amount of $4,000,000
(incorporated by reference to SMC's Quarterly Report on Form
10-Q (File No. 0-20882) for the quarter ended September 30,
1996).
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10.33 Senior Subordinated Convertible Note dated as of November 8,
1996 by and between SMC and Great American Reserve in the
amount of $4,000,000 (incorporated by reference to SMC's
Quarterly Report on Form 10-Q (File No. 0-20882) for the
quarter ended September 30, 1996).
10.34 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).
10.35 Portfolio Indemnify Reinsurance Agreement between Dixie
National Life and Cologne Life Reinsurance Company dated and
effective December 31, 1996.
11 Statement regarding computation of per share earnings
21.1 List of Subsidiaries of SMC
23.1 Consent of Ernst & Young LLP
23.2 Consent of KPMG Audit
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.