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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-K þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the fiscal year endedDecember 31, 2004 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 Commission file number 0-20882 Standard Management Corporation  Indiana
    
    35-1773567(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. employer
identification no.)10689 North Pennsylvania Street, Indianapolis, Indiana 46280
    
    (317) 574-6200(Address of principal executive offices)
    
    (Telephone)
 Securities registered pursuant to Section 12(b) of the Act: NoneSecurities registered pursuant to Section 12(g) of the Act: Common Stock, No Par Value10.25% Trust Preferred Securities due 2031 of SMANCapital Trust I
 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  þ  Noo 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. þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act).
Yes  o  Noþ The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon
the closing sale price of the Registrants common stock as of the end of the most recently
completed second quarter as reported on The NASDAQ National Market, was approximately $22.6
million. Shares of Common Stock held by each executive officer and director and by each person who
owns 5% or more of 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, 2005 Registrant had outstanding 7,921,113 shares of Common Stock. Documents Incorporated by Reference: None




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Table of Contents  
 PagePart IItem 1.
    
    Business
    
    
    3Item 2.
    
    Properties
    
    
    16Item 3.
    
    Legal Proceedings
    
    
    16Item 4.
    
    Submission of Matters to a Vote of Securities Holders
    
    
    16Part IIItem 5.
    
    Market for
Registrants Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities
    
    
    17Item 6.
    
    Selected Financial Data
    
    
    18Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    49Item 8.
    
    Financial Statements and Supplementary Data
    
    
    50Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    50Item 9A.
    
    Controls and Procedures
    
    
    50Item 9B.
    
    Other Information
    
    
    51Part IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    52Item 11.
    
    Executive Compensation
    
    
    55Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    58Item 13.
    
    Certain Relationship and Related Transactions
    
    
    59Item 14.
    
    Principal Accounting Fees and Services
    
    
    60Part IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    61EX-10.36 EMPLOYMENT AGREEMENT / DR. KNIESEREX-21 LIST OF SUBSIDIARIES OF STANDARD MANAGEMENTEX-23.1 CONSENT OF BDO SEIDMAN, LLPEX-23.2 CONSENT OF ERNST & YOUNG LLPEX-31.1 SECTION 302, CERTIFICATION OF THE CEOEX-31.2 SECTION 302, CERTIFICATION OF THE CFOEX-32 SECTION 906, CERTIFICATION




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PART I As used in this report, unless the context otherwise clearly requires, we, our, us, and
Standard Management refer to Standard Management Corporation and its subsidiaries. All financial
information contained in this report is presented in accordance with generally accepted accounting
principles (GAAP) unless otherwise specified. Our website is located at www.sman.com, however,
the information contained on the website is not to be considered incorporated by reference herein. 
 Item 1. Business of Standard Management Overview Standard Management is a holding company that currently conducts its business through two
distinct segments: financial services and health services. The financial services segment is
primarily involved in the asset accumulation business targeting the retirement-age market.
Principally through its wholly owned life insurance subsidiary, Standard Life Insurance Company of
Indiana (Standard Life), we develop, market and administer annuity and life insurance products.
Historically, substantially all of our business has been conducted in the financial services
segment through Standard Life and our other insurance company subsidiaries. In 2002, we entered the health services segment. The health services segment is operated
through our subsidiary, U.S. Health Services Corporation (U.S. Health Services). U. S. Health
Services primarily distributes pharmaceutical products and services to institutions, point of care
programs, contract repackaging services and consumers. On February 9, 2005, Standard Management entered into a definitive Stock and Asset Purchase
Agreement (the Agreement) with Capital Assurance Corporation (Capital Assurance). The
Agreement provides for the sale to Capital Assurance of (1) 100% of the capital stock of Standard
Life and (2) $27 million aggregate principal amount of surplus debentures issued by Standard Life
in favor of Standard Management. The Agreement represents the definitive terms for the
transactions contemplated by the previously reported letter of intent between the parties. While
the proposed transaction is subject to customary conditions, our management expects the transaction
to close in the second quarter of 2005. If the proposed transaction is consummated, we will no
longer have significant operations in the financial services sector and will focus our attention on
our health services business. For more information on this transaction, please see Managements
Discussion and Analysis of Financial Condition and Results of Operations  Recent Developments. Health Services Segment Through a series of strategic acquisitions since 2002, our wholly-owned subsidiary, U.S.
Health Services has built a pharmaceutical and medical products distribution platform as our entry
into the health care business. U.S. Health Services distributes products to patients at a variety
of points along the health care continuum. During 2004, we hired intellectual capital from
nationally recognized companies to integrate our acquisitions and develop the systems to enable us
to effectively and efficiently serve our customers regionally and nationwide. We believe U.S.
Health Services is now positioned to capitalize on this solid business foundation and to deploy
regional distribution centers as it pursues further strategic growth. U.S. Health Services distributes products to patients at a variety of points along the health
care continuum. U.S. Health Services differentiates itself within this segment of the
health care industry by providing a diverse but interwoven national pharmaceutical and medical
supply service. Patients have access to these supplies at all points during their health care and
treatment regimen  from prescriptions via home delivery, at the point of discharge from a doctors
office or hospital, to servicing of the patients needs while in a long-term care facility. Reflecting our focus on delivery at the patient level, U.S. Health Services has adopted
HomeMed as its national brand. No matter where the patient calls home private residence,
retirement village, independent living, assisted living, or skilled nursing facilityHomeMed
reaches the patient with value-added service. U.S. Health Services connects with the patient through three major distribution channels:  
    HomeMed Pharmacyserves patients in their private residence; 3




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
    HomeMed Provider Solutionsserves patients upon discharge from the hospital or
subsequent to a physician office or clinic visit; and
    HomeMed Long-Term Careserves patients at independent, assisted or skilled nursing
facilities and correctional facilities. These distribution channels were chosen for the following reasons:  
    each represents a potentially profitable market segment for U.S. Health Services;
    each represents a concentration of patients consuming high volumes of
pharmaceuticals and medical supplies; and
    by distributing at long-term care facilities, hospitals and physicians offices, we
are able to serve patients at the point of care (and can continue to service the
patient on a longer term basis with direct to home delivery). The level of success we achieve will be impacted by how many patients we serve, how many
patients take advantage of our multiple product offerings, and our focus on specific disease states
(e.g., diabetes) as we effectively exploit particular market niches, such as optical and
veterinary. We believe, based on industry sources, that the U.S. pharmaceuticals market is valued at
approximately $235 billion per year and the medical supply market is valued at approximately $19
billion per year. We believe the market provides great opportunities for HomeMedproducts and services because:  
    the aging U.S. population is increasing and consuming more health care services;
    select demographic groups are prone to certain diseases requiring greater amounts of
medical supplies and pharmaceuticals; and
    providers, employers and insurers are focusing more attention on ensuring patients
receive and follow the clinically proven therapies prescribed by their providers -
compliance, adherence and outcomes. Cross-selling opportunities are significant between U.S. Health Services business lines. A
patient served as a customer with HomeMed Provider Solutionsreceives his initial supply of
prescribed medications upon discharge from the hospital or at the conclusion of his office or
clinic visit. When maintenance medications (long-term medications) are required, the patient
receives those medications and supplies via direct home delivery from HomeMed Pharmacy. One of the
key marketing strategies of HomeMedis to continually capitalize on these cross-selling
opportunities. Growth Strategy U.S. Health Services revenue growth will be addressed by acquiring patients both organically
and through strategic acquisitions. We believe we are well positioned to benefit from a rapidly
growing population utilizing pharmacy services and medical supplies. Patients are acquired through:   The direct selling efforts of our sales force; and   Strategic acquisitions of:  
    profitable and established companies with proven management;
    companies with an existing base of patients; and 4




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
    companies with a product that provides additional cross-selling opportunities. Acquisition Strategy Our acquisition strategy includes acquiring companies to distribute retail and third party
reimbursed pharmaceutical products and services. We have identified several potential strategic
acquisitions in the institutional pharmacy industry, although there are currently no agreements in
place with respect to the acquisition of any entity. These potential acquisitions would also allow
us to build to critical mass in terms of both customers served and human and technological capital.
While we intend to grow this segment of the business quickly and on a regional basis through
acquisitions in the near term, we are also committed to creating operational efficiencies in our
existing operations in an attempt to reduce expenses and increase economies available to us, so
that our business can grow organically as well. We may acquire companies using cash, shares of our
stock, promissory notes or any combination of the three. We intend to use a portion of the net
cash proceeds from the proposed sale of Standard Life for selected acquisitions. See Managements
Discussion and Analysis of Financial Condition and Results of Operations  Recent Developments. Regulatory Factors The pharmaceutical distribution industry has long been subject to regulation by various state
and federal agencies. All of our pharmacies are licensed in the states in which they operate and
are registered with the appropriate federal authorities with respect to the regulation of
controlled substances. Government regulation of pharmacies and drug wholesalers may be expanded in
the United States in the future. The long-term care pharmacy business also operates under regulatory cost containment pressures
through legislation (primarily through Medicaid and Medicare). Any future changes in such
reimbursement programs, or in regulations relating thereto, such as reductions in allowable
reimbursement levels or the timing of processing of payments, could affect our business. On December 8, 2003, President Bush signed into law the Medicare Prescription Drug Improvement
and Modernization Act of 2003, a comprehensive voluntary prescription drug benefit administered
under Medicare Part D effective January 1, 2006. The new Act also provides certain cost-sharing
government subsidies for individuals who might otherwise qualify for drug coverage under Medicaid
or similar government-funded aid programs. Since a portion of our future long-term care pharmacy
business will be made available to Medicare-qualified patients who may qualify for this new
benefit, this new law may have an adverse effect on the profitability of our business. We are subject to Medicare fraud and abuse and anti-self-referral laws which preclude, among
other things, (a) persons from soliciting, offering, receiving or paying any remuneration in order
to induce the referral of a patient for treatment or for inducing the ordering or purchasing of
items or services that are in any way paid for by Medicare or Medicaid, and (b) physicians from
making referrals to certain entities with which they have a financial relationship. The fraud and
abuse laws and regulations are broad in scope and are subject to frequent modification and varied
interpretation. As of December 31, 2004, approximately 26% of our health services pharmacy revenues were from
government sponsored programs. Government sponsored programs include Medicaid and, to a lesser
extent, Medicare. Our remaining billings are currently paid or reimbursed by individual residents,
long-term care facilities and other third-party payors, including private insurers. A portion of
these revenues are indirectly dependent on government programs. We anticipate that as the
institutional pharmacy portion of our health services segment grows, direct reimbursement from
government sponsored programs will become a material portion of our pharmacy billings . Our pharmacy business is subject to extensive and often changing federal, state and local
regulations, and our pharmacy is required to be licensed in the states in which it is located or
does business. While we continuously monitor the effects of regulatory activity on its operations
and believe we currently have all necessary pharmacy licenses, the failure to obtain or renew any
required regulatory approvals or licenses could adversely affect the continued operation of the
business. The long-term care facilities that contract for our services are also subject to federal,
state and local regulations and are required to be licensed in the states in which they are
located. The failure by these long-term care facilities to comply with
these or future regulations or to obtain or renew any required licenses could result in our
inability to provide pharmacy services to these facilities and their residents. We are also subject
to federal and state laws that prohibit some types of direct 5




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and indirect payments between
healthcare providers. These laws, commonly known as the fraud and abuse laws, prohibit payments
intended to induce or encourage the referral of patients to, or the recommendation of, a particular
provider of items or services. Violation of these laws can result in loss of licensure, civil and
criminal penalties and exclusion from the Medicaid, Medicare and other federal healthcare programs. Competitive Factors The pharmaceutical distribution industry is a highly competitive and fragmented industry, both
regionally and nationally. In each of its market segments, U.S. Health Services competes with
local, regional and national organizations focused on similar customer groups. In the direct
dispensing of pharmaceutical products, we compete with local and national retail, mail order and
institutional pharmacies as well as pharmacies owned by long term care facilities. HomeMedcompetes
in this market based on competitive pricing, localized services, a broader product offering,
value-added technologies and partnering initiatives that drive shared revenue. Financial Services Segment Our financial services segment includes Standard Life, our principal insurance subsidiary,
which 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 currently sells deferred annuities, equity-indexed annuities, and
single premium immediate annuities and manages its in force life business. Standard Life has a
rating of B (Fair) from the rating agency A.M. Best Company, Inc. (A.M. Best). This segment
also includes Standard Lifes subsidiary Dixie National Life Insurance Company (Dixie Life),
which has an A.M. Best rating of B. We have entered into a definitive agreement to sell Standard Life and Dixie Life (see
Managements Discussion and Analysis of Financial Condition and Results of Operations  Recent
Developments). Marketing Standard Life offers a full portfolio of annuity products selected on the basis of their
competitive position, profitability and likely consumer acceptance. Such portfolio includes single
and flexible premium deferred annuities, equity-indexed annuities and single premium immediate
annuities. Standard Life does not offer variable annuity products. Our agency force, which
includes approximately 9,400 independent general agents, was organized to provide a lower cost
alternative to the traditional captive agency force. These agents distribute a full line of
annuity products issued by Standard Life. We believe that both agents and policy owners value the
service we provide. We assist agents in 1) submitting and processing policy applications, 2)
training and education, and 3) marketing support. Each general agent operates his own agency and is responsible for all expenses of the agency.
The general agents are compensated directly by Standard Life, which performs issuance, underwriting
and accounting functions related to the policy. Standard Life is not dependent on any one agent or
agency for any substantial amount of its business. No single agent accounted for more than 2% of
Standard Lifes annual annuity sales in 2004, and the top 20 individual agents accounted for
approximately 18% of Standard Lifes annuity sales in 2004. At December 31, 2004, approximately
42% of Standard Lifes independent agents were located in Indiana, California, Florida, Ohio and
Michigan with the remaining agents distributed across the remainder of the country. Standard Life
is attempting to increase the number and geographic diversity of its agents. Standard Life does not have exclusive agency agreements with its agents. Therefore, our
management believes most of these agents sell similar products for other insurance companies, which
could result in a sales decline if Standard Lifes products were to become relatively less
competitive. 6




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Currently Marketed Products We primarily market deferred annuities, equity-indexed annuities, and single premium immediate
annuities. The following table sets forth the amounts and percentages of our net deposits received
from currently marketed products for the years ended December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Deferred
annuities
    
    $
    52,376
    
    
    
    21.2
    
    
    $
    129,391
    
    
    
    30.8
    
    
    $
    320,647
    
    
    
    53.5Equity-indexed
annuities
    
    
    70,634
    

    
    
    28.6
    
    
    
    125,302
    
    
    
    29.8
    
    
    
    126,743
    
    
    
    21.2Single premium immediate annuities and
other
deposits
    
    
    124,261
    
    
    
    50.2
    
    
    
    165,797
    
    
    
    39.4
    
    
    
    151,525
    
    
    
    25.3Total
    
    $
    247,271
    
    
    
    100.0
    
    
    $
    420,490
    
    
    
    100.0
    
    
    $
    598,915
    
    
    
    100.0
 Deferred Annuities. Standard Life markets both single and flexible premium deferred
annuities, which provide for an initial deposit by the owner. Flexible premium products also
provide for optional additional deposits, the time and amount of which are at the discretion of the
owner. Standard Life credits the account of the owner with earnings at interest rates that are
revised periodically until the maturity date. This accumulated value is tax deferred. Revisions to
interest rates on deferred annuities are restricted by an initial crediting rate guaranteed for a
specific period of time, usually one year, and a minimum crediting rate guaranteed for the term of
the deferred annuity, which is typically 2% to 3%. At maturity, the owner can elect a lump sum cash
payment of the accumulated value or one of the various payout options available. Standard Lifes
deferred annuities also typically provide for penalty-free partial withdrawals of up to 10%
annually of the accumulation value after the owner has held the deferred annuity for more than 12
months. In addition, the owner may surrender the deferred annuity 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 deferred annuities from a sharp reduction in the credited interest rate after
a deferred annuity is issued, Standard Life permits the deferred annuity 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. Certain products also contain a market value adjustment feature,
whereby a policyholders surrender value is adjusted for changes in the interest rate environment.
This feature protects us against the risk of policyholder surrender when asset values are
depressed. As of January 1, 2005, the crediting rates available on new sales of Standard Lifes currently
marketed deferred annuities ranged from 3% to 7% with most new issues having an interest rate with
a one-year guarantee period. Crediting rates on in force policies range from 2.5% to 7%. The
surrender charge is initially 7% to 14% of the contract value depending on the product and
decreases over the applicable surrender charge period of 5 to 10 years. As of December 31, 2004,
Standard Life had 3,815 deferred annuity contracts in force from currently marketed products. Equity-Indexed Annuities.In response to consumers desire for alternative investment
products with returns linked to common stocks, Standard Life introduced a line of equity-indexed
annuity products in 1998. The annuitys contract value is equal to the premium paid, increased for
returns based on the change in the Standard & Poors 500 Index (S&P 500 Index) and/or the Dow
Jones Industrial Average Index (DJIA Index). Standard Lifes equity-indexed annuities apply index
credits to policyholders annually, so that a given years equity credits are locked in, and cannot
be reduced by future declines in the index. Two basic index-crediting methods are used for Standard
Lifes equity-indexed annuities, participation rate crediting and spread/cap crediting. For
participation rate products, a percentage (the participation rate) of the change in the index
accrues to the contract value. For spread/cap products, increases in the index up to the spread
amount do not accrue to the contract value, but above the spread, the contract is credited the full
amount of the increase in the index up to the limit of
the cap. Standard Life has the discretion to annually change the participation rates and
spreads/caps on its products. The minimum guaranteed values are equal to between 75% and 90% of
first year premiums and between 87.5% and 90% of renewal premiums collected for equity-indexed
annuities, plus interest credited at an annual rate of 3%. The annuities provide for penalty-free
withdrawals of up to 10% in each year after the first year of the annuitys term. Other
withdrawals from the product are subject to a surrender charge. Standard Life purchases S&Ps 500
Index or DJIA Index call options to mitigate potential increases to policyholder benefits resulting
from increases in the index to which the products return is linked. As of December 31, 2004,
Standard Life had 11,041 equity-indexed contracts in force from currently marketed products. 7




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Single Premium Immediate Annuities and Supplementary Contracts. Standard Life allows
for the payout of premium deposits in an agreed upon payment stream shortly after a premium deposit
is received. The payout stream consists of principal plus accumulated interest credited to the
annuity and is guaranteed for the term of the contract. These contracts are non-surrenderable and
have no commuted value. This product is mainly used for Medicaid Planning, as they are not subject
to Medicaid spend-down rules. A single-premium immediate annuity is designed to provide an
immediate and steady income stream for a specified number of years of lifetime. Standard Lifes
currently marketed deferred annuity and equity indexed annuity products offer policyholders the
right to exchange their deferred annuity contract for a supplementary contract which provides a
guaranteed stream of benefit payments for a fixed period and/or until the death of the annuitant.
These supplementary contracts have characteristics similar to single premium immediate annuities.
As of December 31, 2004, Standard Life had 9,883 single premium immediate annuity contracts in
force. Other Product Information. Premium deposits decreased in 2004 due to management
actions to preserve spread income in response to market conditions. Management actions included
reducing credited rates and temporarily suspending sales of selected products. Additionally,
premium deposits decreased due to the markets reaction to the announced sale of Standard Life, as
more fully described below in Managements Discussion and Analysis of Financial Condition and
Results of Operations  Recent Developments. Our gross sale percentages by geographical region are summarized as follows: State
    
    2004
    
    
    2003
    
    
    2002California
    
    
    29
    %
    
    
    19
    %
    
    
    15
    %Michigan
    
    
    21
    
    
    
    19
    
    
    
    17Ohio
    
    
    11
    
    
    
    6
    
    
    
    6Indiana
    
    
    9
    
    
    
    11
    
    
    
    14Wisconsin
    
    
    4
    
    
    
    4
    
    
    
    4Texas
    
    
    3
    
    
    
    2
    
    
    
    1Georgia
    
    
    3
    
    
    
    2
    
    
    
    2All other states (1)
    
    
    20
    
    
    
    37
    
    
    
    41Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    Former Products (Closed Blocks) We also generate cash flow and income from our closed blocks of in force life insurance and
annuities. Closed blocks consist of in force life insurance and annuities that are not currently
being marketed. The closed block designation does not have legal or regulatory significance and
there are no restrictions on their assets or future profits. The premiums
received on the closed blocks are primarily from the ordinary and universal life business.
Closed block premiums typically decline over extended periods of time as a result of policy lapses,
surrenders and expiries. Annuities.Our closed blocks of deferred annuities consist primarily of flexible
premium deferred annuities and a small amount of single premium deferred annuities, which, unlike
flexible premium deferred annuities, do not provide for additional deposits. As of January 1,
2005, these deferred annuities had crediting rates ranging from 3% to 7% 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. Our closed blocks of
annuities include payout annuities which consist of immediate annuities and supplementary contracts
in which benefits are paid out over a specified time period. Payout annuities cannot be terminated
by surrender or withdrawal. Interest rates used in determining payout annuities range from .7% to
3.0% and cannot be changed after a policy is issued. At December 31, 2004, we had 18,780 annuity
contracts in force for closed blocks. Traditional Life.Our closed blocks of traditional life business include several types
of participating and non-participating, whole life and term life insurance policies. Face amounts
vary, but retained death benefits are $150,000 or less per life (after reinsurance considerations).
Traditional life insurance products involve fixed premium payments made over 8




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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. The term policy provides benefits only as long as premiums
are paid. At December 31, 2004, we had 31,801 traditional life policies in force for closed
blocks. Universal Life.Our closed blocks of universal life business include flexible premium
universal life policies, which provide for periodic deposits, interest credits to account values
and charges to the account values for mortality and administrative costs. As of January 1, 2005,
the credited interest rate on existing flexible premium universal life policies was 3% to 5.5% with
a guaranteed interest rate of 3% to 5.5%. At December 31, 2004, we had 9,158 universal life
policies in force for closed blocks. Operations Our principal administrative departments for our insurance subsidiaries include financial, new
business, policyholder services, and information technology services (IT) departments. The
financial department provides accounting, budgeting, tax, investment, financial reporting and
actuarial services and establishes cost control systems. The new business department reviews policy
applications, and issues and administers our policies. The policyholder services department
authorizes disbursements related to claims and surrenders. The IT department oversees and
administers our information processing systems. Our administrative departments use a common integrated policy administration system that
permits efficiency and cost control. Our IT system services approximately 84,000 active policies
at December 31, 2004. Underwriting Premiums charged on life insurance products are based in part on assumptions about the
incidence and timing of insurance claims. When we issued life insurance business, we adopted and
followed underwriting procedures for traditional and universal life insurance policies. Since we no
longer issue new life insurance policies, life insurance underwriting activities are minimal and
occur only when a policyholder requests a change which is subject to underwriting. Underwriting
with respect to annuities is minimal. Investments Investment activities are an integral part of our business as the investment income of our
insurance subsidiaries is a significant part of total revenues. Profitability is significantly
affected by spreads between interest earned on invested assets and rates credited on insurance
liabilities. The weighted average net yield of our investment portfolio was 4.86%, 5.34% and 6.53%
during 2004, 2003 and 2002, respectively. We balance the duration of our invested assets with the expected duration of benefit payments
arising from insurance liabilities. The duration of a security is a measure of a securitys price
sensitivity to changes in market interest rates. The option-adjusted duration of fixed maturity
securities and short-term investments for our insurance subsidiaries was 4.6 and 4.9 years at
December 31, 2004 and 2003, respectively, which reasonably match the duration of our policy
liabilities of 4.4 at December 31, 2004 and 2003, respectively. Our investment strategy is guided by strategic objectives established by the Investment
Committee of our board of directors. Our major investment objectives are to: 1) maximize book
investment income without exposing surplus to excessive volatility, 2) match the anticipated
duration of investments with the anticipated duration of policy liabilities through our
asset-liability cash flow management process, 3) maximize our company objectives for tax
considerations and realized gain/loss recognition, and 4) provide sufficient liquidity to meet cash
requirements with minimum sacrifice of investment yield. Consistent with this strategy, we invest
primarily in securities of the U.S. government and its agencies, investment grade utilities,
corporate debt securities and collateralized mortgage obligations. When opportunities arise, below
investment grade securities may be purchased; however, protection against default risk is a primary
consideration. We will not invest more than 7% of our bond portfolio in below investment grade
securities. 9




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The National Association of Insurance Commissioners (NAIC) assigns quality ratings to
securities called NAIC Designations which are used by insurers when preparing their annual
statements. The NAIC assigns ratings to publicly traded and privately-placed securities. The
ratings assigned range from Class 1 to Class 6, with a rating in Class 1 being of the highest
quality. The following table sets forth the quality of our fixed maturity securities as of
December 31, 2004, classified in accordance with the ratings assigned by the NAIC: Percent of FixedNAIC Rating
    
    Maturity Securities1
    
    
    802
    
    
    19Total
Investment
Grade
    
    
    993-4
    
    
    15-6
    
    
    0Total
    
    
    100
    %
 Deutsche Investment Management Americas Inc. manages our fixed maturity securities, subject to
the direction of management and our Investment Committee. Approximately 52.4% of our fixed maturity securities at December 31, 2004 are comprised of
mortgage-backed securities that include collateralized mortgage obligations and mortgage-backed
pass-through securities. Approximately 4.2% of the book value of mortgage-backed securities in our
portfolio are backed by the full faith and credit of the U.S. government as to the full amount of
both principal and interest and 63.6% are backed by an agency of the U.S. government (although not
by the full faith and credit of the U.S. government). The following table summarizes our mortgage-backed securities at December 31, 2004 (in
thousands): Estimated
    
    
    Avg.% of
    
    
    
    
    
    
    % of
    
    
    Avg. Life
    
    
    TermAmortized
    
    
    Fixed
    
    
    Fair
    
    
    Fixed
    
    
    of
    
    
    to FinalCost
    
    
    Maturities
    
    
    Value
    
    
    Maturities
    
    
    Investment
    
    
    Maturity(In Years)
    
    
    (In Years)Agency collateralized mortgage obligations:Planned and target amortization
classes
    
    $
    269,730
    
    
    
    16.4
    %
    
    $
    268,299
    
    
    
    16.2
    %
    
    
    4.0
    
    
    
    19.3Sequential and support
classes
    
    
    66,994
    
    
    
    4.1
    %
    
    
    66,095
    
    
    
    4.0
    %
    
    
    6.5
    
    
    
    16.5Total
    
    
    336,724
    
    
    
    20.5
    %
    
    
    334,394
    
    
    
    20.2
    %
    
    
    4.5
    
    
    
    18.7Non-agency collateralized mortgage obligations:Planned and target amortization
classes
    
    
    41
    
    
    
    0.0
    %
    
    
    43
    
    
    
    0.0
    %
    
    
    1.0
    
    
    
    19.2Sequential classes
    
    
    30,532
    
    
    
    1.9
    %
    
    
    30,487
    
    
    
    1.8
    %
    
    
    3.0
    
    
    
    17.5Other
    
    
    100,278
    
    
    
    6.1
    %
    
    
    92,902
    
    
    
    5.6
    %
    
    
    6.5
    
    
    
    7.2Total
    
    
    130,851
    
    
    
    8.0
    %
    
    
    123,432
    
    
    
    7.5
    %
    
    
    5.7
    
    
    
    9.6Total
CMOs
    
    
    467,575
    
    
    
    28.4
    %
    
    
    457,826
    
    
    
    27.6
    %
    
    
    4.8
    
    
    
    16.2Non agency collateralized mortgage-backed
securities
    
    
    182,939
    
    
    
    11.1
    %
    
    
    180,453
    
    
    
    10.9
    %
    
    
    5.5
    
    
    
    3.6Agency mortgage-backed pass-through
securities
    
    
    212,700
    
    
    
    12.9
    %
    
    
    215,863
    
    
    
    13.0
    %
    
    
    24.1
    
    
    
    24.1Total mortgage-backed
securities
    
    $
    863,214
    
    
    
    52.4
    %
    
    $
    854,142
    
    
    
    51.4
    %
    
    
    9.7
    
    
    
    15.5
 The fair values for mortgage-backed securities were determined from broker-dealer
markets, 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 10




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##### Table of Contents



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.
Planned and target amortization class securities 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 collateralized mortgage obligations, which comprised the remaining 35.9% of the book
value of our mortgage-backed securities at December 31, 2004, are more sensitive to prepayment
risk. Reserves Our insurance subsidiaries have established and carry as liabilities in their financial
statements actuarially and otherwise determined liabilities to satisfy their respective annuity
contract and life insurance policy obligations. Insurance policy liabilities for deferred annuities and universal life policies are equal to
the full account value that accrues to the policyholder (cumulative premiums less certain charges,
plus interest credited) with credited interest rates ranging from 2.5% to 7% in 2004 and 3.0% to
7.5% in 2003. Insurance policy liabilities for equity-indexed annuity products are computed in accordance
with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133), and consist of a book value liability for benefits guaranteed
in the contract, combined with a market value liability for equity-linked benefits of the contract. We perform periodic studies to compare current experience for mortality, interest and lapse
rates with projected experience used in calculating the annuity and life insurance policy
liabilities. Differences are reflected currently in earnings for each period. We recorded a charge
of $0 and $7.9 million for 2004 and 2003, respectively, related to the acceleration of deferred
policy acquisition costs (DAC) amortization due to DAC unlocking. Insurance policy liabilities 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 6.2% to 7.5%. Mortality is based upon various actuarial tables,
principally the 1965-1970 or the 1975-1980 Select and Ultimate Table. Withdrawals are based upon
our experience and vary by issue age, type of coverage, and duration. Reinsurance Consistent with the general practice of the life insurance industry, we have reinsured
portions of the coverage provided by our life insurance products with other insurance companies
under agreements of indemnity reinsurance. Our policy risk retention limit on the life of any one
individual does not exceed $150,000. Indemnity reinsurance agreements are intended to limit a life insurers maximum loss on a
particular risk or to obtain a greater diversification of risk. Indemnity reinsurance does not
discharge the primary liability of the original insurer to the insured, but it is the practice of
insurers for statutory accounting purposes (subject to certain limitations of state insurance
statutes) to account for risks which have been reinsured with other approved companies, to the
extent of the reinsurance, as though they are not risks for which the original insurer is liable.
However, under Statement of Financial Accounting Standards No. 113 (SFAS 113), Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, these amounts are added
back to policy reserves and recorded as amounts due from reinsurers. Reinsurance ceded on life insurance policies to unaffiliated companies in 2004, 2003 and 2002,
excluding financial reinsurance agreements, represented 38%, 39%, and 40%, respectively, of our
gross combined individual life insurance in force at the end of such years. Reinsurance assumed in
the normal course from unaffiliated companies in 2004, 2003 and 2002 represented 9%, respectively,
of our net combined individual life insurance in force. 11




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##### Table of Contents



The following is reinsurance ceded information for the four reinsurers to which we have ceded
the largest amount of life reinsurance at December 31, 2004 (in thousands): % of TotalFace Value of
    
    
    Reinsurance
    
    
    ReinsuranceInsurance Company
    
    Life Policies
    
    
    Ceded
    
    
    RecoverableEmployers Reassurance Corporation
    
    $
    115,526
    
    
    
    27.6
    %
    
    $
    1,359Lincoln National Life Insurance Company
    
    
    81,093
    
    
    
    19.4
    %
    
    
    928Generali USA Life Reassurance Company
    
    
    53,887
    
    
    
    12.9
    %
    
    
    413Swiss Re Life & Health America
    
    
    42,343
    
    
    
    10.1
    %
    
    
    452
 Reinsured life insurance in force at December 31, 2004 is ceded to insurers rated A-
(Excellent) or better by A.M. Best. Historically, we have not experienced material losses in
collection of reinsurance receivables. Our largest annuity reinsurer at December 31, 2004, SCOR Life U.S. Insurance Company (SCOR
Life), represented $16.6 million, or 47% of our total reinsurance recoverable and is rated B++
(Very Good) by A.M. Best. Competition The life insurance and annuity 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
Standard Management. According to the American Council of Life Insurers, as of 2003, there were
approximately 1,200 life insurance companies in the United States, which may offer insurance and
annuity products similar to ours. Competition within the life insurance and annuity industry occurs
on the basis of, among other things, 1) product features such as price and interest rates, 2)
perceived financial stability of the insurer, 3) policyholder service, 4) name recognition and 5)
ratings assigned by insurance rating organizations. We must also compete with other insurers to attract and retain the allegiance of agents. We
believe that competition centers more on the strength of the agent relationship rather than on the
insurers name recognition to the customer. We offer competitive products, competitive commission
structures, internet-based agent services, prompt policy issuance and responsive policyholder
service and believe we are successful in attracting and retaining qualified agents. Competition also is encountered from the expanding number of banks, securities brokerage firms
and other financial intermediaries which are marketing insurance and annuity products and which
offer competing products such as savings accounts and securities. The passage, by the U.S.
Congress, of the Gramm-Leach-Bliley Financial Services Modernization Act (GLB Act) has expanded
competitive opportunities for non-insurance financial services companies. Financial institutions, 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 Life each have a rating of B, by A.M. Best. A rating
of B is assigned by A.M. Best to companies that, in their opinion, have achieved good overall
performance when compared to the standards established by A.M. Best. According to A.M. Best, these
companies generally have an adequate ability to meet their obligations to policyholders, but their
financial strength is vulnerable to unfavorable changes in underwriting or economic conditions. In
evaluating a companys financial and operating performance, A.M. Best reviews the companys
profitability, leverage and liquidity as well as the companys book of business, the adequacy and
soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of
its reserves and the experience and competence of its management. A.M. Bests ratings are based
upon factors relevant to policyholders, agents, insurance brokers and intermediaries and are not
directed to the protection of investors. Generally, rating agencies base their ratings on
information furnished to them by the issuer and on their own investigations, studies and
assumptions by the rating agencies. There is no assurance that any particular rating will continue
for any given period of time or that it will not be changed or withdrawn entirely if, in the
judgment of the rating agency, circumstances so warrant. Although a higher rating by A.M. Best or
another insurance rating organization could have a favorable effect on Standard Lifes business,
management believes that it is able to compete on the basis of their competitive crediting rates,
asset quality, strong relations with its independent agents and the quality of service to its
policyholders. 12




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##### Table of Contents



Federal Income Taxation The products marketed and issued by Standard 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 that 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 of 1986, as amended, and is generally followed in all states and other U.S. taxing
jurisdictions. Accordingly, it is subject to change by Congress and the legislatures of the
respective taxing jurisdictions. Regulatory Factors Our insurance subsidiaries are subject to significant 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 or debt holders.
The insurance laws of various jurisdictions establish regulatory agencies with broad administrative
powers relating to 1) the licensing of insurers and their agents, 2) the regulation of trade
practices, 3) management agreements, 4) the types of permitted investments and maximum
concentration, 5) deposits of securities, 6) the form and content of financial statements, 7)
premiums charged by insurance companies, 8) sales literature and insurance policies, 9) accounting
practices and the maintenance of specified reserves and 10) capital and surplus. Our insurance
subsidiaries are required to file detailed periodic financial reports with supervisory agencies in
certain jurisdictions. Most states have also enacted legislation regulating insurance holding company activities
including acquisitions, extraordinary dividends, terms of surplus debentures, terms of affiliate
transactions and other related matters. 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. Recently a number of state regulators have considered
or have enacted legislative proposals that change, and in many cases increase, the authority of
state agencies to regulate insurance companies and holding companies. For additional information
on state laws regulating insurance company subsidiaries, see Managements Discussion and Analysis
of Financial Condition and Results of Operations  Liquidity and Capital Resources and Note 14 to
our Consolidated Financial Statements. 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 these transactions and the Indiana Department of Insurance
has not disapproved of them within the period specified by Indiana law. Among other things, these
transactions are subject to the requirement that their terms and charges or fees for services
performed be fair and reasonable. 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 requirement. 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 these
shares is generally deemed to be the acquisition of control for the purpose of the holding
company statutes. However, in many states the insurance authorities may find that control in fact
does or does not exist in circumstances in which a
person owns or controls either a lesser or a greater amount of securities. See Item 7 
Recent Developments below for more information on the pending sale of Standard Life. 13




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##### Table of Contents



In some instances, state regulatory authorities require deposits of assets for the protection
of either policyholders in those states or for all policyholders. At December 31, 2004, securities
of $11.1 million, or approximately .7% of the book value of our insurance subsidiaries invested
assets, were on deposit with various state treasurers or custodians. These deposits must consist of
securities that comply with the standards that the particular state has established. In recent years, NAIC, and state insurance regulators have examined existing laws and
regulations and their application to insurance companies. This examination has focused on 1)
insurance company investment and solvency issues, 2) risk-based capital guidelines, 3) assumption
reinsurance, 4) interpretations of existing laws, 5) the development of new laws, 6) the
interpretation of non-statutory guidelines, 7) the standardization of statutory accounting rules
and 8) 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. We are unable to predict the future impact of changing state regulation on
our operations. The NAIC and Indiana have each adopted Risk-Based Capital (RBC) requirements for life and
health insurance companies to evaluate the adequacy of statutory capital and surplus in relation to
investment and insurance risks. State insurance regulators use the RBC requirements as regulatory
tools only, which aid in the identification of insurance companies that could potentially lack
sufficient capital. Regulatory compliance is determined by a ratio (the RBC Ratio) of the
companys regulatory total adjusted capital to its authorized control level RBC. The two
components of the RBC Ratio are defined by the NAIC. The RBC ratios that require corrective action
are as follows: Level
    
    RBC Ratio
    
    Corrective ActionCompany Action
    
    1.5 - 2
    
    Company is required to submit a plan to improve its RBC RatioRegulatory Action
    
    1 - 1.5
    
    Regulators will order corrective actionsAuthorized Control
    
    0.7 - 1
    
    Regulators are authorized to take control of the companyMandatory Control
    
    less than 0.7
    
    Regulators must take over the company
 At December 31, 2004, the RBC Ratios of Standard Life and Dixie Life were 6.3 and 8.7,
respectively. If these RBC Ratios should decline in the future, our subsidiaries might be subject
to increased regulatory supervision and decreased ability to pay dividends, management fees and
surplus debenture interest to Standard Management. On the basis of annual statutory statements filed with state regulators, the NAIC calculates
12 financial ratios to assist state regulators in monitoring the financial condition of insurance
companies. A usual range of results for each ratio is used as a benchmark. In the past,
variances in certain ratios of our insurance subsidiaries have resulted in inquiries from insurance
departments to which we have responded. Such inquiries did not lead to any restrictions affecting
our operations. We attempt to manage our assets and liabilities so that income and principal payments received
from investments are adequate to meet the cash flow requirements of our policyholder liabilities.
The cash flows of our liabilities are affected by actual maturities, surrender experience and
credited interest rates. We periodically perform cash flow studies under various interest rate
scenarios to evaluate the adequacy of expected cash flows from our assets to meet the expected cash
requirements of our liabilities. We utilize these studies to determine if it is necessary to
lengthen or shorten the average life and duration of our investment portfolio. Because of the
significant uncertainties involved in the estimation of asset and liability cash flows, there can
be no assurance that we will be able to effectively manage the relationship between our asset and
liability cash flows. The statutory filings of our insurance subsidiaries require classifications of investments and
the establishment of an asset valuation reserve, 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 asset valuation reserve 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 interest maintenance reserve, 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 interest maintenance reserve
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 our insurance
subsidiaries to reflect investment gains and losses in current period statutory earnings and
surplus. 14




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##### Table of Contents



The amounts related to Asset Valuation Reserve and Interest Maintenance Reserve for our
insurance subsidiaries at December 31, 2004 are summarized as follows (in thousands): InterestAsset Valuation
    
    
    Maximum Asset
    
    
    MaintenanceReserve
    
    
    Valuation Reserve
    
    
    ReserveStandard
Life
    
    $
    6,355
    
    
    $
    7,217
    
    
    $
    15,406Dixie
Life
    
    $
    88
    
    
    $
    242
    
    
    $
    19
 The annual addition to the asset valuation reserve consists of a factor-based basic
contribution plus 20% of the difference between the reserve objective and 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, 2004, our insurance
subsidiaries each made the required contribution to the asset valuation reserve. Most jurisdictions require insurance companies to participate in guaranty funds designed to
cover claims against insolvent insurers. Insurers authorized to transact business in these
jurisdictions are generally subject to assessments based on annual direct premiums written in that
jurisdiction to pay such claims, if any. These assessments may be deferred or forgiven under most
guaranty laws if they would threaten an insurers financial strength and, in certain instances, may
be offset against future state premium taxes. The incurrence and amount of such assessments have
increased in recent years and may increase further in future years. The likelihood and amount of
all future assessments cannot be reasonably estimated and are beyond our control. As part of their routine regulatory oversight process, approximately once every three to five
years, state insurance departments conduct periodic detailed examinations of the books, records and
accounts of insurance companies domiciled in their states. Standard Life had an examination during
2001 for the five-year period ended December 31, 2000 and Dixie Life had an examination during 2001
for the three-year period ended December 31, 2000. These final examination reports were issued in
2002 with no adjustments to the statutory statements required. The federal government does not directly regulate the insurance business. However, federal
legislation and administrative policies in several areas, including pension regulation, age and sex
discrimination, financial services regulation and federal taxation, do affect the insurance
business. In addition, legislation has been introduced from time to time in recent years, which,
if enacted, could result in the federal government assuming a more direct role in the regulation of
the insurance industry. The GLB Act has left the currently existing regime of state insurance
regulation largely intact; however, more comprehensive federal legislation in this area is still
being actively considered by Congress. Inflation A primary direct effect of inflation is an increase to our operating expenses. A large portion
of our operating expenses consists of salaries, which are subject to wage increases at least partly
affected by the rate of inflation. The rate of inflation also affects us indirectly. To the extent that the governments
economic policy to control the level of inflation results in changes in our interest rates, our new
sales of annuity products, investment income and withdrawal rates are affected. Changes in the
level of interest rates also have an effect on interest spreads, as investment earnings are
reinvested. Standard Management Federal Income Taxation We file a consolidated return, excluding U.S. Health Services, as well as a U.S. Health
Services return for federal income tax purposes. As of December 31, 2004, Standard Management and
its subsidiaries had consolidated net capital loss carryforwards of approximately $3.2 million of
which $.2 million expires in 2008 and the remainder expires in 2009. 15




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##### Table of Contents



As of December 31, 2004, Standard Management and its subsidiaries had consolidated net
operating loss carryforwards of approximately $19.2 million for tax return purposes, which expire
from 2009 to 2024. Of this amount, $16.5 million will only be able to reduce taxable income of
U.S. Health Services. Employees As of March 1, 2005, we had 172 employees, 76 of whom were in the health services segment, 84
in the financial services segment and 12 in the other services segment. We believe our future
success will depend, in part, on our ability to attract and retain highly-skilled technical,
marketing, support and management personnel. We believe we have excellent relations with our
employees. 
 Item 2. Properties In December 2001, we signed a promissory note and mortgage due December 31, 2011, with a
current outstanding principal amount of $6.4 million at December 31, 2004, used to finance our home
office building consisting of 56,000 square feet and located at 10689 North Pennsylvania Street,
Indianapolis, Indiana. Approximately 43,000 square feet of the building is leased to Standard Life
pursuant to a lease agreement entered into on December 28, 2001. The remaining space is used by
Standard Management and U.S. Health Services. We expect that Standard Life will continue to lease
approximately 22,000 square feet from us in the event that the sale of Standard Life is consummated
as anticipated. U.S. Health Services leases approximately 30,000 square feet in an office and warehouse
building located at 6210 N. Technology Center Drive, Indianapolis, Indiana. The lease expires
April 2007. 
 Item 3. Legal Proceedings We are involved in various legal proceedings in the normal course of business. In most cases,
these proceedings involve claims under insurance policies or other contracts. The outcome of these
legal proceedings are not expected to have a material adverse effect on the consolidated financial
position, liquidity, or future results of our operations based on our current understanding of the
relevant facts and law and our recorded reserves for such matters. 
 Item 4. Submission of Matters to a Vote of Securities Holders None during the 4th quarter of 2004. 16




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##### Table of Contents



Part II 
  Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities Our common stock trades on the NASDAQ National Market under the symbol SMAN. The following
table sets forth, for the periods indicated, the range of the high and low sales prices of our
common stock as reported by NASDAQ. We have never paid cash dividends on our common stock. At the
close of business on February 28, 2005 there were approximately 3,000 holders of record of the
outstanding shares of our common stock. Although our common stock is traded on NASDAQ, no assurance
can be given as to the future price of or the markets for the stock. Common StockHigh
    
    
    Low2004Quarter ended March 31, 2004
    
    $
    4.12
    
    
    $
    3.49Quarter ended June 30, 2004
    
    
    4.18
    
    
    
    3.39Quarter ended September 30, 2004
    
    
    3.64
    
    
    
    3.05Quarter ended December 31, 2004
    
    
    3.98
    
    
    
    2.712003Quarter ended March 31, 2003
    
    $
    4.23
    
    
    $
    2.60Quarter ended June 30, 2003
    
    
    4.69
    
    
    
    3.12Quarter ended September 30, 2003
    
    
    4.65
    
    
    
    3.60Quarter ended December 31, 2003
    
    
    4.25
    
    
    
    3.11
 Equity Compensation Plan Information The following provides tabular disclosure of the number of securities to be issued upon the
exercise of outstanding options, the weighted average exercise price of outstanding options, and
the number of securities remaining available for future issuance under our equity compensation
plans. All of our equity compensation plans have been approved by our shareholders. Number ofsecuritiesNumber of
    
    
    
    
    
    
    remainingsecurities to be
    
    
    
    
    
    
    available forissued upon
    
    
    Weighted-average
    
    
    future issuanceexercise of
    
    
    exercise price of
    
    
    under equityoutstanding
    
    
    outstanding
    
    
    compensationPlan Category
    
    options
    
    
    options
    
    
    plansEquity compensation plans approved by security holders:1992 Stock Option Plan
    
    
    1,806,625
    
    
    $
    6.00
    
    
    
    2002 Stock Incentive Plan
    
    
    683,500
    
    
    
    3.36
    
    
    
    785,569
 17




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##### Table of Contents



Item 6. Selected Financial Data (Dollars
in thousands, except per share amounts and shares
outstanding)
 The following historical financial data was derived from our audited Consolidated Financial
Statements. This historical financial data should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated
Financial Statements and related Notes. Year Ended December 312004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000STATEMENT OF INCOME DATA:Premium income
    
    $
    7,924
    
    
    $
    8,929
    
    
    $
    9,173
    
    
    $
    9,419
    
    
    $
    9,433Net investment income
    
    
    83,393
    
    
    
    83,009
    
    
    
    75,839
    
    
    
    58,539
    
    
    
    50,278Call option gain
(loss)
    
    
    2,449
    
    
    
    11,951
    
    
    
    (10,089
    )
    
    
    (5,906
    )
    
    
    (7,603
    )Net realized investment gain
(loss)
    
    
    (283
    )
    
    
    17,876
    
    
    
    (19,841
    )
    
    
    (10,351
    )
    
    
    (4,492
    )Total revenues
    
    
    118,008
    
    
    
    136,573
    
    
    
    68,224
    
    
    
    66,770
    
    
    
    61,800Total benefit and expenses
    
    
    128,481
    
    
    
    147,396
    
    
    
    85,549
    
    
    
    66,361
    
    
    
    58,524Income (loss) before income taxes,
extraordinary loss, discontinued
operations and cumulative effect
of accounting
change
    
    
    (10,473
    )
    
    
    (10,823
    )
    
    
    (17,325
    )
    
    
    409
    
    
    
    3,276Cumulative effect of accounting change for
goodwill impairment
    
    
    
    
    
    
    
    
    
    
    (1,212
    )
    
    
    
    
    
    
    Net income (loss) from continuing
operations
    
    
    (10,868
    )
    
    
    (10,196
    )
    
    
    (9,070
    )
    
    
    214
    
    
    
    3,189Gain (loss) from discontinued
operations
    
    
    
    
    
    
    (275
    )
    
    
    7,940
    
    
    
    
    
    
    
    Net income (loss)
    
    
    (10,868
    )
    
    
    (10,471
    )
    
    
    (1,130
    )
    
    
    1,780
    
    
    
    5,267PER SHARE DATA:Net income (loss) from continuing operations,
assuming dilution
    
    
    (1.36
    )
    
    
    (1.27
    )
    
    
    (1.03
    )
    
    
    0.03
    
    
    
    0.41Net income (loss), assuming
dilution
    
    
    (1.36
    )
    
    
    (1.30
    )
    
    
    (0.15
    )
    
    
    0.23
    
    
    
    0.66Book value per common
share
    
    
    7.58
    
    
    
    8.93
    
    
    
    11.17
    
    
    
    9.30
    
    
    
    8.34Weighted average common shares
outstanding, assuming dilution for
continuing
operations
    
    
    7,973,029
    
    
    
    8,031,749
    
    
    
    7,623,690
    
    
    
    7,765,378
    
    
    
    7,733,917Common shares
outstanding
    
    
    7,921,113
    
    
    
    8,114,196
    
    
    
    7,854,674
    
    
    
    7,546,493
    
    
    
    7,545,156BALANCE SHEET DATA (at year end)Invested assets
    
    $
    1,685,194
    
    
    $
    1,685,916
    
    
    $
    1,405,807
    
    
    $
    952,754
    
    
    $
    742,463Assets of discontinued
operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    430,330
    
    
    
    548,730Total assets
    
    
    1,947,896
    
    
    
    1,974,771
    
    
    
    1,715,147
    
    
    
    1,613,653
    
    
    
    1,470,457Mortgages payable
    
    
    6,607
    
    
    
    6,795
    
    
    
    6,757
    
    
    
    6,900
    
    
    
    Notes payable
    
    
    26,433
    
    
    
    21,000
    
    
    
    13,000
    
    
    
    19,100
    
    
    
    31,500Subordinated debt
    
    
    20,700
    
    
    
    20,700
    
    
    
    20,700
    
    
    
    20,700
    
    
    
    Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,530Shareholders equity
    
    
    60,032
    
    
    
    72,447
    
    
    
    87,734
    
    
    
    70,189
    
    
    
    62,899
 18




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##### Table of Contents



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 our
operations and the significant changes in our balance sheet items on a consolidated basis for the
periods listed, as well as liquidity and capital resources. This discussion should be read in
conjunction with the accompanying Consolidated Financial Statements, related Notes and Selected
Historical Financial Data. Recent Developments Over the past 18 months, the board and management of the Company considered a variety of
strategic alternatives that might provide it with adequate financing to pursue its growth
strategies for the health services business it embarked on in 2002 and maximize long-term
shareholder value. After considering various options, management, in early 2005, committed to the
sale of 100% of Standard Life, including Dixie Life. Pursuant to this decision and following
months of negotiating, on February 9, 2005, Standard Management entered into a definitive Stock and
Asset Purchase Agreement (the Agreement) with Capital Assurance Corporation (Capital
Assurance). The Agreement provides for the sale to Capital Assurance of (i) 100% of the capital
stock of Standard Life, and (ii) $27 million aggregate principal amount of surplus debentures
issued by Standard Life in favor of Standard Management. The Agreement represents the definitive
terms for the transactions contemplated by the previously reported letter of intent between the
parties. Standard Management expects the transaction to close in the second quarter of 2005. The purchase price under the Agreement is $79.5 million, subject to adjustment as described
below, which will be payable as follows: (i) $5 million of a new class of 7% cumulative
exchangeable preferred stock of Capital Assurance, (ii) assumption by Capital Assurance of
approximately $21 million in intercompany obligations of Standard Management to Standard Life and
(iii) the balance of the purchase price in cash. The cash portion of the purchase price will be
adjusted, post-closing, based on certain changes in the business of Standard Life occurring between
October 1, 2004 and the closing of the transaction, including adjustments for, among other things,
statutory gains from operations of Standard Life, credit related capital gains and losses,
including impairment losses, principal payments on the surplus debentures and capital expenditures
by Standard Life. Management currently estimates that based on anticipated adjustments, the
post-closing, as adjusted purchase price will be approximately $83 million. Standard Management and Capital Assurance have made customary representations, warranties and
covenants in the Agreement, including, among others, covenants by Standard Management (i) to
conduct the business of Standard Life in the ordinary course and maintain necessary permits and
insurance policies during the interim period between the execution of the Agreement and closing,
(ii) to not engage in certain types of transactions during such period, (iii) to cause a meeting of
the shareholders of Standard Management to be held to approve the Agreement and the transactions
contemplated thereby, (iv) to not solicit proposals relating to an alternative sale or business
combination transaction and (v) subject to certain exceptions, not to enter into discussions
concerning or provide confidential information in connection with proposals for alternative sale or
business combination transactions. In addition, Standard Management has agreed to purchase certain
assets from Standard Life at closing for approximately $6 million. Consummation of the transactions contemplated by the Agreement is subject to customary
conditions, including (i) approval of the shareholders of Standard Management, (ii) absence of any
law or order prohibiting the closing, (iii) approval of the Indiana Department of Insurance, and
(iv) expiration or termination of the Hart-Scott-Rodino waiting period. In addition, each partys
obligation to consummate the transactions contemplated by the Agreement is subject to certain
customary conditions, including (i) with certain exceptions, the accuracy of the representations
and warranties of the other party and (ii) material compliance of the other party with its
covenants. Standard Management also agreed to undertake a solicitation of the preferred security holders
of SMAN Capital Trust I, a wholly owned subsidiary of Standard Management (the Trust) at an
estimated cost of approximately $1 million to fund incentive payments in connection with obtaining
the consent of the trust preferred holders. If adopted, the amendment would provide us additional
financing flexibility by allowing us to enter into certain business transactions, such as the sale
of substantially all of our assets, without the acquirer of such assets being required to assume
our responsibilities under the indenture. In the event the requisite consents to amend the
indenture are not received, Standard Management has the right to require Capital Assurance to
assume Standard Managements obligations under the indenture. If this event were to occur,
Standard Management would receive less net cash proceeds from the sale of Standard Life by the
net face amount outstanding of the trust preferred securities. 19




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##### Table of Contents



Also in this Agreement, Standard Management agreed to indemnify Capital Assurance and Standard
Life for any losses arising from breaches of any representation or warranty of Standard Management
made in the Agreement subject to the applicable survival periods and for certain allocated tax
losses, if any of such losses exceed $500,000 in the aggregate. If such indemnification threshold
is exceeded, Standard Management would be responsible for paying $250,000 plus the amount of such
loss in excess of $500,000, up to a maximum amount equal to the purchase price for losses related
to the breach of certain representations and warranties, and up to a maximum amount equal to 50% of
the purchase price for breaches of certain other specified representations and warranties. In
addition, Standard Management agreed to indemnify Capital Assurance and Standard Life for losses
arising out of any litigation pending against Standard Life as of the Closing Date to the extent
the loss exceeds Standard Lifes litigation reserve, for any breach of the covenants and agreements
made by Standard Management in the Agreement and for certain other tax losses. Standard Management
has agreed to pledge the preferred stock to be received as part of the consideration in the
transaction to secure up to $5 million of indemnification liabilities. Capital Assurance also agreed to indemnify us with respect to any breach of a representation,
warranty or covenant made by it under the Agreement, subject to the same limits and the applicable
survival periods. The Agreement provides termination rights for both Standard Management and Capital Assurance,
and further provides that, upon termination of the Agreement under specified circumstances,
Standard Management may be required to pay Capital Assurance a termination fee ranging from $1.6
million to $3.2 million, depending on the circumstance leading to the termination, plus
reimbursement of up to $2 million of expenses incurred by Capital Assurance in connection with the
transaction since November 21, 2004. If the proposed sale is consummated, we estimate that, for federal income tax purposes, we
will recognize a capital loss on the sale of approximately $22 million, equal to the difference
between our adjusted tax basis in Standard Life and the amount realized from the proposed sale. We
may recognize a tax benefit in future periods from this capital loss provided that we recognize
capital gains within five years. In addition, for accounting purposes, we would expect to record a
loss on the sale of approximately $35 million, which is equal to the difference between the
expected net book value of the assets sold on the sale date and the purchase price expected to be
paid by Capital Assurance in the proposed transaction, plus transaction related expenses. Standard Management has filed with the SEC preliminary proxy materials relating to (i) the
special meeting of shareholders to be held for the purpose of approving the Agreement and the
transactions contemplated thereby and (ii) the solicitation of consents from holders of trust
preferred securities of SMAN Capital Trust I to an amendment to the Indenture relating to such
securities. Standard Management has set May 18, 2005 as the date for a special meeting of
shareholders to vote on the approval of the sale of its subsidiary, Standard Life, to Capital
Assurance. Definitive proxy materials will be sent to all shareholders of record (as of April 4,
2005) on or about April 11, 2005. If the sale of Standard Life is consummated, Standard Management will no longer operate in the
insurance industry (other than certain de minimisactivities). At such time, virtually all of our
operations will consist of the business of our U.S. Health Services subsidiary and its several
operating subsidiaries which comprise our health services operations. If the sale is consummated,

Standard Life and its subsidiaries will be treated for accounting purposes as a discontinued
operation of Standard Management and the financial statements for all prior periods will be
restated to show the operations of Standard Life separately from Standard Managements continuing
operations. The discussion of our financial condition and results of operations that follows provides a
discussion of both of our historical business segments. Forward-looking Statements This Annual Report on Form 10-K contains forward-looking statements within the meaning
of Section 27A of the Securities Exchange Act of 1934. All statements, trend analyses, and other
information contained in this Annual Report on Form 10-K relative to markets for our products,
trends in our operations or financial results, statements relating to our ability to consummate the
proposed sale of Standard Life and our belief as to the ultimate purchase price for Standard Life,
if such sale is consummated, as well as other statements that include words such as anticipate,
believe, plan, estimate, expect, intend and other similar expressions, constitute
forward-looking statements. These forward-looking statements 20




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are subject to known and unknown risks, uncertainties and other factors, which may cause
actual results to be materially different from those contemplated by the forward-looking
statements. Such factors include, but are not limited to:  
    Our ability to satisfy the contractual conditions necessary to consummate the sale of
Standard Life.
    The ability of our management team to successfully operate a health services business
with the limited industry experience.
    Our ability to expand our health services business both organically and through
acquisitions, including our ability to identify suitable acquisition candidates, acquire
them at favorable prices and successfully integrate them into our business.
    General economic conditions and other factors, including prevailing interest rate
levels, and stock market performance, which may affect our ability to obtain additional
capital when needed and on favorable terms.
    Our ability to achieve anticipated levels of operational efficiencies at recently
acquired companies, as well as through other cost-saving initiatives.
    Customer response to new products, distribution channels and marketing initiatives.
    Increasing competition in the sale of our products.
    The availability and terms of future acquisitions in our health services segment.
    The risk factors or uncertainties listed from time to time in any document incorporated by reference herein. This Annual Report on Form 10-K also contains forward-looking statements specifically relating
to our insurance business. If the proposed sale of Standard life is not consummated and we
continue to operate in the financial services sector, the following additional factors may cause
actual results to differ from those contemplated by the forward-looking statement:  
    Mortality, morbidity and other factors which may affect the profitability of our
insurance products.
    Regulatory changes or actions, including those relating to regulation of financial
services affecting bank sales and underwriting of insurance products, regulation of the
sale, underwriting, and pricing of insurance products.
    Changes in the federal income tax laws and regulation which may affect the relative tax
advantages of some of our products. We caution you that, while forward-looking statements reflect out good faith beliefs, these
statements are not guarantees of future performance. In addition, we disclaim any obligation to
publicly update or revise any forward-looking statement, whether as a result of new information,
future events or otherwise, except as required by law. Overview Historically we have specialized primarily in the sale of individual annuities. Under
accounting principles generally accepted in the United States, or GAAP, premium collections for
annuities are reported as insurance policy liabilities instead of as revenues. Sources of revenues
for products accounted for as insurance policy liabilities are net investment income, surrender
charges deducted from the account balances of policyholders in connection with withdrawals,
realized gains and losses on investments and call option income. Components of expenses for
products accounted for as insurance policy liabilities are interest credited to account balances,
amortization of deferred policy acquisition costs, and other operating costs and expenses. 21




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##### Table of Contents



Earnings from products accounted for as insurance policy liabilities are primarily generated
from the excess of net investment income earned over the interest credited to the policyholder, or
the investment spread. Our investment spread is summarized as follows for the year ended
December 31: 2004
    
    
    2003
    
    
    2002Net investment yield
on invested
assets
    
    
    4.86
    %
    
    
    5.34
    %
    
    
    6.53
    %Weighted average
effective crediting
rate
    
    
    3.15
    
    
    
    3.84
    
    
    
    4.50Investment
Spread
    
    
    1.71
    
    
    
    1.50
    
    
    
    2.03
 Our profitability depends in large part upon the amount of assets under our management,
investment spreads we earn on our policyholders account balances, our ability to manage our
investment portfolio to maximize returns and minimize risks such as interest rate changes, defaults
or impairment of assets, our ability to manage costs of the options purchased to fund the interest
credits on our equity indexed annuities, our ability to manage the costs of acquiring new business
(principally commissions to agents and first year bonuses credited to policyholders) and our
ability to manage our operating expenses. The weighted average effective credited rate represents interest on interest sensitive
liabilities, including equity indexed annuities, offset by gains on call option assets used to
mitigate changes in equity indexed annuity liabilities. Product Profitability  Financial Services The long-term profitability of life insurance and annuity 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: 1) mortality, 2) persistency, 3) return on cash invested by the insurer during the life of
the policy and 4) expenses of acquiring and administering the policies. Interest spreads represent a major profit source on annuity and interest sensitive life
products. Margins on these products are sensitive to interest rate fluctuations. In general, we
are able to maintain spreads by adjusting credited interest rates for changes in our earned rates,
subject to competitive and timing constraints. However, there are corollary effects of interest
rate changes. Rising interest rates result in a decline in the market value of assets, and also tend to
result in increased policyholder surrenders as other investment options become relatively more
attractive. The effect of increased surrenders is to reduce earnings over the long term. Current
period earnings effect may vary depending on the level of surrender charges and deferred policy
acquisition costs, or DAC, and present value of future profits, or PVFP. In addition, increasing
interest rates give rise to disintermediation risk, the risk that assets must be sold at depressed
values in order to fund increased surrender payments. This risk is mitigated by properly matching
assets and liabilities. We seek to closely match the estimated duration of our invested assets to the expected
duration of our liabilities. When the estimated durations of assets and liabilities are similar,
exposure to interest rate risk is minimized because a change in the value of assets should be
largely offset by a change in the value of liabilities. A significant mismatch of the durations of
invested assets and liabilities could have an impact on our future financial results. Declining interest rates generally have little immediate effect on our investment earnings
rates. Over time, as we invest positive cash flows at lower rates, our earned rates decline. In
such an environment, we attempt to adjust credited interest rates accordingly, subject to
competitive pressures. In most situations, this action allows us to maintain our margins. However,
the sustained period of low interest rates may impact future interest spreads, results of
operations and financial condition. The average expected remaining life of Standard Lifes traditional life and annuity business
in force at December 31, 2004 was 6.3 years. This calculation was determined based upon our
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. 22




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##### Table of Contents



Life insurance policyholders sometimes do not pay scheduled premiums, thus causing their
policies to lapse. For the years 2004, 2003, and 2002 Standard Life experienced total policy
lapses, excluding surrenders, of 1.9%, 3.1% and 3.4% of total policies in force at December 31 of
each year, respectively. Ongoing premiums are not required for annuity policies, so annuities do
not experience policy lapses. Variances Between Actual and Expected Profits.Actual experience on purchased and
produced insurance may vary from projections due to differences in investment spreads, mortality
costs, 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 PVFP and DAC assets, current and future amortization rates
may be adjusted. Product Accounting Present Value of Future Profits.In accordance with industry practice, when we
purchase a block of existing insurance business (which we have not done since 1998), we assign a
portion of the purchase price, PVFP, as the pre-tax value of the business acquired. The asset is
the discounted value of future cash flows arising from the existing block of business. The
discount rate used is based upon many elements, such as yields generated on similar business, our
cost of capital and the interest rate environment as of the purchase date. Discount rates used in
determining our PVFP assets range from 8% to 18%. After purchase, amortization of the asset occurs in proportion to profits emerging from the
purchased policies. The asset is amortized over the expected life of the block of business. The
percentages of expected net amortization of the beginning balance of the total PVFP asset as of
December 31, 2004 are expected to be between 9% and 14% in each of the years 2005 through 2009. Deferred Policy Acquisition Costs.Insurance policies we issue ourselves will generate
significant costs that vary directly with and relate to issuance of that new business. Under GAAP,
these acquisition costs on new policies are to be capitalized and recorded as DAC. For universal
and interest sensitive life and annuity products, the DAC asset is amortized in proportion to
estimated gross profits over the life of the contract. For immediate annuities, DAC is amortized
so as to produce a constant yield on the net policyholder liability. Virtually all of our DAC is a
result of writing annuity products. Net amortization of DAC related to operations was $26.1 million, $22.9 million and $19.0
million for the years ended December 31, 2004, 2003 and 2002, respectively. The increase in
current year amortization expense resulted primarily from the emergence of gross profits from
business sold in recent years. Future expected amortization of DAC, assuming no new business after
December 31, 2004 and current assumptions, is as follows (in thousands): 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009Gross amortization
    
    $
    25,850
    
    
    $
    21,738
    
    
    $
    18,219
    
    
    $
    15,336
    
    
    $
    12,784Interest
accumulation
    
    
    3,178
    
    
    
    2,573
    
    
    
    2,078
    
    
    
    1,662
    
    
    
    1,312Net
amortization
    
    $
    22,672
    
    
    $
    19,165
    
    
    $
    16,141
    
    
    $
    13,674
    
    
    $
    11,472
 Accounting for Deferred Annuities and Universal and Interest-Sensitive Life Products.
We primarily account for our deferred annuity, universal and interest-sensitive life policy
deposits in accordance with Statement of Financial Accounting Standards No. 97 (SFAS 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 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.
These revenues do not include the annuity, 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. 23




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##### Table of Contents



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% of our initial annuity premium deposits are capitalized as DAC. In
accordance with SFAS 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. Accounting for Equity Indexed Annuities. Revenues and expenses for equity-indexed
annuities are recognized in accordance with the SFAS 97 model, described above. Policy liabilities
for equity-indexed annuities are computed in accordance with SFAS 133, which requires that an
equity-indexed annuity liability be bifurcated into a host contract and a derivative contract.
The host contract liability is a book value liability providing for the equity-indexed annuity
policys guaranteed benefits. The derivative contract liability is a market value liability
providing for the equity-linked benefits available in the policy. The derivative liability includes
a liability for equity-linked benefits accruing during the current contract year, as well as
liability amounts for future equity benefits which have not yet been granted. Accounting for Traditional Life Products. Traditional life insurance products are
accounted as long-duration insurance contracts in accordance with Statement of Financial Accounting
Standards No. 60 (SFAS 60), Accounting and Reporting by Insurance Enterprises. Under SFAS 60,
benefit reserves are actuarially calculated using the net level reserve method. Revenues consist of
policy premiums and investment income on assets supporting policy liabilities. Expenses consist of
policy benefits incurred, increases in policy liabilities, and operating costs for policy
administration, and amortization of DAC. Costs related 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 are capitalized as DAC. In accordance with SFAS 60, DAC with interest is
amortized over the lives of the policies in a constant relationship to policy premiums. Accounting for Immediate Annuities. Immediate annuities with no life contingent
payments, which comprise the majority of our immediate annuities in force and the majority of new
immediate annuity sales, are accounted as investment contracts in accordance with SFAS 97. Revenues
consist of investment income, and expenses consist of the imputed interest credits to policies as
well as operating costs for policy administration. An initial net premium policy liability is
established as initial premium less acquisition costs. The imputed credited rate is the rate, which
equates this net premium to the guaranteed payments. After issue, the liability changes by the
amount of imputed interest credits and benefit payments. For balance sheet purposes, this net
premium liability is presented as a gross premium liability offset by a DAC asset. Immediate annuities with payments contingent on the survival of the annuitant are accounted as
limited-payment contracts in accordance with SFAS 60, with revenue recognition, expense recognition,
and liabilities computed as described above for traditional life products. Critical Accounting Policies The accounting polices described below require us to make significant estimates and
assumptions using information available at the time the estimates are made. Such estimates and
assumptions significantly affect various reported amounts of assets and liabilities. We have made
estimates in the past that we believed to be appropriate but were subsequently revised to reflect
actual experience. If our future experience differs materially from these estimates and
assumptions, our results of operations and financial condition could be affected. Accordingly, we
consider them to be critical in preparing our consolidated financial statements. A more detailed
description of our accounting policies is included in the Notes to our Consolidated Financial
Statements. Investments The carrying value of our investment portfolio was $1.7 billion in Financial Services at
December 31, 2004. The accounting risks associated with these assets relate to the recognition of
income, our determination of other-than-temporary impairments and our estimation of fair values. 24




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##### Table of Contents



We amortize premiums and discounts as yield adjustments over the contractual lives of fixed
maturity securities. We consider anticipated prepayments on mortgage-backed securities in
determining estimated future yields on such securities. When we sell a security, we report the difference between the sales proceeds and amortized
cost (determined based on specific identification) as a realized investment gain or loss. We periodically evaluate whether the declines in fair value of our investments are
other-than-temporary. Our evaluation consists of a review of qualitative and quantitative factors.
We also consider additional factors to determine whether the declines in fair value are
other-than-temporary, such as downgrades of the security by a rating agency, deterioration in the
financial condition of the issuer, and other publicly available issuer-specific news or general
market conditions. For investments in companies with no quoted market price, we consider similar
qualitative and quantitative factors and also take into account the cost of the investment, the
type of investment, subsequent purchases of the same or similar investments, the current financial
position and operating results of the company invested in, and such other factors as may be
relevant. Declines in fair values of securities deemed to be other-than-temporary are recognized
as a realized loss. Determining what constitutes an other-than-temporary decline involves significant judgment.
Declines in fair value below cost not considered other-than-temporary in the current period could
be considered other-than-temporary in a future period and reduce earnings to the extent of the
write-down. Estimated fair values for our investments are determined based on estimates from nationally
recognized pricing services, broker-dealer market makers, and internally developed methods. Our
internally developed methods require us to make judgments about the securitys credit quality,
liquidity and market spread. Equity indexed call options are derivative instruments linked to the major stock indices (S&P
500 Index and DJIA Index) which are used to mitigate changes in the equity benefits of our equity
indexed annuity products. We purchase call options whose payoff characteristics offset the equity
benefits of our products. These securities are carried at fair value and the change in fair value
is included in net investment income. DAC and PVFP The combined balance of our DAC and PVFP was $174.2 million at December 31, 2004. The
recovery of these costs is dependent on the future profitability of the related business. Each year, we evaluate the recoverability of the unamortized balance of the DAC and PVFP. We
consider estimated future gross profits or future premiums, expected mortality or morbidity,
interest earned and credited rates, persistency and expenses in determining whether the balance is
recoverable. If we determine a portion of the unamortized balance is not recoverable, it is
charged to amortization expense. The assumptions we use to amortize and evaluate the recoverability of the DAC and PVFP involve
significant judgment. A significant revision to these assumptions will impact future financial
results. We recorded no charge for 2004 and a charge of $7.9 million for 2003 related to the
acceleration of DAC amortization due to DAC unlocking. Goodwill and Intangible Assets The balance of our goodwill and intangible assets was $8.8 million at December 31, 2004. The
recovery of this asset is dependent on the fair value of the business to which it relates.
Pursuant to SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142), goodwill is subject
to annual impairment tests based on the estimated fair value of the business units. There are
numerous assumptions and estimates underlying the determination of the estimated fair value of
these businesses. Different valuation methods and assumptions can produce significantly
different results that could affect the amount of any potential impairment charge that might be
required to be recognized. A charge of $1.0 million resulting from the impairment of goodwill was
recorded in 2004 in the Health Services segment. 25




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##### Table of Contents



Income Taxes Our income tax expense includes deferred income taxes arising from temporary differences
between the financial reporting and tax basis of assets and liabilities and capital loss
carryforwards. We have gross deferred income tax assets of $69.5 million at December 31, 2004. In
assessing the realization of our deferred income tax assets, we consider whether it is more likely
than not that the deferred income tax assets will be realized. The ultimate realization of our
deferred income tax assets depends upon generating future taxable income during the periods in
which our temporary differences become deductible and capital gains before our capital loss
carryforwards expire. We evaluate the recoverability of our deferred income tax assets by
assessing the need for a valuation allowance on a quarterly basis. If we determine that it is more
likely than not that our deferred income tax assets will not be recovered, a valuation allowance
will be established against some or all of our deferred income tax assets. This could have a
significant effect on our future results of operations and financial position. A $7.4 million valuation allowance has been provided on certain operating loss carryforwards
at December 31, 2004. We reached this conclusion after considering the availability of taxable
income in prior carryback years, tax planning strategies, and the likelihood of future taxable
income exclusive of reversing temporary differences and carryforwards. Differences between
forecasted and actual future operating results could adversely impact our ability to realize our
deferred income tax assets. Liabilities for Insurance Products The total balance of our liabilities for insurance products was $1.8 billion at December 31,
2004. These liabilities are often payable over an extended period of time and the profitability of
the related products is dependent on the pricing of the products and other factors. Differences
between pricing assumptions and actual experience will impact future financial results. We calculate and maintain reserves for the estimated future payment of claims to our
policyholders based on actuarial and other assumptions. These assumptions are generally best
estimates, with moderate provision for adverse deviation. Many factors can affect the adequacy of
these reserves and liabilities, such as economic and social conditions, inflation, changes in
doctrines of legal liability and extra contractual damage awards. Therefore, the reserves and
liabilities we establish are necessarily based on extensive estimates, assumptions and historical
experience, all consistently applied. Establishing reserves is an uncertain process, and it is
possible that actual claims will materially exceed our reserves and have a material adverse effect
on our results of operations and financial condition. Our financial results depend significantly
upon the extent to which our actual claims experience is consistent with the assumptions we used in
determining our reserves and pricing our products. If our assumptions with respect to future
claims are incorrect, and our reserves are insufficient to cover our actual losses and expenses, we
would be required to increase our liabilities, negatively affecting our operating results. Liabilities for Loss Contingencies Related to Legal Proceedings We are involved in various legal proceedings in the normal course of business. The ultimate
outcome of these legal proceedings cannot be predicted with certainty. We recognize an estimated
loss from these loss contingencies when we believe it is probable that a loss has been incurred and
the amount of the loss can be reasonably estimated. However, it is difficult to measure the actual
loss that might be incurred related to legal proceedings. The ultimate outcome of these lawsuits
is not expected to have a material adverse effect on our consolidated results of operations and
financial position based on our current understanding of the relevant facts and laws. 26




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##### Table of Contents



Results of operations by segment for the three years ended December 31, 2004: Consolidated Results and Analysis (dollars in thousands)
    
    2004
    
    
    2003
    
    
    2002Loss from continuing operations
    
    $
    (10,868
    )
    
    $
    (10,196
    )
    
    $
    (7,858
    )
 Loss from Continuing Operations  2004 Net loss from continuing operations for 2004 was $10.9 million compared to a loss of $10.2
million for 2003. Health Services: Net loss for 2004 was $10.3 million, compared to a loss of $7.2
million for 2003. The 2004 loss included a goodwill impairment charge
of $1 million and net realized
investment loss of $1 million. Also, 2004 results were reduced by $3.5 million as a
result of recording a valuation allowance on the tax benefits on this segments operating and
capital losses. Financial Services:Net income for 2004 was $2.2 million compared to a net loss of
$.2 million for 2003. The 2004 net income was primarily impacted
by an increase in net spread income and policy
income of $2.1 million net of taxes and net of amortization. The 2003 net loss was
negatively impacted by a charge of accelerated amortization of DAC of $5.2 million. Net realized
gains after taxes and amortization was $.3 million and $5.4 million during 2004 and 2003,
respectively. Other Services: Net loss for 2004 was $2.7 million, compared to a net loss
of $2.8 million for 2003. 27




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##### Table of Contents



Financial Services: 2004
    
    
    2003
    
    
    2002(dollars in thousands)Premiums and deposits collected:Deferred
annuities
    
    $
    52,376
    
    
    $
    129,391
    
    
    $
    320,647Equity-indexed
annuities
    
    
    70,634
    
    
    
    125,302
    
    
    
    126,743Single premium immediate annuities and other
deposits
    
    
    124,261
    
    
    
    165,797
    
    
    
    151,525Universal and interest-sensitive
life
    
    
    496
    
    
    
    542
    
    
    
    601Subtotal  interest-sensitive and other financial products
premium deposits
    
    
    247,767
    
    
    
    421,032
    
    
    
    599,516Traditional
life
    
    
    7,811
    
    
    
    8,929
    
    
    
    9,173Total premiums and deposits
collected
    
    $
    255,578
    
    
    $
    429,961
    
    
    $
    608,689Statement of Operations:Premium
income
    
    $
    7,811
    
    
    $
    8,929
    
    
    $
    9,173Policy
income
    
    
    16,767
    
    
    
    10,839
    
    
    
    8,084Total policy related
income
    
    
    24,578
    
    
    
    19,768
    
    
    
    17,257Net investment
income
    
    
    83,334
    
    
    
    82,904
    
    
    
    75,823Net investment income -
affiliated
    
    
    326
    
    
    
    220
    
    
    
    253Call option gain
(loss)
    
    
    2,449
    
    
    
    11,951
    
    
    
    (10,089
    )Fees and other
income
    
    
    516
    
    
    
    336
    
    
    
    742Net realized investment gain (loss)
    
    
    709
    
    
    
    17,814
    
    
    
    (18,835
    )Total
revenues
    
    
    111,912
    
    
    
    132,993
    
    
    
    65,151Benefits and
claims
    
    
    7,970
    
    
    
    12,942
    
    
    
    9,938Interest credited to interest sensitive annuities and other
financial products
    
    
    56,028
    
    
    
    71,600
    
    
    
    42,650Amortization
    
    
    27,791
    
    
    
    33,916
    
    
    
    10,622Operating
expenses
    
    
    9,657
    
    
    
    8,405
    
    
    
    7,139Operating expenses -
affiliated
    
    
    5,454
    
    
    
    5,454
    
    
    
    4,854Interest expense and financing costs -
affiliated
    
    
    1,702
    
    
    
    1,675
    
    
    
    1,800Total benefits and
expenses
    
    
    108,602
    
    
    
    133,992
    
    
    
    77,003Operating income (loss) before income
taxes
    
    
    3,310
    
    
    
    (999
    )
    
    
    (11,852
    )Federal income tax expense
(benefit)
    
    
    1,126
    
    
    
    (812
    )
    
    
    (6,535
    )Operating income (loss) after income
taxes
    
    
    2,184
    
    
    
    (187
    )
    
    
    (5,317
    )Cumulative effect of accounting change for goodwill
impairment
    
    
    
    
    
    
    
    
    
    
    1,212Net income
(loss)
    
    $
    2,184
    
    
    $
    (187
    )
    
    $
    (6,529
    )
 Supplemental Information: 2004
    
    
    2003
    
    
    2002Number of annuity contracts in
force
    
    
    33,636
    
    
    
    34,424
    
    
    
    38,194Number of life policies in
force
    
    
    40,959
    
    
    
    44,348
    
    
    
    50,791
 28




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##### Table of Contents



General:Our Financial Services segment consists of revenues earned and expenses
incurred from our insurance operations. Our primary products include deferred annuities,
equity-indexed annuities and single premium immediate annuities. The profitability of this segment
is primarily a function of net investment spread (the difference between the investment income
earned on our investments less the interest we credit to our policyholders), persistency of the in
force business, mortality experience and management of our operating expenses. Deposits collected consist of deposits from our flexible premium deferred annuities,
equity-indexed annuities, single premium immediate annuities and other financial products that do
not incorporate significant mortality features. Under GAAP, these premium deposits are not shown as
premium income in the statement of operations. A change in premium deposits in a single period
does not directly cause our operating income to change, although continued increases or decreases
in premiums may affect the growth rate of assets on which investment spreads are earned.  
    Deposits collected for interest sensitive annuities and other financial products for
2004 decreased $173.3 million or 41%, to $247.8 million. Deferred annuities decreased $77.0
million or 60%, to $52.4 million. Equity indexed annuities decreased $54.7 million or 44%,
to $70.6 million. Single premium immediate annuities and other deposits decreased $41.5
million or 25%, to $124.3 million.
    Deposits collected for interest sensitive annuities and other financial products for
2003 decreased $178.5 million or 30%, to $421.0 million. Deferred annuities decreased
$191.3 million or 60%, to $129.3 million. Equity indexed annuities decreased $1.4 million
or 1%, to $125.3 million. Single premium immediate annuities and other deposits increased
$14.3 million or 9%, to $165.8 million. Deposits collected decreased in 2004 and 2003 due to management actions to preserve spread
income in response to market conditions. These actions included reducing crediting rates, and
temporarily suspending sales of selected products. Additionally, deposits collected decreased in
2004 due to the markets reaction to the announced sale of Standard Life, as more fully described
in Recent Developments above. Premium income consists of premiums earned from 1) annuity products that incorporate
significant mortality features and 2) traditional life products.  
    Premium income for 2004 decreased $1.1 million or 13%, to $7.8 million.
    Premium income for 2003 decreased $.2 million or 3%, to $8.9 million. Premium income decreased during 2004 and 2003 primarily as a result of policy lapses and
surrenders. Policy income represents 1) surrender income earned as a result of terminated
universal life and annuity policies and 2) mortality income and administrative fees earned on
universal life products.  
    During 2004, policy income increased $5.9 million or 55%, to $16.8 million.
    During 2003, policy income increased $2.8 million or 34%, to $10.8 million. Policy income increased during 2004 and 2003 primarily as a result of an increase in policy
surrender charges. Net investment income includes interest earned on invested assets and fluctuates with
changes in 1) the amount of average invested assets supporting insurance liabilities and 2) the
average yield earned on those invested assets.  
    During 2004, net investment income increased $.4 million or 1% to $83.3 million. Average
cash and invested assets, at book value, increased by $122.7 million or 8% due to the
growth in insurance liabilities from annuity sales in recent periods. 29




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##### Table of Contents




    During 2003, net investment income increased $7.1 million or 9% to $82.9 million.
Average cash and invested assets, at book value, increased by $348.6 million or 29% due to
the growth in insurance liabilities from annuity sales in recent periods.
    Our net investment yield for 2004, 2003 and 2002 was 4.86%, 5.34% and 6.53%,
respectively.
    The decline in net investment yield for 2004 and 2003 resulted from investing new funds
generated from annuity sales, from principal repayments, and from the sale of securities
during this historically low interest rate environment at interest rates lower than our
average portfolio rate. Call option gain (loss) relates to equity-indexed products that are used to limit risk
against unusually high crediting rates on our equity indexed financial products from favorable
returns in the equity market. The market value of these options fluctuates from period to period
and are substantially offset by amounts credited to policyholder account balances.  
    During 2004, call option gain decreased by $9.5 million to $2.4 million.
    During 2003, call option gain was $12.0 million. The
change in call option results for each period reflects changes in the changes in the S&P
500 Index and the DJIA Index during those periods. See Interest credited to interest sensitive annuities and other financial products below for
additional information regarding the impact of our equity-indexed products. Fees and other income consist of fee income related to servicing unaffiliated blocks
of business and experience refunds.  
    During 2004, fees and other income increased by $.2 million or 54% to $.5 million.
    During 2003, fees and other income decreased by $.4 million or 55% to $.3 million. This
decrease results from the termination of a marketing and administration contract in 2002. Net realized
investment gain (loss) fluctuate from period to period and generally
arise when securities are sold in response to changes in the investment environment. Realized
investment gains may affect the timing of the amortization of DAC and
the amortization of the PVFP.  
    Net realized investment gains for 2004 were $.7 million.
    Net realized investment gains for 2003 were $17.8 million. The majority of the gain was
attributable to a strategy to realize income tax benefits from capital loss carryforwards
during 2003. We maintain a high quality investment portfolio with 99% of our fixed maturity securities
classified as investment grade securities as of December 31, 2004 and 2003. Benefits and claims include 1) mortality experience, 2) benefits from other policies
that incorporate significant mortality features and 3) changes in future policy reserves.
Throughout our history, we have experienced 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 claim experience tend to offset periods of lower claim experience.  
    During 2004, benefits and claims decreased by $5.0 million or 38%, to $8.0 million.
Benefits and claims were lower in 2004 primarily due to favorable mortality experience for
our in-force life policies and lower premium levels. 30




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##### Table of Contents




    During 2003, benefits and claims increased by $3.0 million or 30%, to $13.0 million.
Benefits and claims were higher in 2003 primarily due to increased death claims and other
benefits for our in-force life policies and increased benefit payments for our supplemental
contracts including life contingencies. Interest credited to interest sensitive annuities and other financial products
represents interest credited to insurance liabilities of the deferred annuities, single premium
immediate annuities, equity-indexed annuities and other financial products. This expense fluctuates
with changes in 1) the average interest-sensitive insurance liabilities, 2) the average credited
rate on those liabilities, 3) changes in the market values of securities underlying our
equity-indexed annuities and 4) the impact of SFAS No. 133, Accounting for Derivatives Instruments
and Hedging Activities.  
    During 2004, interest credited decreased $15.6 million or 21.7%, to $56.0 million, of
which $11.3 million related to equity indexed annuity products and the remaining $44.7
million related to all other interest sensitive annuity and life insurance products.
Interest credited decreased $15.9 million due to the impact of lower equity market returns
on equity indexed products. Interest credited increased $7.4 million due to a 9% increase
in average interest sensitive liabilities of $139 million compared to 2003 partially offset
by $7.1 million of reductions due to reduced crediting rates.
    During 2003, interest credited increased $29.0 million to $71.6 million, of which $23.0
million related to equity indexed annuity products and the remaining $48.6 million related
to all other interest sensitive annuity and life insurance products. Interest credited
increased $22.0 million due to the impact of improved equity market performance on equity
products. Interest credited increased $12.5 million due to a 33% increase in average
interest sensitive liabilities of $381 million compared to 2002, partially offset by $5.5
million of reductions due to reduced crediting rates.
    The weighted average credited rate on interest sensitive liabilities, including equity
indexed annuities, for 2004 and 2003 were 3.30% and 4.62%, respectively. The decrease in
average credited rate was due to the impact of less favorable equity market performance on
equity indexed annuity crediting rates, and lower crediting rates on non- equity indexed
business. When offset by gains on call option assets used to hedge equity indexed annuity
liabilities, the effective crediting rates for 2004 and 2003 were 3.15% and 3.84%,
respectively, a reduction of .69% from the prior period. Amortization includes 1) amortization of deferred policy acquisition costs related to
capitalized costs of insurance business sold and 2) amortization related to the present value of
polices purchased from acquired insurance business.  
    During 2004, amortization decreased $6.1 million to $27.8 million. In 2003, the
amortization total included an unlocking charge of $7.9 million plus additional
amortization due to capital gains of $9.1 million was partially offset by higher 2004
amortization of $10.7 million due to increased spread and policy income margins.
    During 2003, amortization increased by $23.3 million or 219%, to $33.9 million. This
increase relates primarily to net realized gains and higher annuity sales volume, offset by
lower gross profits. We recorded a charge of $7.9 million and $7.8 million for 2003 and
2002, respectively, related to the acceleration of DAC amortization due to DAC unlocking. Acquisition costs for deferred annuity contracts and equity-indexed annuity contracts are
required to be amortized over the lives of the contracts in relation to the incidence of estimated
gross profits. Estimated gross profits on fixed and equity indexed annuity contracts include
investment spread, surrender income, expense margins, and realized investment gains and losses.
Gross profit estimates are evaluated regularly, with historical gross profit estimates adjusted to
actual results and projected gross profit estimates updated to reflect current expectations. DAC
amortization is adjusted both retrospectively and prospectively (unlocked) in accordance with the
revised profit stream, and retrospective adjustments are reported in the current reporting period. 31




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Operating expenses consist of general operating expenses, including salaries, net of
deferrable amounts.  
    During 2004, operating expenses increased by $1.2 million or 15%, to $9.6 million.
Operating expenses increased as a result of our capitalizing $.4 million less operating
expense during 2004 as a decline in annuity sales from $421 million for 2003 to $248
million in 2004, did not result in a corresponding decline in variable costs. In addition,
operating expenses in 2004 increased by $.4 million due to corporate reallocations and $.3
million due to start up costs for new fee generation initiatives.
    During 2003, operating expenses increased by $1.3 million or 18%, to $8.4 million.
Operating expenses increased as a result of our capitalizing $1.2 million less operating
expense during 2003 as a decline in annuity sales from the record levels of $600 million
for 2002 to $421 million for 2003 did not result in a corresponding decline in variable
costs. In addition, operating expenses in 2003 increased by $.4 million for legal costs,
including settlement amounts for the favorable disposition of several non-material claims
and proceedings in the normal course of business. Operating expenses  affiliated consist of general operating expenses, including rent
and management fees paid to Standard Management in the Other Services segment.  
    During 2004, affiliated operating expenses remained unchanged from 2003 at $5.5 million.
    During 2003, affiliated operating expenses increased $.6 million or 12%, to $5.5 million
due to increased rental expense. Interest expense and financing costs  affiliated represents interest expense incurred on
the surplus debentures issued to Standard Management.  
    During 2004, affiliated interest expense and financing costs remained unchanged from
2003 at $1.7 million.
    During 2003, affiliated interest expense and financing costs decreased by $.1 million or
7%, to $1.7 million. The decline in interest expense resulted from the decline in the
prime rate. The weighted average interest rate for 2004, 2003, and 2002 was 6.30%, 6.20%, and 6.67%,
respectively. 32




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##### Table of Contents



Health Services: 2004
    
    
    2003
    
    
    2002(dollars in thousands)Statement of Operations:Sales
    
    $
    7,120
    
    
    $
    2,948
    
    
    $
    1,850Cost of goods
sold
    
    
    5,822
    
    
    
    2,445
    
    
    
    1,554Total gross
margin
    
    
    1,298
    
    
    
    503
    
    
    
    296Net realized investment
loss
    
    
    964
    
    
    
    
    
    
    
    Salaries
    
    
    4,563
    
    
    
    1,900
    
    
    
    909Marketing and sales
expenses
    
    
    574
    
    
    
    836
    
    
    
    100Other operating
expenses
    
    
    3,580
    
    
    
    3,952
    
    
    
    920Depreciation and
amortization
    
    
    1,853
    
    
    
    349
    
    
    
    110Interest expense and financing
costs
    
    
    69
    
    
    
    31
    
    
    
    9Total expenses
    
    
    10,639
    
    
    
    7,068
    
    
    
    2,048Loss before
federal income tax
expense
(benefit)
    
    
    (10,305
    )
    
    
    (6,565
    )
    
    
    (1,752
    )Federal income tax expense
(benefit)
    
    
    
    
    
    
    596
    
    
    
    (596
    )Net loss
    
    $
    (10,305
    )
    
    $
    (7,161
    )
    
    $
    (1,156
    )
 General:Our Health Services segment consists of revenues earned and expenses incurred
from our pharmaceutical operations. Our primary customer base consists of academic institutions,
skilled nursing facilities, assisted living facilities, home health care agencies, mental health
facilities, correctional facilities and consumers. The profitability of this segment is primarily a
function of gross margin on sales (the difference between sales and cost of sales) and management
of our operating expenses. Sales  
    During 2004, sales increased $4.2 million or 141.5%, to $7.1 million primarily due to
the acquisition of Apothecary Solutions during the early part of 2004.
    During 2003, sales increased $1.1 million or 59.4%, to $2.9 million. Net realized loss on investment  
    During 2004, net realized investment loss represents the loss on the sale of Medical Care & Outcomes, LLC. Total expenses  
    During 2004, expenses increased $3.6 million or 50.5% to $10.6 million primarily related
to the increased expenses resulting from the Apothecary Solutions acquisition of $3.8
million, primarily salaries for their employees, a $1.0 million goodwill impairment charge,
$.4 million related to acquisition costs and other expenses associated with the continued
development of U. S. Health Services operating platform and infrastructure, as well as
ongoing concentrated marketing initiatives.
    During 2003, expenses increased $5 million or 245.1% to $7.1 million due to the
continued development of U. S. Health Services operating platform and infrastructure, as
well as ongoing concentrated marketing initiatives. 33




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##### Table of Contents



Federal income tax expense  
    During 2004, federal income tax benefit was $0 due to a 100% valuation allowance on the
net loss in 2004.
    During 2003, we reversed the federal income tax benefit we recorded in 2002 and we
recorded a 100% valuation allowance on the net loss. 34




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##### Table of Contents



Other Services: 2004
    
    
    2003
    
    
    2002(dollars in thousands)Statement of Operations:Operating income  affiliated
    
    $
    5,548
    
    
    $
    5,454
    
    
    $
    4,854Interest income  affiliated
    
    
    1,702
    
    
    
    1,675
    
    
    
    1,800Commission income
    
    
    
    
    
    
    614
    
    
    
    2,442Fees and other income
    
    
    182
    
    
    
    19
    
    
    
    17Net realized investment gain (loss)
    
    
    (28
    )
    
    
    63
    
    
    
    (1,001
    )Total revenues
    
    
    7,404
    
    
    
    7,825
    
    
    
    8,112Commission expenses
    
    
    
    
    
    
    10
    
    
    
    777Net investment expenses  affiliated
    
    
    326
    
    
    
    169
    
    
    
    253Other operating expenses
    
    
    6,130
    
    
    
    6,463
    
    
    
    6,461Interest expense and financing costs
    
    
    4,426
    
    
    
    4,443
    
    
    
    4,342Total expenses
    
    
    10,882
    
    
    
    11,085
    
    
    
    11,833Operating loss before income taxes
    
    
    (3,478
    )
    
    
    (3,260
    )
    
    
    (3,721
    )Federal income tax benefit
    
    
    (731
    )
    
    
    (412
    )
    
    
    (2,336
    )Net loss
    
    $
    (2,747
    )
    
    $
    (2,848
    )
    
    $
    (1,385
    )
 General:Our Other Services segment consists of revenues and expenses primarily
related to corporate operations and financing costs. During the third quarter of 2003, we sold the
assets of our marketing services company, Savers Marketing Corporation, for a $200,000 note
receivable. The sale led to the elimination of commission income and commission expenses. Operating income  affiliatedconsists primarily of income from the Financial Services
segment related to management fees and rental income.  
    During 2004, operating income  affiliated remained unchanged at $5.5 million.
    During 2003, operating income  affiliated increased $.6 million or 12%, to $5.5 million
due to increased rental income. Interest income  affiliatedconsists of interest income from the Financial Services
segment related to the surplus debentures issued by Standard Management.  
    During 2004, interest income  affiliated remained unchanged at $1.7 million.
    During 2003, interest income  affiliated decreased $.1 million or 7%, to $1.7 million.
The decline in interest income resulted from the decline in the prime rate. Commission incomeconsists of fee income related to servicing unaffiliated blocks of
business.  
    During 2004, commission income decreased to $0 due to the sale of the assets of Savers
Marketing.
    During 2003, commission income decreased $1.8 million or 73%, to $.6 million due to the
sale of the assets of Savers Marketing. 35




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##### Table of Contents



Commission expenses represents commission expenses related to servicing unaffiliated
blocks of business.  
    During 2004, commission expenses decreased to $0 due to the sale of the assets of Savers
Marketing.
    During 2003, commission expenses decreased $.8 million or 99%, to $10,000 due to the
sale of the assets of Savers Marketing. Net investment expenses  affiliatedrepresents interest expense paid to Financial
Services. Other operating expense consists of corporate operating expenses, including salaries.  
    During 2004, other operating expenses decreased $.3 million or 5% to $6.1 million.
    During 2003, other operating expenses remained unchanged at $6.5 million. Interest expense and financing costs represents interest expense incurred and the
amortization of debt issuance costs.  
    During 2004, interest expense and financing costs remained unchanged at $4.4 million.
    During 2003, interest expense and financing costs increased $.1 million or 2%, to $4.4 million. Federal income tax benefit  
    During 2004, federal income tax benefit increased $.3 million or 77%, to $.7 million.
During 2004 we utilized partial valuation a allowance of
$.4 million.
    During 2003, federal income tax benefit decreased $1.9 million or 82%, to $.4 million.
Federal income tax benefit decreased due to a valuation allowance related to the operating
losses recorded in 2003. Also, in 2002, there was a utilization of a previously reserved
net operating loss carryforward of $1.0 million. 36




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International Operations (discontinued operations): Our International Operations (discontinued operations) were sold in 2002. The 2002 results
included revenues earned and expenses incurred from abroad, primarily Europe, and included fees
collected on our deposits from unit-linked assurance products. The profitability of this segment
primarily was dependant on the amount of separate account assets under management, the management
fee charged on those assets and management of our operating expenses. Net income for this
operation before we sold it for 2002 was $1.1 million and we realized an initial gain of $6.9
million that year upon the sale. Loss from the sale of discontinued operations in 2003 is due to
the Company settling a purchase price adjustment resulting in a $.3 million charge. 37




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Liquidity and Capital Resources Liquidity of Standard Management (Parent Company) We are a holding company whose capital requirements are met through payments received from our
subsidiaries. These payments have historically included 1) surplus debenture interest, 2)
dividends, 3) management fees, 4) equipment rental fees, 5) lease income and 6) allocation of
income taxes, all of which have been subject to restrictions under applicable insurance laws and
are used to pay our operating expenses and meet our debt service obligations. Historically, the
vast majority of our dividend income, management fee income, rental fee income and lease income
have come from Standard Life, which accounted for approximately 94% of our consolidated revenues in
2004. If the proposed sale of Standard Life is consummated, we will no longer have this source of
funds and will rely primarily on our health services operations. In addition, we will no longer
receive interest on the Surplus Debentures, which we intend to sell to Capital Assurance along with
the stock of Standard Life. However, if the sale of Standard Life is consummated, we will receive
a substantial amount of cash proceeds as described below. Additionally, we have borrowed significant amounts from Standard Life to finance the
operations of our Health Services business. As of December 31, 2004, the aggregate amount of such
borrowings was $20.7 million. As part of the purchase price for Standard Life, Capital Assurance
would assume this indebtedness. These internal sources of liquidity are supplemented by external
sources such as revolving credit agreements and long-term debt and equity financing in the capital
markets. We currently have $18.5 million outstanding with our senior secured credit agreement with
a bank. There is currently no availability under this agreement. If the proposed sale of Standard
Life is consummated, we intend to repay this agreement in full. Potential Cash Available for 2005 Historically, from a parent company perspective, available cash from our existing working
capital and from the sources described above would be anticipated to be sufficient to fund our cash
requirements for the following year. However, while we expect that such sources will be sufficient
to fund our operations until the completion of our pending sale of Standard Life, we expect to have
available approximately $27.5 million of net cash proceeds from that sale to fund our subsequent
operations and our growth strategies for our U.S. Health Services business. Should the cash
proceeds from the sale of Standard Life be substantially reduced from our current expectation (as
may be the case as described in the following paragraph), we will need to obtain additional sources
of funds in order to grow our health services business in accordance with our current plan. There
can be no assurances that such funding will be available under terms and conditions that are
favorable to use, if at all. In conjunction with our efforts to sell Standard Life, Standard Management also agreed to
undertake a solicitation of the preferred security holders of SMAN Capital Trust I, a wholly owned
subsidiary of Standard Management (the Trust) at an estimated cost of approximately $1 million to
fund incentive payments in connection with obtaining the consent of the trust preferred holders.
If adopted, the amendment would provide us additional financing flexibility by allowing us to enter
into certain business transactions, such as the sale of substantially all of our assets, without
the acquirer of such assets being required to assume our responsibilities under the indenture. In
the event the requisite consents to amend the indenture are not received, Standard Management has
the right to require Capital Assurance to assume Standard Managements obligations under the
indenture. If this event were to occur, the cash proceeds to be received by us in the sale would
be reduced by the approximately $20.7 million aggregate liquidation amount of trust preferred
securities outstanding, which would reduce the net amount of cash expected to be available to us to
operate and expand our health services business from approximately $27.5 million to approximately
$7 million. Such an event would make it more likely that we would have to secure additional debt
or equity financing to carry out our business plan, and there can be no assurance that we could
obtain such financing on acceptable terms or at all. While we fully anticipate the sale of Standard Life to be consummated and for such sale to
provide significant net cash proceeds to the Company, the following paragraphs assume that such
sale does not occur in order to describe our liquidity circumstances in that event (as well as our
circumstances up through the date of sale.) Surplus Debenture Interest.We loaned $27.0 million to Standard Life pursuant to
unsecured surplus debenture agreements (Surplus Debentures), which requires Standard Life to make
quarterly interest payments at a variable corporate base rate plus 2% per annum, and annual
principal payments of $1.0 million per year beginning in 2007 and concluding in 38




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2033. 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 (Commissioner). For the quarters ended September 30, 2004 and December
31, 2004 the Commissioner had not yet approved our request of $.8 million in aggregate interest
payments. Assuming the approvals are granted and the December 31, 2004 interest rate of 7.5%
continues, we expect to receive interest income of $2.0 million from the Surplus Debentures in
2005, assuming a full year ownership of Standard Life. Dividends paid from Standard Life 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, if the
dividend or distribution, together with all other dividends and distributions paid within the
preceding 12 months, does not exceed the greater of 1) net gain from operations or 2) 10% of
surplus, in each case as shown in its preceding annual statutory financial statements. In 2004 and
2003, there were no dividends received from our subsidiaries. In 2005, we could receive dividends
of $1.1 million from Standard Life, without regulatory approval and an additional $5.6 million with
regulatory approval. However, we do not expect to receive dividends from our subsidiaries in 2005. Management Fees. Pursuant to a management services agreement, Standard Life paid $
3.6 million during 2004 and 2003 for certain management services related to the production of
business, investment of assets and evaluation of acquisitions. In addition, Dixie Life paid
Standard Life $.9 million and $.7 million in 2004 and 2003, respectively, for certain management
services provided. Both of these agreements provide that they may be modified or terminated by the
applicable Departments of Insurance in the event of financial hardship of Standard Life or Dixie
Life. In 2005, we expect to receive management fees of $3.6 million from Standard Life, assuming a
full year ownership of Standard Life. Equipment Rental Fees.In 2004, we received $1.1 million from Standard Life for the
use of our equipment and we expect to receive the same amount in 2005, assuming a full year
ownership of Standard Life. Lease Income.Effective January 1, 2002, we entered into a lease agreement with
Standard Life whereby Standard Life leases approximately 43,000 square feet of our corporate
headquarters in Indianapolis. During 2004, we received approximately $.8 million in lease income
from Standard Life and we expect to receive the same amount in 2005, assuming a full year ownership
of Standard Life. Also associated with this lease, Standard Life is responsible for its share of
building maintenance expenses. During 2004, we received $.3 million in maintenance expenses. We
expect to receive $.3 million in maintenance expense in 2005, assuming a full year ownership of
Standard Life. Anticipated Sale of Standard Life. Based on managements expectations regarding the
estimated adjusted purchase price for Standard Life, and assuming a final, post-adjustment purchase
price of $83 million, we expect the net cash proceeds from the sale, before deducting transaction
related fees and expenses, to be approximately $57 million. We intend to use such cash proceeds as
follows:  
    approximately $17.7 million for the repayment in full of a bank line of credit;
    approximately $6 million to purchase certain assets from Standard Life at closing
pursuant to the Agreement;
    approximately $4.3 million for professional fees (investment bankers, attorneys,
accountants) and miscellaneous other expenses (filing fees, printing and mailing proxy
materials, prepayment penalties, severance payments, etc.);
    approximately $1 million to fund incentive payments in connection with obtaining the
consent of the trust preferred holders;
    $.5 million to reduce the principal amount outstanding under the mortgage on our
home office; and
    the remaining approximately $27.5 million as working capital to support and expand
our health services business, including through selected strategic acquisitions. 39




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In addition, we anticipate that Standard Life, after the sale, will still lease space from us
for at least three years for $480,000 per year. We also anticipate receiving $350,000 of annual
dividends under the $5 million of newly issued 7% perpetual -cumulative exchangeable preferred
stock we expect to receive as partial consideration in our sale of Standard Life. Estimated Cash Required in 2005 The following are the characteristics of our mortgages payable, promissory notes, notes
payable and subordinated debentures, including estimated required payments in 2005. Mortgages Payable: The following are characteristics of our mortgages payable agreement at December 31, 2004:  
    outstanding balance of $6.6 million;
    weighted interest rate of 7.32% per annum;
    principal and interest payments: $57,000 per month through December 2011;
    interest payments required in 2005 based on current balances will be $.4 million;
    mortgage may be prepaid on or before January 2005 at 105% and declining to 101% after December 2008;
    additional $.5 million principal reduction payment to be made upon the sale of Standard Life. Promissory Notes: The following are characteristics of our promissory notes at December 31, 2004:  
    outstanding balance of $1.9 million;
    weighted average interest rate of 2.64% per annum;
    principal and interest payments: $1 million in 2005, $.5 million in 2006, $.3
million in 2007 and $.1 million in 2008. Notes Payable: The following are characteristics of our senior secured credit agreement at December 31, 2004:  
    outstanding balance of $18.5 million;
    weighted average interest rate of 5.86%;
    principal payments: $2.0 million to be paid in 2005, $2.1 million to be paid in
2006, $2.2 million to be paid in 2007, and $12.2 million to be paid in 2008;
    subject to certain restrictions and financial and other covenants;
    interest payments required in 2005 based on current balances
will be $1.0 million;
    entire balance to be repaid upon sale of Standard Life. Convertible Notes Payable: The following are characteristics of our 6% Convertible Notes Due 2008 at December 31, 2004:  
    outstanding balance of $2.75 million;
    interest rate of 6%; 40




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
    interest payments: $.17 million to be paid in each of 2005, 2006 and 2007.
    Conversion price of $4.20 per share of Standard Management common stock. The following are characteristics of our 7% Convertible Notes Due 2009 at December 31, 2004:  
    outstanding balance of $3.3 million;
    interest rate of 7%;
    interest payments: $.12 million to be paid in 2005, $.23 million to be paid in each
of 2006, 2007 and 2008, $.12 million to be paid in 2009;
    Conversion price of $4.20 per share of Standard Management common stock. Subordinated debentures: These securities represent an undivided beneficial interest in the assets of SMAN Capital
Trust I, a Delaware business trust organized to purchase our junior subordinated debentures and
issue preferred securities. The assets of the Trust consist solely of the debentures which were
purchased by the Trust with the proceeds of the offering. On August 9, 2001, the Trust completed a
public offering of $20.7 million of its 10.25% preferred securities. The Trust used the proceeds
of this offering to purchase our 10.25% junior subordinated debentures. The following are characteristics of our trust preferred securities at December 31, 2004:  
    outstanding balance of $20.7 million;
    annual distribution rate of 10.25%; distributions may be deferred up to 20 consecutive quarters;
    matures August 9, 2031;
    may be redeemed on or after August 9, 2006 at $10 per security plus accumulated and unpaid distributions;
    distributions required in 2005 based on current balances will be $2.1 million;
    distributions are classified as interest expense. The proceeds from the offering were immediately loaned to Standard Management by the Trust in
the form of an equal amount of subordinated debentures. The debentures have similar terms as the
preferred securities, including a 10.25% interest rate. Although the Trust is wholly-owned by
Standard Management, Standard Management does not consolidate the Trust because all of the income
and cash flows of the Trust benefit the preferred security holders rather than Standard Management.
As such, the subordinated debentures and related interest expense are reflected in our
consolidated results. General.On a consolidated basis, we reported net cash provided by operations of
$53.5 million and $26.8 million for 2004 and 2003, respectively. Although deposits received on our
interest-sensitive annuities and other financial products are not included in cash flow from
operations under GAAP, these funds, after returns to policyholders, are also available. Cash
generated on a consolidated basis is available to the parent company
only to the extent that it is
generated at the holding company level or is available through interest, dividends, management fees
or other payments from our subsidiaries. At December 31, 2004, we had parent company only cash and short-term investments of $.4
million. These funds are available for general corporate purposes. Our parent company only
operating expenses, not including interest expense, were $6.1 million and $5.5 million for 2004 and
2003, respectively. Contractual Obligations.In our day-to-day business activities, we incur certain
commitments to make future payments under contracts such as operating leases and purchase orders.
Maturities under these contracts, excluding policyholders contracts, are set forth in the following
table as of December 31, 2004 (in thousands) and do not assume the sale of Standard Life and
related transactions: 41




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Payment due by periodTotal
    
    
    Less than 1 year
    
    
    1-2 Years
    
    
    3-4 Years
    
    
    More than 5 yearsLong-Term Debt Obligations
    
    $
    114,889
    
    
    $
    7,160
    
    
    $
    13,062
    
    
    $
    22,060
    
    
    $
    72,607Capital Lease Obligations
    
    
    684
    
    
    
    384
    
    
    
    300
    
    
    
    
    
    
    
    Operating Lease Obligations
    
    
    954
    
    
    
    376
    
    
    
    558
    
    
    
    20
    
    
    
    Purchase Obligations
    
    
    100
    
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    116,627
    
    
    $
    8,020
    
    
    $
    13,920
    
    
    $
    22,080
    
    
    $
    72,607
 (Payments include principal and interest) Off-Balance Sheet Arrangements.We have no off-balance sheet financing arrangements,
other than the Trust as discussed above. Liquidity of Financial Services The principal capital requirements of Standard Life are its 1) contractual obligations to
policyholders, 2) surplus debenture interest, dividends, management fees and rental fees to
Standard Management and 3) 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 annuity products. These sources of liquidity for Standard Life exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including death benefits, 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 rating and events in the industry that affect
policyholders confidence. In July 2004, Standard Life received a rating from A.M. Best of (B),
or fair with a stable outlook, a one-category reduction from its previous rating of (B+), or
very good. The policies and annuities issued by Standard Life contain provisions that allow certain
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, to ensure it has sufficient cash resources in light of
such activity. Changes in interest rates may affect our 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 our earnings if we were required to sell investments at
reduced values to meet liquidity demands. We manage our asset and liability portfolios in order to
minimize the adverse earnings effect of changing market interest rates. We seek assets that have
duration characteristics similar to the liabilities that they support. We also prepare cash flow
projections and perform cash flow tests under various market interest rate scenarios to assist in
evaluating liquidity needs and adequacy. Our 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 our 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: 1)
acquisition costs (primarily commissions and policy issue costs) and 2) reserves for future
guaranteed principal payments and interest in excess of statutory rates, be expensed in the year
the new business is written. These items cause a reduction in statutory surplus or surplus strain
in the year written for many insurance products. We design our products to minimize such first-year
losses, and in 2004 none of our products caused a statutory loss in the year written. Absent the
sale of Standard Life, our long-term growth goals contemplate continued growth in our insurance
businesses. To achieve these growth goals, our insurance subsidiaries will need to increase
statutory surplus. Additional statutory surplus may be secured through various sources such as
internally generated statutory earnings, infusions with funds generated through our debt or equity
offerings, or mergers with other life insurance companies. If additional capital is not available
from one or more of these sources, we believe that we could reduce surplus strain through the use
of reinsurance or through reduced writing of new business. 42




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We believe that the operational cash flow of Standard Life will be sufficient to meet our
anticipated needs for 2005. As of December 31, 2004, Standard Life had statutory capital and
surplus for regulatory purposes of $69.2 million. As the annuity business produced by Standard
Life increases, Standard Life expects to satisfy statutory capital and surplus requirements through
statutory profits and through additional capital contributions by Standard Management. Net cash
flow from operations on a statutory basis of Standard Life, after payment of benefits and operating
expenses, was $(48.7) million and $139.8 million for 2004 and 2003, respectively. The decrease is
primarily due to a decline in annuity premium deposits and an increase in surrenders. If the need
arises for cash, which is not readily available, additional liquidity could be obtained from the
sale of invested assets. Liquidity of Health Services The principal capital requirements of our Health Services segment are its 1) cost of goods
sold, 2) operating expenses, and 3) future acquisitions. The primary source of funding for these
obligations has been 1) cash flow from pharmaceutical sales, 2) internal borrowings from Standard
Management and external borrowings, and 3) capital contributions from Standard Management. The
capital requirements of our Health Services segment have significantly exceeded revenues from
pharmaceutical sales. We believe that the operational cash flow of our Health Services segment will not be
sufficient to meet our anticipated operational needs for 2005. Therefore, this segment is expected
to continue to fund its cash needs through the proceeds of the sale of Standard Life, external
borrowings and capital contributions from Standard Management. Factors That May Affect Future Results If the sale of Standard Life takes place, we will no longer derive revenues or cash flows from
our financial services business and our future value will depend almost entirely on our health
services business. During 2003 and 2004, the financial services segment of our business generated 97% and 95%,
respectively, of our total revenues and generated positive cash flows from operations. All such
revenues and cash flows would cease upon closing of the sale of Standard Life. Following the
proposed sale, our future prospects, and our value as an ongoing enterprise, will depend on the
performance of our health services business, which is subject to the risks described below. The possibility of a failure to complete the sale of Standard Life could have serious negative
implications. If the sale of Standard Life is not completed, we could be materially adversely affected. We
would be forced to determine whether to attempt to sell the financial services business again,
continue to operate the financial services business or explore another strategic alternative. If
we try to sell the financial services business, we would need to expend significant time and
resources that would otherwise be used to operate the health services business and we would likely
have to sell the financial services business on terms that could be less favorable to us than the
terms currently being offered by Capital Assurance. In addition, if we were to engage in some form
of alternative transaction, there could be no assurance that it would not be significantly dilutive
to shareholders. If we fail to obtain the necessary consents in the trust preferred consent solicitation and
nevertheless elect to proceed with the proposed sale of Standard Life under the terms of the
Agreement, the net cash proceeds available for the operation and expansion of our health services
business will be significantly reduced. If we fail to receive sufficient consents for the amendment to the indenture in the trust
preferred consent solicitation, we intend to nevertheless proceed with the proposed sale of
Standard Life to Capital Assurance (assuming all other conditions to such sale are satisfied) by
exercising our right to require Capital Assurance to assume our obligations under the indenture.
In such event, the cash proceeds to be received by us in the sale would be reduced by the
approximately $20.7 million aggregate liquidation amount of trust preferred securities outstanding.
As a result, our cash proceeds from the sale would reduce from approximately $57 million to
approximately $36.3 million which, unless we adjust our expected use of such proceeds, would reduce
the amount of cash available to operate and expand our health services business from approximately
$27.5 million to approximately $7 million. Such an event would make it more likely that we would
have to seek additional debt or equity financing to carry out our business plan, and there can be
no assurance that we could obtain such financing on acceptable terms or at all. 43




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The price of our common stock has demonstrated increased volatility upon the
announcement of a proposed sale of Standard Life and may continue to do so upon the consummation of
the sale and could decline below recent levels. In the event of a significant and sustained
decline, our stock could be delisted from the NASDAQ National Market. Our common stock has exhibited increased volatility upon the announcement of the sale of
Standard Life and may continue to do so on the consummation of the sale of Standard Life.
Depending upon investor acceptance of the proposed transaction, the price of the stock could
decline below recent levels. If such decline were severe and sustained, NASDAQ could initiate
action to delist our shares from the NASDAQ National Market, which could further negatively impact
the price and/or marketability of the shares. Risks Related to our Health Services Segment Our health services subsidiary has not been profitable and we expect it to continue to incur
substantial losses. U.S. Health Services and its subsidiaries have incurred substantial net losses since we have
operated them. U.S. Health Services on a consolidated basis incurred a net loss of $10.3 million
and $7.1 million, for 2004 and 2003, respectively. We expect net losses to continue until we
generate significant revenues and achieve economies of scale in our operations. There can be no
assurance that we will ever be able to successfully develop and market these products. Our future
profitability will depend on several factors including:  
    our ability to access reasonably priced capital that will provide long-term
flexibility for the Company;
    our ability to execute a planned strategy that will provide for cash flow from
operations which will fund growth; and
    our ability to acquire appropriately priced and profitable businesses that provide
cash flow and synergies to our current business. We are subject to a number of factors affecting our business, including intense competition in
the industry and the ability to attract and retain suppliers, clients and employees. If we are
unable to respond appropriately to any of these factors, business and financial results could
suffer. Our operating results are affected by many factors, including competition, changes in the
regulatory environment with respect to pharmacy service providers, relationships with suppliers of
inventory, relationships with large institutional clients, general governmental regulation and
general business conditions, many of which are outside our control. Our health services segment operates in a highly competitive environment and is in direct and
indirect competition with a number of other companies that operate in the pharmaceutical market,
including other retail, institutional and wholesale pharmacies, health insurers, health management
organizations, pharmacy benefit managers and discount drug programs offered directly by
pharmaceutical manufacturers. In addition, the provision of drugs and pharmacy benefits is a
highly dynamic and evolving business which is tied closely to changes in the Medicare/Medicaid
reimbursement environment, governmental entitlement program budget restrictions exercised at both
the state and federal levels, cost controls imposed by third-party payors in an attempt to exercise
control over increasing health care costs, and increasing competition from pharmacies operating
outside the United States which ship drugs to U.S. residents over the Internet and using other
distribution channels. There are currently a number of active initiatives being pursued by local
and national legislatures. On December 8, 2003, President Bush signed into law the Medicare
Prescription Drug Improvement and Modernization Act of 2003, a comprehensive voluntary prescription
drug benefit administered under Medicare Part D effective January 1, 2006. The new act also
provides certain cost-sharing government subsidies for individuals who might otherwise qualify for
drug coverage under Medicaid or similar government-funded aid programs. Since a notable portion of our future institutional pharmacy business will be made available
to Medicare-qualified patients who may qualify for this new benefit, it may have a substantial and
lasting effect on the profitability of our business depending on how it and similar initiatives are
administered by the government agencies charged with implementation. Since important elements of
the new act relating to issues as formulary development, drug pricing and drug discount cards have
yet to be finalized, it is impossible to predict the impact of the act on our profitability. 44




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Our profitability and ability to conduct business in the health services segment could be
negatively impacted by a change in our relationships with our largest institutional clients. A large portion of the present and future growth of our institutional pharmacy business is
contingent upon our ability to acquire and retain long-term contracts at favorable terms with
institutional care facilities. Currently we have more than 20 contractual relationships with
institutional clients. We are presently attempting to grow and diversify the number, type and
terms of these contracts, but a number of factors  including the ability to favorably compete with
respect to pricing, our relationships with drug and supplement manufacturers and suppliers, and the
economic solvency and profitability of our institutional clients  can impact our profitability and
opportunities for future growth. In addition, although we believe our current relationship with
our institutional clients is strong, the loss of key institutional clients would materially affect
the operation of our health services segment. Because our health services business model is relatively new and unproven, our limited
operating history in this segment is not indicative of future performance, and this part of our
business is difficult to evaluate. Because we have only recently entered the health services segment, we do not have an operating
history upon which an investor can evaluate our prospects. In attempting to implement our business
model, we may need to significantly change our business operations, sales and implementation
practices, customer service and support operations and management focus. We are also facing new
risks and challenges, including a lack of meaningful historical financial data upon which to plan
future budgets, the need to develop strategic relationships and other risks in this report. Continuing efforts to contain healthcare costs may reduce our future health services revenue. The sales and profitability of the health services segment are affected by the efforts of
healthcare payors to contain or reduce the cost of healthcare by lowering reimbursement rates,
limiting the scope of covered services, and negotiating reduced or capitated pricing arrangements.
Any changes which lower reimbursement levels under Medicaid, Medicare or private pay programs,
including managed care contracts, could reduce our future revenue. Furthermore, other changes in
these reimbursement programs or in related regulations could reduce its future revenue. These
changes may include modifications in the timing or processing of payments and other changes
intended to limit or decrease the growth of Medicaid, Medicare or third party expenditures. If we fail to comply with licensure requirements, fraud and abuse laws or other applicable
laws, it may need to curtail operations, and could be subject to significant penalties. Our pharmacy business is subject to extensive and often changing federal, state and local
regulations, and our pharmacy is required to be licensed in the states in which it is located or
does business. While we continuously monitor the effects of regulatory activity on its operations
and believe we currently have all necessary pharmacy licenses, the failure to obtain or renew any
required regulatory approvals or licenses could adversely affect the continued operation of the
business. The long-term care facilities that contract for our services are also subject to federal,
state and local regulations and are required to be licensed in the states in which they are
located. The failure by these long-term care facilities to comply with these or future regulations
or to obtain or renew any required licenses could result in our inability to provide pharmacy
services to these facilities and their residents. We are also subject to federal and state laws
that prohibit some types of direct and indirect payments between healthcare providers. These laws,
commonly known as the fraud and abuse laws, prohibit payments intended to induce or encourage the
referral of patients to, or the recommendation of, a particular provider of items or services.
Violation of these laws can result in loss of licensure, civil and criminal penalties and exclusion
from the Medicaid, Medicare and other federal healthcare programs. If we or our client institutions fail to comply with Medicaid and Medicare reimbursement
regulations, our health services revenue could be reduced, we could be subject to penalties and we
could lose our eligibility to participate in these programs. As of December 31, 2004, approximately 26% of our health services pharmacy revenues were from
government sponsored programs. Government sponsored programs include Medicaid and, to a lesser
extent, Medicare. Our remaining billings are currently paid or reimbursed by individual residents,
long-term care facilities and other third-party payors, 45




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including private insurers. A portion of these revenues are indirectly dependent on government
programs. We anticipate that as the institutional pharmacy portion of our health services segment
grows, direct reimbursement from government sponsored programs will become a material portion of
our pharmacy billings. The Medicaid and Medicare programs are highly regulated. The failure, even if inadvertent, of
us and/or our client institutions to comply with applicable reimbursement regulations could
adversely affect our reimbursement under these programs and our ability to continue to participate
in these programs. In addition, our failure to comply with these regulations could subject us to
other penalties. Changes in governmental regulation and legislation could have a substantial impact on our
profitability. Our health services segment is subject to substantial regulation at both the state and Federal
levels. Our ability to continue operating as a retail, mail order and institutional pharmacy is
contingent upon our ability to maintain appropriate licenses in all the states in which they
currently conduct business. We are also required to comply with a comprehensive set of regulations
under the Federal Health Insurance Portability and Accountability Act (HIPAA) with respect to the
privacy and security of patient health information and the method in which this information is
electronically transmitted to payors and governmental agencies such as the agencies responsible for
implementing the Medicare and Medicaid programs. Regulations implementing HIPAA are still being
disseminated, revised and actively reviewed as of the time of this writing. It is possible that
substantial changes in these regulations, or in the strictness of interpretation of these
regulations, may adversely affect our relationships with our clients and materially affect our
future operations by increasing the costs of regulatory compliance. As with the insurance laws, we
cannot predict the impact of future state or Federal laws or regulations on its health services
business. We are subject to various risks relating to our acquisition strategy. One component of our growth strategy contemplates our making selected acquisitions that will
help grow the health services segment. Recently, we terminated the agreements to acquire two
separate organizations in the health services segment that would have significantly increased the
size of this part of our business. Acquisitions involve inherent uncertainties. These
uncertainties include the effect on the acquired businesses of integration into a larger
organization and the availability of management resources to oversee the operations of these
businesses. The successful integration of acquired businesses will require, among others:  
    consolidation of financial and managerial functions and elimination of operational redundancies;
    achievement of purchasing efficiencies;
    the addition and integration of key personnel; and
    the maintenance of existing business. Even though an acquired business may have experienced positive financial performance as an
independent company prior to an acquisition, we cannot be sure that the business will continue to
perform positively after an acquisition. We also may acquire businesses with unknown or contingent liabilities, including liabilities
for failure to comply with healthcare laws and regulations. We have policies and procedures to
conduct reviews of potential acquisition candidates for compliance with healthcare laws and to
conform the practices of acquired businesses to its standards and applicable laws. We also
generally seek indemnification from sellers covering these matters. We may, however, incur material
liabilities for past activities of acquired businesses. We cannot be sure of the successful integration of any acquisition or that an acquisition will
not have an adverse impact on our results of operations or financial condition. We are likely to require additional funding, which may be difficult to obtain. Our health services business has had negative cash flows and net losses since its inception in
2002. We expect negative cash flows from operations to continue until we achieve substantial sales
increases of our health services products. The proceeds of the proposed sale of Standard Life, if
consummated, would provide us with significant funding, but we would lose the positive cash flows
generated by our financial services business. Even though we would receive significant cash
proceeds from the sale, our health services business has significant cash needs, including in
connection with making strategic acquisitions. As a result, we will likely need to seek additional
capital, which we may do through public or private equity or debt financing. There can be no
assurance that such funding will be available to us on acceptable terms, if at all. 46




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Risks Related to our Financial Services Segment In the event that the sell of Standard Life is not consummated, and in any case, until such
sale occurs, we are also subject to the following risks. We are subject to a number of factors affecting our insurance business, including intense
competition in the industry and the ability to attract and retain agents, suppliers, clients and
employees. If we are unable to respond appropriately to any of these factors, business and
financial results could suffer. Our operating results are affected by many factors, including competition, lapse rates,
interest rates, maintenance of insurance ratings, changes in the regulatory, general governmental
regulation and general business conditions, many of which are outside our control. Our financial services division operates in a highly competitive environment and is in direct
competition with a large number of insurance companies, many of which offer a greater number of
products through a greater number of agents and have greater financial and other resources. In
addition, we may be subject, from time to time, to new competition resulting from additional
insurance carriers introducing products similar to those offered by us. Moreover, as a result of
recent federal legislation, commercial banks, insurance companies, and investment banks may now
combine, provided certain requirements are satisfied, and we can expect to encounter increased
competition from these providers of financial services. This competitive environment could result
in lower premiums, loss of sales and reduced profitability. We believe that the ability to compete is dependent upon, among other things, the ability to
retain and attract independent general agents to market products and the ability to develop
competitive products that also are profitable. Although management believes that good relationships
with our independent general agents exist, competition for those agents among insurance companies
is intense. Our independent general agents typically represent other insurance companies and may
sell products that compete with its products. Sales of our annuity products and, therefore, our
results of operations and financial condition may be adversely affected if we are unsuccessful in
attracting and retaining independent agents and marketing organizations. Our Financial results could suffer if our A.M. Best ratings are downgraded. Insurers compete with other insurance companies, financial intermediaries and other
institutions on the basis of a number of factors, including the ratings assigned by A.M. Best.
A.M. Best assigns ratings labeled (A++) through (F) (Superior, Excellent, Very Good,
Fair, Marginal, Weak, Poor, Under Regulatory Supervision, and In Liquidation).
Standard Life and Dixie Life both have a rating of (B) (Fair) by A.M. Best. A.M. Bests ratings
represent their opinion based on a comprehensive quantitative and qualitative review of our
financial strength, operating performance and market profile. A rating of (B) is assigned by
A.M. Best to companies that, in their opinion, have achieved good overall performance when
compared to the standards established by A.M. Best. According to A.M. Best, these companies
generally have an adequate ability to meet their obligations to policyholders, but their financial
strength is vulnerable to unfavorable changes in underwriting or economic conditions. In
evaluating a companys financial and operating performance, A.M. Best reviews the companys
profitability, leverage and liquidity as well as the companys book of business, the adequacy and
soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy
of its reserves, and the experience and competence of its management. A.M. Best reviews its
ratings of insurance companies from time to time. If the A.M. Best ratings were downgraded, sales
of annuity products could be significantly impacted and the financial condition and results of
operations could be materially adversely affected. Changes in governmental regulation and legislation could have a substantial impact on our
profitability. Our insurance subsidiaries are subject to substantial governmental regulation in each of the
jurisdictions in which they conduct business. Changes in these regulations could have a
significant impact on our profitability. The primary purpose of these regulations is to protect
policyholders, not investors. These regulations are vested in governmental agencies having broad
administrative power with respect to all aspects of our insurance business, including premium
rates, policy forms and applications, marketing illustrations, dividend payments, capital adequacy
and the amount and type of investments we may have. 47




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The NAIC and state insurance regulators continually reexamine existing laws and regulations
and their application to insurance companies. Changes in the NAIC or state regulations, including,
for example, changes in the risk-based capital requirements, which are determined by the NAIC and
state regulators, could affect the ability of our subsidiaries to pay dividends to us which could
affect our ability to make payments upon our contractual obligations. In addition, the federal government has become increasingly involved with insurance regulation
in recent years, including the passage of the Gramm-Leach-Bliley Act, and more comprehensive
federal legislation in this area is still being considered by Congress. Federal legislation and
administrative policies in several areas, including pension regulation, age and sex discrimination,
financial services regulation and federal taxation, affect us specifically and the insurance
business in general. New state or federal laws or regulations, as well as a more strict
interpretation of existing laws or regulations, may adversely affect our current claims exposure,
adversely affect the profitability of our current and future products, and materially affect our
future operations by increasing the costs of regulatory compliance. We cannot predict the impact
of future state or federal laws or regulations on our business. See Business of Standard
Management  Regulatory Factors. Under the Internal Revenue Code of 1986, as amended (Code), income tax payable by
policyholders on investment earnings is deferred during the accumulation period of certain life
insurance and annuity products. The favorable tax treatment may give certain of our products a
competitive advantage over other non-insurance products. On May 28, 2003, President Bush signed
the Jobs and Growth Tax Relief Reconciliation Act of 2003, which reduces the federal income tax
rates applicable to certain dividends and capital gains realized by individuals. This legislation
may lessen the competitive advantage of certain of our products relative to other investments that
generate dividend or capital gain income. As a result, demand for certain of our products that
offer income tax deferral may be negatively affected. Additionally, Congress has from time to time
considered other legislation that would reduce or eliminate the relative benefits to policy owners
of the deferral of taxation on the accretion of value within certain insurance products or might
otherwise affect the taxation of insurance products and insurance companies. In particular,
President Bush recently proposed legislation, currently under consideration by Congress, that would
increase the amount that taxpayers may contribute each year to individual retirement accounts,
which provide deferral benefits similar to those offered by our tax-deferral products. To the
extent that the Code is revised in accordance with these proposals or otherwise in a manner that
reduces the tax-deferred status of insurance products, or reduces the taxation of, or expands the
market for, competing products, all life insurance companies, including us, could be adversely
affected. Interest rate fluctuations could negatively affect spread income. Significant changes in interest rates expose insurance companies to the risk of not earning
anticipated spreads between the interest rate earned on investments and the credited interest rates
paid on outstanding policies. Both rising and declining interest rates can negatively affect
spread income. Although we develop and maintain asset/liability management programs and procedures
designed to preserve spread income in rising or falling interest rate environments, changes in
interest rates could adversely affect these spreads. Our financial results are highly dependent on the financial condition of the companies in
which we make investments and could suffer if the value of our investments decreases due to factors
beyond our control. Our invested assets, approximately $1.7 billion, represented approximately 87% of our total
assets at December 31, 2004. These investments are subject to customary risks of credit defaults
and changes in market values. In addition, the value of our investment portfolio depends in part
on the financial condition of the companies in which we have made investments. Factors beyond our
control, including interest rate levels, financial market performance, and general economic
conditions may have a significant negative impact on our investment income and the value of our
investment assets, which would have a material adverse affect on our financial condition. Our policy claims fluctuate from year to year, and future benefit payments may exceed our
established reserves, which would cause our earnings to suffer. Our earnings are significantly dependent upon the extent to which the actual claims received
by our subsidiaries is consistent with the actuarial assumptions we use in establishing reserves
for the payment of benefit claims. To the extent that the actual claims experience of our
subsidiaries exceeds our established reserves, our operating income would be negatively affected,
resulting in an adverse effect on our earnings. 48




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Volatility in benefit claims is common in the life insurance industry. While our reserves
have been sufficient to cover policy claims in the past and we attempt to limit the risk by
carefully underwriting new policies and sharing risks with reinsurance companies, we may still
experience a period of higher than anticipated benefit claims that exceeds our established
reserves. If this were to happen, it could result in increased operating losses. Because a significant portion of our annuity contracts are surrenderable, any substantial
increase in the level of surrenders could negatively affect financial results. As of December 31, 2004, approximately 75.3% or $1.2 billion of annuity contracts in force
were surrenderable. Approximately 16.5% of those contracts or approximately $205.7 million of
annuity contracts in force are surrenderable without charge. Changes in prevailing interest rates,
ratings or other factors, which result in, or lead to significant levels of surrenders of existing
annuity contracts could have a material adverse effect on our financial condition and results of
operations. Surrenders result in a reduction of invested assets that earn investment income and a
reduction of policyholder account balances that credit interest. Our financial results could be materially adversely affected if our assumptions regarding the
value of intangible assets prove to be incorrect. Included in our financial statements are certain assets that are primarily valued, for
financial statement purposes, on the basis of managements assumptions. These assets include items
such as:  
    deferred policy acquisition costs;
    present value of future profits;
    intangibles;
    goodwill; and
    organization and deferred debt issuance costs. The assumptions are based upon, among others, interest rate spread and rates of mortality,
surrender and lapse. If, for instance, future mortality rates were higher than expected, projected
margins would be lower and deferred policy acquisition cost amortization would increase. The value
of these assets reflected in our December 31, 2004 balance sheet totaled $185 million, or 10% of
our assets. Although we have established procedures to periodically review the assumptions used to
value these assets and determine the need to make adjustments, if our assumptions are incorrect and
adjustments need to be made, our financial results could be materially adversely affected. 
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk We seek to invest available funds in a manner that will maximize shareholder value and fund
future obligations to policyholders and debtors, subject to appropriate risk considerations. Many
of our products incorporate surrender charges, market interest rate adjustments or other features
to encourage persistency. Approximately 65.2% of the total insurance liabilities at December 31,
2004 had surrender penalties or other restrictions, approximately 25.5% are not subject to
surrender, and 9.3% may be withdrawn without penalty. We also seek to maximize the total return on our investments through active investment
management. Accordingly, we have determined that the entire portfolio of fixed maturity securities
is available to be sold in response to:  
    changes in market interest rates;
    changes in relative values of individual securities and asset sectors;
    changes in prepayment risks;
    changes in credit quality outlook for certain securities; 49




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
    liquidity needs; and
    other factors. Profitability of many of our products is significantly affected by the spreads between
interest yields on investments and rates credited on insurance liabilities. Although substantially
all credited rates on annuity products may be changed annually (subject to minimum guaranteed
rates), changes in competition and other factors, including the impact of the level of surrenders
and withdrawals, may limit the ability to adjust or to maintain crediting rates at levels necessary
to avoid narrowing of spreads under certain market conditions. As of December 31, 2004, the
average yield, computed on the cost basis of the investment portfolio, was 4.86%, and the weighted
average effective crediting rate was 3.15%. Computer models were used to perform simulations of the cash flows generated from our existing
business under various interest rate scenarios. These simulations measured the potential gain or
loss in fair value of interest rate-sensitive financial instruments. With such estimates, we seek
to closely match the duration of assets to the duration of liabilities. When the estimated duration
of assets and liabilities are similar, exposure to interest rate risk is minimized because a change
in the value of assets should be largely offset by a change in the value of liabilities. At
December 31, 2004, the option adjusted duration of fixed maturity securities and short-term
investments were approximately 4.6, and the option adjusted duration of insurance liabilities was
approximately 4.4. The option adjusted duration compares the change in the value of an asset or
liability with a change in interest rates. This means in general that if interest rates increased
100 basis points, the value of our asset portfolio would decrease by approximately 4.6%. If interest rates were to increase by 100 basis points from their December 31, 2004 levels,
our fixed maturity securities and short-term investments (net of the corresponding changes in the
values of cost of policies purchased, cost of policies produced and insurance liabilities) would
decline in fair value by approximately $72.2 million. The calculations involved in our computer simulations incorporate numerous assumptions,
require significant estimates and assume an immediate change in interest rates without any
management of the investment portfolio in reaction to such change. Consequently, potential changes
in the value of our financial instruments indicated by the simulations will likely be different
from the actual changes experienced under given interest rate scenarios, and the differences may be
material. Because our investments and liabilities are actively managed, actual losses could be
less than those estimated above. 
 Item 8. Financial Statements and Supplementary Data The financial statements and supplementary data required with respect to this Item 8 are
listed in Item 15(a) (1) and included in a separate section of this report and are incorporated
herein by reference. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure At a meeting held on October 27, 2004, the Board of Directors of Standard Management approved
the engagement of BDO Seidman, LLP as its independent registered public accounting firm for the
fiscal year ended December 31, 2004 to replace Ernst & Young LLP, who had declined to stand for
re-election before the Audit Committee as independent auditors of the Company effective October 27,
2004. The Audit Committee of the Companys Board of Directors approved the change in auditors on
October 27, 2004. The audit reports of Ernst & Young on the Companys financial statements for the fiscal years
ended December 31, 2003 and December 31, 2002 did not contain an adverse opinion or a disclaimer of
opinion, nor were such reports qualified or modified as to uncertainty, audit scope or accounting
principles. For more information on our change of independent registered public accounting firm, please
see the Current Report on Form 8-K we filed with the SEC on November 1, 2004. 
 Item 9A. Controls and Procedures Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of
our disclosure controls and procedures (as defined in Rule 13a-4c under the Securities Exchange Act
of 1934) as of December 31, 2004 (the 50




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Evaluation Date). They have concluded that, as of the Evaluation Date, our disclosure
controls and procedures were adequate and effective. There were no significant changes in our
internal controls or in other factors that could significantly affect disclosure controls and
procedures subsequent to the Evaluation Date. 
 Item 9B. Other Information None. 51




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PART III 
 Item 10. Directors and Executive Officers of the Registrant Our executive officers and directors are as follows: Name
    
    Age
    
    Position HeldRonald D. Hunter
    
    
    53
    
    
    Chairman of the Board and Chief Executive OfficerP.B. (Pete) Pheffer
    
    
    54
    
    
    President, Chief Financial Officer and DirectorStephen M. Coons
    
    
    63
    
    
    Executive Vice President, General Counsel,
Secretary and DirectorMarc D. Novotney
    
    
    50
    
    
    President of Standard Life Insurance Company of
IndianaMartial R. Knieser
    
    
    62
    
    
    President of U.S. Health Services and DirectorDainforth (Dan) B. French, Jr.
    
    
    38
    
    
    DirectorMichael G. Browning
    
    
    59
    
    
    DirectorJames H. Steane II
    
    
    60
    
    
    Director
 Ronald D. Hunter. Mr. Hunter has been our Chairman of the Board and Chief Executive Officer
since our formation in June 1989 and the Chairman of the Board and Chief Executive Officer of
Standard Life since December 1987. From June 1989 until 2002, Mr. Hunter also served as our
President. Previously, Mr. Hunter held several management and sales positions in the life
insurance industry with a number of companies. Mr. Hunter has been widely recognized for his
vision and leadership qualities, earning him the distinction of being a finalist four times for the
Ernst & Young Entrepreneur of the Year award and becoming a winner in 2004 in the financial
services category. He has also become well-known as the author of the book, Vision Questing:
Turning Dreams into Realities. P.B. (Pete) Pheffer. Mr. Pheffer has been our President since 2002 and Chief Financial
Officer and a director since June 1997. Prior to joining us, Mr. Pheffer was Senior Vice President,
Chief Financial Officer and Treasurer of Jackson National Life Insurance Company from 1994 to 1996
and prior to that was Senior Vice President and Chief Financial Officer at Kemper Life Insurance
Companies from 1992 to 1994. Mr. Pheffer, a CPA, received his MBA from the University of Chicago in
1988. Stephen M. Coons. Mr. Coons has been a director since August 1989. Mr. Coons has been our
General Counsel and Executive Vice President since March 1993 and has been our Secretary since
March 1994. He was of counsel to the law firm of Coons, Maddox & Koeller from March 1993 to
December 1995. Prior to March 1993, Mr. Coons was a partner with the law firm of Coons & Saint. He
has been practicing law for over 30 years. Mr. Coons served as Indiana Securities Commissioner from
1978 to 1983. Marc D. Novotney. Mr. Novotney served as President of Standard Life Insurance Company of
Indiana from March 2003 until his resignation on February 15, 2005. Mr. Novotney was the President
of Western Security Life Insurance Company, an AmerUs Company, from 1995 to 2002. Mr. Novotney
also served as Senior Vice President, Multi-Company Business of Indianapolis Life Insurance Company
from 1999 to 2002. Mr. Novotney received his MBA from Indiana Wesleyan University. Martial R. Knieser. Dr. Knieser has served as President of U.S. Health Services since January
2004 and has been a director of Standard Management since 1990. He was Director of Laboratories of
Community Hospital Indianapolis from 1978 to 1991 and was Medical Director of Stat Laboratory
Services from 1989 to 1999. Dr. Knieser also has been Medical 52




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Director of Standard Life since December 1987. Dr. Knieser currently serves as Director of
Laboratories of St. Vincent Mercy Hospital, Elwood, Indiana. James H. Steane II. Mr. Steane has been a director since 2002. In 1999 Mr. Steane retired
from Fleet Bank after 29 years in corporate banking, where he held a number of positions, including
Senior Vice President and Senior Lending Officer in the Insurance and Mutual Fund Group of Fleet
Bank. Mr. Steane is also the past President of Junior Achievement of Hartford, Connecticut and the
American School for the Deaf. Mr. Steane received his MBA from Adelphi University. Dainforth B. French Jr.Mr. French has been a director since October 2004. Mr.
French has served as President of Leonard Capital Markets an investment banking firm in Grosse
Pointe, Michigan, since October 2004. Prior thereto from 2000 to 2004, he served as Managing
Director of Donnelly Penman & Partners, an investment banking firm in Grosse Pointe, Michigan. Mr.
French received his B.A. from Georgetown University and obtained his M.B.A. degree from the
University of Detroit. Michael G. Browning.Mr. Browning has been a director since October 2004. He has served as
Chairman and President of Browning Investments, Inc. a real estate developer in Indianapolis,
Indiana, since 1981. Mr. Browning serves on the board of Cinergy Corp., Indianapolis Indians, Inc.
and is a member of the State of Indiana, Public Officer Compensation Commission. Mr. Browning
received his B.S. from the University of Notre Dame. Board of Directors Our board of directors consists of seven directors and is divided into three classes, each
serving a three-year term. Messrs. Hunter, Steane and Browning serve as Class III directors until
the 2007 annual meeting of shareholders. Mr. French currently serves as the sole Class I director
and due to his recent appointment to the board, under our bylaws, he will be subject to election at
the 2005 annual meeting of shareholders. Additionally, Mr. Browning, due to his recent appointment
to the board, under our bylaws, will be subject to election at the 2005 annual meeting of
shareholders. Messrs. Coons, Knieser and Pheffer serve as Class II directors until the 2006 annual
meeting of shareholders. While we currently do not have a board of directors which consists of a
majority of independent directors, as required by the SEC and NASDAQ, we intend to comply with
these requirements by nominating additional independent directors at the 2005 annual meeting of
shareholders or asking certain inside directors to resign. Our board of directors has five standing committees: the Executive Committee, the Audit
Committee, the Compensation Committee, the Incentive Stock Option Committee and the Nominating
Committee. The principal function of the Executive Committee is to act for the full board of directors in
the management of business when action is required between board of directors meetings. The
committee meets as necessary, and all actions by the committee are reported at the next board of
directors meeting. Members of the Executive Committee are Messrs. Hunter (Chairman), Coons, Pheffer
and Browning. The Audit Committee reviews the results and scope of the audit and other services provided by
its independent registered public accounting firm and recommends the
appointment of the independent
registered public accounting firm to the board of directors. In addition, the committee also
monitors the effectiveness of the audit effort and financial reporting and the adequacy of
financial and operating controls. Members of the Audit Committee are Messrs. Steane (Chairman),
Browning and French. Mr. Steane has been designated by our board of directors as the audit
committee financial expert. The Compensation Committee approves compensation objectives and policy for all employees and
is responsible for developing and making recommendations to the board of directors with respect to
the Companys executive compensation policies. In addition, the Compensation Committee determines
periodically and recommends to the board of directors the base cash compensation for our Chief
Executive Officer and other executive officers. The committee reports to shareholders on
executive compensation items as required by the SEC. Members of the Compensation Committee are
Messrs. Browning (Chairman), Steane and French. The Incentive Stock Option Committee has responsibility for granting stock options to eligible
members of management under, and otherwise administers both the 2002 Stock Incentive Plan and the
Amended and Restated 1992 Stock Option Plan. The entire board of directors comprises the members
of the Incentive Stock Option Plan Committee. 53




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The Nominating Committee recommends to the full board of directors qualified candidates for
election as our directors and officers. Members of the Nominating Committee are Messrs. Browning
(Chairman), French and Steane. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934 requires our executive officers and
directors, and persons who own more than ten percent (10%) of our common stock (Reporting
Persons), to file reports of ownership and changes in ownership with the Securities and Exchange
Commission. Reporting Persons are required by the Securities and Exchange Commission regulations
to furnish us with copies of all Section 16(a) reports they file. Based solely on our review of
the copies of such forms received by us and written representations from certain Reporting Persons,
we believe that during 2004 our Reporting Persons complied with all filing requirements applicable
to them. Code of Ethics We have adopted a Code of Business Conduct and Ethics that applies to our Chief Executive
Officer, Chief Financial Officer, and the principal accounting officer. A copy of this Code of
Business Conduct and Ethics is available without charge upon request from the Chief Financial
Officer at Standard Management Corporation, 10689 N. Pennsylvania, Indianapolis, Indiana 46280. If
we make any substantive amendments to this Code of Business Conduct and Ethics or grant any waiver
from a provision of it, we will disclose the nature of such amendment or waiver on our website at
www.sman.com or in a Current Report on Form 8-K. 54




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##### Table of Contents



Item 11. Executive Compensation The following table sets forth the annual and certain other components of the compensation for
the last three fiscal years earned by Mr. Hunter, Chairman and Chief Executive Officer of the
Company, and our other currently serving executive officers whose salary and bonus exceeded
$100,000 during fiscal year 2004 (Messrs. Pheffer, Coons, Knieser and Novotney). SUMMARY COMPENSATION TABLE LONG TERMCOMPENSATIONAWARDSSecurities
    
    
    All OtherFiscal
    
    
    ANNUAL COMPENSATION
    
    
    Underlying
    
    
    CompensationName and Principal Position
    
    Year
    
    
    Salary
    
    
    Bonus
    
    
    Other (1)
    
    
    Options
    
    
    (2)Ronald D. Hunter
    
    
    2004
    
    
    $
    498,696
    
    
    $
    49,870
    
    
    $
    19,220
    
    
    $
    
    
    
    $
    57,695Chairman of the Board
    
    
    2003
    
    
    
    475,008
    
    
    
    148,700
    
    
    
    13,020
    
    
    
    250,000
    
    
    
    63,695and Chief Executive Officer
    
    
    2002
    
    
    
    402,240
    
    
    
    447,500
    
    
    
    19,608
    
    
    
    
    
    
    
    66,695P.B. (Pete) Pheffer
    
    
    2004
    
    
    
    364,560
    
    
    
    36,456
    
    
    
    
    
    
    
    
    
    
    
    25,052President and
    
    
    2003
    
    
    
    350,016
    
    
    
    135,602
    
    
    
    
    
    
    
    125,000
    
    
    
    28,052Chief Financial Officer
    
    
    2002
    
    
    
    283,664
    
    
    
    285,000
    
    
    
    
    
    
    
    
    
    
    
    28,431Stephen M. Coons
    
    
    2004
    
    
    
    229,638
    
    
    
    22,964
    
    
    
    
    
    
    
    
    
    
    
    19,173Executive Vice President,
    
    
    2003
    
    
    
    224,256
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,819General Counsel and Secretary
    
    
    2002
    
    
    
    219,864
    
    
    
    121,986
    
    
    
    
    
    
    
    
    
    
    
    16,789Martial R. Knieser
    
    
    2004
    
    
    
    204,167
    
    
    
    
    
    
    
    277,813
    
    
    
    100,000
    
    
    
    998President
    
    
    2003
    
    
    
    
    
    
    
    
    
    
    
    60,940
    
    
    
    
    
    
    
    U.S. Health Services
    
    
    2002
    
    
    
    
    
    
    
    
    
    
    
    58,280
    
    
    
    1,500
    
    
    

    Marc D. Novotney(3)
    
    
    2004
    
    
    
    230,400
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,582President
    
    
    2003
    
    
    
    196,875
    
    
    
    
    
    
    
    
    
    
    
    75,000
    
    
    
    3,000Standard Life Insurance
    
    
    2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    2004 amounts include $19,220 imputed interest on an interest-free loan made to Mr.
Hunter in 1997. The balance of the loan at December 31, 2004 is $775,500. Such amounts
include medical consulting fees for Standard Life of $57,640, $60,940, and $58,280 in
2004, 2003, and 2002, respectively, and consulting fees for U.S. Health Services of
$220,173 in 2004 to Dr. Knieser.(2)
    
    Amounts reported for fiscal year 2004 were as follows: Key Man
    
    
    Disability
    
    
    
    
    
    
    Total401K
    
    
    Insurance
    
    
    Insurance
    
    
    Travel
    
    
    OtherName
    
    Contribution
    
    
    Premiums
    
    
    Premiums
    
    
    Allowance
    
    
    CompensationRonald D. Hunter
    
    $
    8,000
    
    
    $
    39,740
    
    
    $
    6,955
    
    
    $
    3,000
    
    
    $
    57,695P.B. (Pete) Pheffer
    
    
    8,000
    
    
    
    9,350
    
    
    
    6,202
    
    
    
    1,500
    
    
    
    25,052Stephen M. Coons
    
    
    6,525
    
    
    
    2,408
    
    
    
    2,240
    
    
    
    8,000
    
    
    
    19,173Marc D. Novotney
    
    
    7,582
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,582Martial R. Knieser
    
    
    
    
    
    
    998
    
    
    
    
    
    
    
    
    
    
    
    998
   (3)
    
    Mr. Novotney resigned as an officer effective February 15, 2005. 55




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##### Table of Contents



The following table provides information regarding stock options granted to the named
executive officers (collectively, Messrs. Hunter, Pheffer, Coons, Knieser and Novotney are referred
to as the Named Executive Officers) during the year ended December 31, 2004. INDIVIDUAL GRANTS Number of
    
    
    % of Total
    
    
    Exercise
    
    
    
    
    
    
    Potential Realizable ValueSecurities
    
    
    Options
    
    
    or Base
    
    
    
    
    
    
    at Assumed Annual RatesUnderlying
    
    
    Granted to
    
    
    Price
    
    
    
    
    
    
    of Stock Appreciation forOptions
    
    
    Employees in
    
    
    ($/Share)
    
    
    Expiration
    
    
    Option Term(1)Name
    
    Granted
    
    
    Fiscal Year
    
    
    (1)
    
    
    Date
    
    
    5%
    
    
    10%Ronald D. Hunter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    P. B. (Pete) Pheffer
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Marc D. Novotney
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stephen M. Coons
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Martial R. Knieser
    
    
    100,000
    
    
    
    49.3
    %
    
    $
    3.70
    
    
    
    2014
    
    
    $
    232,691
    
    
    $
    589,685
   (1)
    
    The potential realizable value illustrates value that might be
realized upon exercise of the options immediately prior to the
expiration of their term, assuming the specified compounded rates of
appreciation on the common stock over the terms of the options. These
numbers do not take into account plan provisions providing for
termination of the options following termination of employment of
non-transferability. No stock options were exercised by Named Executive Officers during fiscal year 2004. The
following table sets forth information with respect to Named Executive Officers concerning
unexercised options held as of the end of fiscal year 2004. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES Number of Securities
    
    
    Value of UnexercisedUnderlying Unexercised
    
    
    In the MoneyOptions at FY-End
    
    
    Options at FY-End ($)Name
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableRonald D. Hunter
    
    
    854,762
    
    
    
    83,333
    
    
    $
    11,667
    
    
    $
    5,833P. B. (Pete) Pheffer
    
    
    375,833
    
    
    
    41,667
    
    
    
    5,833
    
    
    
    2,917Marc D. Novotney
    
    
    50,000
    
    
    
    25,000
    
    
    
    1,167
    
    
    
    583Stephen M. Coons
    
    
    265,260
    
    
    
    
    
    
    
    
    
    
    
    Martial R. Knieser
    
    
    78,858
    
    
    
    66,667
    
    
    
    
    
    
    
    
 Employment Agreements We have employment agreements with Messrs. Hunter, Pheffer, Coons and Knieser. These employment agreements terminate as follows:  
    Mr. Hunters employment agreement will initially run for a five-year period
terminating on January 1, 2008, and it shall automatically renew annually for
successive five-year periods on January 1 of each year, unless either party elects not
to renew in accordance with the terms of the agreement.
    Mr. Pheffers employment agreement will initially run for a three-year period
terminating on January 1, 2006, and it shall automatically renew annually for
successive three-year periods on January 1 of each year, unless either party elects not
to renew in accordance with the terms of the agreement. 56




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##### Table of Contents




    Mr. Coons employment agreement terminates on July 1, 2006.
    Dr. Kniesers employment agreement terminates on June 1, 2006. If Mr. Hunter or Mr. Pheffers employment is terminated, for a period of two years thereafter,
each shall not:  
    Within Indiana, render any services as an agent, independent contractor, consultant
or otherwise become employed in the business of selling or providing life, accident or
health insurance products or lending or other financial products or services sold by us
or our subsidiaries.
    Within Indiana, in any manner compete with us or with any of our subsidiaries.
    Solicit or attempt to convert to other insurance carriers providing similar products
or services provided by us, and our customers or policyholders. If Mr. Coons employment is terminated, for a period of one year thereafter, he shall not:  
    Sell or attempt to sell, within Indiana, any type of our insurance products.
    Sell or attempt to sell any types of our insurance products that we market to our customers.
    Within Indiana, own, be employed by, or be connected in any manner with any business
similar to our type of business. If Dr. Kniesers employment is terminated, for a period of two years thereafter, he shall not:  
    Engage in any business which of the source type so engaged in by U.S. Health
Services or any of its subsidiaries, within the geographical area that he has been
performing services for U.S. Health Services. Following a termination of Mr. Hunters employment with us, in the event of a
change-in-control, Mr. Hunter would be entitled to receive a lump-sum payment equal to five times
the sum of his then-current base salary, and the average amount of the bonuses paid to him for the
five preceding fiscal years. Mr. Hunter would also be entitled to receive a lump-sum payment equal
to the amount determined by multiplying the number of shares of common stock subject to unexercised
stock options previously granted by us and held by Mr. Hunter on the date of termination, whether
or not such options are then exercisable, by the greater of (1) the highest sales price of the
common stock during the preceding six-month period, and (2) the highest price paid to the holders
of our common stock whereby the change in control takes place. Following a termination of Mr. Pheffers employment with us, in the event of a
change-in-control, Mr. Pheffer would be entitled to receive a lump-sum payment equal to three times
the sum of his then-current base salary, and the average amount of the bonuses paid to him for the
three preceding fiscal years. Mr. Pheffer would also be entitled to receive a lump-sum payment
equal to the amount determined by multiplying the number of shares of common stock subject to
unexercised stock options previously granted by us and held by Mr. Pheffer on the date of
termination, whether or not such options are then exercisable, by the greater of (1) the highest
sales price of the common stock during the preceding six-month period, and (2) the highest price
paid to the holders of our common stock whereby the change in control takes place. Following a termination of Mr. Coons employment with us in the event of a change-in-control,
Mr. Coons would be entitled to receive a lump sum payment equal to 2.99 times his average annual
compensation payable by us to him for the five preceding calendar years and a lump sum payment, the
amount determined by multiplying the number of shares of common stock subject to unexercised stock
options previously granted by us and held by Mr. Coons on the date of termination, whether or not
such options are then exercisable, and the highest per share fair market value of the common stock
on any day during the six-month period ending on the date of termination. Upon payment of such
amount, such unexercised stock options will be deemed to be surrendered and canceled. 57




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##### Table of Contents



Following a termination of Dr. Kniesers employment with us in the event of a
change-in-control, Dr. Knieser would be entitled to receive a lump sum payment equal to 2.99 times
his then-current base salary, plus a severance payment equal to 12 months salary. We are obligated to pay a minimum bonus to the Messrs. Hunter, Pheffer Coons and Knieser as
follows:        Mr. Hunter receives a minimum bonus equal to 3% of our annual gross operating
income, but not less than 10% of his annual salary.        Mr. Pheffer receives a minimum bonus equal to 2% of our annual gross operating
income, but not less than 10% of his annual salary.        Mr. Coons receives a minimum bonus equal to 1 1/2% of our annual gross operating
income, but not less than 10% of his annual salary.        Dr. Knieser receives a bonus equal to 1% of the earnings, before interest and taxes, of U.S. Health Services. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth certain information as of February 28, 2005 with respect to
ownership of our outstanding common stock by:  
    all persons known to us to own more than 5% of the outstanding shares of our common stock;
    each of our directors;
    each Named Executive Officer (as such term is defined herein); and
    all of our executive officers and directors as a group. Number ofName
    
    Shares Owned (1)
    
    PercentRonald D. Hunter (2)
    
    
    1,194,652
    
    
    
    13.48
    %P.B. (Pete) Pheffer (3)
    
    
    447,784
    
    
    
    5.37Martial R. Knieser (4)
    
    
    375,426
    
    
    
    4.69Stephen M. Coons (5)
    
    
    445,586
    
    
    
    5.44Michael G. Browning (6)
    
    
    64,374
    
    
    
    *James H. Steane II (7)
    
    
    3,500
    
    
    
    *Dainforth
B. French Jr. (8)
    
    
    30,400
    
    
    
    *All directors and executive officers as a
group (7 persons) (9)
    
    
    2,510,907
    
    
    
    26.10Marc
D. Novotney (10)
    
    
    63,333
    
    
    
    *Dimensional Fund Advisors, Inc. (11)
1299 Ocean Avenue, 11th Floor
Santa Monica, California 90401
    
    
    459,855
    
    
    
    5.81Henry George Luken, III (12)
900 Fairway Lane
Soddy Daisy, Tennessee 37379
    
    
    565,845
    
    
    
    7.14
   *
    
    Represents less than one percent 58




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##### Table of Contents



(1)
    
    The information set forth in this table with respect to our common stock ownership
reflects beneficial ownership as determined in accordance with Rule 13d-3 under the
Securities Exchange Act of 1934, as amended. Beneficial ownership includes shares for which
an individual, directly or indirectly, has or shares voting or investment power or both and
also includes options which are exercisable within sixty days of the date hereof. The
percentages are based upon 7,921,113 shares outstanding as of March 1, 2005. The percentages
for each of those parties who hold options exercisable within 60 days of the date of this
proxy statement are based upon the sum of 7,921,113 shares plus the number of shares subject
to such options held by each such party, as indicated in the following notes.(2)
    
    Includes 3,870 shares beneficially owned by Mr. Hunters spouse/child, as to which Mr. Hunter
disclaims beneficial ownership, and 37,531 shares held on Mr. Hunters behalf pursuant to the
Standard Management 401(k) Plan as to which Mr. Hunter has investment power. Also includes
938,095 shares subject to options exercisable within 60 days of March 1, 2005. Mr. Hunters
address is 10689 North Pennsylvania Street, Indianapolis, Indiana 46280.(3)
    
    Includes 10,284 shares held on Mr. Pheffers behalf pursuant to the Standard Management
401(k) Plan as to which Mr. Pheffer has investment power and 417,500 shares subject to options
exercisable within 60 days of March 1, 2005. Mr. Pheffers address is 10689 North
Pennsylvania Street, Indianapolis, Indiana 46280.(4)
    
    Includes 2,900 shares held on Dr. Kniesers behalf pursuant to the Standard Management 401(k)
Plan as to which Dr. Knieser has investment power and 78,858 shares subject to options
exercisable within 60 days of March 1, 2005. Dr. Kniesers address is address is 10689 North
Pennsylvania Street, Indianapolis, Indiana 46280.(5)
    
    Includes 2,068 shares held on Mr. Coons behalf pursuant to the Standard Management 401(k)
Plan as to which Mr. Coons has investment power, 144,058 additional shares held under the
Standard Management 401(k) Plan as to which Mr. Coons shares voting power as a result as his
service as a trustee under the plan (which share amount includes the shares beneficially held
under the plan for Messrs. Hunter, Pheffer and Knieser, as indicated above). Also includes
265,260 shares subject to options exercisable within 60 days of March 1, 2005. Mr. Coons
address is 10689 North Pennsylvania Street, Indianapolis, Indiana 46280.(6)
    
    Includes 5,700 shares held by Mr. Brownings spouse and 3,200 shares pursuant to which Mr.
Browning has shared voting power, in both cases, as to which Mr. Browning disclaims beneficial
ownership. Mr. Brownings address is 10689 North Pennsylvania Street, Indianapolis, Indiana
46280.(7)
    
    Includes 500 shares subject to options exercisable within 60 days of March 1, 2005.(8)
    
    Includes 10,000 shares held by Mr. Frenchs family, as to which Mr. French disclaims
beneficial ownership. Mr. Frenchs address is 10689 North Pennsylvania Street, Indianapolis,
Indiana 46280.(9)
    
    Includes a total of 1,699,713 shares subject to options exercisable within 60 days of March
1, 2005.(10)
    
    Includes 58,333 shares subject to options exercisable within 60 days of March 1, 2005.
Subsequent to the year ended December 31, 2004, Mr. Novotney is no longer employed by Standard
Management.(11)
    
    Information with respect to Dimensional Fund Advisors, Inc. is based solely on a Schedule 13G
filed by this entity with the SEC on February 9, 2005. Standard Management makes no
representation as to the accuracy or completeness of the information reported by this entity.(12)
    
    Information with respect to Henry George Luken, III is based solely on a Schedule 13D filed
by Mr. Luken with the SEC on May 14, 2003. Standard Management makes no representation as to
the accuracy or completeness of the information reported by Mr. Luken. 
 Item 13. Certain Relationship and Related Transactions Our Articles of Incorporation and Bylaws provide for indemnification of our officers and
directors to the maximum extent permitted under the Indiana Business Corporation Law (IBCL). In
addition, we have entered into separate indemnification agreements with some of our directors which
may require, among other things, to indemnify them against certain liabilities that may arise by
reason of their status or service as directors to the maximum extent permitted under the IBCL. On October 28, 1997, we made an interest free loan to Mr. Hunter, Chairman and Chief Executive
Officer, in the amount of $775,500. The loan is repayable within 10 days of Mr. Hunters voluntary
termination or resignation as our Chairman and Chief Executive Officer. In the event of a
termination of Mr. Hunters employment following a change in control, the loan is deemed to be
forgiven. As of December 31, 2004, all $775,500 remained outstanding under this loan. 59




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##### Table of Contents



Item 14. Principal Accounting Fees and Services The following table sets forth the fees paid to the Companys independent registered public
accounting firm since that firm was engaged by the Company in the fourth quarter of 2004: BDO Seidman, LLP2004Audit fees
    
    $
    340,000Audit-related fees
    
    
    Tax fees
    
    
    2,800All other fees
    
    
    
 Audit Feesare fees for professional services rendered by our independent public
accountants for the audit of our annual financial statements, review of our quarterly financial
statements or services normally provided in connection with statutory or regulatory filings. Audit-Related Feesare fees for assurance and related services reasonably related
to the performance of the audit or review of our financial statements. Tax Feesare fees for professional services rendered by our independent public
accountants for tax compliance, tax advice and tax planning. Services performed in this category
included the review of our federal income tax returns. All Other Feesare fees for professional services not included in the first three
categories. Each of the above services was approved by the Audit Committee. Each engagement of
the independent registered public accounting firm to perform audit or non-audit services must be
approved in advance by our Audit Committee or by its Chairman pursuant to delegated authority. 60




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##### Table of Contents



PART IV 
 Item 15. Exhibits and Financial Statement Schedules (a)(1) and (2) The response to this portion of Item 15 is listed on page F-1 of this report. (a)(3) List of Exhibits: ExhibitNumber
    
    Description of Document3.1
    
    Amended and Restated Articles of Incorporation, as amended (incorporated by reference
to Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31,
1996).3.2
    
    Amended and Restated Bylaws as amended (incorporated by reference to Registration
Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on
January 27, 1993 and to Exhibit 3 of Quarterly Report on Form 10-Q (File No. 0-20882)
for the quarter ended September 30, 1994).4.1
    
    Certificate of Trust of SMAN Capital Trust I (incorporated by reference to
Registration Statement on Form S-1 (Registration No. 333-60886)).4.2
    
    Trust Agreement of SMAN Capital Trust I (incorporated by reference to Registration
Statement on Form S-1 (Registration No. 333-60886)).4.3
    
    Form of Amended and Restated Trust Agreement of SMAN Capital Trust I among Standard
Management, Bankers Trust Company and Bankers Trust (Delaware) (incorporated by
reference to Registration Statement on Form S-1 (Registration No. 333-60886)).4.4
    
    Form of Preferred Securities Certificates (incorporated by reference to Registration
Statement on Form S-1 (Registration No. 333-60886)).4.5
    
    Form of Junior Subordinated Indenture between Standard Management and Bankers Trust
Company (incorporated by reference to Registration Statement on Form S-1
(Registration No. 333-60886)).4.6
    
    Form of Junior Subordinated Debenture (incorporated by reference to Registration
Statement on Form S-1 (Registration No. 333-60886)).4.7
    
    Form of Preferred Securities Guarantee Agreement between Standard Management and
Bankers Trust Company (incorporated by reference to Registration Statement on Form
S-1 (Registration No. 333-60886)).4.8
    
    Form of Presidents Club Warrant (incorporated by reference to Annual Report on Form
10-K (File No. 0-20882)).4.9
    
    Indenture dated November 30, 2004 by and between Standard Management Corporation and
U.S. Bank National Association (includes the form of 6% Convertible Note due 2008)
(incorporated by reference to the Current Report on Form 8-K (File No. 0-20882) date
of report November 30, 2004.10.1*
    
    Employment Agreement by and between Standard Management and Ronald D. Hunter, dated
and effective January 1, 2003 (incorporated by reference to Quarterly Report on Form
10-Q (File No. 0-20882) for the quarter ended March 31, 2003).
 61




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##### Table of Contents



ExhibitNumber
    
    Description of Document10.2*
    
    Second Amended and Restated Employment Contract by and between Standard Management
and Stephen M. Coons dated and effective, as amended, July 1, 1999 (incorporated by
reference to Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended
September 30, 1999).10.3*
    
    Indemnification Agreement between Standard Management and Stephen M. Coons and Coons
& Saint, dated August 1, 1991 (incorporated by reference to Registration Statement on
Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27,
1993).10.4*
    
    Standard Management Amended and Restated 1992 Stock Option Plan (incorporated by
reference to Registration Statement on Form S-4 (Registration No. 333-35447) as filed
with the Commission on September 11, 1997.10.5
    
    Lease by and between Standard Life
and Standard Management, dated December 28, 2001 (incorporated
by reference to Annual Report on Form 10-K (File
No. 0-20882) for the year ended December 31, 2003).10.6
    
    Management Service Agreement between Standard Life and Standard Management dated
August 1, 1992, as amended on January 1, 1997 and as further amended on January 1,
1999 (incorporated by reference to Annual Report on Form 10-K (File No. 0-20882)).10.7
    
    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
Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the
Commission on January 27, 1993).10.8
    
    Reinsurance Agreement between Standard Life and Swiss Re Life and Health effective
May 1, 1975 (incorporated by reference to Registration Statement on Form S-1
(Registration No. 33-53370) as filed with the Commission on January 27, 1993).10.9
    
    Reinsurance Agreement between Firstmark Standard Life Insurance Company and Swiss Re
Life and Health effective February 1, 1984 (incorporated by reference to Registration
Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on
January 27, 1993).10.10
    
    Reinsurance Contract between First International and Standard Life dated July 10,
1992 (incorporated by reference to Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993).10.11
    
    Amended Reinsurance Agreement between Standard Life and Winterthur Life Re Insurance
Company effective January 1, 1995 (incorporated by reference to Annual Report on Form
10-K (File No. 0-20882) for the year ended December 31, 1996).10.12
    
    Assignment of Management Contract dated October 2, 1995 of Management Contract dated
January 1, 1987 between DNC and Dixie Life to Standard Life (incorporated by reference
to Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31,
1996).10.13
    
    Automatic Indemnity Reinsurance Agreement between First International and The
Guardian Insurance & Annuity Company, Inc. dated and effective January 1, 1996
(incorporated by reference to Annual Report on Form 10-K (File No. 0-20882) for the
year ended December 31, 1996).10.14
    
    Indemnity Retrocession Agreement between The Guardian Insurance & Annuity Company,
Inc. and Standard Life dated and effective January 1, 1996 (incorporated by reference
to Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31,
1996).10.15
    
    Automatic Indemnity Reinsurance Agreement between The Guardian Insurance & Annuity
Company, Inc. and Standard Life dated and effective January 1, 1996 (incorporated by
reference to Annual Report on Form 10-K (File No. 0-20882) for the year ended December
31, 1996).
 62




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##### Table of Contents



ExhibitNumber
    
    Description of Document10.16
    
    Administrative Services Agreement between First International and Standard Life
dated and effective March 18, 1996 (incorporated by reference to Annual Report on Form
10-K (File No. 0-20882) for the year ended December 31, 1996).10.17
    
    Surplus Debenture dated as of November 8, 1996 by and between Standard Management
and Standard Life in the amount of $13,000,000 (incorporated by reference to Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended September 30, 1996).10.18
    
    Portfolio Indemnify Reinsurance Agreement between Dixie Life and Cologne Life
Reinsurance Company dated and effective December 31, 1997 (incorporated by reference
to Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31,
1996).10.19
    
    Coinsurance Agreement effective as of July 1, 1997 by and between Savers Life and
World Insurance Company (incorporated by reference to Registration Statement on Form
S-4 (Registration No. 333-35447)).10.20
    
    Amendment I to the Guardian Indemnity Retrocession Agreement effective as of January
1, 1996 by and between The Guardian Insurance and Annuity Company and Standard Life
(incorporated by reference to Registration Statement on Form S-4 (Registration No.
333-35447)).10.21
    

    Promissory Note from Ronald D. Hunter to Standard Management in the amount of
$775,500 executed October 28, 1997 (incorporated by reference to Quarterly Report on
Form 10-Q (File No. 0-20882) for the quarter ended September 30, 1997).10.22
    
    Reinsurance Agreement between Standard Life and Life Reassurance Corporation of
America effective September 1, 1997 (incorporated by reference to Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31, 1997).10.23
    
    Reinsurance Agreement between Standard Life and Business Mens Assurance Company of
America effective September 1, 1997 (incorporated by reference to Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31, 1997).10.24
    
    Indemnity Reinsurance Agreement between Standard Life and the Mercantile and General
Life Reassurance Company of America dated March 30, 1998 and effective June 1, 1997
(incorporated by reference to Quarterly Report on Form 10-Q (File No. 0-20882) for the
quarter ended June 30, 1998).10.25
    
    Quota Share Reinsurance Agreement between Savers Life and the Oxford Life Insurance
Company dated September 24, 1998 and effective July 1, 1998 (incorporated by reference
to Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended September
30, 1998).10.26
    
    Addendum No. 5 to Reinsurance Agreement between Standard Life and Winterthur Life Re
Insurance Company dated August 20, 1998 and effective October 1, 1998 (incorporated by
reference to Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended
September 30, 1998).10.27
    
    Surplus debenture dated as of December 31, 1998 by and between Standard Management
and Standard Life in the amount of $8.0 million (incorporated by reference to Annual
Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1998).10.28
    
    Surplus debenture dated as of December 31, 1998 by and between Standard Management
and Standard Life in the amount of $6.0 million (incorporated by reference to Annual
Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1998).
 63




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##### Table of Contents



ExhibitNumber
    
    Description of Document10.29*
    
    Employment Agreement between Standard Management and P.B. (Pete) Pheffer dated and
effective January 1, 2003, (incorporated by reference to Quarterly Report on Form 10-Q
(File No. 0-20882) for the quarter ended March 31, 2003).10.30
    
    Promissory Note for $6.9 million between Standard Management and Republic Bank dated
December 28, 2001 (incorporated by reference to Annual Report on Form 10-K (File No.
0-20882) for the year ended December 31, 2001).10.31*
    
    Standard Management Corporation 2002 Stock Incentive Plan (incorporated by reference
to Standard Managements Registration Statement on Form S-8 (Registration No.
333-101359)).10.32*
    
    Deferred Compensation Plan of Standard Management dated and effective December 31,
2001 (incorporated by reference to Annual Report on Form 10-K (File No. 0-20882) for
the year ended December 31, 2001).10.33
    
    Senior Secured Credit Agreement, dated November 13, 2003, between Standard
Management and The CIT Group/Equipment Financing, Inc. (incorporated by reference to
Current Report on Form 8-K, (File No. 0-20882), date of report November 17, 2003).10.34
    
    Pledge Agreement, dated November 13, 2003, between Standard Management and The CIT
Group/Equipment Financing, Inc. (incorporated by reference to Current Report on Form
8-K, (File No. 0-20882), date of report November 17, 2003).10.35
    
    Security Agreement, dated November 13, 2003, between Standard Management and The CIT
Group/Equipment Financing, Inc. (incorporated by reference to Current Report on Form
8-K, (File No. 0-20882), date of report November 17, 2003).10.36*
    
    Employment Agreement by and between Standard Management and Dr. Martial R. Knieser,
dated and effective June 1, 2004.16.1
    
    Letter from Ernst & Young LLP to the SEC dated November 22, 2004 (incorporated by
reference to Current Report on Form 8-K, (File No. 0-20882), date of report November
1, 2004).21
    
    List of Subsidiaries of Standard Management.23.1
    
    Consent of BDO Seidman, LLP.23.2
    
    Consent of Ernst & Young LLP.24
    
    Powers of Attorney (Included on the signature page to this Form 10-K).31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
   *
    
    Management contract or compensation plan or arrangement required to be filed as an exhibit to this
Report on Form 10-K pursuant to Item 15(c) of Form 10-K. 64




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##### Table of Contents



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 24, 2005STANDARD MANAGEMENT CORPORATION/s/ Ronald D. HunterRonald D. HunterDirector, Chairman and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below on March 24, 2005 by the following persons on behalf of the Registrant and in the capacities
indicated. KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and
appoints Ronald D. Hunter and Stephen M. Coons and each of them (with full power of each of them to
act alone), his attorneys-in-fact and agents, with full power of substitution, for him and in his
name, place and stead in any and all capacities, to sign any and all amendments to this Annual
Report on Form 10-K or any other instruments he deems necessary or appropriate, and to file the
same, with all exhibits thereto and other documents in connection therewith, with the Securities
and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority
to do and perform each and every act and thing requisite and necessary to be done as fully to all
intents and purposes as he might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them may lawfully do or cause to be done by virtue
thereof. /s/ Ronald D. HunterRonald D. Hunter
    
    Director, Chairman and Chief Executive Officer(Principal Executive Officer)/s/ P.B. (Pete) PhefferP.B. (Pete) Pheffer
    
    Director, President and Chief Financial Officer
(Principal Financial Officer)/s/ Michael B. EdwardsMichael B. Edwards
    
    Vice President and Corporate Controller
(Principal Accounting Officer)/s/ Stephen M. CoonsStephen M. Coons
    
    Director/s/ Martial R. KnieserMartial R. Knieser
    
    Director/s/ Michael G. BrowningMichael G. Browning
    
    Director/s/ James H. Steane IIJames H. Steane II
    
    Director/s/ Dainforth B. French, Jr.Dainforth B. French, Jr.
    
    Director
 65




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ANNUAL REPORT ON FORM 10-K ITEM 8, ITEM 14(a)(1) AND (2),(c) AND (d) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA LIST OF FINANCIAL STATEMENTS and FINANCIAL STATEMENT SCHEDULES CERTAIN EXHIBITS FINANCIAL STATEMENT SCHEDULES Year Ended December 31, 2004 STANDARD MANAGEMENT CORPORATION INDIANAPOLIS, INDIANA




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES PageAudited Consolidated Financial StatementsReport of Independent Registered Public Accounting Firm
    
    
    F-2Report of Independent Auditors
    
    
    F-3Consolidated Balance Sheets as of December 31, 2004 and 2003
    
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2004, 2003 and 2002
    
    
    F-5Consolidated Statements of Shareholders Equity for the Years Ended December 31, 2004, 2003 and 2002
    
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Financial Statement Schedules
 The following consolidated financial statement schedules are included in this report and should be read in
conjunction with the Audited Consolidated Financial Statements. Schedule II  Condensed Financial Information of Registrant
(Parent Company) for the Years Ended December 31, 2004, 2003 and 2002
    
    
    F-34Schedule IV  Reinsurance for the Years Ended December 31, 2004, 2003 and 2002
    
    
    F-38
 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
related Notes. F-1




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##### Table of Contents



Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors
Standard Management Corporation
Indianapolis, Indiana We have audited the accompanying consolidated balance sheet of Standard Management Corporation
and subsidiaries (the Company) as of December 31, 2004, and the related consolidated statement of
operations, shareholders equity and cash flows for the year then ended. Our audit also included
the 2004 information included in the financial statement schedules listed in the Index at page F-1.
These 2004 financial statements and schedule information are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements and schedule
information based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and schedule information are
free of material misstatement. An audit includes consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements and schedule information, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statements and schedule
information presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Standard Management Corporation and
subsidiaries at December 31, 2004, and the consolidated results of their operations and their cash
flows for the year then ended, in conformity with accounting principles generally accepted in the
United States. Also, in our opinion, the related 2004 information included in the financial statement
schedules present fairly, in all material respects, that information set forth therein. /s/ BDO Seidman, LLP Chicago, Illinois
February 28, 2005 F-2




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##### Table of Contents



Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors of
Standard Management Corporation We have audited the accompanying consolidated balance sheet of Standard Management Corporation
and subsidiaries as of December 31, 2003, and the related consolidated statements of operations,
shareholders equity and cash flows for each of the two years in the period ended December 31,
2003. Our audits also included the 2003 and 2002 information included in the financial statement
schedules listed in the Index at Item 15 (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 conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). 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 consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management and
evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Standard Management Corporation and subsidiaries
at December 31, 2003, and the consolidated results of their operations and their cash flows for
each of the two years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the 2003 and 2002
information included in 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. As discussed in Note 1 to the consolidated financial statements, in 2002 the Company adopted
Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. /s/ Ernst & Young LLP
 Indianapolis, Indiana
March 2, 2004 F-3




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
  December 312004
    
    
    2003ASSETSInvestments:Securities available for sale:Fixed maturity securities, at fair value (amortized cost:$1,648,504 in 2004 and $1,638,048 in 2003)
    
    $
    1,661,277
    
    
    $
    1,644,837Mortgage loans on real estate
    
    
    819
    
    
    
    3,937Policy loans
    
    
    10,783
    
    
    
    12,308Real estate
    
    
    1,524
    
    
    
    1,843Equity-indexed call options
    
    
    8,831
    
    
    
    19,711Other invested assets
    
    
    1,367
    
    
    
    2,690Short-term investments
    
    
    593
    
    
    
    590Total investments
    
    
    1,685,194
    
    
    
    1,685,916Cash and cash equivalents
    
    
    9,557
    
    
    
    17,296Accrued investment income
    
    
    16,005
    
    
    
    17,002Amounts due and recoverable from reinsurers
    
    
    34,945
    
    
    
    36,277Deferred policy acquisition costs
    
    
    159,923
    
    
    
    166,411Present value of future profits
    
    
    14,250
    
    
    
    16,508Goodwill and intangibles
    
    
    8,823
    
    
    
    10,961Property and equipment (less accumulated depreciation of $6,955 in 2004
and $5,286 in 2003)
    
    
    11,905
    
    
    
    12,770Federal income tax recoverable
    
    
    1,843
    
    
    
    6,429Deferred income taxes
    
    
    151
    
    
    
    Other assets
    
    
    5,300
    
    
    
    5,201Total assets
    
    $
    1,947,896
    
    
    $
    1,974,771LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Insurance policy liabilities
    
    $
    1,825,894
    
    
    $
    1,841,545Accounts payable and accrued expenses
    
    
    7,659
    
    
    
    8,117Obligations under capital lease
    
    
    571
    
    
    
    551Mortgages payable
    
    
    6,607
    
    
    
    6,795Notes payable
    
    
    26,433
    
    
    
    21,000Deferred income taxes
    
    
    
    
    
    
    3,616Payable to subsidiary trust issuer of company-obligated trust preferred securities
    
    
    20,700
    
    
    
    20,700Total liabilities
    
    
    1,887,864
    
    
    
    1,902,324Shareholders Equity:Common stock and additional paid in capital, no par value
authorized 20,000,000 shares; issued 9,446,191 in 2004 and 9,629,167 in 2003
    
    
    64,369
    
    
    
    68,077Treasury stock, at cost, 1,525,078 shares in 2004 and 1,515,078 in 2003
    
    
    (7,703
    )
    
    
    (7,671
    )Accumulated other comprehensive income
    
    
    4,895
    
    
    
    2,702Retained earnings (loss)
    
    
    (1,529
    )
    
    
    9,339Total shareholders equity
    
    
    60,032
    
    
    
    72,447Total liabilities and shareholders equity
    
    $
    1,947,896
    
    
    $
    1,974,771
 See accompanying notes to consolidated financial statements. F-4




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 )
 Year Ended December 312004
    
    
    2003
    
    
    2002Revenues:Premium income
    
    $
    7,924
    
    
    $
    8,929
    
    
    $
    9,173Net investment income
    
    
    83,393
    
    
    
    83,009
    
    
    
    75,839Call option gain (loss)
    
    
    2,449
    
    
    
    11,951
    
    
    
    (10,089
    )Net realized investment gain (loss)
    
    
    (283
    )
    
    
    17,876
    
    
    
    (19,841
    )Policy income
    
    
    16,767
    
    
    
    10,839
    
    
    
    8,084Sales of goods
    
    
    7,120
    
    
    
    2,948
    
    
    
    1,850Fee and other income
    
    
    638
    
    
    
    1,021
    
    
    
    3,208Total revenues from continuing operations
    
    
    118,008
    
    
    
    136,573
    
    
    
    68,224Benefits and expenses:Benefits and claims
    
    
    7,954
    
    
    
    12,977
    
    
    
    9,938Interest credited to interest-sensitive annuities and other financial
products
    
    
    56,110
    
    
    
    71,600
    
    
    
    42,650Amortization of DAC and PVFP
    
    
    27,791
    
    
    
    33,916
    
    
    
    10,622Operating expenses
    
    
    26,388
    
    
    
    21,984
    
    
    
    16,434Cost of goods sold
    
    
    5,822
    
    
    
    2,445
    
    
    
    1,554Interest expense and financing costs
    
    
    4,416
    
    
    
    4,474
    
    
    
    4,351Total benefits and expenses from continuing operations
    
    
    128,481
    
    
    
    147,396
    
    
    
    85,549Loss before federal income tax expense (benefit)
    
    
    (10,473
    )
    
    
    (10,823
    )
    
    
    (17,325
    )Federal income tax expense (benefit)
    
    
    395
    
    
    
    (627
    )
    
    
    (9,467
    )Loss from continuing operations
    
    
    (10,868
    )
    
    
    (10,196
    )
    
    
    (7,858
    )Discontinued operations:Income from discontinued operations, less income taxes of $550
    
    
    
    
    
    
    
    
    
    
    1,068Gain (loss) from the sale of discontinued operations, less
income taxes of $0 and $4,125, respectively
    
    
    
    
    
    
    (275
    )
    
    
    6,872Total income (loss) from discontinued operations
    
    
    
    
    
    
    (275
    )
    
    
    7,940Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (1,212
    )Net loss
    
    $
    (10,868
    )
    
    $
    (10,471
    )
    
    $
    (1,130
    )Loss per common share  basic and diluted:Net loss from continuing operations
    
    $
    (1.36
    )
    
    $
    (1.27
    )
    
    $
    (1.03
    )Discontinued operations:Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.14Gain (loss) from the sale of discontinued operations
    
    
    
    
    
    
    (0.03
    )
    
    
    0.90Total income (loss) from discontinued operations
    
    
    
    
    
    
    (0.03
    )
    
    
    1.04Cumulative effect of accounting change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.16
    )Net loss
    
    $
    (1.36
    )
    
    $
    (1.30
    )
    
    $
    (0.15
    )Weighted average shares outstanding
    
    
    7,973,029
    
    
    
    8,031,749
    
    
    
    7,623,690
 See accompanying notes to consolidated financial statements. F-5




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
  Accumulatedother
    
    
    RetainedCommon
    
    
    Treasury
    
    
    comprehensive
    
    
    earningsTotal
    
    
    stock
    
    
    stock
    
    
    income (loss)
    
    
    (loss)Balance at January 1, 2002
    
    $
    70,189
    
    
    $
    63,011
    
    
    $
    (7,589
    )
    
    $
    (6,173
    )
    
    $
    20,940Comprehensive income:Net loss
    
    
    (1,130
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,130
    )Other comprehensive income:Change in unrealized gain on securities,
net taxes of $8,155
    
    
    15,665
    
    
    
    
    
    
    
    
    
    
    
    15,665
    
    
    
    Change in foreign currency
translation
    
    
    2,247
    
    
    
    
    
    
    
    
    
    
    
    2,247
    
    
    
    Comprehensive income
    
    
    16,782Issuance of common stock in business acquisitions and
common stock warrants
    
    
    878
    
    
    
    878
    
    
    
    
    
    
    
    
    
    
    
    Exercise of common stock options
    
    
    (33
    )
    
    
    (33
    )
    
    
    
    
    
    
    
    
    
    
    Purchase of treasury stock
    
    
    (82
    )
    
    
    
    
    
    
    (82
    )
    
    
    
    
    
    
    Balance at December 31, 2002
    
    $
    87,734
    
    
    $
    63,856
    
    
    $
    (7,671
    )
    
    $
    11,739
    
    
    $
    19,810Comprehensive income:Net loss
    
    
    (10,471
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,471
    )Other comprehensive income:Change in unrealized loss on securities,
net taxes of $4,563
    
    
    (9,037
    )
    
    
    
    
    
    
    
    
    
    
    (9,037
    )
    
    
    Comprehensive loss
    
    
    (19,508
    )Issuance of common stock in business acquisitions and
common stock warrants
    
    
    243
    
    
    
    243
    
    
    
    
    
    
    
    
    
    
    
    Exercise of common stock options
    
    
    (22
    )
    
    
    (22
    )
    
    
    
    
    
    
    
    
    
    
    Purchase of MCO
    
    
    4,000
    
    
    
    4,000
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2003
    
    $
    72,447
    
    
    $
    68,077
    
    
    $
    (7,671
    )
    
    $
    2,702
    
    
    $
    9,339Comprehensive income:Net loss
    
    
    (10,868
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,868
    )Other comprehensive income:Change in unrealized gain on securities,
net taxes of $1,130
    
    
    2,193
    
    
    
    
    
    
    
    
    
    
    
    2,193
    
    
    
    Comprehensive loss
    
    
    (8,675
    )Purchase of treasury stock
    
    
    (32
    )
    
    
    
    
    
    
    (32
    )
    
    
    
    
    
    
    Issuance of common stock in business acquisitions
    
    
    293
    
    
    
    293
    
    
    
    
    
    
    
    
    
    
    
    Exercise of common stock options
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    Sale of MCO
    
    
    (4,000
    )
    
    
    (4,000
    )
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2004
    
    $
    60,032
    
    
    $
    64,369
    
    
    $
    (7,703
    )
    
    $
    4,895
    
    
    $
    (1,529
    )
 See accompanying notes to consolidated financial statements. F-6




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year Ended December 312004
    
    
    2003
    
    
    2002Operating ActivitiesNet loss
    
    $
    (10,868
    )
    
    $
    (10,471
    )
    
    $
    (1,130
    )Adjustments to reconcile net loss to net cash provided by operating activities:Amortization of DAC and PVFP
    
    
    27,791
    
    
    
    18,914
    
    
    
    10,894Deferral of policy acquisition costs
    
    
    (21,298
    )
    
    
    (24,301
    )
    
    
    (62,619
    )Deferred federal income provision
    
    
    (2,874
    )
    
    
    (6,585
    )
    
    
    (8,917
    )Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    1,212Depreciation and amortization
    
    
    3,023
    
    
    
    1,529
    
    
    
    1,509Change in insurance policy liabilities
    
    
    42,581
    
    
    
    58,212
    
    
    
    55,888Net realized investment gain (loss)
    
    
    (283
    )
    
    
    (17,876
    )
    
    
    19,841Change in accrued investment income
    
    
    13,177
    
    
    
    7,020
    
    
    
    1,285Change in
other assets and liabilities, net, excluding effect of business acquisitions
    
    
    2,288
    
    
    
    347
    
    
    
    443Net cash provided by operating activities
    
    
    53,537
    
    
    
    26,789
    
    
    
    18,406Investing ActivitiesFixed maturity securities available for sale:Purchases
    
    
    (584,955
    )
    
    
    (1,553,539
    )
    
    
    (1,674,454
    )Sales
    
    
    412,270
    
    
    
    953,962
    
    
    
    1,218,478Maturities, calls and redemptions
    
    
    153,579
    
    
    
    322,838
    
    
    
    9,141Change in short-term investments, net
    
    
    10,876
    
    
    
    (3,731
    )
    
    
    (5,624
    )Cash paid
for health services acquisitions, net of cash acquired
    
    
    (823
    )
    
    
    (145
    )
    
    
    (1,215
    )Proceeds from the sale of International Operations
    
    
    
    
    
    
    
    
    
    
    25,690Change in other investments, net
    
    
    4,136
    
    
    
    (353
    )
    
    
    (2,304
    )Net cash used by investing activities
    
    
    (4,917
    )
    
    
    (280,968
    )
    
    
    (430,288
    )Financing ActivitiesBorrowings
    
    
    6,050
    
    
    
    26,915
    
    
    
    200Repayments of notes payable
    
    
    (1,787
    )
    
    
    (19,323
    )
    
    
    (6,943
    )Premiums received on interest-sensitive annuities and other financial products
credited to policyholder account balances, net of premiums ceded
    
    
    247,767
    
    
    
    421,032
    
    
    
    599,516Return of policyholder account balances on interest-sensitive annuities and other
financial products
    
    
    (308,356
    )
    
    
    (217,324
    )
    
    
    (138,723
    )Issuance of common stock and warrants
    
    
    (1
    )
    
    
    (22
    )
    
    
    (33
    )Purchase of common stock for treasury stock
    
    
    (32
    )
    
    
    
    
    
    
    (82
    )Net cash provided (used in) by financing activities
    
    
    (56,359
    )
    
    
    211,278
    
    
    
    453,935Net increase (decrease) in cash and cash equivalents
    
    
    (7,739
    )
    
    
    (42,901
    )
    
    
    42,053Cash and cash equivalents at beginning of year
    
    
    17,296
    
    
    
    60,197
    
    
    
    18,144Cash and cash equivalents at end of year
    
    $
    9,557
    
    
    $
    17,296
    
    
    $
    60,197
 See accompanying notes to consolidated financial statements. F-7




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER 31, 2004
 1. Basis of Presentation Organization Standard Management Corporation (we, our, us, Standard Management or the Company) is
a holding company that, through our subsidiaries, a) develops, markets and/or administers annuity
and life insurance products and b) distributes pharmaceutical goods and services through its health
subsidiary. Standard Managements subsidiaries at December 31, 2004 primarily include: 1) Standard Life
Insurance Company of Indiana (Standard Life) and its subsidiary, Dixie National Life Insurance
Company (Dixie Life) and 2) U.S. Health Services Corporation (U.S. Health Services) and its
subsidiaries. In February 2005, Standard Management entered into an agreement to sell Standard
Life and Dixie Life. See note 19 for further description. This sale, if it is consummated, will
have a significant impact on our Company as the operations of Standard Life and Dixie Life have
historically represented in excess of 95% of our consolidated operations. Operating Segments Health Services Our Health Services segment, which was formed in 2002, and is conducted primarily through our
subsidiary U.S. Health Services, develops and distributes retail and third party reimbursed
pharmaceutical products and services through direct-to-consumer as well as institutional channels.
Our primary customer base consists of consumers, academic institutions, skilled nursing facilities,
assisted living facilities, home health care agencies and correctional and mental health
facilities. In addition, U.S. Health Services acts as a wholesale distributor/repackager and a
pharmacy management solution to various sectors of the veterinary care industry. The profitability
of this segment is primarily a function of gross margin on sales (the difference between sales and
cost of sales) and management of our operating expenses. Effective May 13, 2004, we purchased the assets of RoyalMed, LLC for 50,000 shares of our
common stock. The purchase price included contingent consideration, based on a targeted closing
sales price of our common stock on the anniversary date of the acquisition over the next two years.
The contingent consideration has been recognized as additional paid in capital in our consolidated
financial statements. Effective April 1, 2004, we sold 95% of Medical Care & Outcomes, LLC (MCO) back to its
original owners. We recognized a loss on the sale and related severance costs of $964,000 in the
first quarter of 2004 in the Health Services segment. MCO was originally purchased in 2003 with $4
million of our common stock. The divestiture of MCO resulted in the return of our common stock and
therefore in a decrease to equity of $4 million in the second quarter of 2004. Effective February 6, 2004, our newly formed subsidiary, Apothecary Solutions Corporation
(Apothecary Solutions), acquired certain assets of Alliance Center, Inc. Apothecary Solutions is
an institutional pharmacy. The purchase price was $3.7 million. The purchase price was paid in
the form of cash of $.8 million and the assumption of $2.9 million of debt and a seller note. During 2003, we acquired the business assets of MyDoc.com. The purchase price was $645,000
paid in the form of cash of $145,000 and a seller note of $500,000. During 2002, we purchased three health services companies. The aggregate purchase price of
$2.8 million was in the form of $.9 million of our common stock, cash of $1.2 million and $.7
million of debt and seller notes. Financial Services Our Financial Services segment consists of revenues earned and expenses incurred from our
insurance operations, particularly Standard Life and Dixie Life. Our primary insurance products
include deferred annuities, single premium immediate annuities and equity-indexed annuities. The
profitability of this segment is primarily a function of net investment spread (the difference
between the investment income earned on our investments less the interest we credit to our
policyholders), persistency of our in force business, mortality experience and management of our
operating expenses. See note 19. F-8




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 1. Basis of Presentation (continued) Other Services Our Other Services segment consists of revenues and expenses primarily related to corporate
operations and financing costs. Discontinued Operations  International Operations In 2002, we sold our International Operations which consisted of 100% of the shares in Premier
Life (Luxembourg) S.A. and the portfolio of Premier Life (Bermuda) Limited to Winterthur Life, a
division of Credit Suisse Group, resulting in a gain from the sale of discontinued operations of
$6.9 million in 2002. The 2002 results included revenues earned and expenses incurred from abroad,
primarily Europe, and include fees collected on our deposits from unit-linked assurance products.
The profitability of this segment primarily was dependant on the amount of separate account assets
under management, the management fee charged on those assets and management of our operating
expenses. Loss from the sale of discontinued operations in 2003 is due to the Company settling a
purchase price adjustment resulting in a $.3 million charge. Certain post-sale provisions continue
to apply that could result in a future settlement between the parties. 2. Summary of Significant Accounting Policies Use of Estimates The nature of our business requires us to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying notes. For example, we
use significant estimates and assumptions in calculating deferred policy acquisition costs, present
value of future profits, goodwill, future policy benefits and deferred federal income taxes. If
future actual experience differs from these estimates and assumptions, our financial statements
could be materially affected. Investments We classify our fixed maturity and equity securities as available for sale and, accordingly,
these 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
immediate effect on net income (loss). 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. Prior to adjusting for fair value changes, the cost of our 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 consolidated balance sheets, are comprised principally of obligations backed by an agency of
the United States government or by the full faith and credit of the U.S. government. The income
from these securities is recognized using a constant effective yield based on anticipated
prepayments and the estimated economic life of the securities. Mortgage loans on real estate and policy loans are carried at unpaid principal balances and
are collateralized. Real estate investments are carried at cost, less accumulated depreciation.
Short-term investments are carried at amortized cost, which approximates fair value. F-9




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 2. Summary of Significant Accounting Policies (continued) Equity-indexed call options are derivative instruments linked to the major stock indices (S&P
500 Index and DJIA Index), which are used to mitigate exposure of our equity-indexed
annuity products. We purchase call options whose payoff characteristics offset the equity benefits
of our products. These securities are carried at fair value and the change in fair value is
included in call option gain (loss). The liabilities for the related equity indexed annuity
contracts are adjusted based on the return in the market indices and are reflected in Insurance
Policy Liabilities in the Consolidated Balance Sheets. Net Realized Investment Gains and Losses Realized gains and losses on sales of investments are determined by specific identification
and are included in net income (loss). We periodically evaluate whether the decline in fair value of our investments is
other-than-temporary. Our evaluation consists of a review of qualitative and quantitative factors.
We also consider additional factors to determine whether the decline in fair value is
other-than-temporary, such as downgrades of the security by a rating agency, deterioration in the
financial condition of the issuer, and other publicly available issuer-specific news or general
market conditions. For investments in companies with no quoted market price, we consider similar
qualitative and quantitative factors and also take into account the cost of the investment, the
type of investment, subsequent purchases of the same or similar investments, the current financial
position and operating results of the company invested in, and such other factors as may be
relevant. A decline in fair value of securities deemed to be other-than-temporary is recognized as
a realized loss. Determining what constitutes an other-than-temporary decline involves significant judgment. A
decline in fair value below cost not considered other-than-temporary in the current period could be
considered other-than-temporary in a future period and reduce earnings to the extent of the
write-down. 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). Insurance policy liabilities for equity-indexed annuity products are computed in accordance
with Statement of Financial Accounting Standards (SFAS) No. 133 (SFAS 133), Accounting for
Derivative and Hedging Activities, and consist of a book value liability for benefits guaranteed
in the contract, combined with a market value liability for equity-linked benefits of the contract. 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 6.2% to 7.5%. Mortality is based upon various actuarial tables,
principally the 1965-1970 or the 1975-1980 Select and Ultimate Table. Withdrawals are based upon
our experience and vary by issue age, type of coverage, and duration. Our immediate annuities generally do not incorporate significant insurance risk and are
therefore classified as investment contracts rather than insurance contracts. Consistent with
similar types of investment contracts, immediate annuity liabilities are computed using the
constant yield method. Recognition of Insurance Policy Revenue and Related Benefits and Expenses Unless otherwise indicated, premiums received for annuities and life insurance products are
not recognized as income. Those premiums are generally invested in one or more investments that,
in turn, result in net investment income revenue. Other revenue sources and expense items are
described below. Expenses relating to immediate annuities include interest credited to policyholder liabilities
and administrative expenses. F-10




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 2. Summary of Significant Accounting Policies (continued) Revenue for deferred and equity-indexed annuity contracts also consists of policy charges for
surrender, a component of policy income. 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 and administrative expenses. Revenue for universal life insurance policies consists of policy charges for the cost of
insurance, policy administration charges and surrender charges. Expenses related to universal life
policies include interest credited to policyholder account balances, administrative expenses and
death benefits incurred in excess of policyholder account balances. Traditional life insurance premiums are recognized as premium revenue 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 and are accounted for on a basis consistent with
those used in accounting for the original policies issued and the terms of the reinsurance
contracts. Income Taxes Income 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 basis. Deferred income tax assets and liabilities are measured
using enacted income tax rates in effect for the year in which those temporary differences are
expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a
change in income tax rates is recognized in income in the period in which the change is enacted. A
valuation reserve is recognized based on the evidence available, if it is more likely than not that
some portion or all of the deferred income tax asset will not be realized. We file a consolidated return, excluding U.S. Health Services, and a separate U.S. Health
Services return for federal income tax purposes. Deferred Policy Acquisition Costs Costs relating to the production of new business (primarily commissions and certain costs of
marketing, policy issuance and underwriting) are deferred and included in the deferred policy
acquisition cost asset to the extent that such costs are recoverable from future related policy
revenues. For interest-sensitive annuities and other financial products, deferred policy
acquisition costs, with interest, are amortized over the lives of the policies and products in a
constant relationship to the present value of estimated future gross profits, discounted using the
interest rate credited to the policy. Traditional life insurance deferred policy acquisition costs
are being amortized over the premium-paying period of the related policies using assumptions
consistent with those used in computing policy benefit reserves. We review the recoverability of the carrying value of the deferred policy acquisition costs
each year. For interest-sensitive annuities and other financial products, we consider estimated
future gross profits in determining whether the carrying value is appropriate; for other insurance
products, we consider estimated future premiums. In all cases, we consider 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. Immediate annuity deferred policy acquisition cost amortization is computed in conjunction
with the liability for future benefits using the constant yield method. F-11




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 2. Summary of Significant Accounting Policies (continued) Present Value of Future Profits Present value of future profits are recorded in connection with acquisitions of insurance
companies or a block of policies. There were no such acquisitions in 2004, 2003 or 2002. 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, we use 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 in force insurance purchased is amortized on a constant yield basis over its estimated
life from the date of acquisition in proportion to the emergence of profits or the expected premium
pattern over a period of approximately 20 years. For acquisitions we made on or before November 1992, we amortize the asset with interest at
the same discount rate used to determine the present value of future profits at the date of
purchase. For acquisitions after November 1992, we amortize the asset using the interest rate
credited to the underlying policies. Property and Equipment Property and equipment is stated at cost, less accumulated depreciation. Depreciation is
provided using the straight-line method in amounts considered sufficient to amortize the cost of
the assets to operations over their estimated service lives or lease terms which range from three
to ten years for equipment and leasehold improvements and 40 years for our headquarters building
which represents our most significant asset in this category. Goodwill and Intangible Assets The Financial Accounting Standards Board (FASB) issued SFAS No. 142, Goodwill and Other
Intangible Assets (SFAS 142) in 2001. SFAS 142 addresses accounting and reporting of acquired
goodwill and other intangible assets. We completed our impairment testing under the requirements of
SFAS 142 during the fourth quarter of 2002 and the results were applied retroactively to January 1,
2002. As a result of our initial transitional impairment test, we recorded an impairment charge of
approximately $1.2 million in our financial services segment retroactive to the first quarter of
2002, which is presented as a cumulative effect of a change in accounting principle in our
consolidated financial statements. Other Assets Other assets include, among other things, inventories and accounts receivables related to our
health services operations. Inventories are stated on a lower of first-in, first-out cost or
market value basis and predominately include purchased finished pharmaceutical products. Accounts
receivable are customer obligations due under normal trade terms and are reduced by managements
estimate of uncollectible balances and expected discounts, including those ultimately granted under
payment programs, such as Medicare and private insurance. These estimates are based on recent
historical experience and specific customer situations. Generally, accounts receivables are not
secured. Revenues in the health services business are recognized when the products are shipped to the
customer pursuant to customer orders. F-12




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 2. Summary of Significant Accounting Policies (continued) Stock Options The provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosures allows companies to either expense the estimated fair
value of stock options or to continue the earlier practice of accounting for stock options and
disclose the pro forma effects on net income and earnings per share had the fair value of the
options been expensed. We have elected to continue our practice of recognizing compensation
expense using the intrinsic value based method of accounting and to provide the required pro forma
information. The compensation cost based on fair value at the grant date, which is consistent with
the provisions of SFAS 123, as amended by SFAS 148, would result in pro forma net loss and pro
forma loss per share of the following for the years ended December 31 (in thousands, except per
share amounts): Year Ended December 312004
    
    
    2003
    
    
    2002Reported net loss
    
    $
    (10,868
    )
    
    $
    (10,471
    )
    
    $
    (1,130
    )Less: Total stock-based employee compensation expense
determined under fair value based
method for all grants
    
    
    165
    
    
    
    332
    
    
    
    141Pro forma net loss
    
    $
    (11,033
    )
    
    $
    (10,803
    )
    
    $
    (1,271
    )Loss per share:Basic and diluted  as reported
    
    $
    (1.36
    )
    
    $
    (1.30
    )
    
    $
    (0.15
    )Basic and diluted  pro forma
    
    
    (1.38
    )
    
    
    (1.34
    )
    
    
    (0.17
    )
 The Black-Scholes option-valuation model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including the expected stock
price volatility. Our employee stock options have characteristics significantly different from
those of traded options, and changes in subjective assumptions can materially affect the fair value
estimate, therefore in managements opinion, the existing models do not provide a reliable single
measure of the fair value of its employee stock options. The fair value of each option grant is estimated on the date of grant using the Black-Scholes
option-valuation model with the following weighted-average assumptions: 2004
    
    
    2003
    
    
    2002Risk-free interest rates
    
    
    3.1
    %
    
    
    3.1
    %
    
    
    3.6
    %Volatility factors
    
    
    0.44
    
    
    
    0.52
    
    
    
    0.62Weighted average expected life
    
    5 years
    
    6 years
    
    7 yearsDividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
 Net Loss Per Common Share Basic net loss per common share is based upon weighted average common shares outstanding.
Diluted net loss per common share is based upon the weighted average number of common shares
outstanding, including the dilutive effect, if any, of stock options, warrants and convertible
securities. However, due to net losses in each of the last three years, the Company has no
dilutive stock options, warrants or convertible securities. Antidilutive shares excluded from the
computation of diluted net loss per share included 4,317,101, 3,348,304, and 3,349,869 in 2004,
2003, and 2002, respectively, related to options, warrants and convertible debt. F-13




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 2. Summary of Significant Accounting Policies (continued) Reclassifications Certain amounts in the 2003 and 2002 consolidated financial statements and notes have been
reclassified to conform to the 2004 presentation. These reclassifications had no effect on
previously reported shareholders equity or net income (loss) in the periods presented. New Accounting Policies In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46), which provides guidance on when to consolidate certain entities considered to
be variable interest entities (VIEs). FIN 46 was revised in 2004. An entity is considered to be
a VIE when it has equity investors who lack the characteristics of having a controlling financial
interest, or its capital is insufficient to permit it to finance its activities without additional
subordinated financial support. Consolidation of a VIE by an investor is required when it is
determined that the investor will absorb a majority of the VIEs expected losses if they occur,
receive a majority of the entitys expected residual returns if they occur, or both. The Company
adopted FIN 46 effective the first quarter of 2004. The adoption had no material impact on the
financial position or results of operations of the Company, but did result in the Company
deconsolidating the Trust (see note 5). Although the Trust is wholly owned by the Company, all of
its earnings and cash flows, represented by principal and interest payments under subordinated
debentures payable to it from Standard Management, are for the benefit of the holders of the
Trusts preferred securities. As such, rather than the Company reflecting debt payable and
interest expense related to the preferred securities, it reflects debt payable and interest expense
related to the subordinated debentures. As both instruments have nearly identical terms, the
difference noted above is not material. In December 2004, the FASB issued Statement of Financial Accounting Standards 123 (revised
2004) Share-Based Payments (SFAS 123R). Among other things, SFAS 123R requires expensing the
fair value of stock options which was previously optional. SFAS 123R is effective as of July 1,
2005. The Company expects the impact of adopting SFAS 123R will be similar to the pro forma
impacts as described in note 2  Stock Options. F-14




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 3. Investments The amortized cost, gross unrealized gains and losses and estimated fair value of securities
available for sale are as follows (in thousands): December 31, 2004Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueSecurities available for sale:Fixed maturity securities:United States Treasury securities and
obligations of United States
government agencies
    
    $
    35,254
    
    
    $
    470
    
    
    $
    71
    
    
    $
    35,653Utilities
    
    
    48,043
    
    
    
    1,297
    
    
    
    267
    
    
    
    49,073Corporate bonds
    
    
    697,950
    
    
    
    23,339
    
    
    
    2,952
    
    
    
    718,337Mortgage-backed securities
    
    
    863,214
    
    
    
    2,076
    
    
    
    11,148
    
    
    
    854,142Redeemable preferred stock
    
    
    4,043
    
    
    
    29
    
    
    
    
    
    
    
    4,072Total fixed maturity securities
    
    $
    1,648,504
    
    
    $
    27,211
    
    
    $
    14,438
    
    
    $
    1,661,277
 December 31, 2003Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueSecurities available for sale:Fixed maturity securities:United States Treasury securities and
obligations of United States
government agencies
    
    $
    35,087
    
    
    $
    358
    
    
    $
    279
    
    
    $
    35,166Foreign government securities
    
    
    1,316
    
    
    
    
    
    
    
    
    
    
    
    1,316Utilities
    
    
    58,438
    
    
    
    1,180
    
    
    
    610
    
    
    
    59,008Corporate bonds
    
    
    716,299
    
    
    
    18,903
    
    
    
    11,546
    
    
    
    723,656Mortgage-backed securities
    
    
    823,908
    
    
    
    9,230
    
    
    
    10,604
    
    
    
    822,534Redeemable preferred stock
    
    
    3,000
    
    
    
    157
    
    
    
    
    
    
    
    3,157Total fixed maturity securities
    
    $
    1,638,048
    
    
    $
    29,828
    
    
    $
    23,039
    
    
    $
    1,644,837
 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 rating, and maturity of the
investments. As of December 31, 2004, the fair value of securities in an unrealized loss position greater
than one year is $194.6 million with an unrealized loss of $9.1 million. The fair value of
securities in an unrealized loss position less than one year is $535.8 million with an unrealized
loss of $5.3 million. As of December 31, 2003, the fair value of securities in an unrealized loss
position greater than one year is $30.0 million with an unrealized loss of $3.0 million. The fair
value of securities in an unrealized loss position less than one year is $708.0 million with an
unrealized loss of $20.0 million. We concluded that none of the above unrealized losses are other
than temporary. We believe the above fixed maturity unrealized losses are not other than temporary
because the Company has the ability and intent to hold the investments for a period of time
sufficient for a forecasted market price recovery up to or beyond the cost of the investment.
Also, in our opinion, evidence indicating the cost of the investment is recoverable within a
reasonable period of time outweighs evidence to the contrary in considering the severity and
duration of the impairment in relation to the forecasted market price recovery. F-15




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 3. Investments (continued) The amortized cost and estimated fair value of fixed maturity securities at December 31, 2004,
by contractual maturity are shown below (in thousands): Amortized
    
    
    FairCost
    
    
    ValueDue in one year
    
    $
    11,275
    
    
    $
    11,451Due after one year through five years
    
    
    140,560
    
    
    
    143,422Due after five years through ten years
    
    
    502,600
    
    
    
    518,706Due after ten years
    
    
    126,812
    
    
    
    129,484Subtotal
    
    
    781,247
    
    
    
    803,063Redeemable preferred stock
    
    
    4,043
    
    
    
    4,072Mortgage-backed securities
    
    
    863,214
    
    
    
    854,142Total fixed maturity securities
    
    $
    1,648,504
    
    
    $
    1,661,277
 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. Net investment income was attributable to the following for the years ended December 31 (in
thousands): 2004
    
    
    2003
    
    
    2002Fixed maturity securities
    
    $
    82,716
    
    
    $
    82,201
    
    
    $
    74,994Mortgage loans on real estate
    
    
    375
    
    
    
    589
    
    
    
    743Policy loans
    
    
    770
    
    
    
    817
    
    
    
    814Real estate
    
    
    32
    
    
    
    30
    
    
    
    27Short-term investments and other
    
    
    909
    
    
    
    816
    
    
    
    398Gross investment income
    
    
    84,802
    
    
    
    84,453
    
    
    
    76,976Less: investment expenses
    
    
    1,409
    
    
    
    1,444
    
    
    
    1,137Net investment income
    
    $
    83,393
    
    
    $
    83,009
    
    
    $
    75,839
 Net realized investment gains (losses) were attributable to the following for the years ended
December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Fixed maturity securities available for sale:Gross realized gains
    
    $
    6,205
    
    
    $
    30,494
    
    
    $
    20,467Gross realized losses
    
    
    (5,234
    )
    
    
    (8,232
    )
    
    
    (19,276
    )Other-than-temporary decline in fair value
    
    
    (1,254
    )
    
    
    (4,386
    )
    
    
    (20,027
    )Net
    
    
    (283
    )
    
    
    17,876
    
    
    
    (18,836
    )Other losses
    
    
    
    
    
    
    
    
    
    
    (1,005
    )Net realized investment gain (loss)
    
    $
    (283
    )
    
    $
    17,876
    
    
    $
    (19,841
    )
 F-16




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 3. Investments (continued) Life insurance companies are required to maintain certain amounts of assets with state or
other regulatory authorities. At December 31, 2004, fixed maturity securities of $10.6 million and
cash and short-term investments of $.5 million were held on deposit by various state regulatory
authorities in compliance with statutory regulations. Comprehensive income excludes reclassification adjustments for net realized investment gains
(losses) after income taxes (benefits) of ($.2) million, $11.8 million, and ($13.1) million in
2004, 2003, and 2002, respectively. The income tax rate used for comprehensive income is 34%. 4. Deferred Policy Acquisition Costs and Present Value of Future Profits The activity related to deferred policy acquisition (DAC) costs is summarized as follows for
the years ended December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Balance, beginning of year
    
    $
    166,411
    
    
    $
    153,954
    
    
    $
    109,844Additions
    
    
    21,298
    
    
    
    39,304
    
    
    
    62,618Amortization
    
    
    (26,303
    )
    
    
    (32,476
    )
    
    
    (9,097
    )Adjustment relating to net unrealized (gain) loss on
securities available for sale
    
    
    (1,483
    )
    
    
    5,629
    
    
    
    (9,411
    )Balance, end of year
    
    $
    159,923
    
    
    $
    166,411
    
    
    $
    153,954
 The activity related to present value of future profits is summarized as follows for the years
ended December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Balance, beginning of year
    
    $
    16,508
    
    
    $
    14,949
    
    
    $
    22,269Interest accreted on unamortized balance
    
    
    2,467
    
    
    
    2,686
    
    
    
    2,902Amortization
    
    
    (3,954
    )
    
    
    (4,126
    )
    
    
    (4,700
    )Adjustments relating to net unrealized (gain) loss on
securities available for sale
    
    
    (771
    )
    
    
    2,999
    
    
    
    (5,522
    )Balance, end of year
    
    $
    14,250
    
    
    $
    16,508
    
    
    $
    14,949
 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, are expected to be
between 9% and 14% in each of the years 2004 through 2005. Future net amortization is based on the
present value of future profits at December 31, 2004, and current assumptions as to future events
on all policies in force. The discount rate used to calculate the present value of future profits
reflected in our consolidated balance sheets at December 31, 2004, ranged from 8% to 18%. Included in the amortization line above are changes of $7.9 million and $7.8 million for 2003
and 2002, respectively, related to the acceleration of DAC amortization due to DAC unlocking. No
such change was required in 2004. F-17




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 5. Mortgages Payable, Notes Payable and Subordinated Debentures Mortgages payable, Notes payable and Subordinated debentures were as follows at December 31
(in thousands): InterestRate(1)
    
    
    2004
    
    
    2003Mortgages payable
    
    
    7.32
    %
    
    $
    6,607
    
    
    $
    6,795Notes payable:Promissory notes
    
    
    2.64
    %
    
    $
    1,883
    
    
    $
    1,000Senior secured credit agreement
    
    
    5.86
    %
    
    
    18,500
    
    
    
    20,000Convertible notes
    
    
    6.55
    %
    
    
    6,050
    
    
    
    $
    26,433
    
    
    $
    21,000Subordinated debentures
    
    
    10.25
    %
    
    $
    20,700
    
    
    $
    20,700
   (1)
    
    Current weighted average rate at December 31, 2004 Mortgages payable On December 28, 2001, we signed a promissory note due January 2012, in the principal amount of
$6.9 million in order to finance the purchase of our corporate headquarters. The note bears
interest at 7.375% per annum and is payable in equal monthly installments of $56,000, with a final
payment of $4.678 million. The note may be prepaid in whole or in part at our option commencing on
or before January 1, 2005, at a redemption price equal to 105% of the principal amount (plus
accrued interest) and declining to 101% of the principal amount (plus accrued interest) if
prepayment is made after January 1, 2008. The note and all amounts due are secured by a mortgage
that conveys a first mortgage security interest in certain real and personal property we own. On May 1, 2003, we signed a promissory note due June 2008, in the principal amount of $.2
million. The note bears interest at 5.75% per annum and is payable in equal monthly installments
of $1,256, with a final payment of $198,345. The note may be repaid in whole or in part at our
option. The note and all amounts due are secured by a mortgage that conveys a first mortgage
security interest in certain real and personal property we own. Promissory notes As of December 31, 2004, we have four unsecured promissory notes totaling $1.9 million related
to the acquisitions of various health services companies. Annual principal payments are due in
2005 through 2008 in the amounts of $1 million, $453,000, $291,000 and $100,000, respectively. Senior secured credit agreement In November 2003, we entered into a senior secured credit agreement which provides for a $10.0
million revolving credit line and a $8.5 million term loan as of December 31, 2004. Initial
borrowings under the senior secured credit agreement were primarily used for debt refinancing and
for contributions to surplus of our insurance subsidiaries. The debt is secured by all of the
issued and outstanding shares of common stock of Standard Life. Interest on borrowings under the
revolving credit line is determined, at our option, to be: 1) a fluctuating rate of interest equal
to the corporate base rate announced by the bank periodically, plus 1.15% per annum, or 2) a rate
equal to 90 Day London Inter-Bank Offered Rate (LIBOR) plus 3.95%. Interest on borrowings under
the term loan is fixed at 6.63%. Maximum borrowings under the revolving credit line would be
reduced by $2.5 million every quarter starting in February 2008 and has a scheduled final maturity
in November 2008. The term loan is payable in quarterly installments ranging from $500,000 to
$550,000 that started in May 2004 and are scheduled to end in November 2008. However, all
outstanding balances under the entire senior secured credit agreement are expected to be repaid
upon the sale of Standard Life (see note 19.) F-18




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 5. Mortgages Payable,
Notes Payable and Trust Subordinated Debentures (continued) Indebtedness incurred under the senior secured credit agreement is subject to certain
restrictions and covenants including, among other things, certain minimum financial ratios, minimum
risk based capital ratios and minimum statutory surplus requirements for our insurance
subsidiaries, and certain limitations on acquisitions, additional indebtedness, investments,
mergers, consolidations and sales of assets. As of December 31, 2004, and at other dates
throughout 2004, the Company was in violation of one financial covenant (debt leverage) under our
senior secured credit agreement. Additionally, at December 31, 2004, we are in violation of a
covenant limiting Standard Managements indebtedness to Standard Life. We have obtained from the
lender a waiver of these covenants through the earlier of the consummation of the sale of Standard
Life (see note 19) or September 30, 2005. Convertible Notes On February 10, 2004, we issued $3.3 million of our 7% unsecured convertible notes due 2009.
The notes are convertible at a price equal to $4.20 per share at any time at the holders option
subject to certain conditions. Because our common shares were trading at lower than $4.20 per
share upon issuance of the notes, no value was assigned to the conversion feature. On November 30, 2004, we issued $2.75 million of our 6% mandatory unsecured convertible notes
due 2008. The notes are convertible into shares of our common stock at a price equal to $4.20 per
share at any time at the holders option subject to certain conditions. Because our common shares
were trading at lower than $4.20 per share upon issuance of the notes, no value was assigned to the
conversion feature. Subordinated debentures On August 9, 2001, SMAN Capital Trust I (the Trust), a wholly owned subsidiary of Standard
Management, completed a public offering of $20.7 million of its 10.25% preferred securities, which
mature on August 9, 2031, at $10 per preferred security. The proceeds from the offering were immediately loaned to Standard Management by the Trust in
the form of an equal amount of subordinated debentures. The debentures have similar terms as the
preferred securities, including a 10.25% interest rate. Although the Trust is wholly-owned by
Standard Management, Standard Management does not consolidate the Trust because all of the income
and cash flows of the Trust benefit the preferred security holders rather than Standard Management.
As such, the subordinated debentures and related interest expense are reflected in our
consolidated results. The preferred securities may be redeemed at any time on or after August 9, 2006, at a
redemption price of $10 plus accumulated and unpaid distributions. If the Trust redeems the
preferred securities or is liquidated and the debentures are not redeemed, debentures will be
distributed to the holders of the preferred securities rather than cash. Standard Management
guarantees the payments on these securities to the extent that the Trust has available funds. The Trusts preferred securities are traded on the NASDAQ National Market under the symbol
SMANP. Interest Paid Cash paid for interest was $4.0 million, $4.4 million, and $4.0 million in 2004, 2003, and
2002, respectively. F-19




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 6. Income Taxes The components of the federal income tax expense (benefit), applicable to pre-tax income
(loss) from continuing operations, were as follows for the years ended December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Current income taxes
    
    $
    3,269
    
    
    $
    (3,161
    )
    
    $
    3,550Deferred income taxes
    
    
    (2,874
    )
    
    
    2,534
    
    
    
    (13,017
    )Federal income tax expense (benefit)
    
    $
    395
    
    
    $
    (627
    )
    
    $
    (9,467
    )
 The effective income tax rate on pre-tax income (loss) from continuing operations differs from
the statutory corporate federal income tax rate as follows for the years ended December 31 (in
thousands): 2004
    
    
    2003
    
    
    2002Federal income tax expense (benefit) at statutory rate (34%)
    
    $
    (3,548
    )
    
    $
    (3,773
    )
    
    $
    (5,890
    )Recognition of previously reserved NOL carryforwards
    
    
    (1,071
    )
    
    
    
    
    
    
    (2,654
    )Increase in valuation allowance
    
    
    4,358
    
    
    
    3,030
    
    
    
    Other items, net
    
    
    656
    
    
    
    116
    
    
    
    (923
    )Federal income tax expense (benefit)
    
    $
    395
    
    
    $
    (627
    )
    
    $
    (9,467
    )Effective tax rate
    
    
    4
    %
    
    
    6
    %
    
    
    55
    %
 We recovered $1 million and $.1 million in federal income taxes in 2004 and 2002,
respectively. We paid federal income taxes of $1.7 million, $5.9 million, and $1.2 million in
2004, 2003 and 2002, respectively. Deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for tax return purposes. Significant temporary differences included in our deferred income tax
assets (liabilities) are as follows at December 31 (in thousands): 2004
    
    
    2003Deferred income tax assets:Future policy benefits
    
    $
    60,459
    
    
    $
    59,310Capital and net operating loss carryforwards
    
    
    8,459
    
    
    
    3,211Other, net
    
    
    593
    
    
    
    727Gross deferred income tax assets
    
    
    69,511
    
    
    

    63,248Valuation allowance for deferred income tax assets
    
    
    7,388
    
    
    
    3,030Deferred income tax assets, net of valuation allowance
    
    
    62,123
    
    
    
    60,218Deferred income tax liabilities:Present value of future profits
    
    
    (5,486
    )
    
    
    (5,991
    )Deferred policy acquisition costs
    
    
    (48,810
    )
    
    
    (49,378
    )Securities available for sale
    
    
    (3,281
    )
    
    
    (6,549
    )Other
    
    
    (1,746
    )
    
    
    (404
    )Unrealized gain on securities available for sale
    
    
    (2,649
    )
    
    
    (1,512
    )Total deferred income tax liabilities
    
    
    (61,972
    )
    
    
    (63,834
    )Net deferred income tax asset
    
    $
    151
    
    
    $
    (3,616
    )
 As of December 31, 2004, Standard Management and its subsidiaries had consolidated net capital
loss carryforwards of approximately $3.2 million of which $.2 million expires in 2008 and the
remainder expires in 2009. As of December 31, 2004, Standard Management and its subsidiaries had consolidated net
operating loss carryforwards of approximately $19.2 million for tax return purposes, which expire
from 2009 to 2024. Of this amount, $16.5 million will only be able to reduce taxable income of
U.S. Health Services. F-20




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 6. Income Taxes (continued) A $7.4 million valuation allowance has been provided primarily related to certain operating
loss carryforwards in the Health Services and Other Services segments at December 31, 2004. 7. Shareholders Equity Warrants The Company issued warrants to purchase common stock to 1) our independent agents as an
inducement for annuity sales and 2) as a component of the purchase price of health services
acquisitions. During 2004, we had 157,500 warrants expire unexercised. The following table
represents outstanding warrants to purchase common stock as of December 31: Exercise
    
    
    Warrants OutstandingIssue Date
    
    Expiration Date
    
    Price
    
    
    2004
    
    
    2003January 2001
    
    January 2004
    
    $
    3.00
    
    
    
    
    
    
    
    157,750January 2002
    
    January 2005
    
    
    6.02
    
    
    
    287,000
    
    
    
    287,000June 2002
    
    June 2005
    
    
    7.61
    
    
    
    89,500
    
    
    
    89,500October 2002
    
    October 2007
    
    
    4.92
    
    
    
    10,000
    
    
    
    10,000386,500
    
    
    
    544,250
 Changes in Shares of Common Stock and Treasury Stock The following table represents changes in the number of common and treasury shares as of
December 31: 2004
    
    
    2003
    
    
    2002Common Stock:Balance, beginning of year
    
    
    9,629,167
    
    
    
    9,369,752
    
    
    
    9,039,471Net issuance (repurchase) of common stock
    
    
    (182,976
    )
    
    
    259,415
    
    
    
    330,281Balance, end of year
    
    
    9,446,191
    
    
    
    9,629,167
    
    
    
    9,369,752Treasury Stock:Balance, beginning of year
    
    
    (1,515,078
    )
    
    
    (1,515,078
    )
    
    
    (1,492,978
    )Treasury stock acquired
    

    
    (10,000
    )
    
    
    
    
    
    
    (22,100
    )Balance, end of year
    
    
    (1,525,078
    )
    
    
    (1,515,078
    )
    
    
    (1,515,078
    )
 The increase in common stock outstanding in 2002 and 2003 was attributable primarily to common
stock issued in the purchase of various health services businesses. Additionally, the decrease in
common stock outstanding in 2004 was attributable primarily due to the return of common stock
related to the April 2004 sale of 95% of Medical Care & Outcomes, LLC (MCO) back to its original
owners. MCO was originally purchased in 2003 with our common stock. The divestiture of MCO
resulted in the return of our common stock and therefore in a decrease to common stock outstanding. At December 31, 2004 we were authorized to purchase an additional 692,690 shares under our
treasury stock repurchase program. F-21




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##### Table of Contents



STANDARD MANAGEMENT
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 7. Shareholders Equity (continued) Unrealized Gain on Securities The components of unrealized gain on securities available for sale in shareholders equity are
summarized as follows at December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Fair value of securities available for sale
    
    $
    1,661,277
    
    
    $
    1,644,837
    
    
    $
    1,379,792Amortized cost of securities available for sale
    
    
    1,648,504
    
    
    
    1,638,048
    
    
    
    1,350,961Unrealized gain on securities available for sale
    
    
    12,773
    
    
    
    6,789
    
    
    
    28,831Adjustments for:Deferred policy acquisition costs
    
    
    (2,797
    )
    
    
    (1,114
    )
    
    
    (6,942
    )Present value of future profits
    
    
    (1,885
    )
    
    
    (1,313
    )
    
    
    (4,113
    )Deferred federal income taxes (benefits)
    
    
    (2,649
    )
    
    
    (1,512
    )
    
    
    (6,075
    )Other
    
    
    (547
    )
    
    
    (148
    )
    
    
    38Net unrealized gain on securities available for sale
    
    $
    4,895
    
    
    $
    2,702
    
    
    $
    11,739
 F-22




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 8. Stock Option Plan Effective June 12, 2002, we adopted our 2002 Stock Incentive Plan (the Plan) which authorizes the
granting of options to employees, directors and consultants of the Company to purchase up to
990,000 shares of our common stock at a price not less than its market value on the date the option
is granted. The number of shares of stock available for issuance pursuant to the Plan is
automatically increased on the first trading day of each calendar year beginning January 1, 2003,
by an amount equal to 3% of the shares of stock outstanding on the trading day immediately
preceding January 1. As of January 1, 2005, there were 1,023,202 shares of our common stock
available for grant under Plan. Options may not be granted under the Plan on a date that is more
than ten years from the date of its adoption. The options may become exercisable immediately or
over a period of time. Any shares subject to an option that for any reason expires or is terminated
unexercised may again be subject to an option under the Plan. The Plan also permits granting of
stock appreciation rights and restricted stock awards. In addition to the 2002 Stock Incentive
Plan, the 1992 Stock Option Plan has 1,806,625 shares outstanding. No additional shares remain
available for future issuance under the 1992 Stock Option Plan. A summary of our stock option activity and related information for the years ended December 31
is as follows: 2004
    
    
    2003
    
    
    2002Weighted-
    
    
    
    
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOptions outstanding, beginning of year
    
    
    2,804,054
    
    
    $
    5.58
    
    
    
    2,409,869
    
    
    $
    6.00
    
    
    
    2,461,933
    
    
    $
    6.03Exercised
    
    
    (8,000
    )
    
    
    3.25
    
    
    
    (6,225
    )
    
    
    3.36
    
    
    
    (106,385
    )
    

    
    5.81Granted
    
    
    203,000
    
    
    
    3.72
    
    
    
    580,000
    
    
    
    3.97
    
    
    
    65,000
    
    
    
    4.25Expired or forfeited
    
    
    (508,929
    )
    
    
    6.39
    
    
    
    (179,590
    )
    
    
    5.56
    
    
    
    (10,679
    )
    
    
    4.11Options outstanding, end of year
    
    
    2,490,125
    
    
    $
    5.28
    
    
    
    2,804,054
    
    
    $
    5.58
    
    
    
    2,409,869
    
    
    $
    6.00Options exercisable, end of year
    
    
    2,182,125
    
    
    $
    5.54
    
    
    
    2,450,722
    
    
    $
    5.80
    
    
    
    2,351,436
    
    
    $
    6.05Weighted-average fair value of options
granted during the year
    
    $
    1.58
    
    
    
    
    
    
    $
    1.39
    
    
    
    
    
    
    $
    2.71
 Information with respect to stock options outstanding at December 31, 2004, is as follows: Options Outstanding
    
    
    Options ExercisableWeighted-Average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Range of
    
    
    
    
    
    Remaining
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    Number
    
    
    Contractural
    
    
    Exercise
    
    
    Number
    
    
    PricePrices
    
    Outstanding
    
    
    Life (years)
    
    
    Price
    
    
    Exercisable
    
    
    Exercise$3.00-4.99
    
    
    954,175
    
    
    
    6.75
    
    
    $
    3.65
    
    
    
    646,175
    
    
    $
    3.755.00-6.49
    
    
    763,475
    
    
    
    3.08
    
    
    
    5.77
    
    
    
    763,475
    
    
    
    5.776.50-7.61
    
    
    772,475
    
    
    
    2.32
    
    
    
    6.80
    
    
    
    772,475
    
    
    
    6.802,490,125
    
    
    
    
    
    
    
    
    
    
    
    2,182,125
 F-23




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 9. Reinsurance Standard Life and Dixie Life 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, and provide additional capacity for future growth. The maximum amount of life
insurance face amount retained on any one life ranges from $30,000 to $150,000. Amounts of
standard risk in excess of that limit are reinsured. Reinsurance premiums ceded to other insurers were $2.5 million, $4.0 million, and $3.0 million
in 2004, 2003 and 2002, respectively. Reinsurance ceded has reduced benefits and claims incurred
by $3.7 million, $3.5 million, and $5.2 million in 2004, 2003 and 2002, respectively. A contingent
liability exists to the extent any of the reinsuring companies are unable to meet their obligations
under the reinsurance agreements. To minimize exposure to significant losses from reinsurance
insolvencies, we evaluate the financial condition of our reinsurers and monitor concentrations of
credit risk arising from similar geographic regions, activities or economic characteristics of the
reinsurers. Based on our periodic reviews of these companies, we believe the assuming companies
are able to honor all contractual commitments under the reinsurance agreements. At December 31, 2004, SCOR Life U.S. Insurance Company, our largest annuity reinsurer, which
is rated B++ (Very Good) by A.M. Best, represented $16.6 million, or 47% of our total reinsurance
recoverable. 10. Goodwill and Intangible Assets The activity related to goodwill is summarized as follows for December 31 (in thousands): 2004
    
    
    2003Balance, beginning of year
    
    $
    9,961
    
    
    $
    6,417Goodwill acquired
    
    
    2,263
    
    
    
    3,544Goodwill disposed of in MCO sale
    
    
    (3,603
    )
    
    
    Goodwill impairment
    
    
    (963
    )
    
    
    Balance, end of year
    
    $
    7,658
    
    
    $
    9,961
 Our operating segments had the following goodwill balances at December 31 (in thousands): 2004
    
    
    2003Financial
Services
    
    $
    3,674
    
    
    $
    3,674Health
Services
    
    
    3,725
    
    
    
    6,028Other Services
    
    
    259
    
    
    
    259$
    7,658
    
    
    $
    9,961
 The intangible asset balance was $1.2 million and $1.0 million at December 31, 2004 and 2003,
respectively. The intangible asset balance primarily relates to customer lists obtained by U.S.
Health Services in various business acquisitions during 2004 and 2003. Intangible amortization
expense was $.2 million and $.1 million in 2004 and 2003, respectively. Future amortization for
these assets is expected to be approximately $.2 million annually. We completed our impairment testing under the requirements of SFAS 142 during the fourth
quarter of 2004. The goodwill impairment test compares the fair value of a reporting unit with its
carrying value. We relied on the merger and acquisition method and the discounted future benefits
method to calculate fair value using an outside appraisal. Finally we compared the implied
goodwill from the calculated fair value of the reporting unit with the carrying amount of goodwill
for the reporting unit. As a result of our impairment test, we recorded an impairment charge of
approximately $1 million for our Health Services segment. F-24




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 11. Related Party Transactions In 1997, we made an interest-free loan to one of our officers. The principal balance of the
loan was $775,500 at December 31, 2004 and 2003, respectively. Repayment is due within 10 days of
voluntary termination or resignation as an officer. In the event of a termination of the officers
employment following a change in control, the loan is deemed to be forgiven. 12. Commitments and Contingencies Lease Commitments We rent office and storage space under noncancellable operating leases and we incurred rent
expense for operating leases of $.6 million, $.7 million, and $.5 million in 2004, 2003 and 2002,
respectively. Future required minimum rental payments, by year and in the aggregate, under operating leases as of
December 31, 2004, are as follows (in thousands): 2005
    
    $
    3762006
    
    
    3612007
    
    
    1972008
    
    
    202009
    
    
    Total minimum lease payments
    
    $
    954
 Employment Agreements Certain officers are employed pursuant to executive employment agreements that create certain
liabilities in the event of the termination of the covered executives following a change in control
of Standard Management. The commitment under these agreements is approximately three to five times
their current annual salaries plus bonuses and would aggregate to $6.1 million as of December 31,
2004. Additionally, following termination due to 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 1,620,855 shares at December 31,
2004 with a payment value of $6.5 million. 13. Litigation We are 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 Standard Management.
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 Standard Management
based on our current understanding of the relevant facts and law and our recorded reserves for such
matters 14. Statutory Accounting Information of Subsidiaries Our 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 to GAAP. Standard Life had consolidated statutory capital and surplus of $69.9 million and $62.8
million at December 31, 2004 and 2003, respectively. Income, excluding realized capital gains and
losses of Standard Life, on a statutory basis is $1.1 million, $10.4 million, and $4.1 million for
the years ended December 31, 2004, 2003 and 2002, respectively. Net income (loss) of Standard Life
on a statutory basis is $2.8 million, $11.3 million, and ($8.4) million for the years ended
December 31, 2004, 2003 and 2002, respectively. F-25




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 14. Statutory Accounting Information of Subsidiaries (continued) State insurance regulatory authorities impose minimum risk-based capital requirements on
insurance enterprises that were developed by the National Association of Insurance Commissioners
(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. At
December 31, 2004, the RBC Ratios of Standard Life and Dixie Life were both at least three times
greater than the levels at which company action is required. We loaned $27.0 million to Standard Life pursuant to an Unsecured Surplus Debenture Agreement
(Surplus Debenture) which requires Standard Life to make quarterly interest payments at a
variable corporate base rate plus 2% per annum, and annual principal payments of $1.0 million per
year beginning in 2007 and concluding in 2033. As required by state regulatory authorities, the
balance of the surplus debenture at December 31, 2004 and 2003 of $27.0 million 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 the levels of Standard Lifes capital and surplus and general approval
of the Commissioner of the Indiana Department of Insurance. For the quarters ended September 30,
2004 and December 31, 2004, the Commissioner had not yet approved our request of $.8 million in
aggregate interest payments. These debentures will be assumed by the buyer of Standard Life (see
note 19). Our 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 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 the
preceding year statutory surplus and net income. Standard Life did not pay any dividends in 2004
and 2003. During 2005, Standard Life can pay dividends of $1.1 million, without regulatory approval
and an additional $5.6 million with regulatory approval. 15. Operations by Business Segment Our reportable segments are as follows: Health Services Our Health Services segment, which was formed in 2002, and is conducted through U.S. Health
Services, develops and distributes retail and third party reimbursed pharmaceutical products and
services through direct-to-consumer as well as institutional channels. Our primary customer base
consists of consumers, academic institutions, skilled nursing facilities, assisted living
facilities, home health care agencies and mental health facilities. In addition, U.S. Health
Services acts as a wholesale distributor/repackager and a pharmacy management solution to various
sectors of the veterinary care industry. The profitability of this segment is primarily a function
of gross margin on sales (the difference between sales and cost of sales) and management of our
operating expenses. Financial Services Our Financial Services segment consists of revenues earned and expenses incurred from our
insurance operations, particularly Standard Life and Dixie Life. Our primary insurance products
include deferred annuities, single premium immediate annuities and equity-indexed annuities. The
profitability of this segment is primarily a function of net investment spread (the difference
between the investment income earned on our investments less the interest we credit to our
policyholders), persistency of our in force business, mortality experience and management of our
operating expenses (see note 19). F-26




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 15. Operations by Business Segment (continued) Other Services Our Other Services segment consists of revenues and expenses primarily related to corporate
operations and financing costs. The accounting policies of the segments are the same as described in Note 2 (Summary of
Significant Accounting Policies). The following segment presentation contains the same operating
data and results the Company uses to evaluate the performance of the reporting units for the year
ended December 31 (in thousands): 2004
    
    
    2003
    
    
    2002Revenues:Financial Services
    
    $
    111,912
    
    
    $
    132,993
    
    
    $
    65,151Health Services
    
    
    7,120
    
    
    
    2,948
    
    
    
    1,850Other Services
    
    
    7,404
    
    
    
    7,825
    
    
    
    8,112Intercompany eliminations
    
    
    (8,428
    )
    
    
    (7,193
    )
    
    
    (6,889
    )Consolidated revenues
    
    $
    118,008
    
    
    $
    136,573
    
    
    $
    68,224Income (loss) from continuing operations before
income tax:Financial Services
    
    $
    3,310
    
    
    $
    (999
    )
    
    
    (11,852
    )Health Services
    
    
    (10,305
    )
    
    
    (6,565
    )
    
    
    (1,752
    )Other Services
    
    
    (3,478
    )
    
    
    (3,260
    )
    
    
    (3,721
    )Intercompany eliminations
    
    
    
    
    
    
    1
    
    
    
    Consolidated loss from continuing operations before income
tax
    
    $
    (10,473
    )
    
    $
    (10,823
    )
    
    
    (17,325
    )Assets:Financial Services
    
    $
    1,947,100
    
    
    $
    1,960,793
    
    
    $
    1,698,666Health Services
    
    
    9,223
    
    
    
    9,942
    
    
    
    4,307Other Services
    
    
    143,296
    
    
    
    163,881
    
    
    
    161,979Intercompany eliminations
    
    
    (151,723
    )
    
    
    (159,845
    )
    
    
    (149,805
    )Consolidated assets
    
    $
    1,947,896
    
    
    $
    1,974,771
    
    
    $
    1,715,147
 Revenues by product have not been disclosed because it is impracticable for us to provide this
information. Although premiums and deposits collected by product are available on a statutory
basis, it is impracticable to disclose revenues by product on a GAAP basis because we do not
allocate certain components of revenues such as net investment income, net realized investment
gains (losses) and fee and other income to our products. F-27




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 16. Derivative Financial Instruments We offer equity-indexed annuity products that provide a base rate of return with a higher
potential return linked to the performance of a broad-based equity index. We buy S&P 500 Index
options and DJIA Index options (collectively known as the options) in an effort to mitigate
potential increases to policyholder benefits resulting from increases in the S&P 500 Index and DJIA
Index to which the products returns are linked. The cost of the options is included in the pricing
of the equity-indexed annuity products. The changes in the value of the options are reflected as
call option gain (loss) and fluctuate in relation to changes in interest credited to policyholder
account balances for these annuities. Total revenues include $2.4 million, $12.0 million, and ($10.1) million in 2004, 2003 and
2002, respectively, related to changes in the fair value of the options. These investment gains
(losses) were substantially offset by amounts credited to policyholder account balances. The fair
value of the options was $8.8 million and $19.7 million at December 31, 2004 and 2003,
respectively. The notional amounts were $262.9 million and $247.7 million at December 31, 2004 and
2003, respectively. The options settle throughout the year. If the counterparties of the aforementioned financial instruments do not meet their
obligations, we may have to recognize a loss. We limit our exposure to such losses by diversifying
among several counterparties believed to be strong and creditworthy. At December 31, 2004, all of
the counterparties were rated A or higher by Standard & Poors. 17. Fair Value of Financial Instruments The following outlines the methods and assumptions we use in estimating our fair value
disclosures for our financial instrument assets and liabilities. Because fair values for all
balance sheet items are not required to be disclosed pursuant to SFAS No. 107, Disclosures about
Fair Values of Financial Instruments, the aggregate fair value amounts presented herein do not
necessarily represent our underlying value, likewise, care should be exercised in deriving
conclusions about our business or financial condition based on this fair value information. 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 rating and maturity of the investments. Derivative securities:The fair values for derivative securities are based on internal methods
developed by our investment advisor. Mortgage loans and policy loans:The 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. Insurance liabilities for investment contracts:Fair values for our investment-type insurance
contract liabilities 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, 2004 and 2003. This is due to 1)
credited rates on the vast majority of account balances approximating current rates paid on similar
investments and 2) rates not generally being guaranteed beyond one year. Insurance liabilities for non-investment contracts:Fair value disclosures for our reserves
for insurance contracts other than investment-type contracts are not required and have not been
determined. However, we closely monitor the level of our insurance liabilities and that the fair
value of reserves under all insurance contracts is taken into consideration in the overall
management of interest rate risk. Mortgages payable, notes payable and subordinated debt:The estimated fair values for
mortgages payable, notes payable and subordinated debt are estimated using discounted cash flow
analyses and interest rates currently being offered for similar loans to borrowers with similar
credit ratings at December 31, 2004. The carrying amounts of all other financial instruments approximate their fair values. F-28




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 17. Fair Value of Financial Instruments (continued) The fair value of our financial instruments is shown below using a summarized version of
assets and liabilities at December 31 (in thousands). Refer to Note 3 for additional information
relating to the fair value of investments. 2004
    
    
    2003Fair
    
    
    Carrying
    
    
    Fair
    
    
    CarryingValue
    
    
    Amount
    
    
    Value
    
    
    AmountAssets:Investments:Securities available for sale:Fixed maturity securities
    
    $
    1,661,277
    
    
    $
    1,661,277
    
    
    $
    1,644,837
    
    
    $
    1,644,837Equity interest call options
    
    
    8,831
    
    
    
    8,831
    
    
    
    19,711
    
    
    
    19,711Mortgage loans on real estate
    
    
    1,617
    
    
    
    819
    
    
    
    4,735
    
    
    
    3,937Policy loans
    
    
    12,143
    
    
    
    10,783
    
    
    
    13,668
    
    
    
    12,308Cash and cash equivalents
    
    
    9,557
    
    
    
    9,557
    
    
    
    17,296
    
    
    
    17,296Liabilities:Insurance liabilities for investment contracts
    
    $
    1,659,739
    
    
    $
    1,659,739
    
    
    $
    1,685,289
    
    
    $
    1,685,289Mortgage payable
    
    
    6,778
    
    
    
    6,607
    
    
    
    6,994
    
    
    
    6,795Notes payable
    
    
    25,981
    
    
    
    26,433
    
    
    
    19,403
    
    
    
    21,000Subordinated debt
    
    
    18,630
    
    
    
    20,700
    
    
    
    19,520
    
    
    
    20,700
 F-29




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 18. Quarterly Financial Data (unaudited) (in thousands, except per share amounts) Earnings per common and common equivalent share for each quarter are computed independently of
earnings (loss) 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 (loss)
during the year, the sum of the quarterly earnings (loss) per share may not equal the earnings
(loss) per share for the year. 2004 QuartersFirst
    
    
    Second
    
    
    Third
    
    
    FourthTotal revenues
    
    $
    30,434
    
    
    $
    28,930
    
    
    $
    25,757
    
    
    $
    32,887Net income (loss)
    
    $
    (1,767
    )
    
    $
    (2,467
    )
    
    $
    (2,695
    )
    
    $
    (3,939
    )Net loss per common share
    
    $
    (0.22
    )
    
    $
    (0.31
    )
    
    $
    (0.34
    )
    
    $
    (0.50
    )Net loss per common share, assuming dilution
    
    $
    (0.22
    )
    
    $
    (0.31
    )
    
    $
    (0.34
    )
    
    $
    (0.50
    )
 2003 QuartersFirst
    
    
    Second
    
    
    Third
    
    
    FourthTotal revenues
    
    $
    33,126
    
    
    $
    41,457
    
    
    $
    27,005
    
    
    $
    34,985Components of net income (loss):Income (loss) from continuing operations
    
    $
    2,010
    
    
    $
    1,032
    
    
    $
    (2,937
    )
    
    $
    (10,302
    )Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    (275
    )
    
    
    Net income (loss)
    
    $
    2,010
    
    
    $
    1,032
    
    
    $
    (3,212
    )
    
    $
    (10,302
    )Net income (loss) per common share
    
    $
    0.26
    
    
    $
    0.13
    
    
    $
    (0.40
    )
    
    $
    (1.27
    )Net income (loss) per common share, assuming dilution
    
    $
    0.25
    
    
    $
    0.13
    
    
    $
    (0.40
    )
    
    $
    (1.27
    )
 Reporting the results of our operations on a quarterly basis requires the use of numerous
estimates throughout the year, primarily in the computation of reserves, amortization of deferred
policy acquisition costs and present value of future profits, and the effective rate for income
taxes. It is our 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 are we able to assess the accuracy of our previous quarterly estimates. Our
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-30




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 19. Subsequent Events (unaudited) As previously disclosed, over the past 18 months, the board and management of the Company
considered a variety of strategic alternatives that might provide it with adequate financing to
pursue its growth strategies for the health services business it embarked on in 2002 and maximize
long-term shareholder value. After considering various options, management, in early 2005,
committed to the sale of 100% of Standard Life, including Dixie Life. Pursuant to this early 2005
decision, on February 9, 2005, Standard Management entered into a definitive Stock and Asset
Purchase Agreement (the Agreement) with Capital Assurance Corporation (Capital Assurance). The
Agreement provides for the sale to Capital Assurance of (i) 100% of the capital stock of Standard
Life, and (ii) $27 million aggregate principal amount of surplus debentures issued by Standard Life
in favor of Standard Management. The Agreement represents the definitive terms for the
transactions contemplated by the previously reported letter of intent between the parties.
Standard Management expects the transaction to close in the second quarter of 2005. The purchase price under the Agreement is $79.5 million, subject to adjustment as described
below, which will be payable as follows: (i) $5 million of a new class of 7% cumulative convertible
preferred stock of Capital Assurance, (ii) assumption by Capital Assurance of approximately $21
million in intercompany obligations of Standard Management to Standard Life and (iii) the balance
of the purchase price in cash. The cash-portion of the purchase price will be adjusted,
post-closing, based on certain changes in the business of Standard Life occurring between October
1, 2004 and the closing of the transaction, including adjustments for, among other things,
statutory gains from operations of Standard Life, credit related capital gains and losses,
including impairment losses, principal payments on the surplus debentures and capital expenditures
by Standard Life. Management currently estimates that based on anticipated adjustments, the
post-closing, as adjusted purchase price expected to be paid will be approximately $83 million. Standard Management and Capital Assurance have made customary representations, warranties and
covenants in the Agreement, including, among others, covenants by Standard Management (i) to
conduct the business of Standard Life in the ordinary course and maintain necessary permits and
insurance policies during the interim period between the execution of the Agreement and closing,
(ii) to not engage in certain types of transactions during such period, (iii) to cause a meeting of
the shareholders of Standard Management to be held to approve the Agreement and the transactions
contemplated thereby, (iv) to not solicit proposals relating to an alternative sale or business
combination transaction and (v) subject to certain exceptions, not to enter into discussions
concerning or provide confidential information in connection with proposals for alternative sale or
business combination transactions. In addition, Standard Management has agreed to purchase certain
assets from Standard Life at closing for approximately $6 million. Consummation of the transactions contemplated by the Agreement is subject to customary
conditions, including (i) approval of the shareholders of Standard Management, (ii) absence of any
law or order prohibiting the closing, (iii) approval of the Indiana Department of Insurance, and
(iv) expiration or termination of the Hart-Scott-Rodino waiting period. In addition, each partys
obligation to consummate the transactions contemplated by the Agreement is subject to certain
customary conditions, including (i) with certain exceptions, the accuracy of the representations
and warranties of the other party and (ii) material compliance of the other party with its
covenants. Standard Management also agreed to undertake a solicitation of the preferred security holders
of SMAN Capital Trust I, a wholly owned subsidiary of Standard Management (the Trust) at an
estimated cost of approximately $1 million to fund incentive payments in connection with obtaining
the consent of the trust preferred holders. If adopted, the amendment would provide us additional
financing flexibility by allowing us to enter into certain business transactions, such as the sale
of substantially all of our assets, without the acquirer of such assets being required to assume
our responsibilities under the indenture. In the event the requisite consents to amend the
indenture are not received, Standard Management has the right to require Capital Assurance to
assume Standard Managements obligations under the indenture. If this event were to occur,
Standard Management would receive less net cash proceeds from the sale of Standard Life by the net
face amount outstanding of the trust preferred securities. F-31




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 19. Subsequent Events (unaudited) (continued) Standard Management agreed to indemnify Capital Assurance and Standard Life for any losses
arising from breaches of any representation, warranty or covenant of Standard Management made in
the Agreement and for all pending litigation of Standard Life subject to the applicable survival
periods, if such losses exceed $500,000 in the aggregate. If such indemnification threshold is
exceeded, Standard Management would be responsible for paying $250,000 plus the amount of such loss
in excess of $500,000, up to a maximum amount equal to the purchase price for losses related to the
breach of certain representations and warranties, and up to a maximum amount equal to 50% of the
purchase price for breaches of certain other specified representations and warranties. The Agreement provides termination rights for both Standard Management and Capital Assurance,
and further provides that, upon termination of the Agreement under specified circumstances,
Standard Management may be required to pay Capital Assurance a termination fee ranging from $1.6
million to $3.2 million, depending on the circumstance leading to the termination, plus
reimbursement of up to $2 million of expenses incurred by Capital Assurance in connection with the
transaction since November 21, 2004. If the proposed sale is consummated, we estimate that, for federal income tax purposes, we
will recognize a capital loss on the sale of approximately $22 million, equal to the difference
between our adjusted tax basis in Standard Life and the amount realized from the proposed sale. We
may recognize a tax benefit in future periods from this capital loss provided that we recognize
capital gains within five years. In addition, for accounting purposes, we would expect to record a
loss on the sale of approximately $35 million, which is equal to the difference between the
expected net book value of the assets sold on the sale date and the purchase price expected to be
paid by Capital Assurance in the proposed transaction, plus transaction related expenses. Standard Management has filed with the SEC preliminary proxy materials relating to (i) the
special meeting of shareholders to be held for the purpose of approving the Agreement and the
transactions contemplated thereby and (ii) the solicitation of consents from holders of trust
preferred securities of SMAN Capital Trust I to an amendment to the Indenture relating to such
securities. Standard Management has set May 18, 2005 as the date for a special meeting of
shareholders to vote on the approval of the sale of its subsidiary, Standard Life, to Capital
Assurance. Definitive proxy materials will be sent to all shareholders of record (as of April 4,
2005) on or about April 11, 2005. Use of Cash Proceeds. Based on managements expectations regarding the anticipated
adjustment in the purchase price, and assuming a final, post-adjustment purchase price of $83
million, we expect the net cash proceeds from the sale, before deducting transaction related fees
and expenses, to be approximately $57 million. We intend to use such cash proceeds as follows:  
    approximately $17.7 million for the repayment in full of a bank line of credit;
    approximately $6 million to purchase certain assets from Standard Life at closing
pursuant to the Agreement;
    approximately $4.3 million for professional fees (investment bankers, attorneys,
accountants) and miscellaneous other expenses (filing fees, printing and mailing proxy
materials, prepayment penalties, severance payments, etc.);
    approximately $1 million to fund incentive payments in connection with obtaining the
consent of the trust preferred holders;
    $.5 million to reduce the principal amount outstanding under the mortgage on our
home office; and
    the remaining approximately $27.5 million as working capital to support and expand
our health services business, including through selected strategic acquisitions. F-32




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 19. Subsequent Events (unaudited) (continued) In addition, we anticipate that Standard Life, after the sale, will still lease space from us
for at least three years for $480,000 per year. We also anticipate receiving $350,000 of annual
dividends under the $5 million of newly issued 7% cumulative exchangeable preferred stock we expect
to receive as partial consideration in our sale of Standard Life. The following unaudited condensed consolidated balance sheet of Standard Life at December 31,
2004, is presented, for informational purposes only, to highlight the net assets affected by the
sale of Standard Life. Standard Life
Unaudited Condensed Consolidated Balance Sheet
As of December 31, 2004
(dollars in thousands) Assets:Total investments
    
    $
    1,686,396Deferred policy acquisition costs and present value of future profits
    
    
    174,173Other assets
    
    
    86,530Total assets
    
    $
    1,947,099Liabilities:Insurance policy liabilities
    
    $
    1,824,736Accounts payable and accrued expenses
    
    
    32,040Total liabilities
    
    $
    1,856,776
 On March 21, 2005, the Company issued a $4.75 million Secured Convertible Term Note due on or
before March 21, 2008 (the Note). The Note was issued pursuant to a Securities Purchase
Agreement entered into by the Company and Laurus Master Fund, Ltd. The Note bears interest at a
rate equal to the prime rate plus 2%, with a floor of 7.25%. The interest rate may, under
specified circumstances, be reduced in the event that the trading price for the Companys common
stock increases above certain levels. Principal payments commence on September 1, 2005 and
continue on the first of each month thereafter in an amount equal to $158,333 per month. Under
certain circumstances, the Company may make a monthly payment in shares of its common stock. The
holder of the Note may at any time convert the outstanding principal and unpaid interest due under
the Note to shares of the Companys common stock at a conversion price of $3.28 subject to certain
limitations described in the Note. The Company has agreed to issue to the holder a warrant to
purchase 532,511 shares of the Companys common stock at an exercise price of $3.90 per share. The
term of the warrant is five years. In addition, the Company has agreed to pay to Laurus Capital
Management, LLC, the manager of the holder of the Note, a fee equal to 4% of the original principal
amount of the Note ($190,000) and to reimburse the holder for its reasonable expenses, including
legal fees. The Company intends to use the proceeds from the issuance of the Note for general
corporate purposes. F-33




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##### Table of Contents



Schedule II  Condensed Financial Information of Registrant STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY) CONDENSED BALANCE SHEETS
(dollars in thousands) December 312004
    
    
    2003ASSETSInvestments:Investment in subsidiaries
    
    $
    101,730
    
    
    $
    111,452Surplus debenture due from Standard Life
    
    
    27,000
    
    
    
    27,000Equity securities available for sale, at fair value (cost: $25)
    
    
    25
    
    
    
    25Real estate
    
    
    
    
    
    
    313Notes receivable from officer and director
    
    
    776
    
    
    
    776Total investments
    
    
    129,531
    
    
    
    139,566Cash and cash equivalents
    
    
    445
    
    
    
    263Property and equipment, less depreciation of $5,584 in 2004 and $4,516 in
2003
    
    
    9,761
    
    
    
    10,560Amounts receivable from subsidiaries
    
    
    24,676
    
    
    
    12,673Other assets
    
    
    2,708
    
    
    
    (374
    )Total assets
    
    $
    167,121
    
    
    $
    162,688LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Notes payable
    
    $
    24,950
    
    
    $
    20,500Capital lease obligations
    
    
    235
    
    
    
    447Mortgages payable
    
    
    6,607
    
    
    
    6,795Amounts due to subsidiaries
    
    
    49,800
    
    
    
    38,148Other liabilities
    
    
    4,797
    
    
    
    2,651Payable to company-obligated trust preferred securities
    
    
    20,700
    
    
    
    20,700Total liabilities
    
    
    107,089
    
    
    
    89,241Shareholders Equity:Common stock and additional paid-in capital, no par value
    
    
    64,369
    
    
    
    68,077Treasury stock, at cost
    
    
    (7,703
    )
    
    
    (7,671
    )Accumulated other comprehensive income
    
    
    4,895
    
    
    
    2,702Retained earnings (loss)
    
    
    (1,529
    )
    
    
    9,339Total shareholders equity
    
    
    60,032
    
    
    
    72,447Total liabilities and shareholders equity
    
    $
    167,121
    
    
    $
    161,688
 See accompanying notes to condensed financial statements. F-34




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Schedule II  Condensed Financial Information of Registrant  (continued) STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY) CONDENSED STATEMENTS OF OPERATIONS
(dollars in thousands) December 312004
    
    
    2003
    
    
    2002Revenues:Management
fees from subsidiaries
    
    $
    3,600
    
    
    $
    3,600
    
    
    $
    3,500Interest income from subsidiaries
    
    
    1,702
    
    
    
    1,675
    
    
    
    1,915Rental income from subsidiaries
    
    
    1,948
    
    
    
    1,901
    
    
    
    1,854Other income
    
    
    76
    
    
    
    94
    
    
    
    15Net realized investment gains (losses)
    
    
    (28
    )
    
    
    63
    
    
    
    (1,001
    )Total revenues
    
    
    7,298
    
    
    
    7,333
    
    
    
    6,283Expenses:Operating expenses
    
    
    6,070
    
    
    
    5,452
    
    
    
    5,548Interest expense and financing costs
    
    
    5,705
    
    
    
    5,590
    
    
    
    4,767Interest expense on note payable to affiliate
    
    
    
    
    
    
    
    
    
    
    50Total expenses
    
    
    11,775
    
    
    
    11,042
    
    
    
    10,365Loss before federal income taxes and equity in earnings of
consolidated subsidiaries
    
    
    (4,477
    )
    
    
    (3,709
    )
    
    
    (4,082
    )Federal income tax benefit
    
    
    (752
    )
    
    
    (318
    )
    
    
    (2,353
    )Loss before equity in earnings of consolidated
subsidiaries
    
    
    (3,725
    )
    
    
    (3,391
    )
    
    
    (1,729
    )Equity in earnings (loss) of consolidated
subsidiaries
    
    
    (7,143
    )
    
    
    (7,080
    )
    
    
    599Net loss
    
    $
    (10,868
    )
    
    $
    (10,471
    )
    
    $
    (1,130
    )
 See accompanying notes to condensed financial statements. F-35




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Schedule II  Condensed Financial Information of Registrant  (continued) STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS
(dollars in thousands) December 312004
    
    
    2003
    
    
    2002Operating ActivitiesNet loss
    
    $
    (10,868
    )
    
    $
    (10,471
    )
    
    $
    (1,130
    )Change in income taxes
    
    
    (752
    )
    
    
    (318
    )
    
    
    (1,481
    )Depreciation and amortization
    
    
    1,262
    
    
    
    2,078
    
    
    
    1,391Equity in earnings (loss) of subsidiaries
    
    
    7,143
    
    
    
    7,080
    
    
    
    (599
    )Net realized investment gains (losses)
    
    
    28
    
    
    
    (63
    )
    
    
    1,001Other
    
    
    1,598
    
    
    
    (1,269
    )
    
    
    633Net cash used by operating activities
    
    
    (1,589
    )
    
    
    (2,963
    )
    
    
    (185
    )Investing ActivitiesInvestments, net
    
    
    80
    
    
    
    (258
    )
    
    
    (18
    )Capital contribution to Standard Life
    
    
    
    
    
    
    (5,000
    )
    
    
    (15,000
    )Cash paid for health services acquisitions,
net of cash acquired
    
    
    (2,303
    )
    
    
    (145
    )
    
    
    (1,215
    )Purchase of property and equipment
    
    
    (268
    )
    
    
    (522
    )
    
    
    (777
    )Net cash used by investing activities
    
    
    (2,491
    )
    
    
    (5,925
    )
    
    
    (17,010
    )Financing ActivitiesBorrowings
    
    
    6,261
    
    
    
    26,915
    
    
    
    200Borrowings from affiliates
    
    
    (211
    )
    
    
    (27
    )
    
    
    25,321Repayments of notes payable
    
    
    (1,788
    )
    
    
    (19,378
    )
    
    
    (6,942
    )Issuance of common stock and warrants
    
    
    1
    
    
    
    33
    
    
    
    (33
    )Purchase of common stock for treasury stock
    
    
    (1
    )
    
    
    
    
    
    
    (82
    )Net cash provided by financing activities
    
    
    4,262
    
    
    
    7,543
    
    
    
    18,464Net increase (decrease) in cash and cash equivalents
    
    
    182
    
    
    
    (1,345
    )
    
    
    1,269Cash and
cash equivalents at beginning of year
    
    
    263
    
    
    
    1,608
    
    
    
    339Cash and cash equivalents at end of year
    
    $
    445
    
    
    $
    263
    
    
    $
    1,608
 See accompanying notes to condensed financial statements. F-36




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Schedule II  Condensed Financial Information of Registrant  (continued) STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY) NOTES TO CONDENSED FINANCIAL STATEMENTS
December 31, 2004 1. Basis of Presentation For purposes of these condensed financial statements, Standard Management carries its
investments in subsidiaries at cost plus equity in undistributed earnings of subsidiaries since
date of acquisition. Net income (loss) of its subsidiaries is included in income using the equity
method. These condensed financial statements should be read in conjunction with our consolidated
financial statements included elsewhere in this document. 2. Dividends from Subsidiaries Standard Management did not receive any dividends from its subsidiaries in 2004, 2003 and
2002. 3. Amounts due to subsidiaries In addition to normal advances, we have $26.0 million of outstanding affiliated borrowings at
December 31, 2004, pursuant to a $30 million Revolving Line of Credit Agreement between Standard
Management Financial Corporation and the Company. Borrowings under the Revolving Line of Credit
Agreement may be used for general corporate purposes and to repay outstanding debt. The
outstanding balance bears interest equal to the prime rate and interest payments are payable
quarterly. F-37




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##### Table of Contents



Schedule IV  Reinsurance STANDARD MANAGEMENT CORPORATION Years Ended December 31, 2004, 2003 and 2002
(dollars in thousands) PercentageCeded to
    
    
    Assumed
    
    
    
    
    
    
    of AmountGross
    
    
    Other
    
    
    From Other
    
    
    
    
    
    
    Assumed toAmount
    
    
    Companies
    
    
    Companies
    
    
    Net Amount
    
    
    Net AmountYear Ended December 31, 2004Life insurance in force
    
    $
    1,024,685
    
    
    $
    490,209
    
    
    $
    61,735
    
    
    $
    596,211
    
    
    
    10.35
    %Premiums:Life insurance and annuities
    
    $
    8,193
    
    
    $
    2,414
    
    
    $
    578
    
    
    $
    6,357Accident and health insurance
    
    
    10
    
    
    
    8
    
    
    
    
    
    
    
    2Supplementary contract and other funds on deposit
    
    
    1,565
    
    
    
    
    
    
    
    
    
    
    
    1,565Total premiums
    
    $
    9,768
    
    
    $
    2,422
    
    
    $
    578
    
    
    $
    7,924Year Ended December 31, 2003Life insurance in force
    
    $
    1,054,341
    
    
    $
    475,704
    
    
    $
    67,684
    
    
    $
    646,321
    
    
    
    10.47
    %Premiums:Life insurance and annuities
    
    $
    10,001
    
    
    $
    4,040
    
    
    $
    706
    
    
    $
    6,667Accident and health insurance
    
    
    12
    
    
    
    9
    
    
    
    
    
    
    
    3Supplementary contract and other funds on deposit
    
    
    2,259
    
    
    
    
    
    
    
    
    
    
    
    2,259Total premiums
    
    $
    12,272
    
    
    $
    4,049
    
    
    $
    706
    
    
    $
    8,929Year Ended December 31, 2002Life insurance in force
    
    $
    1,089,067
    
    
    $
    543,782
    
    
    $
    73,145
    
    
    $
    618,430
    
    
    
    11.83
    %Premiums:Life insurance and annuities
    
    $
    10,079
    
    
    $
    2,946
    
    
    $
    785
    
    
    $
    7,918Accident and health insurance
    
    
    13
    
    
    
    10
    
    
    
    
    
    
    
    3Supplementary contract and other funds on deposit
    
    
    1,252
    
    
    
    
    
    
    
    
    
    
    
    1,252Total premiums
    
    $
    11,344
    
    
    $
    2,956
    
    
    $
    785
    
    
    $
    9,173
 F-38