Annual Report (Form 10-K), fiscal year 1994

ITEM 1. BUSINESS -----------------
GENERAL
Pioneer Financial Services, Inc. (the Company) markets and underwrites life insurance and health insurance in selected niche markets throughout the United States. The Company concentrates on three core insurance businesses: Life Insurance, Senior Health Insurance and Group Medical. The Company also has a Medical Utilization Management unit which in part supports the Group Medical Division.
The Life Insurance Division underwrites mid-sized term insurance, interest sensitive and universal life insurance for the middle income and Senior markets. In January 1995, the Company acquired Connecticut National Life Insurance Company which will increase gross annual revenue by approximately $35 million and total assets by over $350 million.
The Life Insurance Division is organized to sell its products through a national network of brokerage general agents (BGAs). Manhattan National Life has developed a network of 50 BGAs who in the aggregate contract with approximately 10,000 brokers across the nation to sell the Company's product line to fit their niche needs. With the addition of Connecticut National Life, 50 BGAs and approximately 10,000 brokers are added to this national distribution system. Since the distribution systems of Connecticut National Life and Manhattan National Life are nearly mirror images, the blending of companies enhances the product portfolios of each company.
The Senior Health Insurance Division concentrates on underwriting and administering a full range of specialty health insurance for Americans age 65 and older. The products include traditional Medicare supplement, Medicare Select, group Medicare supplement, long term care and home health care. A nationwide brokerage network of 15,000 individual agents sells the Company's Senior products. These agents also distribute the Company's life insurance and annuity products, with this revenue being reflected in the Life Insurance Division. The Senior Health Insurance Division accounted for 34% of the Company's health insurance premiums in 1994.
The Group Medical Division markets, underwrites and administers small group and individual major medical policies and markets managed care products (health maintenance organizations--HMOs) for self-employed individuals and small business owners. The Division also provides insurance and non- insurance marketing services for unaffiliated insurance companies and associations. The Company's marketing subsidiaries in this Division receive commission overrides and other fee income from these client companies, which increases revenues without adding to the insurance underwriting risk liability. The Division markets through two sales units: a nationwide force of approximately 1,800 trained career agents, an a network of over 50 professional telemarketing representatives who access approximately 9,500 independent insurance brokers nationwide through the Company's computer database. The Company also has an established telemarketing subsidiary with facilities in Phoenix, Arizona, and Arlington, Texas. The Division accounted for 66% of the Company's health insurance premiums in 1994.
The Company's Medical Utilization Management unit provides healthcare coordination to control medical expense costs for insurance companies, government agencies, self-insured businesses, unions, HMOs and third party
administrators. Services include precertification of care, provider networks and case management. This unit's services provide significant claims cost savings for the Company's Group Medical Division. In addition, the unit markets its services to many unaffiliated companies and organizations. In 1994, approximately 68% of the unit's revenue was derived from services provided to unaffiliated organizations.
The Company was organized in Delaware in 1982 as a successor to an Illinois holding company formed in 1957. The Company's largest operating insurance subsidiary is Pioneer Life Insurance Company of Illinois (Pioneer Life), a successor to a company organized in 1926. Health and Life Insurance Company of America, National Group Life Insurance Company, Manhattan National Life Insurance Company and Continental Life & Accident Company were acquired in 1985, 1986, 1990 and 1993, respectively, primarily for specialized marketing purposes.
The executive offices of the Company are located at 1750 East Golf Road, Schaumburg, Illinois 60173, and it telephone number is (708) 995-0400. The term "Company" refers to Pioneer Financial Services, Inc. (PFS) and, unless the context otherwise requires, its subsidiaries.
Information on revenue and pre-tax income by Business Division is set forth in Note 20 of the Notes to Consolidated Financial Statements.
PRODUCTS
LIFE INSURANCE DIVISION
Substantially all of the Company's life insurance policies are individually and medically underwritten and issued, other than small accidental death benefit policies, which are not material to the Company.
The following table sets forth the breakdown of premiums collected (including receipts not related to policy charges) among traditional life policies (term and whole life), interest sensitive and universal life policies and annuities for the periods shown:
Year Ended December 31, ---------------------------------------------------------- 1994 1993 1992 ---------------- ----------------- ----------------- Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- (Dollars in thousands)
Traditional $32,238 44 $26,353 50 $20,300 45 Int Sensitive & Univ Life 17,590 24 16,300 31 18,399 41 Annuties 22,807 32 10,004 19 6,212 14 ------- --- ------- --- ------- --- Total $72,635 100 $52,657 100 $44,911 100
For 1992, premium collected from the Company's life insurance products were approximately 27% first year and 73% renewal, for 1993 approximately 24% were first year and 76% renewal, and for 1994 premiums collected were approximately 28% first year and 72% renewal.
The Company's gross life insurance in force was as follows at the dates shown:
December 31, ------------------------------ 1994 1993 1992 ---- ---- ---- (Dollars in millions) Traditional $10,803 $10,320 $ 8,757 Interest Sensitive & Universal Life Policies 1,779 1,503 1,582 ------- ------- ------- Total $12,582 $11,823 $10,339
TRADITIONAL LIFE. The largest portion of the Life Insurance Division's business is in term life insurance, specializing in face amounts of $100,000 to $500,000, sold to middle and higher income families. Marketed under the name "Super Saver Term," this series features low cost 5, 10 and 15 year term life insurance products.
In 1994 the Company also began selling a significant amount of smaller unit whole life insurance policies specifically designed to cover final expenses for senior citizens.
For a number of years, the Company's subsidiary, Manhattan National Life, has offered individually underwritten insurance on lives of persons who, to varying degrees, do not meet the requirements of standard insurability. Higher premiums are charged for these "impaired" or "substandard" lives, and, where the amount of insurance is large or the risk is significant, a portion of the risk is reinsured.
INTEREST SENSITIVE LIFE AND UNIVERSAL LIFE. The Company's interest sensitive and universal life insurance products provide life insurance with rates of return which are adjusted in relation to prevailing interest rates. The policies permit the Company to change the rate of interest credited to the policy from time to time. Universal life insurance products credit current interest rates to cash value accumulations, permit adjustments in benefits and premiums at the policyholder's option, and deduct mortality and expense charges monthly. Under other interest sensitive policies, premiums are flexible, allowing the policyholders to vary the frequency and amount of premium payments, but typically death benefit changes may not be made by the policyholders. Some universal life products offer lower premiums for non- smokers in good health. For both universal life and other interest sensitive policies, surrender charges, if any, are deducted from the policyholder's account value at the time of surrender. No surrender charges are deducted if death benefits are paid or if the policy remains in force for a specified period.
The Company's "Interest Sensitive Series" includes whole life policies ideally suited for the impaired risk market. This product series provides permanent protection with a fixed, guaranteed level premium and an interest rate persistency bonus. The "Financial Lifestyle II" is a highly flexible back-load universal life policy providing low-cost protection with tax- deferred cash accumulation.
ANNUITIES. The Company's single and flexible premium deferred annuities are offered to individuals. An annuity contract generally involves the accumulation of premiums at a compound interest rate until the maturity date, at which time the policyholder can choose one of the various payment options. Options include periodic payments during the annuitant's lifetime or the lifetime of the annuitant and spouse, with or without a guaranteed minimum
period; periodic payments for a fixed period regardless of the survival of the annuitant; or lump sum cash payment of the accumulated value. The Company's annuities typically provide for the crediting of interest at rates set from time to time by the Company.
SENIOR HEALTH INSURANCE DIVISION
The Company's Senior Health products, all of which are individually underwritten and issued, include Medicare supplement insurance, long term care, home health care and various specialty health coverages.
MEDICARE SUPPLEMENT. Since the inception of the Medicare program in 1966, the Company has offered policies designed to supplement Medicare benefits. Such policies accounted for approximately 37% of health premiums in 1992, approximately 33% of health premiums in 1993 and approximately 27% of health premiums in 1994. These policies provide payment for deductibles and the excess over maximum limits of the federal Medicare program. Under these policies, annual premiums may be increased if policy benefits increase as a result of changes in Medicare coverage. In 1991 the National Association of Insurance Commissioners (NAIC) defined 10 model Medicare supplement policies. In states which have adopted the NAIC model, only those 10 policies can be sold. In most states, the Company markets 8 of the 10 model policies--those which the Company believes are most applicable to the Company's market. All states have adopted the NAIC model or similar legislation which specifically defines policy models.
The federal government began a test program, allowing 15 specified states to participate in a "Medicare Select" program. Medicare Select policies combine the cost advantages of a preferred provider organization with a Medicare supplement policy to provide a reduced premium cost for policyholders. Utilizing specified medical providers, certain costs are reduced and these savings are passed on to the consumer through the insurance company. The Company markets Medicare Select policies in a number of states and has plans to expand into the other available states. In addition, if the federal government allows the Medicare Select program to expand to other states, the Company plans to also expand its marketing to those additional states.
LONG TERM CARE AND HOME HEALTH CARE. The Company also offers long term care and home health care products designed principally for Senior citizens. Long term care policies generally provide specified per day benefits for nursing home confinements. Home health care policies provide specified per day benefits for required health services received in the home, and comprehensive coverages which provide benefits for all levels of nursing home care, home health care and adult day care.
SPECIALTY HEALTH. The Company offers various specialty health products which typically are sold in conjunction with the Company's principal health products. Policies include hospital indemnity, private duty nursing and cancer plans.
GROUP MEDICAL DIVISION
The Group Medical Division's products include health insurance products individually underwritten and issued. For 1992, 1993 and 1994, the Division produced health insurance premium revenue of approximately $306,880,000, $357,784,000 and $431,831,000, respectively. The Division also derives marketing commission revenue and other fee income through marketing insurance and other products of unaffiliated companies and associations.
The insurance products marketed and underwritten by the Company's subsidiaries include major hospital and specialty health insurance products.
MAJOR HOSPITAL. The Company offers major hospital insurance plans on an individual basis and on a group trust and association basis and has issued master policies for such plans to several trusts and associations. These plans are designed to cover in-hospital expenses for self-employed individuals, small business owners, employees and their families. Hospital, surgical and other medical expenses are covered on an expense incurred basis with certain benefit limits after a prescribed deductible. The Company provides products with benefit alternatives such as increased deductibles and different benefit structures designed to enable policyholders to maintain insurance protection without increased premium rates. In 1994 the Company introduced "ChoicePlus," a product which combines HMO-type wellness features within a specific provider network along with in-network and out-of-network indemnity benefits.
In December 1991, the NAIC adopted the Small Employers Availability Act (Act). This Act affects the rating and underwriting methodology that can be applied to insurance coverage sold to small employers, generally categorized as those employing 25 people or less. In response to the Act, the Company has modified and continues to modify its new products for sale in those states adopting the Act or adopting other healthcare reforms.
The Marketing Unit of the Group Medical Division also derives revenue through sales of products of unaffiliated insurance companies. These products include medical insurance for medium-sized groups (50 or more), employer self-funded plans, flexible premium universal life insurance, disability income protection and annuities. The Company also markets HMO products in areas where these products have a significant competitive advantage over traditional indemnity insurance products. The HMO products are sold in selected states through marketing relationships with regional HMOs. In addition to commission revenue, sales of these HMOs provide the sales force with opportunities to cross-sell the Company's other products.
Another unit of this Division markets membership benefit packages to various national associations. These packages include discounts on dental services, hotels/motels, airfares, prescription drugs, vision and hearing aid equipment and other services.
PREMIUMS AND LOSS RATIOS
In both the Senior Health Insurance Division and the Group Medical Division, the Company may adjust premium rates by class, policy form and state in which the policy is issued subject to applicable regulation in order to maintain anticipated loss ratios. Since premium rate adjustments can have the tendency to increase policy lapses, conservation and customer service activities are emphasized. As a result, the Company has successfully avoided any significant increases in policy lapses in both the small business and Senior citizen markets. Both health insurance divisions follow a proactive approach involving strict scrutiny of all health premium rates on a monthly basis. The matching of pricing structure with the actual claims experience varies by product line and state. This ongoing analysis provides the time basis necessary for orderly adjustment of premiums.
The Company's loss ratios have varied over the years reflecting changes in medical claim costs and the frequency of benefit utilization by its insureds. The following table sets forth the earned premiums, losses and loss adjustment expenses incurred and loss ratios for the Company's accident and
health business. Earned premiums reflect written premiums adjusted for reinsurance and changes in unearned premiums. In the Company's statement of consolidated operations, premiums represent premiums written, adjusted for reinsurance; the changes in unearned premiums are reflected in benefits, together with losses and loss adjustment expenses. Losses and loss adjustment expenses include losses incurred on insurance policies and the expenses of settling insurance claims, including legal and other related fees and expenses.
Year Ended December 31, ---------------------------------------------- 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------ (Dollars in thousands)
Senior Health Earned premiums . . . . . $225,604 $243,482 $264,697 $298,653 $249,409 Losses and loss adjustment expenses . . . . . . . 137,853 154,561 176,149 200,446 173,307 Loss ratio . . . . . . . 61% 63% 67% 67% 69% Group Medical Earned premiums . . . . . $443,599 $375,275 $302,881 $294,431 $234,004 Losses and loss adjustment expenses . . . . . . . 279,419 251,955 200,781 176,222 168,939 Loss ratio . . . . . . . 63% 67% 66% 60% 72% Total Accident and Health Earned premiums . . . . . $669,203 $618,757 $567,578 $593,084 $483,413 Losses and loss adjustment expenses . . . . . . . $417,272 $406,516 376,930 376,668 342,246 Loss ratio . . . . . . . 62% 66% 66% 64% 71%
PREMIUM DISTRIBUTION
The Company's insurance subsidiaries collectively are licensed to sell insurance in 49 states and the District of Columbia. The importance to the Company of particular states may vary over time as the composition of its agency network changes. The geographic distribution of collected premiums (before reinsurance) of the Company's subsidiaries in 1994 was as follows:
Total Percent _____ _______ (Dollars in thousands)
Texas $77,298 10.3 Florida 77,151 10.2 California 57,779 7.7 Illinois 57,087 7.6 North Carolina 31,640 4.2 Ohio 22,992 3.1 Pennsylvania 22,891 3.0 Other (1) 406,471 53.9 -------- ----- Total $753,309 100.0
(1) Includes 42 other states, the District of Columbia, and certain U.S. territories and foreign countries, each of which account for less than 3% of collected premiums.
UNDERWRITING
A major portion of the Company's insurance coverages are individually underwritten to assure that policies are issued by the Company's insurance subsidiaries based upon the underwriting standards and practices established by the Company. Applications for insurance are reviewed to determine if any additional information is required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Such additional information may include medical examinations, statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. If deemed necessary, the Company uses investigative services to supplement and substantiate information. For certain coverages, the Company may verify information with the applicant by telephone. After reviewing the information collected, the Company either issues the policy as applied for, issues the policy with an extra premium charge due to unfavorable factors, issues the policy excluding benefits for certain conditions for a period of time or rejects the application. For certain of its coverages, the Company has adopted simplified policy issue procedures in which the applicant submits a simple application for coverage typically containing only a few health related questions instead of a complete medical history.
In common with other life and health insurance companies, the Company may be exposed to the risk of claims based on AIDS. The Company's AIDS claims to date have been insignificant. Because of its emphasis on policies written for the senior citizen market and its underwriting procedures and selection processes, the Company believes its risk of AIDS claims is less than the risk to the industry in general.
REINSURANCE
The Company's insurance subsidiaries reinsure portions of the coverages provided by their insurance products with other insurance companies on both an excess of loss and co-insurance basis. Co-insurance generally transfers a fixed percentage of the Company's risk on specified coverages to the reinsurer. Excess of loss insurance generally transfers the Company's risk on coverages above a specified retained amount. Under its excess of loss reinsurance agreements, the maximum risk retained by the Company on one individual in the case of life insurance is $100,000 ($250,000 in the case of Manhattan National Life) and in the case of accident and health insurance is $250,000.
Reinsurance agreements are intended to limit an insurer's maximum loss on the specified coverages. The ceding of reinsurance does not discharge the primary liability of the original insurer to the insured, but it is the practice of insurers (subject to certain limitations of state insurance statutes) to account for risks which have been reinsured with other approved companies, to the extent of the reinsurance, as though they are not risks for which the original insurer is liable. See Note 6 of Notes to Consolidated Financial Statements.
The Company has occasionally used assumption reinsurance to acquire blocks of business from other insurers. In addition, the Company has from time to time entered into agreements to assume certain insurance business from companies for which it is marketing insurance products. The Company intends to continue these programs if they assist in expanding product lines and marketing territories.
INVESTMENTS
Investment income represents a significant portion of the Company's
total revenues. Insurance company investments are subject to state insurance laws and regulations which limit the types and concentration of investments. The following table provides information on the Company's investments as of the dates indicated.
December 31, ------------------------------------- 1994 1993 -------------- ------------- Amount % Amount % ------ --- ------ --- (Dollars in thousands)
Fixed maturities to be held to maturity: U.S. Treasury $ 8,891 1% $ 9,124 1% States and political subdivisions 8,888 1 5,200 1 Foreign governments 2,992 1 - - Corporate securities 147,419 20 119,276 18 Mortgage-backed securities 210,460 29 192,912 29 -------- ---- -------- ---- Total fixed maturities to be held to maturity 378,650 52 326,512 49
Fixed maturities available for sale: U.S. Treasury 21,852 3 26,894 4 States and political subdivisions 25,819 3 21,571 3 Foreign governments 3,465 1 4,056 1 Corporate securities 89,401 12 73,981 11 Mortgage-backed securities 78,211 11 131,215 19 -------- ---- -------- ---- Total fixed maturities available for sale 218,748 30 257,717 38 -------- ---- -------- ----
Equity securities........... 15,440 2 17,436 3 Real estate................. 16,959 2 - - Mortgage and policy loans... 24,888 4 27,189 4 Short-term investments...... 69,152 10 45,352 6 -------- ---- -------- ----
Total Investments....... $723,837 100% $674,206 100% ======== ==== ======== ====
At December 31, 1994, the average expected term of the Company's fixed maturity investments was approximately five years. The results of the investment portfolio for the periods shown were as follows:
Year Ended December 31, ----------------------------------- 1994 1993 1992 -------- -------- -------- (Dollars in thousands)
Average month-end investments . $679,331 $592,546 $549,643 Net investment income . . . . . 42,786 40,242 43,555
Average annualized yield on investments (1) . . . . . . . 6.3% 6.8% 7.9% Realized investment losses (2) . . . . . . . . . . $ (383) $ (1,336) $ (47)
(1) Not computed on a taxable equivalent basis. Includes interest income paid or accrued on fixed maturity securities and loans and dividends on equity securities.
(2) See Note 4 of Notes to Consolidated Financial Statements for information on unrealized appreciation (depreciation) on investments.
The Company's investment policy is to balance its portfolio between long-term and short-term investments so as to achieve investment returns consistent with preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. Current policy is to invest primarily in fixed income securities of the U.S. government and its agencies and authorities, and in fixed income corporate securities with investment grade ratings of Baa or better. At December 31, 1994, less than 1% of the Company's total investment portfolio was below investment grade or unrated. The Company intends to invest no more than 4% of its admitted assets in securities below investment grade.
For a detailed discussion of the Company's investment portfolio, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
POLICY LIABILITIES
The Company records reserves for future policy benefits to meet future obligations under outstanding policies. These reserves are amounts which are calculated to be sufficient to meet policy and contract obligations as they mature. The amount of reserves for insurance policies is calculated using assumptions for interest, mortality and morbidity, expenses and withdrawals. Reserves are established at the time the policy is issued and adjusted periodically based on reported and unreported claims or other information. See Note 1 of Notes to Consolidated Financial Statements.
COMPETITION
The insurance business is highly competitive and includes a large number of insurance companies, many of which have substantially greater financial resources and larger and more experienced staffs than the Company. The Company competes with other insurers to attract and retain the allegiance of its independent agents and marketing organizations who at this time are responsible for most of the Company's premiums. Methods of competition include the Company's ability to offer competitive products and to service these programs efficiently. Other competitive factors applicable to the Company's business include policy benefits, service to policyholders and premium rates.
HEALTHCARE REFORM
Many proposals have been introduced in Congress and various state legislatures to reform the present healthcare system. Most of these proposals are specifically directed at the small group healthcare market, a significant portion of the Company's health business. At the state level, a number of states have passed or are considering legislation that would limit the differentials in rates that carriers could charge between new business
and renewal business with respect to similar demographic groups. Legislation also has been adopted or is being considered that would make health insurance available to all small groups by requiring coverage of all employees and their dependents, by limiting the applicability of pre-existing conditions exclusions, by requiring carriers to offer a basic plan exempt from certain mandated benefits as well as a standard plan and by establishing a mechanism to spread the risk of high risk employees to all small group carriers.
At the federal level, it is not possible to predict which proposal, if any, will be adopted by Congress or when such a proposal may be enacted. However, we do expect there to be insurance market reforms in any package that would be passed. The Company is monitoring developments concerning healthcare reform and preparing its strategic responses to different possible reform scenarios. In response to existing legislation and in anticipation of future healthcare reform, the Company has broadened its senior health insurance, life insurance and medical utilization management business and has continued to diversify products and services in selected market areas that the Company believes will be consistent with its targeted market focus and be less affected by healthcare reform. It is likely that healthcare reform at the federal and state levels will require the Company to make significant changes to the way it conducts its health insurance business, but it is not possible at this time to predict the nature or effects of healthcare reform or how soon it will be adopted and implemented, if at all. If state small group reform continues to add restrictions to insurance business and the federal government assumes responsibility for regulation and payment of much of the healthcare that is now handled by the private sector, this would significantly reduce or eliminate the Company's group medical insurance business.
GOVERNMENT REGULATION
In common with all domestic insurance companies, the Company's insurance subsidiaries are subject to regulation and supervision in the jurisdictions in which they do business under statutes which typically delegate regulatory, supervisory and administrative powers to state insurance commissions. The method of such regulation varies, but regulation relates generally to the licensing of insurers and their agents, the nature of and limitations on investments, approval of policy forms, reserve requirements, the standards of solvency which must be met and maintained, deposits of securities for the benefit of policyholders, periodic examination of insurers, and trade practices, among other things. The Company's accident and health coverages generally are subject to rate regulation by state insurance departments which in certain cases require that certain minimum loss ratios be maintained.
Certain states also have insurance holding company laws which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The Company's insurance subsidiaries are subject to such laws and are registered as controlled insurers in those jurisdictions in which such registration is required. Such laws vary from state to state but typically require periodic disclosure concerning the corporation which controls the registered insurers and all subsidiaries of such corporation, and prior notice to, or approval by, the state insurance department of intercorporate transfers of assets and other transactions (including payments of dividends in excess of specified amounts by the insurance subsidiary) within the holding company system.
EMPLOYEES
As of December 31, 1994, the Company employed approximately 1,900 persons on a full-time basis. The Company considers its employee relations to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning the executive officers and directors of the Company is set forth below:
Peter W. Nauert............... 51 Chairman, Chief Executive Officer, Director
Charles R. Scheper............ 42 President - Life Division and Director
Thomas J. Brophy.............. 59 President - Health Division and Director
William B. Van Vleet.......... 70 Executive Vice President, General Counsel, and Director
Anthony J. Pino............... 47 Executive Vice President
Philip J. Fiskow.............. 38 Senior Vice President and Chief Investment Officer
Ernest T. Giambra, Jr..........47 Executive Vice President
David I. Vickers.............. 34 Vice President, Treasurer and Chief Financial Officer
Michael A. Cavataio........... 50 Director
Richard R. Haldeman........... 51 Director
R. Richard Bastian, III....... 48 Director
Karl-Heinz Klaeser............ 62 Director
Michael K. Keefe.............. 50 Director
Robert F. Nauert.............. 70 Director
Carl A. Hulbert............... 72 Director
All executive officers are elected annually and serve at the pleasure of the Board of Directors.
Peter W. Nauert has been Chief Executive Officer and a director of the Company since its incorporation in 1982. He was President of the Company from 1982 to 1988 and became Chairman of the Company in 1988. On September 1, 1991, he was again elected President. Since 1968, Mr. Nauert has been employed in an executive capacity by one or more of the Company's insurance subsidiaries.
Charles R. Scheper was elected President of the Company in March 1995. He was Vice President of the Company from 1991 to March 1995 and was Chief Financial Officer from May 1993 to December 1993. In March 1992, he was elected Executive Vice President. Since February 14, 1992, he has been President and Vice Chairman of the Board of Manhattan National Life. Prior
to the Company's acquisition of Manhattan National Life, Mr. Scheper was Manhattan's Senior Vice President and Chief Financial Officer, a position which he held from May 1987. Prior to joining Manhattan National Life, Mr. Scheper was with Union Central Life from 1979, having served as Vice President and Controller since 1985.
Thomas J. Brophy was elected President of the Company in March 1995. He was Senior Vice President since joining the Company in November 1993. Prior to joining the Company, Mr. Brophy was President and Chief Operating Officer of Southwestern Life Insurance Company from June 1990 to September 1993. Mr. Brophy also held senior executive positions with various I.C.H. Corporation subsidiaries from March 1974 to his joining of the Company in November 1993.
William B. Van Vleet has been Executive Vice President of the Company since 1986 and a director of the Company since 1982. He was General Counsel of the Company from 1982 to 1988. In June 1991, he was again elected General Counsel. Mr. Van Vleet has served Pioneer Life since 1948 as General Counsel and a Director. Mr. Van Vleet also serves as an Officer and Director of other subsidiaries of the Company.
Anthony J. Pino was elected Executive Vice President of the Company in May 1993. He was Senior Vice President of the Company from March 1992 to May 1993 and was President of National Group Life Insurance Company from July 1991 to June 1992. Mr. Pino has served as President of National Health Services since 1992. Prior to joining the Company, Mr. Pino was Chief Operating Manager of American Postal Workers' Union Health Plan, a position which he held from October 1982.
Philip J. Fiskow has been Senior Vice President since May 1993 and the Chief Investment Officer since joining the Company in 1991. He was Vice President of the Company from June 1991 until May 1992. He is also an officer of other subsidiaries of the Company. Mr. Fiskow was with Asset Allocation and Management as an Investment Advisory Portfolio Manager from January 1989 to June 1991. From May 1987 to December 1988 he was an Investment Advisor with Van Kampen Merritt and a Portfolio Manager with Aon Corporation from May 1981 to May 1987.
Ernest T. Giambra, Jr. was elected Senior Vice President of the Company in June 1993. Prior to joining the Company, Mr. Giambra had been with Bankers Life Holding Corporation since 1969 where he had served as Vice President of Sales since 1988.
David I. Vickers has been with the Company since June 1992 and has been a Vice President of the Company since December 1992, Treasurer since May 1993 and Chief Financial Officer since January 1994. He is also an Officer and Director of several subsidiaries of the Company. Prior to joining the Company he was with the public accounting firm of Ernst & Young since 1983 where he was a Senior Manager in the Insurance Division. Mr. Vickers also serves as Treasurer for certain of the Company's insurance subsidiaries.
Michael A. Cavataio has been a Director of the Company since 1986. Mr. Cavataio has also been President of Lillians, a chain of retail clothing stores, since 1980.
Richard R. Haldeman has been a Director of the Company since 1986 and was Secretary from 1988 to June 1990. Mr. Haldeman has been a partner of Haldeman & Associates, a law firm, since June 1990. He was a partner of Williams & McCarthy, P.C., a law firm, from 1975 to May 1990.
R. Richard Bastian, III has been a Director of the Company since December 1994. Mr. Bastian is a management consultant, specializing in strategic planning and organizational development. Mr. Bastian's career includes over twenty-eight years in the financial services industry, most recently as President and Chief Executive Officer of Heritage Bank & Trust of Racine, Wisconsin. Prior to Heritage, he served as Chairman, President and Chief Executive Officer of Bank One, Rockford and its predecessor, First Community Bancorp, an $800 million multi-bank holding company. He has also held management positions at banks in Tulsa and Philadelphia where his banking career began in 1966.
Karl-Heinz Klaeser has been a Director of the Company since 1986. Mr. Klaeser has also been a Director of LSW Holding Corporation and Insurance Investors Life Insurance Company and the Chairman of the Board of Life Insurance Company of the Southwest since 1989 and a Director of Personal Assurance Company PLC (United Kingdom) since 1991.
Michael K. Keefe has been a Director of the Company since March 1994. Mr. Keefe has been Chief Executive Officer and Chairman of the Board of Keefe Real Estate, Inc., a family owned real estate brokerage operation since 1982. Mr. Keefe has also been Chairman of the Board of Southern Wisconsin Bankshares, Inc. since 1988.
Robert F. Nauert has been a Director of the Company since November 1991. Mr. Nauert has also been a Director and President of Pioneer Life since 1988 and is a Director and Officer of various subsidiaries of the Company. Mr. Nauert is the brother of Peter W. Nauert.
Carl A. Hulbert was elected Director of the Company in March 1995. Mr. Hulbert is a management consultant, specializing in the insurance industry. Mr. Hulbert is a past Insurance Commissioner of the state of Utah. He has also been a Director for numerous insurance companies during his 49 year business career.
Item 2.



Item 2. Properties -------------------
The principal executive offices of the Company are located in Schaumburg, Illinois in a building purchased by the Company in January 1994. The Company, through a subsidiary, owns three buildings in Rockford, Illinois. The Company believes these facilities will adequately serve its needs for the foreseeable future and could accommodate expansion of the Company's business. The Company, through another subsidiary, also owns a building in the Dallas, Texas metropolitan area which currently serves as the main administrative office for the Company's Group Medical Division. The Company leases the office of its other regional service centers. The executive and administrative offices of Manhattan National Life are located in Cincinnati, Ohio in leased space.
Item 3.

Item 3. Legal Proceedings --------------------------
The Company and its subsidiaries are named as defendants in various legal actions, some claiming significant damages, arising primarily from claims under insurance policies, disputes with agents, and other matters. The Company's management and its legal counsel are of the opinion that the disposition of these actions will not have a material adverse effect on the Company's financial position.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders ------------------------------------------------------------
NONE
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholders Matters -----------------------------------------------------------------------
The Company's Common Stock is traded on the New York Stock Exchange and Chicago Stock Exchange. The following table sets forth, for the periods indicated, the high and low last reported sale prices for the Common Stock on the New York Stock Exchange as reported on the consolidated transaction reporting system.
High Low -------- ------- Quarter ended:
March 31, 1993.............. 5 1/2 4 3/4 June 30, 1993............... 9 1/8 5 1/4 September 30, 1993.......... 10 7/8 8 3/8 December 31, 1993........... 14 10 1/2
March 31, 1994.............. 14 3/4 11 1/8 June 30, 1994............... 12 10 September 30, 1994.......... 10 1/2 8 3/4 December 31, 1994........... 10 8 3/4
As of December 31, 1994, there were approximately 550 holders of record of the Company's Common Stock.
On March 18, 1994, the Company's Board of Directors announced a quarterly common stock dividend of 3.75 cents per share with a total of 15 cents per share paid in 1994.
On March 18, 1995, the Company's Board of Directors announced a quarterly common stock dividend of 4.5 cents per share with an expectation of a total of 18 cents per share to be paid for 1995.
Item 6.

Item 6. Selected Consolidated Financial Data ---------------------------------------------
The following selected consolidated financial data for the five years ended December 31, 1994; are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.
(In thousands except per share amounts) Year Ended December 31, -------------------------------------------- 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------
Operating Data:
Accident and health premiums$659,180 $601,684 $559,894 $593,236 $508,957 Life and annuity premiums and policy charges 44,929 39,282 35,219 33,321 30,693 Net investment income 42,786 40,242 43,555 47,974 48,416 Other income and realized
investment gains/losses 27,260 17,920 17,305 34,207 22,951 ------- ------- ------- ------- ------- Total revenues 774,155 699,128 655,973 708,738 611,017
Accident and health benefits 407,249 397,963 368,046 376,820 367,790 Life and annuity benefits 42,947 39,419 47,622 46,128 46,889 ------- ------- ------- ------- ------- Total benefits 450,196 437,382 415,668 422,948 414,679 ------- ------- ------- ------- ------- Total benefits and expenses 748,133 680,364 681,409 695,418 625,178 ------- ------- ------- ------- -------
Income (loss) before income taxes 26,022 18,764 (25,436) 13,320 (14,161)
Net income (loss) 17,149 12,145 (16,959) 8,872 (9,346)
Preferred stock dividends 1,904 2,021 2,039 2,039 2,164 ------- -------- ------- -------- --------
Income (loss) applicable to common stockholders $15,245 $ 10,124 $(18,998) $ 6,833 $(11,510) ======= ======== ========= ======== =========
Net income (loss) per common share Primary $ 2.36 $ 1.51 $(2.85) $ 1.02 $(1.72) Fully diluted 1.58 1.26 (2.85) 1.02 (1.72)
Dividends declared per common share .15 - - - -
Average common and common equivalent shares outstanding Primary 6,459 6,724 6,660 6,699 6,690 Fully diluted 12,734 10,731 8,195 8,234 8,226
(In thousands except per share amounts) December 31, ------------------------------------------- Balance Sheet Data 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------
Total investments $723,837 $674,206 $568,349 $528,725 $563,807 Deferred policy acquisition costs 225,618 260,432 269,674 313,453 309,016 Total assets 1,075,700 1,108,271 978,689 969,190 990,560 Policy liabilities 868,608 903,105 805,696 776,571 739,845 Short-term notes payable 20,093 5,575 12,931 6,371 16,218 Long-term notes payable 2,520 1,125 25,170 21,600 27,000 Subordinated Debentures 57,427 57,477 - - - Redeemable Preferred Stock 21,682 23,675 23,990 23,990 23,990 Stockholders' equity 68,328 68,872 62,732 75,470 64,738 Stockholders' equity per common share $ 11.55 $ 10.86 $ 9.21 $ 11.39 $ 9.77
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations -------------------------------------------------------------------------
RESULTS OF OPERATIONS
1994 COMPARED TO 1993
DIVISION OVERVIEW -----------------
The income (loss) before income taxes by Division for 1994 and 1993 is as follows (in thousands):
1994 1993 ---- ----
Group Medical $ 10,889 $ 6,528 Senior Health 13,420 12,255 Life Insurance 8,537 7,623 Medical Utilization Mgmt 2,026 (1,211) Corporate (8,850) (6,431) -------- -------- Total $ 26,022 $ 18,764 ======== ========
GROUP MEDICAL -------------
The increase in pre-tax income for 1994 was due primarily to inclusion of the profits of Continental Life & Accident Company (CLAC), acquired in August 1993, and continued cost reduction plans. CLAC produced pre-tax profits of $2,787,000 in 1994 compared to a small loss in 1993.
The Division incurred a pre-tax charge of $1,700,000 in the third quarter of 1994 which was the net effect of a $16,700,000 adjustment to the deferred acquisition cost (DAC) asset and a reduction of group medical claim reserve margins of $15,000,000. Through its periodic review of the DAC asset, the Company recognized the impact of state healthcare reforms on the future profitability of certain of its group medical products. These reforms include mandated benefits, guaranteed issue requirements and limitations on premium rate increases. The Company identified blocks of this business that are not anticipated to achieve the future profit margins originally assumed.
The Company has also historically held margins in its group accident and health claim reserves to provide for potential adverse deviation. The claim reserve estimates are continually reviewed and adjusted as necessary. Based on payments through the first nine months of 1994, the Company determined that claim reserves contained significantly higher margins than originally projected. As a result, claim reserve margins of $15,000,000 were released in the third quarter of 1994. The Company continues to hold additional margins which it considers to be reasonable in its group medical claim reserves.
SENIOR HEALTH -------------
The increase in pre-tax income was due to the reduction in loss ratios, from 63.5% to 61.1%, primarily on a mature block of nursing home business and realized investment gains compared to realized losses of $2,520,000 in 1993.
The improvements were offset by a 6.8% reduction in collected premium revenue during 1994.
LIFE INSURANCE --------------
The increase in pre-tax income for the Life Insurance Division was due to a substantial increase in new sales, improved spreads on interest sensitive business, and a slight improvement in the unit cost per policy. Despite the decline in the average annual investment yield in 1994, the Division continued to aggressively manage the interest rate crediting strategy. The unit cost per policy improved 5% to approximately $76 in 1994 as compared to $80 in 1993. The mortality was consistent with levels experienced in 1993. Realized investment losses were $158,000 in 1994 compared to realized investment gains of $621,000 in 1993.
MEDICAL UTILIZATION MANAGEMENT ------------------------------
The improvement in pre-tax profitability of this Division in 1994 compared to losses experienced in 1993 was due to the elimination of an unprofitable operating subsidiary in the fourth quarter of 1993 and a significant increase in new sales to unaffiliated customers. The revenue from unaffiliated customers increased 131% to $10,416,000 in 1994 of which 53% or $5,498,000 was related to the 1993 acquisition of Healthcare Review Corporation. The consolidation of certain operations in July 1994 resulted in reduced expense levels the second half of the year.
CORPORATE EXPENSE AND INTEREST ------------------------------
Interest expense increased in 1994 as compared to 1993 due to the issuance of the convertible subordinated debentures in July 1993 and the increase in other notes payable in 1994.
CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS ----------------------------------------------------------
The Company reported net income of $17,149,000 for the twelve months ended December 31, 1994, compared to $12,145,000 for the comparable period in 1993. The increase was due to profits from Continental Life & Accident Company (CLAC), improved loss ratios in the Senior Health Division, expense reductions and improved spreads in the Life Insurance Division, and increased revenue and margins in the Medical Utilization Management Division.
Total revenues increased $75,027,000 or 11% for the twelve month period in 1994 as compared to 1993. The increase in revenue is primarily due to the increase in premiums and policy charges of $63,143,000.
Accident and health insurance premiums increased $57,496,000, or 10% in 1994 as compared to 1993. Premiums from major hospital plans increased $81,472,000 in 1994 as compared to 1993 primarily due to the acquisition of CLAC completed in August 1993. Total premiums attributable to the remaining mix of Medicare supplement and long-term care products decreased $23,976,000 or 4%.
Net investment income increased $2,544,000 or 6% in 1994 compared to 1993. Annualized investment yields decreased from 6.8% in 1993 to 6.3% in 1994. The decrease in the investment yield was principally due to the
shortening of the Company's average duration and the increased emphasis on tax-exempt securities included in the Company's portfolio.
Other income and realized investment gains and losses increased $9,340,000 or 52% in 1994 compared to 1993. The increase in other income was due to the acquisitions of Healthcare Review Corporation (HRC) and CLAC in August 1993. In addition, the Company realized increased sales to unaffiliated customers in the Medical Utilization Management Division and by its marketing subsidiaries. Realized investment losses were $383,000 in 1994 compared to $1,336,000 in 1993. The remaining other income generated by the Company's other non-insurance subsidiaries remained relatively unchanged.
Total benefits increased $12,814,000 or 3% in 1994 as compared to 1993. Life and annuity benefits increased $3,528,000 or 9% in 1994 as compared to 1993 due to higher mortality on a closed block of universal life and an increase in in-force business. Accident and health benefits, which include the change in unearned premiums, increased $9,286,000 or 2%. The increase was due primarily to the increased amount of collected premiums. The accident and health loss ratios decreased to 62% from 66% in 1994 as compared to 1993. The improved loss ratios were due primarily to the previously discussed reduction in the group medical claim reserve margins.
In 1994 and 1993, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Division of $67,000,000 and $41,000,000, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows:
1994* 1993* ---- ----
PPOs (preferred provider organization) networks 40% 49% Precertification 10 5 Large case management 22 32 Usual and customary, rebundling, and prompt pay discounts 28 14 --- --- 100% 100% === ===
--------------------- * Percent of total estimated savings from managed healthcare efforts.
The Company expects to continue to emphasize medical utilization management procedures to control claim costs. Although the Company cannot accurately determine the amount of savings which may be realized from such efforts in the future, the Company believes that it will be increasingly difficult to maintain this level of growth in cost savings due to the efficiencies that have already been achieved.
General expenses as a percent of premiums decreased in 1994 as compared to 1993 due to the continued emphasis on cost reduction in the Health and Life Insurance Divisions. However, insurance and general expenses (which include commission compensation to agents) increased $29,979,000 or 18% in 1994 compared to 1993. The increase was primarily caused by the increase in premium and policy charges and the acquisitions of HRC and CLAC.
Interest expense increased in 1994 due to the issuance of the convertible subordinated debentures in July 1993 and the increase in other notes payable in 1994.
Amortization of deferred policy acquisition costs (DAC) increased $23,198,000 or 30% in 1994 as compared to 1993. The increase was due primarily to the adjustment in the DAC asset on group and individual medical business issued in recent years. These blocks of business have achieved lower margins than expected due primarily to mandated state healthcare reforms. The Company is now assuming a lower level of profitability on these blocks. The Company continues to monitor the profitability of its business. Increased lapses or unprofitability on the business could result in an increase in the amortization rate of DAC, which would adversely impact future earnings.
The effective tax rate of the Company decreased to approximately 34% in 1994 from 35% in 1993. The decrease was due to the increased investment in tax-exempt securities included in the Company's portfolio and net operating loss carryforwards utilized from CLAC.
The Company acquired the building containing its corporate headquarters in Schaumburg, Illinois, in January 1994 resulting in the increase in investment real estate. Cash decreased due to increased investment in short- term investments. Reinsurance receivables decreased due to the timing of payments due from reinsurers. Deferred policy acquisition costs decreased as a result of the third quarter write-down and the decrease in new business issues in 1994. General expenses and other liabilities decreased due to the timing of payments for federal income taxes and amounts due to reinsurers. Notes payable increased due to the utilization of the line of credit by the Company.
1993 COMPARED TO 1992
CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS ----------------------------------------------------------
The Company reported net income of $12,145,000 for the twelve months ended December 31, 1993, compared to a net loss of $16,959,000 for the comparable period in 1992. The net loss for 1992 was primarily attributable to a $30,000,000 pre-tax write-down of deferred policy acquisition costs. The remaining increase was due to improved loss ratios on the Medicare supplement business, expense reductions in the Life Insurance Division and increased revenue and margins in the Group Medical Division.
Total revenues increased $47,751,000 or 7% for the twelve month period in 1993 as compared to 1992. The increase in revenue is due to the increase in premiums and policy charges of $50,449,000 which was partially offset by reduced levels of net investment income.
Accident and health insurance premiums increased $41,790,000, or 7%, in 1993 as compared to 1992. Premiums from major hospital plans increased $56,694,000 in 1993 as compared to 1992 due to rate increases implemented in 1993, and approximately $11,000,000 from the acquisition of Continental Life & Accident Company. Offsetting the increase was a decline in Medicare supplement premiums of $9,176,000 due to lower than anticipated new sales and a $3,496,000 decrease in premiums of specialty health care plans. Life and annuity premiums and policy charges increased $8,659,000 due to an increase in new life sales during 1993.
Net investment income decreased $3,313,000 or 8% in 1993 compared to 1992. Annualized investment yields decreased from 7.9% in 1992 to 6.8% in 1993. The decrease in investment yield was due to the general decline in current interest rates and a higher quality portfolio with a shortened duration.
Other income and realized investment gains and losses increased $615,000, or 4% in 1993 as compared to 1992. Other income increased $1,904,000 in 1993 due to increased sales to unaffiliated customers in both the Group Medical Division and the Medical Utilization Management Division. Realized investment losses increased $1,289,000 due to write-downs on certain mortgage-backed derivative securities.
Total benefits increased $26,310,000 or 6% in 1993 as compared to 1992. Life and annuity benefits decreased $3,607,000 or 8% due to the general decline in credited rates during 1993 and improved mortality over the higher levels experienced during 1992. Accident and health benefits, which includes the change in unearned premiums, increased $29,917,000 or 8% in 1993 as compared to 1992. The change was primarily due to the 7% increase in accident and health premiums. The Company's accident and health loss ratios were unchanged over 1992 at 66%. The improved loss ratios on the Medicare supplement business were offset by the fourth quarter loss ratio on Continental Life & Accident business of 79%. The Company is attempting to control claim costs on this block of business by implementing additional managed healthcare efforts.
In 1993 and 1992, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Unit of $41,000,000 and $27,000,000, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows:
1993* 1992* ---- ---- PPOs (preferred provider organization) networks 49% 64% Precertification 5 17 Large case management 32 11 Other 14 8 ___ ___ 100% 100% === ===
----------------
* Percent of total estimated savings from managed healthcare efforts.
Amortization of deferred policy acquisition costs (DAC) decreased $23,840,000, or 24%, in 1993 as compared to 1992. The decrease was due to the $30,000,000 pre tax write-down of DAC in the fourth quarter of 1992 primarily on major medical policies sold in the self-employed and small business owner market. The 1993 amortization rate on Medicare supplement is higher than 1992 because of the accelerated rate increase implementation which occurred in 1993.
The Company's effective tax rate was approximately 35% in 1993. The Company recorded a tax benefit for 1992 due to the operating loss incurred. The effective federal income tax rate increased in 1993 due to the Revenue
Reconciliation Act of 1993.
Effective January 1, 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." FASB Statement No. 113 requires that reinsurance receivables, including amounts related to claims incurred but not reported, and prepaid insurance premiums, be reported as assets as opposed to reductions in the related liabilities. As a result of the adoption of FASB Statement No. 113, amounts on deposit and due from reinsurers and policy liabilities each increased $19,453,000 at December 31, 1993.
Effective January 1, 1993, the Company also changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109 "Accounting For Income Taxes." The cumulative effect of adopting FASB Statement No. 109 was not significant.
Investments, equipment, policy liabilities, and general expenses and other liabilities increased due to the acquisition of Continental Life & Accident. Other assets increased primarily due to expenses capitalized in conjunction with the public offering of the convertible subordinated debentures.
DEFERRED POLICY ACQUISITION COSTS
Under generally accepted accounting principles, a deferred acquisition cost asset (DAC) is established to properly spread the acquisition costs for a block of policies against the expected future revenues from the policies. The acquisition costs which are capitalized and amortized consist of first year commissions in excess of renewal commissions and certain home office expenses related to selling, policy issue, and underwriting.
The deferred acquisition costs for accident and health policies and traditional life policies are amortized over future revenues of the business to which the costs are related. The rate of amortization depends on the expected pattern of future revenues for the block of policies. The scheduled amortization for a block of policies is established when the policies are issued.
The amortization schedule is based on the expected persistency and profitability of the policies. The actual amortization of DAC reflects the actual persistency and profitability of the business. For example, if actual policy terminations are higher than expected or actual profits are lower than originally assumed, DAC could be amortized more rapidly than originally scheduled.
EFFECT OF INFLATION
In pricing its insurance products, the Company gives effect to anticipated levels of inflation; however, the Company believes that the high rate of medical cost inflation during recent years had an adverse impact on its major hospital accident and health claims experience. The Company continues to implement rate increases in response to this experience.
LIQUIDITY AND CAPITAL RESOURCES
The Company's consolidated liquidity requirements are created and met primarily by operations of its insurance subsidiaries. The insurance subsidiaries' primary sources of cash are premiums, investment income, and investment sales and maturities. The primary uses of cash are operating
costs, policy acquisition costs, payments to policyholders and investment purchases.
In addition, liquidity requirements of the Company are created by the dividend requirements of the $2.125 Preferred Stock, common stock dividends, interest payments on the Convertible Subordinated Debentures and other debt service requirements. The Company's liquidity requirements are met primarily by dividends declared by its subsidiaries. Payments of dividends by the insurance subsidiaries to the Company is subject to certain regulatory restrictions. (See Note 11 of the consolidated financial statements).
The Company's life and health insurance subsidiaries require capital to fund acquisition costs incurred in the initial year of policy issuance and to maintain adequate surplus levels for regulatory purposes. These capital requirements have been met principally from internally generated funds, including premiums and investment income, and capital provided from reinsurance and the financing or sale of agent debit balances.
The Company has offered agent commission financing to certain of its agents and marketing organizations which consists primarily of annualization of first year commissions. This means that when the first year premium is paid in installments, the Company will advance a percentage of the commissions that the agent would otherwise receive over the course of the first policy year. The Company through a subsidiary has entered into agreements with an unaffiliated corporation to provide financing for its agent commission financing program through the sale of agent receivables. Proceeds from such sales during 1994 and 1993 were $24,393,0l00 and $25,376,000, respectively. The termination date of the current program is December 31, 1997, subject to extension or termination as provided therein.
In July 1993 the Company issued $57,477,000 of 8% convertible subordinated debentures due 2000. Net proceeds from the offering totaled $54,000,000. The debentures are convertible into the Company's common stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share.
In August 1993 a subsidiary of the Company borrowed $1,500,000 to finance the acquisition of Healthcare Review Corporation. Interest on the note is payable quarterly at six percent. The note requires principal repayments of $75,000 per quarter through July 31, 1998.
Short-term notes payable included $18,950,000 at December 31, 1994, drawn under a line of credit arrangement. In March 1995, $15,000,000 of the line of credit was replaced with a five year term loan. The remaining balance under the line of credit is due in October 1995.
At December 31, 1994, a subsidiary of the Company had an unsecured loan of $1,125,000. The portion of the loan due in 1995 of $300,000 is included in short-term notes payable. The remainder of the note is included in long- term notes payable. The note bears interest currently at prime and is payable quarterly with the final payment due July 1998.
At December 31, 1994 a subsidiary of the Company had two unsecured loans totaling $2,275,000. The portion of the loans due in 1995 of $580,000 is included in short-term notes payable. The remainder of the notes are included in long-term notes payable. The notes bear interest at prime and are payable quarterly with the final payment due December 1999. The Company has guaranteed payment of the notes.
In March, June, September and December 1994, the Company's Board of Directors announced a quarterly Common Stock dividend of $.0375 per share, for a total of 15 cents per share to be paid for 1994.
The concept of risk-based capital has been adopted for regulatory monitoring of the life and health insurance industry. Risk based capital standards are used by regulators to set in motion appropriate regulatory actions relating to insurers which show signs of weak or deteriorating conditions. The Company's insurance subsidiaries, total adjusted capital, authorized control risk based capital, and related ratio by company as disclosed in the 1994 annual statement are as follows:
Authorized Adjusted Control Company Capital Level RBC RBC Ratio ------ -------- ---------- --------- (Dollars in thousands) Pioneer Life Insurance Company of Illinois $87,591 $25,595 342%
Manhattan National Life Insurance Company 43,096 4,974 866%
National Group Life Insurance Company 42,932 10,461 410%
Continental Life & Accident Company 17,518 5,205 337%
Health and Life Insurance Company of America 3,921 273 1,440%
Interest paid amounted to $4,950,000, $1,023,000 and $2,274,000 for 1994, 1993, and 1992, respectively.
Management believes that the diversity of the Company's investment portfolio and the liquidity attributable to the large concentration of investments in highly liquid United States government agency securities provide sufficient liquidity to meet foreseeable cash requirements. Prior to January 1, 1994, the Company's fixed maturity portfolio was segregated into two components: fixed maturities held-to-maturity and fixed maturities available-for-sale. Fixed maturities, where the intent was to hold to maturity, were carried at amortized cost, adjusted for other-than-temporary impairments. Fixed maturities that were available for sale were carried, on an aggregate basis, at the lower of amortized cost or fair value.
In 1993, the Financial Accounting Standards Board (FASB) issued Statement 115, "Accounting for Certain Investments in Debt and Equity Securities." Statement 115 requires that fixed maturity securities are to be classified as either held-to-maturity, available-for-sale, or trading. The Company adopted Statement 115 as of January 1, 1994, with no effect on net income and a $3,605,000 increase in stockholders' equity.
The Company believes that it has the ability and intent to hold to maturity its fixed maturity investments that are classified as "held-to- maturity." However, the Company also recognizes that there may be circumstances where it may be appropriate to sell a security prior to maturity in response to unforeseen changes in circumstances. Recognizing the need for the ability to respond to changes in market conditions and in tax
position, the Company has designated a portion of its investment portfolio as available-for-sale. As required by Statement 115, the Company adjusted the carrying value of it fixed maturity investments that are classified as investments available-for-sale to fair value at January 1, 1994.
At January 1, 1994, the remainder of the Company's portfolio of fixed maturity investments was classified as held-to-maturity. Although the Company has the ability and intent to hold those securities to maturity, there could occur infrequent and unusual conditions under which it would sell certain of those securities. Those conditions would include unforeseen changes in asset quality, significant changes in tax law affecting the taxation of securities, a significant business acquisition or disposition, and changes in regulatory capital requirements or permissible investments.
Life insurance and annuity liabilities are generally long term in nature although subject to earlier surrender as a result of the policyholder's ability to withdraw funds or surrender the policy, subject to surrender and withdrawal penalties. The Company believes its policyholder liabilities should be backed by an investment portfolio that generates predictable investment returns. The Company seeks to limit exposure to risks associated with interest rate fluctuations by concentrating its invested assets principally in high quality, readily marketable debt securities of intermediate duration and by attempting to balance the duration of its invested assets with the estimated duration of benefit payments arising from contract liabilities.
INVESTMENT PORTFOLIO
At December 31, 1994, the Company had invested assets of $723,837,000, compared to $674,206,000 at December 31, 1993. The Company manages all of its investments internally with resource and evaluation assistance provided by independent investment consultants. Government and mortgage-backed obligations and corporate fixed maturity securities collectively comprised approximately 83% and 87% of the Company's investment portfolio at December 31, 1994 and 1993, respectively. The remainder of the invested assets were in short-term investments, equity securities, real estate, policy loans and mortgage loans.
Fixed Maturity Investments. With the adoption of risk based capital rules and consumer concerns over insurance company solvency and financial stability, the asset quality of insurance companies' investment portfolios has become of greater concern to policyholders and has come under closer scrutiny by insurance regulators and investors. In response, the Company holds investments in below-investment grade fixed maturity securities in an amount less than 1% of its invested assets at December 31, 1994. This reduction resulted from sales and writedowns of the carrying value of such securities in prior periods, and the elimination of new purchases. The Company has a policy not to invest more than 4% of its admitted assets in securities below investment grade.
Investments in below-investment grade fixed maturity securities generally have greater risks (and potentially greater returns) than other corporate fixed maturity investments. Risk of loss upon default by the issuer is significantly greater for these securities because they are generally unsecured and are often subordinated to other creditors of the issuer, and because these issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. Also, the market for below-investment grade securities is less liquid and not as
actively traded as the market for investment grade securities.
The investment objectives of the Company are to maximize investment yield without sacrificing high investment quality and matched liquidity.
The Company continually evaluates the creditworthiness of each issuer of securities held in its portfolio. When the fair value of an individual security declines materially, or when the Company's ongoing evaluation indicates that it may be likely that the Company will be unable to realize the carrying value of its investment, significant review and analytical procedures are increased to determine the extent to which such declines are attributable to changing market expectations regarding general interest rates and inflation and other factors, such as a perceived increase in the credit risk of the issuer, a general decrease in a particular industry sector or an overall economic decline.
Declines in fair value attributable to factors other than market expectations regarding general interest rates and inflation are reviewed and analyzed in further detail to determine if the decline in value is other than temporary, and the carrying amount of the investment is reduced to its fair value based principally on available market prices. The amount of the reduction is reported as a realized loss on investments and the net fair value becomes the new cost basis of the investment. In addition, the Company reverses any accrued interest income previously recorded for the investment and records future interest income only when cash is received.
Yields recognized in future periods on such investments may be less than yields recognized on other investments and will be less than the yield expected when the fixed maturity security was originally purchased. The affect on net income from declines in interest income and portfolio yield from impaired securities in future periods will depend on many factors, including, in life insurance business, the level of interest rates credited to policyholder account balances. Inasmuch as interest rates credited to the Company's policyholders are typically only guaranteed for one year, the Company does not expect any material adverse affect on net income in future periods from declines in yields from impaired securities.
Mortgage-Related Securities. At December 31, 1994, the Company had $293,481,000, or 49%, of its fixed maturities portfolio in mortgage-related securities ($324,127,000 at December 31, 1993). The yield characteristics of mortgage-related securities differ from those of traditional fixed income securities. The major differences typically include more frequent interest and principal payments, usually monthly, and the possiblity that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty. The yields to maturity of the mortgage-related securities will be affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans.
In general, prepayments on the underlying mortgage loans, and subsequently the mortgage-related securities backed by these loans, increases when the level of prevailing interest rates declines significantly below the interest rates on such loans. When declines in interest rates occur, the proceeds from the prepayment of such securities are likely to be reinvested at lower rates than the Company was earning on such securities.
The Company's mortgage-related securities portfolio is well diversified as to collateral, maturity/duration and other characteristics. The majority
of the mortgage-related securities portfolio has the guarantee or backing of agencies of the United States government. Generally, the mortgage-related securities consist of pools of single-family, residential mortgages.
Derivative securities were acquired to protect the Company in the event of adverse interest rate fluctuations. The yields and fair values of the derivative securities are generally more sensitive to changes in interest rates and prepayments than other mortgage-related securities.
The Company's mortgage-related securities portfolio at December 31, 1994, included $84,016,000 of CMOs and pass-through certificates issued by non-government agencies ($37,049,000 at December 31, 1993). The Company's holdings consist solely of senior securities in the CMO structures which are collateralized by first mortgage liens on single family residences. These securities are rated AAA or AA by Standard & Poor's, or the comparable equivalent rating by another independent nationally recognized rating agency.
The creditworthiness of these securities is based solely on the underlying mortgage loan collateral and credit enhancements in the form of senior/subordinated structures, letters of credit, mortgage insurance or surety bonds. The underlying mortgage loan collateral principally consists of whole loan mortgages that exceed the maximum imposed by both the Federal National Mortgage Associaton and the Federal Home Loan Mortgage Corporation and, as such, the collateral tends to be concentrated in states with the greatest number of higher priced single family residences, including California, New York, New Jersey, Maryland, Virginia and Illinois. The maximum average loan-to-value ratio for the collateral is 80%.
The following table summarizes the components of the Company's mortgage- related securities portfolio at December 31, 1994, and December 31, 1993 (in thousands):
December 31, 1994 December 31, 1993 ----------------- ----------------- Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- -----
Inverse floaters and interest only CMO tranches $ 14,961 $ 8,940 $ 18,954 $ 13,551 Accrual bonds: U.S. government agency - - 6,968 7,386
Other CMOs: U.S. government agency 151,697 137,138 187,871 190,141 Non-government agency 29,379 27,404 21,154 21,919 ------- ------- -------- -------- Total other CMOs 181,076 164,542 209,025 212,060
U.S. government agency pass-through 42,807 39,414 73,285 74,004 Non-government agency pass-through 54,637 50,555 15,895 16,041 -------- ------- -------- -------- Total mortgage-backed securities $293,481 $263,451 $324,127 $323,042 ======== ======== ======== ========
RECENTLY ISSUED ACCOUNTING STANDARDS
For a discussion of a new investments accounting standard, a new income tax accounting standard and a new reinsurance accounting standard and the
impact these standards had on the financial statements of the Company, see Note 2 of Notes to Consolidated Financial Statements.
Item 8.


Item 8. Financial Statements and Supplementary Data -----------------------------------------------------
Consolidated Financial Statements are included in Part IV, Item 14 of this report.
Item 9.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure -------------------------------------------------------------------------
Not applicable.
PART III
Item 10.



Item 10. Directors and Executive Officers of the Registrant ------------------------------------------------------------
The section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1995 annual meeting of stockholders entitled "Election of Directors" is incorporated herein by this reference.
For information on executive officers of the registrant, reference is made to the item entitled "Executive Officers of the Registrant" in Part I of this report.
Item 11.

Item 11. Executive Compensation --------------------------------
The section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1995 annual meeting of stockholders entitled "Executive Compensation" is incorporated herein by this reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------
The section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1995 annual meeting of stockholders entitled "Principal Holders of Securities" is incorporated herein by this reference.
Item 13.

Item 13. Certain Relationships and Related Transactions --------------------------------------------------------
The section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1994 annual meeting of stockholders entitled "Certain Transactions" is incorporated herein by this reference.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K -----------------------------------------------------------------
(a) Documents filed as a part of this report:
PIONEER FINANCIAL SERVICES, INC.
1. Financial Statements --------------------
Report of Independent Auditors . . . . . . . . . . . Consolidated Financial Statements . . . . . . . . . . . . Statements of Consolidated Operations . . . . . . Consolidated Balance Sheets . . . . . . . . . . . Statements of Consolidated Stockholders' Equity. . Statements of Consolidated Cash Flows . . . . . . Notes to Consolidated Financial Statements . . . .
2. Financial Statement Schedules -----------------------------
Schedule I - Consolidated Summary of Investments - Other Than Investments in Related Parties . . . . . .
Schedule II - Condensed Financial Information of Registrant - Condensed Balance Sheets . . . . . .
Schedule II - Condensed Financial Information of Registrant - Condensed Statements of Operations . . .
Schedule II - Condensed Financial Information of Registrant - Condensed Statements of Cash Flows. . . . . . . . . . . . . . . . . . . . . .
Schedule II - Note to Condensed Financial Statements Schedule III - Supplementary Insurance Information. . Schedule IV - Reinsurance . . . . . . . . . . . . . .
Schedule V - Valuation and Qualifying Accounts . . .
All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto.
3. Exhibits --------
See Exhibit Index below.
(b) Reports on Form 8-K -------------------
The Company filed no reports on Form 8-K during the fourth quarter of 1994.
(c) Index to Exhibits
-----------------
Exhibit Sequentially Number Description of Document Numbered Page ------ ----------------------- -------------
3 (a) Certificate of Incorporation of the Company (filed as Exhibit 3(a) to the Company's Registration Statement on Form S-1 (No. 33-7759) and incorporated herein by reference)
3 (b) Amended Bylaws of the Company (filed as Exhibit 3(b) to Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-30017) and incorporated herein by reference)
4 (a) Certificate of Designations with respect to the Company's $2.125 Cumulative Convertible Exchangeable Preferred Stock ("Preferred Stock") (filed as Exhibit 4(a) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-30017) and incorporated herein by reference)
4 (b) Proposed form of Indenture with respect to the Company's 8 1/2% Convertible Subordinated Debentures due 2014 into which the Preferred Stock is exchangeable (filed as Exhibit 4(b) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-30017) and incorporated herein by reference)
4 (c) Rights Agreement dated as of December 12, 1990 between the Company and First Chicago Trust Company of New York as Rights Agent (including exhibits thereto) (filed as Exhibit 1 to the Company's registration statement on Form 8-A dated December 14, 1990 and incorporated herein by reference)
10 (a) Form of contract with independent agents (filed as Exhibit 10(f) to the Company's Registration Statement on Form S-1 (No. 33-7759) and incorporated herein by reference)
*10 (b) Nonqualified Stock Option Plan (filed as Exhibit 10(g) to the Company's Registration Statement on Form S-1 (No. 33-7759) and incorporated herein by reference)
*10 (c) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(d)
to the Company's Registration Statement on Form S-8 (No. 33-26455) and incorporated herein by reference)
*10 (d) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(c) to the Company's Registration Statement on Form S-1 (No. 33-17011) and incorporated herein by reference)
*10 (e) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(e) to the Company's registration statement on Form S-8 (No. 33-37305) and incorporated herein by reference)
10 (f) Amended and Restated Receivables Purchase Agreement dated as of October 1, 1992 by and between Design Benefit Plans, Inc. (formerly National Group Marketing Corporation) and National Funding Corporation (filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)
*10 (g) Employment Agreement dated December 3, 1993 by and between the Company and Peter W. Nauert (filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)
10 (h) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and Pioneer Life Insurance Company of Illinois (filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)
10 (i) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and National Group Life (filed as Exhibit 10(w) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)
*10 (j) Employment Agreement dated December 31, 1991 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed as Exhibit 10(x) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)
*10 (k) Amendment to Employment Agreement dated March 26, 1993 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed as Exhibit 10(k) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)
*10 (l) Employment Agreement dated December 31, 1991 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed as Exhibit 10(y) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)
*10 (m) Amendment to Employment Agreement dated March 26, 1993 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed as Exhibit 10(m) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)
10 (n) Credit Agreement dated as of December 22, 1993 by and among the Company and American National Bank and Trust Company of Chicago, as Agent and American National Bank and Trust Company of Chicago, Firstar Bank Milwaukee, N.A. and Bank One, Rockford, N.A., as Banks (filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)
10 (o) Stock Purchase Agreement dated November 21, 1994 among the Company, United Life Holdings, Inc. and GRENEL Financial Corporation (filed as Exhibit 2(a) to the Company Current Report on Form 8-K, dated January 31, 1995 and incorporated herein by reference)
10 (p) Second Amended and Restated Receivables Purchase Agreement dated as of October 1, 1994 by and between Design Benefit Plans, Inc. (formerly National Group Marketing Corporation) and National Funding Corporation (filed herewith)
10 (q) Consent and Agreement dated as of October 1, 1994 among Design Benefit Plans, Inc., Pioneer Financial Services, Inc., American National Bank and Trust Company of Chicago, and National Funding Corporation (filed herewith)
11 Statement of Computation of per share net income or loss (filed herewith)
21 List of subsidiaries (filed herewith)
23 Consent of Ernst & Young LLP (filed herewith)
27 Financial Data Schedule
* Indicates management employment contracts or compensatory plans or arrangements.
Report of Independent Auditors
Board of Directors Pioneer Financial Services, Inc.
We have audited the accompanying consolidated balance sheets of Pioneer Financial Services, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related statements of consolidated operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits 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 Pioneer Financial Services, Inc. and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 1994, the Company changed its method of accounting for investments in debt and equity securities.
ERNST & YOUNG LLP Chicago, Illinois March 22, 1995
Pioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Operations (In Thousands, Except Per Share Amounts)
YEAR ENDED DECEMBER 31 1994 1993 1992 ---- ---- ---- REVENUES Premiums and policy charges (Note 6): Accident and health $ 659,180 $ 601,684 $ 559,894 Life and annuity 44,929 39,282 35,219 --------- --------- --------- 704,109 640,966 595,113 Net investment income (Note 4) 42,786 40,242 43,555 Other income and realized investment gains and losses (Note 4) 27,260 17,920 17,305 --------- --------- --------- 774,155 699,128 655,973 BENEFITS AND EXPENSES Benefits: Accident and health 407,249 397,963 368,046 Life and annuity 42,947 39,419 47,622 --------- --------- --------- 450,196 437,382 415,668 Insurance and general expenses 192,810 162,831 162,837 Interest expense (Notes 9 and 12) 5,054 3,276 2,189 Amortization of deferred policy acquisition costs (Note 10) 100,073 76,875 100,715 --------- --------- --------- 748,133 680,364 681,409 --------- --------- --------- Income (loss) before income taxes 26,022 18,764 (25,436) Income taxes (benefit) (Note 5): Current 6,570 10,858 2,878 Deferred 2,303 (4,239) (11,355) --------- --------- --------- 8,873 6,619 (8,477) --------- --------- --------- Net income (loss) 17,149 12,145 (16,959)
Preferred stock dividends (Note 13) 1,904 2,021 2,039 --------- --------- --------- Income (loss) applicable to common stockholders $ 15,245 $ 10,124 $ (18,998) ========= ========== =========
Net income (loss) per common share: Primary $ 2.36 $ 1.51 $ (2.85) Fully diluted 1.58 1.26 (2.85)
Dividends declared per common share .15 - -
Average common and common equivalent shares outstanding: Primary 6,459 6,724 6,660 Fully diluted 12,734 10,731 8,195
See notes to consolidated financial statements.
Pioneer Financial Services, Inc. and Subsidiaries Consolidated Balance Sheets (In Thousands, Except Share and Per Share Amounts)
DECEMBER 31 1994 1993 -------------------- ASSETS
Investments (Note 4 and 19): Securities available-for-sale: Fixed maturities, at fair value $218,748 Fixed maturities, at cost - $257,717 Equity securities, at fair value 15,440 17,436 Fixed maturities held-to-maturity, principally at amortized cost 378,650 326,512 Real estate - at cost, less accumulated depreciation 16,959 - Mortgage loans at unpaid balance 1,806 3,201 Policy loans at unpaid balance 23,082 23,988 Short-term investments at cost, which approximates fair value 69,152 45,352 ---------- ---------- Total investments 723,837 674,206
Cash 8,612 23,379 Premiums and other receivables, less allowance for doubtful accounts (Notes 7 and 18) 20,102 20,734 Reinsurance receivables and amounts on deposit with reinsurers (Note 6) 41,426 74,366 Accrued investment income 8,873 8,482 Deferred policy acquisition costs (Note 10) 225,618 260,432 Land, building, and equipment at cost, less accumulated depreciation (Note 18) 20,314 22,248 Deferred federal income taxes (Note 5) 7,262 3,922 Other 19,656 20,502 ---------- ----------
$1,075,700 $1,108,271 ========== ==========
DECEMBER 31 1994 1993 --------------------
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS' EQUITY Policy liabilities: Future policy benefits: Life $246,953 $244,249 Annuity 210,132 208,155 Accident and health 163,477 158,330 Unearned premiums 76,266 87,945 Policy and contract claims (Note 8) 155,373 189,389 Other 16,407 15,037 ---------- ----------- 868,608 903,105 General liabilities: General expenses and other liabilities 37,042 48,442 Short-term notes payable (Notes 9, 21 and 22) 20,093 5,575 Long-term notes payable (Notes 9, 19, 21 and 22) 2,520 1,125
Convertible subordinated debentures (Notes 12 and 19) 57,427 57,477 ---------- ----------- Total liabilities 985,690 1,015,724
Commitments and contingencies (Notes 5 to 11 and 16)
Redeemable Preferred Stock, no par value (Note 13): $2.125 cumulative convertible exchangeable preferred stock: Authorized: 5,000,000 shares Issued and outstanding: (1994 - 867,300 shares; 1993 - 947,000 shares) 21,682 23,675
Stockholders' equity (Notes 5 and 11 to 15): Common Stock, $1 par value: Authorized: 20,000,000 shares Issued, including shares in treasury (1994 - 6,996,157; 1993 - 6,900,000) 6,996 6,900 Additional paid-in capital 29,299 28,814 Unrealized appreciation (depreciation) of available-for-sale securities (Notes 2 and 4) (7,193) 3,285 Retained earnings 48,960 34,645 Treasury stock at cost (1994 - 1,078,400 shares; 1993 - 556,800 shares) (9,734) (4,772) ---------- ----------- Total stockholders' equity 68,328 68,872 ---------- ----------- $1,075,700 $1,108,271 ========== ===========
See notes to consolidated financial statements.
Pioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Stockholders' Equity (In Thousands, Except Share and Per Share Amounts)
Pioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Cash Flows (In Thousands)
YEAR ENDED DECEMBER 31 1994 1993 1992 ---- ---- ---- OPERATING ACTIVITIES Net income (loss) $ 17,149 $ 12,145 $ (16,959) Adjustments to reconcile net income or loss to net cash provided by operating activities: Decrease (increase) in premiums receivable 4,981 (3,912) 5,673 Increase (decrease) in policy liabilities (34,498) 31,132 12,734 Deferral of policy acquisition costs (65,258) (67,633) (56,936) Amortization of deferred policy acquisition costs (Note 10) 100,073 76,875 100,715 Deferred income tax expense (benefit) 2,303 (4,239) (11,355) Change in other assets and liabilities 21,392 (13,423) (10,597) Depreciation, amortization, and accretion (102) 9,795 10,303 Realized losses (Note 4) 383 1,336 47 --------- ---------- --------- Net cash provided by operating activities 46,423 42,076 33,625
INVESTING ACTIVITIES Securities available-for-sale: Purchases - fixed maturities (110,416) (120,228) (29,001) Sales - fixed maturities 99,865 51,780 13,367 Maturities - fixed maturities 44,116 18,836 17,106 Purchases - equity securities (4,609) (5,532) (4,085) Sales - equity securities 2,558 14,845 13,651 Securities held-to-maturity: Purchases (84,010) (256,579) (587,931) Sales 9,427 126,072 424,404 Maturities 21,472 102,535 90,453 Purchase of investment real estate (17,442) - - Net decrease (increase) in other investments (21,499) 26,038 22,080 Net purchases of property and equipment (2,957) (3,956) (4,434) Purchase of subsidiaries including a cash overdraft of $1,019 (Note 3) - (9,685) - --------- ---------- --------- Net cash used by investing activities (63,495) (55,871) (44,390)
FINANCING ACTIVITIES Net proceeds from issuance of convertible subordinated debentures (Note 12) - 54,055 - Increase in notes payable 21,225 - 14,030 Repayment of notes payable (5,362) (31,401) (3,900) Proceeds from sale of agent receivables (Note 7) 24,393 25,376 20,347 Transfer of collections on previously sold agent receivables (Note 7) (28,743) (22,981) (22,437) Dividends paid - preferred (1,904) (2,021) (2,039) Dividends paid - common (930) - - Stock options exercised 495 451 165 Purchase of treasury stock (4,963) (4,720) (52) Retirement of preferred stock (1,993) (315) - Other 87 44 717 --------- ---------- --------- Net cash provided by financing activities 2,305 18,488 6,831 --------- ---------- ---------
Increase (decrease) in cash (14,767) 4,693 (3,934) Cash at beginning of year 23,379 18,686 22,620 --------- ---------- --------- Cash at end of year $ 8,612 $ 23,379 $ 18,686 ========= ========== =========
Pioneer Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) and include the accounts and operations, after intercompany eliminations, of Pioneer Financial Services, Inc. (PFS) and its subsidiaries.
INVESTMENTS
Prior to January 1, 1994, PFS' fixed maturity portfolio was segregated into two components: fixed maturities held-to-maturity and fixed maturities available-for-sale. Fixed maturities, where the intent was to hold to maturity, were carried at amortized cost, adjusted for other-than-temporary impairments. Fixed maturities that were available for sale were carried, on an aggregate basis, at the lower of amortized cost or fair value.
In 1993, the Financial Accounting Standards Board ("FASB") issued Statement 115, "Accounting for Certain Investments in Debt and Equity Securities." Statement 115 requires that fixed maturity securities are to be classified as either held-to-maturity, available-for-sale, or trading. PFS adopted Statement 115 as of January 1, 1994, with no effect on net income and a $3,605,000 increase in stockholders' equity (see Note 2).
PFS believes that it has the ability and intent to hold to maturity its fixed maturity investments that are classified as "held-to-maturity." However, PFS also recognizes that there may be circumstances where it may be appropriate to sell a security prior to maturity in response to unforeseen changes in circumstances. Recognizing the need for the ability to respond to changes in market conditions and in tax position, PFS has designated a portion of its investment portfolio as available-for-sale. As required by Statement 115, PFS adjusted the carrying value of its fixed maturity investments that are classified as investments available-for-sale to fair value at January 1, 1994.
At January 1, 1994, the remainder of PFS' portfolio of fixed maturity investments was classified as held-to-maturity. Although PFS has the ability and intent to hold those securities to maturity, there could occur infrequent and unusual conditions under which it would sell certain of those securities. Those conditions would include unforeseen changes in asset quality, significant changes in tax law affecting the taxation of securities, a significant business acquisition or disposition, and changes in regulatory capital requirements or permissable investments.
Sales of two held-to-maturity securities in 1994 with an amortized cost of $9,803,000 resulted after discussions with an insurance rating agency regarding specific investments of PFS' insurance subsidiaries and evidence of a significant deterioration in credit worthiness. Sales of these securities, all of which were owned at January 1, 1994, resulted in a realized loss of $376,000.
Subsequent to January 1, 1994, all securities purchased are designated for inclusion in either the available-for-sale or held-to-maturity categories based on PFS' intent and the nature of the securities purchased.
Changes in fair values of available-for-sale securities, after adjustment of deferred policy acquisition costs ("DAC"), if any, and deferred income taxes, are reported as unrealized appreciation or depreciation directly in stockholders' equity and, accordingly, have no effect on net income. DAC offsets to the unrealized appreciation or depreciation represent valuation adjustments or reinstatements of DAC that would have been required as a change or credit to operations had such unrealized amounts been realized.
The amortized cost of fixed maturity investments classified as available-for- sale and as held-to-maturity is adjusted for amortization of premiums and accretion of discounts. That amortization or accretion is included in net investment income.
For the mortgage-backed portion of the fixed maturity securities portfolio, PFS recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the security is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security. That adjustment is included in net investment income.
As regards equity securities, changes in unrealized appreciation or temporary depreciation, after deferred income tax effects, are reported directly in stockholders' equity.
Realized gains and losses on the sale of investments, and declines in value considered to be other-than-temporary, are recognized in operations on the specific identification basis.
REVENUES
Revenues for interest-sensitive life insurance and annuities consist of charges assessed against policy account values. For accident and health and other life insurance, premiums are recognized as revenue when due. Accident and health group association dues and fees, included in other revenues, are recognized as revenue when received.
FUTURE POLICY BENEFITS
The liabilities for future policy benefits related to the annuity and interest-sensitive life insurance policies are calculated based on accumulated fund values. As of December 31, 1994, interest credited during the contract accumulation period ranged from 5.0% to 8.0%. Investment spreads and mortality gains are recognized as profits when realized, based on the difference between actual experience and amounts credited or charged to policies.
The liabilities for future policy benefits on other life insurance and accident and health insurance policies have been computed by a net level method based on estimated future investment yield, mortality or morbidity, and withdrawals, including provisions for adverse deviation. Interest rate assumptions range from 3.5% to 8.5% depending on the year of issue. The provisions for future policy benefits and the deferral and amortization of policy acquisition costs are intended to result in benefits and expenses being associated with premiums proportionately over the policy periods.
UNEARNED PREMIUMS
Unearned premiums are calculated using the monthly pro-rata basis.
DEFERRED POLICY ACQUISITION COSTS
Costs that vary with, and are primarily related to, the production of new business are deferred. Such costs are primarily related to accident and health business and principally include the excess of new business commissions over renewal commissions and underwriting and sales expenses.
For annuities and interest-sensitive life insurance policies, deferred costs are amortized generally in proportion to expected gross profits arising from the difference between investment and mortality experience and amounts credited or charged to policies. That amortization is adjusted retrospectively when estimates of current or future gross profits (including the impact of realized investment gains and losses) to be realized from a group of products are revised. For other life and accident and health policies, costs are amortized over the premium-paying period of the policies, using the same mortality or morbidity, interest, and withdrawal assumptions that are used in calculating the liabilities for future policy benefits.
The unamortized cost of purchased insurance in force is included in DAC ($21,291,000 and $23,078,000 at December 31, 1994 and 1993, respectively). Amortization of these amounts is in relation to the present value of estimated gross profits over the estimated remaining life of the related insurance in force.
POLICY AND CONTRACT CLAIMS
The liabilities for policy and contract claims, principally accident and health, are determined using case-basis evaluations and statistical analyses based on past experience and represent estimates of the ultimate net cost of incurred claims and the related claim adjustment expenses. Although considerable variability is inherent in such estimates, management believes that these liabilities are adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations. PFS maintains an additional provision for adverse deviation in its accident and health claim liability estimates.
REINSURANCE
Reinsurance premiums, commissions, expense reimbursements, and receivables related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums reinsured to other companies have been reported as reductions of premium revenues. Amounts recoverable for reinsurance related to future policy benefits, unearned premium reserves, and claim liabilities have been reported as reinsurance receivables; expense allowances received in connection with reinsurance have been accounted for as a reduction of the related DAC and are deferred and amortized accordingly.
Acquisition costs relating to the production of new business result in a reduction of statutory-basis net income. PFS had entered into certain financial reinsurance agreements that had the effect of deferring this statutory-basis reduction and amortizing costs over future periods. The remaining effect of such reinsurance has been eliminated from the accompanying consolidated financial statements.
FEDERAL INCOME TAXES
Federal income tax provisions are based on income or loss reported for financial statement purposes and tax laws and rates in effect for the years presented. For 1992, deferred federal income taxes were provided for the differences between the recognition of income and loss determined for financial reporting purposes and income tax purposes. Effective January 1, 1993, deferred federal income taxes have been provided using the liability method an accordance with FASB Statement No. 109 "Accounting for Income Taxes." Under this method deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates. The cumulative effect of adopting Statement No. 109 as of January 1, 1993, was not significant and has not been separately disclosed.
DEPRECIATION
Building, equipment and investment real estate are recorded at cost and are depreciated using principally the straight-line method.
NET INCOME OR LOSS PER COMMON SHARE
Primary net income or loss per share of Common Stock is determined by dividing net income or loss, less dividends on Preferred Stock, by the weighted-average number of Common Stock and Common Stock equivalents (dilutive stock options) outstanding. Where the effect of Common Stock equivalents on net income or loss per share would be antidilutive, they are excluded from the average shares outstanding. Fully diluted net income or loss per share is computed as if the Preferred Stock and Convertible Subordinated Debentures had been converted to Common Stock. Where the effect of the assumed conversion on net income or loss per share would be antidilutive, fully diluted net income or loss per share represents the primary amount.
COST IN EXCESS OF NET ASSETS OF COMPANIES ACQUIRED
The cost in excess of net assets of companies acquired (goodwill) ($5,317,000 and $5,449,000 at December 31, 1994 and 1993, respectively) is included in other assets and is being amortized principally on a straight-line basis over periods from seven to forty years.
TREASURY STOCK
The board of directors has authorized PFS to buy back shares of its own common and preferred stock on the open market from time to time. During 1994, 1993 and 1992 PFS repurchased 521,600, 546,200 and 10,600 shares, respectively, of their common stock. During 1994 and 1993, PFS repurchased 78,900 and 13,400 shares of their preferred stock. Treasury stock is accounted for using the cost method.
CASH FLOW INFORMATION
Cash includes cash on hand and demand deposits.
RECLASSIFICATIONS
Certain amounts in the 1992 and 1993 financial statements have been reclassified to conform to the 1994 presentation.
2. CHANGES IN ACCOUNTING PRINCIPLES
FASB Statement 115, "Accounting for Certain Investments in Debt and Equity Securities" was adopted by PFS as of January 1, 1994. In accordance with Statement 115, PFS' prior year financial statements have not been restated to reflect the change in accounting principle. Under Statement 115, securities are classified as available-for-sale, held-to-maturity, or trading. PFS classified a portion of its fixed maturity securities portfolio as available- for-sale with the remainder classified as held-to-maturity. Securities classified as available-for-sale are carried at fair value and unrealized gains and losses on such securities are reported as a separate component of stockholders' equity. Securities classified as held-to-maturity are carried at cost, adjusted for amortization of premium or discount.
With the classification of a portion of the portfolio as available-for-sale, the January 1, 1994, balance of stockholders' equity was increased by $3,605,000 (net of adjustments to deferred income taxes) to reflect the net unrealized gains on fixed maturity securities classified as available-for- sale that were previously carried at amortized cost. The adoption of Statement 115 had no effect on net income or PFS' accounting policy for equity securities.
Effective January 1, 1993, PFS changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, "Accounting for Income Taxes." As permitted under the new rules, prior years' financial statements have not been restated. The cumulative effect of adopting Statement No. 109 as of January 1, 1993, was not significant.
Effective January 1, 1993, PFS changed its method of accounting for reinsurance contracts in accordance with FASB Statement No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." Under Statement No. 113, all assets and liabilities related to reinsured insurance contracts are reported on a gross basis rather than the previous practice of reporting such assets and liabilities net of reinsurance. The effect of adopting Statement No. 113 was to increase both assets and liabilities by $19,453,000 at December 31, 1993. The adoption of Statement No. 113 had no effect on net income.
The Financial Accounting Standards Board has issued Statements No. 114 and 118 which relate to accounting by creditors for impairment of a loan. The Statements require that impaired loans are to be valued at the present value of expected future cash flows, at the loan's observable market price, or at the fair value of the collateral if the loan is collateral dependent. PFS anticipates adopting these Statements in its 1995 financial statements as required. Implementation of these Statements is not expected to have a material effect on PFS' financial statements.
3. BUSINESS COMBINATIONS
On January 31, 1995, Pioneer acquired for a cost of $24,000,000 (purchase price $23,700,000 and $300,000 of additional costs), the outstanding common shares of Connecticut National Life Insurance Company.
The acquisition will be accounted for by the purchase method and, accordingly, the purchase price is allocated to assets and liabilities acquired based on estimates of their fair values. These allocations, summarized below, may be adjusted upon final determination of such values:
(IN THOUSANDS) --------------
Assets Acquired Cash $ 2,900 Investments 287,500 Value of insurance in force 1,500 Receivables and amounts on deposit with reinsurers 87,100 Other assets 6,700
Liabilities Assumed Policy liabilities 353,700 Other liabilities 8,000 -------
Total purchase price $ 24,000 =======
The value of insurance inforce will be amortized over the estimated remaining life of the insurance inforce.
The following unaudited pro-forma consolidated results of operations have been prepared as if the acquisition had been made as of January 1, 1994:
YEAR ENDED DECEMBER 31, 1994 (IN THOUSANDS) -----------------
Revenues $809,500 Net income 18,700 Net income per share Primary 2.60 Fully-diluted 1.70
The foregoing pro-forma information is not necessarily indicative of either the results of operations that would have occurred had the acquisition been effective on January 1, 1994, or of future results of operations of the consolidated companies.
In August 1993, PFS purchased 80% of the outstanding common stock of Continental Life & Accident Company and 100% of the outstanding common stock of Continental Marketing Corporation for $7,100,000 in cash. The total assets acquired at the purchase date were approximately $80,000,000.
Also in August 1993, PFS purchased Healthcare Review Corporation, a managed care company, for $1,566,000 in cash. The total assets acquired at the purchase date were approximately $2,000,000.
Revenues included in PFS' 1993 consolidated statements of operations relating to these acquired entities were $25,671,000. The operations of the entities did not have a material effect on PFS' 1993 net income.
4. INVESTMENTS
Realized investment gains (losses), including provisions for other-than- temporary impairments on investments held, and the change in unrealized appreciation (depreciation) on fixed maturities, equity securities, and other investments during the years shown are summarized as follows:
FIXED EQUITY MATURITIES SECURITIES OTHER TOTAL
---------- ---------- ----- ----- (IN THOUSANDS) REALIZED $ (94) $ 211 $ (500) $ (383) UNREALIZED (44,685) (2,098) - (46,783) ---------- --------- ------- --------- $ (44,779) $ (1,887) $ (500) $(47,166) ========== ========= ======= =========
Realized $ (1,638) $ 293 $ 9 $ (1,336) Unrealized 3,864 442 - 4,306 ---------- --------- ------- --------- $ 2,226 $ 735 $ 9 $ 2,970 ========== ========= ======= =========
Realized $ (91) $ 44 $ - $ (47) Unrealized (11,144) 6,998 - (4,146) ---------- --------- ------- --------- $ (11,235) $ 7,042 $ - $ (4,193) ========== ========= ======= =========
The cost of available-for-sale equity securities was $12,484,000 at December 31, 1994, and $12,382,000 at December 31, 1993. At December 31, 1994, gross unrealized appreciation on available-for-sale equity securities was $3,514,000 and gross unrealized depreciation was $558,000. At December 31, 1993, gross unrealized appreciation on equity securities was $5,067,000 and gross unrealized depreciation was $13,000.
A comparison of amortized cost to fair value of fixed maturity investments by category is as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ----- ----- (IN THOUSANDS) At December 31, 1994: HELD TO MATURITY U.S. Treasury $ 8,891 $ 25 $ (840) $ 8,076 States and political subdivisions 8,888 - (810) 8,078 Foreign governments 2,992 - (197) 2,795 Corporate securities 147,419 90 (13,158) 134,351 Mortgage-backed securities 210,460 558 (25,778) 185,240 --------- -------- --------- --------- $378,650 $ 673 $(40,783) $338,540 ========= ======== ========= ========= AVAILABLE FOR SALE U.S. Treasury $ 23,207 $ 2 $ (1,357) $ 21,852 States and political subdivisions 26,579 - (760) 25,819 Foreign governments 4,024 - (559) 3,465 Corporate securities 95,939 - (6,538) 89,401 Mortgage-backed securities 83,020 37 (4,846) 78,211 --------- -------- --------- --------- $232,769 $ 39 $(14,060) $218,748 ========= ======== ========= ========= At December 31, 1993: HELD TO MATURITY
U.S. Treasury $ 9,124 $ 100 $ (61) $ 9,163 States and political subdivisions 5,200 - - 5,200 Corporate securities 119,276 2,653 (312) 121,617 Mortgage-backed securities 192,912 1,908 (5,260) 189,560 --------- -------- --------- --------- $ 326,512 $ 4,661 $ (5,633) $325,540 ========= ======== ========= ========= AVAILABLE FOR SALE U.S. Treasury $ 26,894 $ 570 $ (26) $ 27,438 State and political subdivisions 21,571 121 - 21,692 Foreign governments 4,056 2 (119) 3,939 Corporate securities 73,981 744 (465) 74,260 Mortgage-backed securities 131,215 5,029 (310) 135,934 --------- -------- --------- --------- $ 257,717 $ 6,466 $ (920) $263,263 ========= ======== ========= =========
The amortized cost and fair value of fixed maturities at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
AMORTIZED FAIR COST VALUE --------- ----- HELD TO MATURITY: (IN THOUSANDS) Due in 1995 $ 510 $ 512 Due 1996-2000 51,247 47,784 Due 2001-2005 69,574 62,956 Due after 2005 46,859 42,048 Mortgage-backed securities 210,460 185,240 --------- -------- $378,650 $338,540 ========= ======== AVAILABLE FOR SALE: Due in 1995 $ 830 $ 831 Due 1996-2000 59,914 56,399 Due 2001-2005 62,665 57,900 Due after 2005 26,340 25,407 Mortgage-backed securities 83,020 78,211 --------- -------- $232,769 $218,748 ========= ========
Proceeds from sales of investments (principally fixed maturities) during 1994, 1993 and 1992 were $111,850,000, $192,697,000 and $451,422,000, respectively. Gross gains of $1,448,000, $10,834,000 and $8,073,000 and gross losses of $1,542,000, $12,472,000 and $8,164,000 were realized on fixed maturity sales in 1994, 1993 and 1992, respectively.
Major categories of net investment income are summarized as follows:
1994 1993 1992 ---- ---- ---- (IN THOUSANDS) Fixed maturities $40,172 $34,529 $39,384 Short-term investments 1,549 2,691 2,083 Other 4,189 4,069 3,733 -------- -------- --------
Total investment income 45,910 41,289 45,200 Investment expenses (3,124) (1,047) (1,645) -------- -------- -------- Net investment income $42,786 $40,242 $43,555 ======== ======== ========
At December 31, 1994 and 1993 the net appreciation (depreciation) of available-for-sale securities in stockholders' equity consisted of gross appreciation (depreciation) of ($11,066,000) and $5,054,000, respectively, net of deferred tax assets (liabilities) of $3,873,000 and ($1,769,000), respectively.
At December 31, 1994, securities with a carrying value of $96,247,000 were on deposit with various government authorities to meet regulatory requirements.
At December 31, 1994, the amortized cost of fixed maturity investments in any one entity, other than the U.S. government or a U.S. government agency or authority, which exceeded 10% of PFS' consolidated stockholders' equity were as follows:
GE Capital Mortgage Services, Inc. $23,576,000 Prudential Home 11,131,000 Ford Capital 10,648,000 Nomura Asset Securities 10,102,000 State of Washington 9,651,000 GMAC 9,877,000 Associates Corporation 7,237,000 Citibank 6,900,000
Investment real estate (net of $483,000 of accumulated depreciation) at December 31, 1994 consists principally of land and a building used, in part, as PFS' corporate headquarters.
At December 31, 1994, PFS held unrated or less-than-investment-grade securities with a carrying value of $6,269,000 and an aggregate fair value of $5,479,000. Those holdings amounted to less than 1% of PFS' total investments at December 31, 1994.
At December 31, 1994, fixed maturities with a carrying value of $16,400,000 had been non-income producing for the preceding 12-month period.
5. FEDERAL INCOME TAXES
PFS adopted FASB Statement No. 109 as of January 1, 1993. The cumulative effect of the change in accounting for income taxes was not significant. 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 income tax purposes. Significant components of PFS' deferred tax liabilities and assets are as follows:
DECEMBER 31 1994 1993 ---- ---- (IN THOUSANDS) DEFERRED TAX LIABILITIES Deferred policy acquisition costs $72,306 $86,545 Net unrealized appreciation on available-for-sale securities - 1,769 Other 1,537 1,367
-------- -------- Total deferred tax liabilities 73,843 89,681 -------- --------
DEFERRED TAX ASSETS Policy liabilities 69,101 77,493 Financial reinsurance 3,788 11,150 Net unrealized depreciation on available-for-sale securities 3,873 - Other 8,213 8,830 -------- -------- Total deferred tax assets 84,975 97,473 Valuation allowance for deferred tax assets (3,870) (3,870) -------- --------
Deferred tax assets net of valuation allowance 81,105 93,603 -------- -------- Net deferred tax asset $ 7,262 $ 3,922 ======== ========
The nature of PFS' deferred tax assets and liabilities are such that the reversal pattern for these temporary differences should generally result in realization of PFS' deferred tax assets. PFS establishes a valuation allowance for any portion of the deferred tax asset that management believes may not be realized. There was no change in the valuation allowance in 1994, and in 1993 the valuation allowance increased by $1,221,000 principally due to the acquisition of Continental Life & Accident Company (See Note 3).
The deferred tax benefit for 1992 includes the effects of the following items (in thousands):
Deferred policy acquisition costs $(16,232) Policy liabilities 2,966 Decrease in operating loss carryforward 143 General expenses 1,537 Financial statement capital gains greater than tax capital gains 148 Other 83 --------- Deferred federal income tax benefit $(11,355) =========
PFS' effective federal income tax rate varied from the statutory federal income tax rate as follows:
LIABILITY METHOD DEFERRED METHOD 1994 1993 1992 AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- (DOLLARS IN THOUSANDS)
Statutory federal income tax rate applied to income or loss before income taxes $ 9,108 35.0% $ 6,567 35.0% $(8,648) 34.0% Nondeductible goodwill amortization 109 .4 319 1.7 192 (.8) Tax exempt interest (307) (1.2) (99) (.5) - -
Other (37) (.1) (168) (.9) (21) .1 -------- ----- -------- ----- -------- ----- Income taxes (benefit) and effective rate $ 8,873 34.1% $ 6,619 35.3% $(8,477) 33.3% ======== ===== ======== ===== ======== =====
Taxes paid amounted to $9,731,000, $5,735,000, and $8,828,000 for 1994, 1993, and 1992, respectively.
Under pre-1984 life insurance company income tax laws, a portion of a life insurance company's gain from operations was not subjected to current income taxation but was accumulated, for tax purposes, in a memorandum account designated as the policyholders' surplus account. The balance in this account at December 31, 1994 for PFS' life insurance subsidiaries was $10,040,000. Should the policyholders' surplus accounts of PFS' life insurance subsidiaries exceed their respective maximums, or should distributions in excess of their tax-basis shareholders' surplus account be made by the life insurance subsidiaries, such excess or distribution would be subject to federal income taxes at rates then in effect. Deferred taxes of $3,500,000 have not been provided on amounts included in the policyholders' surplus accounts, since PFS contemplates no such taxable events in the foreseeable future.
As of December 31, 1994, PFS' life insurance subsidiaries had combined tax- basis shareholders' surplus accounts of $46,000,000. Distributions up to that amount would result in no income tax liability.
6. REINSURANCE
PFS' insurance subsidiaries reinsure risks with other companies to permit the recovery of a portion of the direct losses. These reinsured risks are treated as though, to the extent of the reinsurance, they are risks for which the subsidiaries are not liable. PFS remains liable to the extent that the reinsuring companies do not meet their obligations under these reinsurance treaties.
PFS' premiums were reduced for reinsurance premiums by $37,273,000, $40,592,000, and $30,469,000 in 1994, 1993, and 1992, respectively. Under various reinsurance arrangements, PFS' premiums were increased by $16,928,000, $19,338,000, and $15,403,000 in 1994, 1993, and 1992, respectively. PFS' policy benefits have been reduced for reinsurance recoveries of $23,319,000 in 1994, $21,871,000 in 1993, and $22,171,000 in 1992. At December 31, 1994, approximately 40% of PFS' reinsurance receivables and amounts on deposit with reinsurers were due from Employers Reinsurance Corporation, 14% from North American Reassurance, and 12% from The Universe Life Insurance Company. The amounts due from The Universe Life Insurance Company were held in a financial institution trust account.
7. SALE OF AGENT RECEIVABLES
In 1994, 1993, and 1992 a subsidiary of PFS sold agent receivables to an unaffiliated company for proceeds of $24,393,000, $25,376,000, and $20,347,000, respectively. The outstanding balances of such agent receivables sold that remained uncollected at December 31, 1994 and 1993 were $7,937,000 and $9,815,000, respectively. PFS remains subject to a maximum credit exposure under this agreement amounting to 10% of agent receivables at December 31, 1994.
8. RECONCILIATION OF LIABILITY FOR POLICY AND CONTRACT CLAIMS
The following table provides a reconciliation of the beginning and ending policy and contract claim liability balances reported in PFS' balance sheets:
YEAR ENDED DECEMBER 31 1994 1993 1992 ---- ---- ---- (IN THOUSANDS)
Policy and contract claim liability beginning of year $189,389 $148,141 $151,577
Incurred claims 445,794 410,607 377,063
Deduct claims paid related to:
Current year 350,210 260,702 251,773 Prior years 129,600 108,657 128,726 --------- --------- --------- Total claims paid 479,810 369,359 380,499 --------- --------- ---------
Policy and contract claim liability end of year $155,373 $189,389 $148,141 ========= ========= =========
PFS has historically held margins in its accident and health claim reserves to provide for potential adverse deviation. The claim reserve estimates are continually reviewed and adjusted as necessary. Based on payments through the first nine months of 1994, PFS determined that claim reserves contained significantly higher margins than originally projected. As a result, claim reserve margins of $15,000,000 were released in the third quarter of 1994. PFS continues to hold additional margins which it considers to be reasonable in its medical claim reserves.
9. NOTES PAYABLE
Short-term notes payable included $18,950,000 at December 31, 1994, drawn under a line of credit arrangement. The borrowings are due in 1995 and bear interest at prime and payable quarterly (See Note 22). The remaining balance under the line of credit is due in October 1995.
At December 31, 1994, a PFS subsidiary had an unsecured loan of $1,125,000. The portion of the loan due in 1995 of $300,000 is included in short-term notes payable. The remainder of the note is included in long-term notes payable. The note bears interest currently at prime and is payable quarterly with the final payment due July 1998.
At December 31, 1994, a PFS subsidiary has two unsecured loans totaling $2,275,000. The portion of the loans due in 1995 of $580,000 are included in short-term notes payable. The remainder of the notes are included in long- term notes payable. The notes bear interest at prime and are payable quarterly with the final payment due December 1999. PFS has guaranteed payment of the notes.
At December 31, 1994, PFS had $263,000 of short-term debt liability for which a PFS agency subsidiary's future renewal commissions were pledged as collateral.
The weighted average interest rate on short-term notes payable at year end
was 7.7%, 5.0% and 5.6% in 1994, 1993 and 1992, respectively.
Interest paid amounted to $4,950,000, $1,023,000, and $2,274,000 for 1994, 1993, and 1992, respectively.
10. ACCIDENT AND HEALTH BUSINESS
In making the determination that policy liabilities, future premiums, and anticipated investment income will be adequate to provide for future claims and expenses (including the amortization of deferred policy acquisition costs), PFS has made assumptions with regard to each of these items. Although there is significant variability inherent in these estimates, management believes that these assumptions are reasonable.
Pursuant to an actuarial study performed in the third quarter of 1994, PFS revised certain of these assumptions to reflect present and anticipated future experience. This study resulted in increased amortization of deferred policy acquisition costs of $16,700,000 in the third quarter of 1994. A similar actuarial study performed in 1992 resulted in increased amortization of deferred policy acquisition costs of $30,000,000 in the fourth quarter of 1992.
11. STATUTORY-BASIS FINANCIAL INFORMATION
The following tables compare combined net income and stockholders' equity for PFS' insurance subsidiaries determined on the basis as prescribed or permitted by regulatory authorities (statutory basis) with consolidated net income (loss) and stockholders' equity reported in accordance with GAAP. Statutory basis accounting emphasizes solvency rather than matching revenues and expenses during an accounting period. The significant differences between statutory basis accounting and GAAP are as follows:
Deferred Policy Acquisition Costs. Costs of acquiring new policies are expensed when incurred on a statutory basis rather than capitalized and amortized over the term of the related polices in the GAAP financial statements.
Policy Liabilities. Certain policy liabilities are calculated based on statutorily required methods and assumptions on a statutory basis rather than on estimated expected experience or, for annuity and interest- sensitive life insurance, actual account balances for GAAP.
Financial Reinsurance. The effects of certain financial reinsurance transactions are included in the statutory basis financial statements but are eliminated from the GAAP financial statements.
Deferred Federal Income Taxes. Deferred federal income taxes are not provided on a statutory basis for differences between financial statement and tax return amounts.
Surplus Notes. Surplus notes are reported in capital and surplus on a statutory basis rather than as liabilities in the GAAP financial statements.
Non-insurance Companies' Equity. Contributions by PFS to the capital and surplus of its insurance subsidiaries increases the stockholders' equity of those insurance subsidiaries on a statutory basis but does not effect the consolidated stockholders' equity on a GAAP basis.
Unrealized Depreciation On Fixed Maturities Available-For-Sale. Fixed maturity securities classified as available-for-sale are carried principally at amortized cost on a statutory basis rather than at fair value with unrealized gains and losses on such securities reported as a separate component of stockholders' equity in the GAAP financial statements.
1994 1993 1992 ---- ---- ---- (IN THOUSANDS)
Combined net income on a statutory basis $ 6,986 $ 10,155 $ 3,629
Adjustments for: Deferred policy acquisition costs (34,814) (12,842) (43,779) Policy liabilities 26,544 (18,494) (19,957) Financial reinsurance 17,544 34,017 33,118 Deferred federal income taxes (2,303) 4,239 11,355 Non-insurance companies, eliminations, and other adjustments 3,192 (4,930) (1,325) ---------- --------- ----------
Consolidated net income (loss) in accordance with GAAP $ 17,149 $ 12,145 $ (16,959) ========== ========= ==========
DECEMBER 31 1994 1993 ------------------ (IN THOUSANDS)
Combined stockholders' equity on a statutory basis $ 124,284 $ 106,567
Adjustments for: Deferred policy acquisition costs 225,618 260,432 Policy liabilities (180,422) (206,966) Financial reinsurance (12,748) (30,292) Deferred federal income taxes 7,262 3,922 Non-admitted assets 10,813 11,743 Surplus notes (4,436) (4,116) Unrealized depreciation on available-for-sale fixed maturities (14,021) - Other (12,296) (12,229) --------- ----------
Combined insurance subsidiaries stockholders' equity on a GAAP basis 144,054 129,061
Non-insurance companies equity, eliminations and other adjustments (75,726) (60,189) --------- ----------
Consolidated stockholders' equity in accordance with GAAP $ 68,328 $ 68,872 ========= ==========
Dividends from PFS' insurance subsidiaries unassigned surplus are limited to the greater of the prior-year statutory-basis net gain from operations or 10% of statutory-basis surplus. The total amount of dividends that could be paid
in 1995 without regulatory approval is $7,419,000. At December 31, 1994, PFS' retained earnings was $34,460,000 in excess of the combined statutory- basis unassigned surplus of the insurance subsidiaries.
PFS is required to maintain adequate amounts of statutory-basis capital and surplus to satisfy regulatory requirements and provide capacity for production of new business. Acquisition costs relating to the production of new business result in a reduction of statutory-basis net income and capital and surplus.
12. CONVERTIBLE SUBORDINATED DEBENTURES
In July 1993 PFS issued $57,477,000 of 8% convertible subordinated debentures due in 2000. Interest on the debentures is payable in January and July of each year. Net proceeds from the offering totaled approximately $54,000,000 and were used, in part, to repay long-term notes payable. The debentures are convertible into PFS' Common Stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share.
The debentures are redeemable by PFS under certain conditions after July 1996.
At December 31, 1994, 4,887,404 shares of PFS' Common Stock were reserved for conversion of the outstanding convertible subordinated debentures.
13. REDEEMABLE PREFERRED STOCK
In 1989, PFS issued 1,000,000 shares of $2.125 Cumulative Convertible Exchangeable Preferred Stock. The proceeds of the public offering were $23,337,000 after reduction for expenses of $1,663,000, which expenses were charged to additional paid-in capital. The Preferred Stock is carried on PFS' balance sheet at the redemption and liquidation value of $25 per share.
Each share of Preferred Stock is convertible by the holders at any time into 1.6 shares of PFS Common Stock. Annual cumulative dividends of $2.125 per share are payable quarterly. The preferred stock is nonvoting unless dividends are in arrears. At December 31, 1994, 1,387,680 shares of PFS' Common Stock were reserved for conversion of the outstanding preferred stock.
The Preferred Stock is redeemable at the option of the holders upon certain acquisitions or other business combinations involving PFS Common Stock.
The Preferred Stock is redeemable by PFS at redemption prices of $26.06 per share in 1994, declining to $25 in 1999. The Preferred Stock is exchangeable in whole at PFS' option on any dividend payment date for PFS' 8 1/2% Convertible Subordinated Debentures due in 2014 at the rate of $25 principal amount of Subordinated Debentures for each share of Preferred Stock.
14. SHAREHOLDER RIGHTS AGREEMENT
In 1990, PFS distributed one preferred share purchase right for each outstanding share of Common Stock. The rights are intended to cause substantial dilution to a person or group that attempts to acquire PFS on terms not approved by PFS' directors. The rights expire in 2000 or PFS may redeem the rights prior to exercise for $.01 per right.
The rights are not exercisable unless a person or group acquires, or offers to acquire, 20% or more of PFS' Common Stock under certain circumstances. The rights, when exercisable, entitle the holder to purchase one-tenth of a
share of a new series of PFS Series A Junior Preferred Stock at a purchase price of $45. Such preferred shares, of which 2,000,000 are authorized, would be voting and would be entitled to distributions that are ten times the distributions to common shareholders. Subsequent to exercise of the rights, in the event of certain business combinations involving PFS, a holder of rights would have the right to receive PFS Common Stock with a value of two times the exercise price of the rights.
15. STOCK OPTIONS AND RIGHTS
PFS has a nonqualified stock option plan and certain stock incentive programs principally for directors and key employees of PFS and its subsidiaries. PFS' Board of Directors grants the options and specifies the conditions of the options. The number of shares of common stock available for benefits under the plan is equal to 15% of the average fully diluted shares outstanding for the prior fiscal year. Options expire ten years after grant. Information with respect to these options is as follows:
1994 1993 NUMBER NUMBER OF EXERCISE OF EXERCISE SHARES PRICE SHARES PRICE ------ -------- ------ -------- Options outstanding at beginning of year 733,250 $5.50 - $12.00 594,250 $5.50 - $12.00 Granted 480,321 8.88 - 11.38 225,000 5.50 Exercised 85,500 5.50 - 11.00 72,000 5.50 - 12.00 Canceled/repurchased 82,500 5.50 - 12.00 14,000 5.50 --------- -------------- ------- -------------- Options outstanding at end of year 1,045,571 $5.50 - $12.00 733,250 $5.50 - $12.00 ========= =======
Options exercisable at end of year 561,250 573,250 ========= =======
Unoptioned shares available for granting of options 1,535,201 22,900 ========= =======
16. COMMITMENTS AND CONTINGENCIES
PFS and its subsidiaries are named as defendants in various legal actions, some claiming significant damages, arising primarily from claims under insurance policies, disputes with agents, and other matters. PFS' management and its legal counsel are of the opinion that the disposition of these actions will not have a material adverse effect on PFS' financial position.
PFS leases various office facilities furniture and equipment and computer equipment under noncancelable operating leases. Rent expense was $4,530,000, $4,516,000, and $3,700,000 in 1994, 1993, and 1992, respectively. Minimum future rental commitments in connection with noncancelable operating leases are as follows:
1995 $ 3,203,000 1996 2,445,000 1997 939,000 1998 258,000
1999 106,000
PFS has entered into employment agreements with certain officers.
The number of insurance companies that are under regulatory supervision has increased, and that increase is expected to result in an increase in assessments by state guaranty funds to cover losses to policyholders of insolvent or rehabilitated companies. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. For all assessment notifications received, PFS has accrued for those assessments net of estimated future premium tax reductions.
17. BENEFIT PLAN
PFS has a defined-contribution employee benefit plan that covers substantially all home office employees who have attained age 21 and completed one year of service. Plan participants may contribute from 1% to 10% of their total compensation subject to an annual maximum. The plan also provides for PFS to match participants' contributions up to $1,000 per year and 50% of participants, contributions above $1,000 up to the annual Internal Revenue Service limit ($9,240 in 1994). PFS makes employer contributions to the plan in cash or in PFS Common Stock at the discretion of PFS' Board of Directors. At December 31, 1994, the Plan's assets included PFS Common Stock of $2,915,775, at fair value. PFS' contibutions charged to operations were $1,365,000 in 1994, $1,073,000 in 1993, and $852,000 in 1992.
A PFS subsidiary, which owns insurance and agency companies, had a stock purchase plan that allowed certain eligible agents to purchase common stock in the subsidiary at the subsidiary's per share book value. The plan was terminated in November 1992. In accordance with the plan's provisions, agents became fully vested. Eligible agents were given the option to participate in a new agent stock purchase plan. This new plan allows agents to purchase PFS Common Stock. Stock purchases are limited to a specific percentage of the agent's commission as determined by PFS but in no event to be less than 3%. Under the plan the agents are also credited with additional shares of PFS Common Stock as determined by PFS. In 1994, 1993 and 1992, 6,332 shares, 8,057 shares and 163,566 shares, respectively, of PFS Common Stock were issued under this plan.
18. ALLOWANCES AND ACCUMULATED DEPRECIATION
Allowances for doubtful accounts related to other receivables amounted to $895,000 at December 31, 1994, and $1,271,000 at December 31, 1993.
Accumulated depreciation related to building and equipment amounted to $19,325,000 at December 31, 1994, and $16,891,000 at December 31, 1993.
19. FAIR VALUE INFORMATION
The following methods and assumptions were used by PFS in estimating its fair values for financial instruments:
Cash, short-term investments, short-term notes payable, and accrued investment income: The carrying amounts reported in the balance sheets for these instruments approximate their fair values.
Investment securities: Fair values for fixed maturity securities (including redeemable preferred stocks) 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, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield quality, and maturity of the investments. The fair values for equity securities are based on quoted market prices.
Mortgage loans and policy loans: The carrying amount of PFS' mortgage loans approximates their fair values. The fair values for policy loans are estimated using capitalization of earnings methods, using interest rates currently being offered for similar loans to borrowers with similar credit ratings.
Investment contracts: Fair values for PFS' liabilities under investment-type insurance contracts are based on current cash surrender values.
Fair values for PFS' insurance policies other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance policies are taken into consideration in PFS' overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance policies.
Long-term notes payable: The fair value of PFS' long-term notes payable approximates the carrying value.
Convertible subordinated debentures: The fair value of PFS' convertible subordinated debentures is based on quoted market prices.
The fair values of certain financial instruments along with their corresponding carrying values of December 31, 1994 and 1993 are as follows:
1994 1993 FAIR CARRYING FAIR CARRYING VALUE VALUE VALUE VALUE ----- -------- ----- -------- (IN THOUSANDS) Financial Assets
Fixed Maturities: Available-or-sale $218,748 $218,748 $263,263 $257,717 Held-to-maturity 338,540 378,650 325,540 326,512 Equity securities 15,440 15,440 17,436 17,436 Mortgage loans 1,806 1,806 3,201 3,201 Policy loans 22,025 23,082 21,011 23,988
Financial Liabilities
Investment contracts 194,072 203,654 191,816 200,894 Long-term notes payable 2,520 2,520 1,125 1,125 Subordinated debentures 54,843 57,427 70,122 57,477
During the fourth quarter of 1994, PFS began using exchange-traded treasury futures contracts as part of its overall interest rate risk management strategy for a small portion of its life and annuity business. The initial margin deposit paid for the futures represents their cost basis which is adjusted to fair value in the financial statements. Realized and unrealized gains and losses, which were immaterial in 1994, are recognized as an adjustment to the carrying amount of the asset being hedged.
20. SEGMENT INFORMATION
PFS has four business segments: Group Medical, Senior Health, Life Insurance, and Medical Utilization Management. The segments are based on PFS' main Divisions. Allocations of investment income and certain general expenses are based on various assumptions and estimates, and reported operating results by segment would change if different methods were applied. Assets are not individually identifiable by segment and have been allocated based on the amount of policy liabilities by segment and by other formulas. Depreciation expense and capital expenditures are not considered material. Realized investment gains and losses are allocated to the appropriate segment. General corporate expenses are not allocated to the individual segments. Revenues, income or loss before income taxes, and identifiable assets by business segment are as follows:
1994 1993 1992 ---- ---- ---- (IN THOUSANDS) REVENUES -------- Group Medical: Unaffiliated $ 457,633 $ 379,742 $ 327,033 Inter-segment 35,373 30,439 26,500 Senior Health 235,031 247,100 258,608 Life Insurance 71,075 67,780 68,411 Medical Utilization Management: Unaffiliated 10,416 4,506 1,921 Inter-segment 4,927 4,358 2,041 ---------- ---------- --------- 814,455 733,925 684,514 Eliminations 40,300 34,797 28,541 ---------- ---------- --------- Total $ 774,155 $ 699,128 $ 655,973 ========== ========== =========
INCOME (LOSS) BEFORE INCOME TAXES --------------------------------- Group Medical $ 10,889 $ 6,528 $(25,235) Senior Health 13,420 12,255 1,966 Life Insurance 8,537 7,623 340 Medical Utilization Management 2,026 (1,211) 335 Corporate expenses (8,850) (6,431) (2,843) ---------- ---------- --------- Total $ 26,022 $ 18,764 $(25,437) ========== ========== =========
IDENTIFIABLE ASSETS AT YEAR-END ------------------------------- Group Medical $ 245,763 $ 287,713 $ 206,194 Senior Health 291,703 301,700 292,449 Life Insurance 533,070 514,154 478,529 Medical Utilization Management 5,164 4,704 1,517 ---------- ---------- --------- Total $1,075,700 $1,108,271 $ 978,689 ========== ========== =========
21. CREDIT ARRANGEMENTS
PFS has a line of credit arrangement for short-term borrowings with three
banks amounting to $20,000,000 through April 1996, of which $18,950,000 was used at December 31, 1994. The line of credit arrangement can be terminated, in accordance with the agreement, at PFS' option.
22. SUBSEQUENT EVENT
As discussed in Note 3, on January 31, 1995, PFS acquired all of the outstanding common shares of Connecticut National Life Insurance Company for a cost of $24,000,000. To fund the acquisition, PFS utilized $15,000,000 from its available line of credit and internal cash sources. The line of credit was replaced with a five year term loan totaling $15,000,000 in March 1995.
23. QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of unaudited quarterly results of operations for 1994 and 1993 is as follows (in thousands, except per share amounts):
---- 1ST 2ND 3RD 4TH --- --- --- --- Premiums and policy charges $172,898 $176,803 $176,190 $178,219
Net investment income and other 18,367 16,926 17,674 17,079
Net income 4,500 4,403 3,321 4,926
Net income per share: Primary .60 .59 .44 .73 Fully diluted .40 .40 .32 .46
---- 1ST 2ND 3RD 4TH --- --- --- --- Premiums and policy charges $155,343 $154,189 $154,132 $177,302
Net investment income and other 14,369 13,928 15,802 14,063
Net income 2,295 2,627 3,128 4,095
Net income per share: Primary .26 .31 .40 .54 Fully diluted .26 .31 .31 .37
SCHEDULE I
PIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1994
Amount Shown in the Consolidated Amortized Fair Balance Type of Investment Cost Value Sheet ------------------ --------- ----- ------------ (in thousands) Fixed maturities to be held to maturity: U.S. Treasury $ 8,891 $ 8,076 $ 8,891 States and political subdivisions 8,888 8,078 8,888 Foreign governments 2,992 2,795 2,992 Corporate securities 147,419 134,351 147,419 Mortgage-backed securities 210,460 185,240 210,460 -------- -------- -------- TOTAL FIXED MATURITIES TO BE HELD TO MATURITY 378,650 338,540 378,650 -------- -------- --------
Fixed maturities available for sale: U.S. Treasury 23,207 $ 21,852 21,852 States and political subdivisions 26,579 25,819 25,819 Foreign governments 4,024 3,465 3,465 Corporate securities 95,939 89,401 89,401 Mortgage-backed securities 83,020 78,211 78,211 -------- -------- -------- TOTAL FIXED MATURITIES AVAILABLE FOR SALE 232,769 218,748 218,748 -------- -------- --------
Equity securities: Common stocks: Banks, trusts, and insurance companies 9,145 $ 12,526 12,526 Nonredeemable preferred stocks 3,339 2,914 2,914 -------- -------- --------
TOTAL EQUITY SECURITIES 12,484 $ 15,440 15,440 -------- ======== --------
Real estate 16,959 16,959 Mortgage loans on real estate 1,806 1,806 Policy loans 23,082 23,082 Short-term investments 69,152 69,152 -------- --------
TOTAL INVESTMENTS $734,902 $723,837 ======== ========
SCHEDULE II
PIONEER FINANCIAL SERVICES, INC. (Parent Company) CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (In thousands, except share and per share amounts)
December 31 1994 1993 ------ ------ ASSETS Investments in subsidiaries* $122,310 $107,620 Cash 157 1,711 Note receivable from United Group Holdings* 38,704 37,495 Other notes receivable from subsidiaries* 3,517 403 Due from affiliates* 132 1,014 Prepaid expenses 592 573 Deferred debenture offering expenses 3,214 3,799 Other assets 2,014 363 -------- --------- $170,640 $152,978 ======== =========
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS' EQUITY Liabilities: General expenses and other liabilities $ 3,481 $ 2,444 Preferred stock dividends payable 772 510 Short-term notes payable 18,950 - Convertible subordinated debentures 57,427 57,477 -------- -------- 80,630 60,431 Redeemable Preferred Stock, no par value: $2.125 cumulative convertible exchangeable preferred stock Authorized: 5,000,000 shares Issued and outstanding: (1994-867,300 shares; 21,682 23,675 1993-947,000 shares)
Stockholders' equity: Common Stock, $1 par value: Authorized: 20,000,000 shares Issued, including shares in treasury (1994 - 6,996,157; 1993 - 6,900,000) 6,996 6,900 Additional paid-in capital 29,299 28,814 Unrealized appreciation (depreciation) of equity securities (7,193) 3,285 Retained earnings 48,960 34,645 Less treasury stock at cost (1994 - 1,078,400) 1993 - 556,800) (9,734) (4,772) -------- -------- Total stockholders' equity 68,328 68,872 -------- -------- $170,640 $152,978 ======== ========
See note to condensed financial statements.
*Eliminated in consolidation.
SCHEDULE II
PIONEER FINANCIAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued
CONDENSED STATEMENTS OF OPERATIONS (In thousands)
Year Ended December 31 1994 1993 1992 ------ ------ ------
Revenues: Interest income from subsidiaries* $ 2,972 $ 1,090 $ 1,835 Other investment income 109 62 15 Dividends from consolidated subsidiaries* 10,225 10,345 10,482 -------- -------- -------- 13,306 11,497 12,332
Expenses: Operating and administrative expenses 5,672 4,702 2,154 Interest expense 4,894 3,204 2,206 -------- -------- -------- 10,566 7,906 4,360 -------- -------- --------
Income before equity in undistributed net income or loss of subsidiaries 2,740 3,591 7,972
Equity in undistributed net income (loss) of subsidiaries* 14,409 8,554 (24,931) -------- -------- --------
Net income (loss) 17,149 12,145 (16,959)
Preferred stock dividends 1,904 2,021 2,039 -------- -------- --------
Income (loss) applicable to common stockholders $ 15,245 $ 10,124 $(18,998) ======== ======== ========
See note to condensed financial statements.
*Eliminated in consolidation.
SCHEDULE II
PIONEER FINANCIAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued
CONDENSED STATEMENTS OF CASH FLOWS (In thousands)
Year Ended December 31 1994 1993 1992 ------ ------ ------
OPERATING ACTIVITIES Net income (loss) $ 17,149 $ 12,145 $(16,959) Adjustments to reconcile net income or loss to net cash provided by operating activities: Change in other assets and liabilities 1,095 1,678 (929) Equity in undistributed net (income) loss of subsidiaries* (14,409) (8,554) 24,931 -------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,835 5,269 7,043
INVESTING ACTIVITIES Additional investment in consolidated subsidiaries* (10,758) (15,219) (13)
FINANCING ACTIVITIES Decrease (increase) in notes receivable from PLIC - 29,128 (11,597) Increase in notes receivable from UGH (1,209) (37,495) - Net proceeds from issuance of convertible subordinated debentures - 54,055 - Increase in notes payable 18,950 - 10,000 Repayment of notes payable (50) (31,600) (3,900) Decrease (increase) in other notes receivable from subsidiaries* (3,114) 3,591 (447) Stock options exercised 495 451 165 Dividends paid-preferred (1,904) (2,021) (2,039) Dividends paid-common (930) - - Purchase of treasury stock (4,963) (4,720) (52) Retirement of preferred stock (1,993) (315) - Other 87 44 717 -------- -------- --------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 5,369 11,118 (7,153) -------- -------- --------
INCREASE (DECREASE) IN CASH (1,554) 1,168 (123)
CASH AT BEGINNING OF YEAR 1,711 543 666 -------- -------- --------
CASH AT END OF YEAR $ 157 $ 1,711 $ 543
======== ======== ========
See note to condensed financial statements.
*Eliminated in consolidation.
SCHEDULE II
PIONEER FINANCIAL SERVICES, INC. (Parent Company)
NOTE TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Pioneer Financial Services, Inc.
At December 31, 1994 and 1993, the notes receivable from United Group Holdings of Delaware (UGH) represents the purchase of National Group Life Insurance Company from the parent company. The note bears interest at the rate of 8% and matures on December 31, 1998.
SCHEDULE III
PIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION (In thousands)
December 31 ----------------------------------------------------- Deferred Future Policy Policy Benefits and Acquisition Policy and Unearned Other Policy Segment Costs Contract Claims Premiums Liabilities ------- ----------- --------------- -------- -------------
1994: Group Medical $ 68,608 $121,098 $ 16,176 $ 4,343
Senior Health 95,191 191,800 60,090 4,461
Life Insurance 61,819 463,037 - 7,603
Medical Utilization Management - - - - -------- -------- -------- -------- $225,618 $775,935 $ 76,266 $ 16,407 ======== ======== ======== ========
1993: Group Medical $ 92,153 $126,684 $ 15,844 $ 3,862
Senior Health 111,708 215,232 72,101 4,204
Life Insurance 56,571 458,207 - 6,971
Medical Utilization Management - - - - -------- -------- -------- -------- $260,432 $800,123 $ 87,945 $ 15,037 ======== ======== ======== ========
1992: Group Medical $ 81,408 $ 85,257 $ 14,028 $ 1,361
Senior Health 133,749 203,709 76,852 1,471
Life Insurance 54,517 417,590 - 5,428
Medical Utilization Management - - - - -------- -------- -------- -------- $269,674 $706,556 $ 90,880 $ 8,260 ======== ======== ======== ========
SCHEDULE III (continued)
PIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION (In thousands)
Amortization Net of Premiums Investment Deferred and Income and Policy Other Policy Realized Gains Acquisition Other Operating Segment Charges and Losses* Benefits Costs Income Expenses* ------- ------ ------------- -------- ---------- ------ ---------
1994:
Group Medical $431,831 $ 9,184 $267,450 $ 62,281 $ 16,618 $117,013
Senior Health 227,349 6,516 139,799 29,807 1,166 52,005
Life Insurance 44,929 26,700 42,947 7,985 (554) 11,606
Medical Utilization Management - 3 - - 10,413 8,390
Corporate Expenses - - - - - 8,850 -------- -------- -------- -------- --------- -------- $704,109 $ 42,403 $450,196 $100,073 $ 27,643 $197,864 ======== ======== ======== ======== ========= ========
1993:
Group Medical $357,784 $ 8,033 $246,117 $ 36,189 $ 13,925 $ 90,908
Senior Health 243,900 2,393 151,846 30,132 800 52,860
Life Insurance 39,282 28,478 39,419 10,554 27 10,191
Medical Utilization Management - 2 - - 4,504 5,717
Corporate Expenses - - - - - 6,431 -------- -------- -------- -------- --------- -------- $640,966 $ 38,906 $437,382 $ 76,875 $ 19,256 $166,107 ======== ======== ======== ======== ========= ========
1992:
Group Medical $306,880 $ 6,806 $197,058 $ 55,701 $ 13,348 $ 99,510
Senior Health 253,014 3,476 170,988 35,928 2,117 49,724
Life Insurance 35,219 33,222 47,622 9,086 (30) 11,363
Medical Utilization Management - 4 - - 1,917 1,586
Corporate Expenses - - - - - 2,843
-------- -------- -------- -------- --------- -------- $595,113 $ 43,508 $415,668 $100,715 $ 17,352 $165,026 ======== ======== ======== ======== ========= ========
*Allocations of net investment income and other operating expenses are based on a number of assumptions and estimates and results would change if different methods were applied. Interest expense has been included with other operating expenses. Realized investment gains and losses were allocated to the appropriate segment.
SCHEDULE IV
PIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES
REINSURANCE (In thousands)
Assumed Percentage Ceded to from of Amount Gross Other Other Net Assumed Amount Companies Companies Amount to net ------- --------- --------- ------ ----------
Year Ended December 31, 1994: Life insurance in force*$12,581,797 $ 3,801,387 $ - $8,780,410 - =========== =========== ========== ========== ====
Premiums and Policy Charges:
Group Medical $ 435,166 $ 19,121 $ 15,786 $ 431,831 3.6% Senior Health 227,349 - - 227,349 - Life Insurance 61,939 18,152 1,142 44,929 2.5 Medical Utilization Managment - - - - ----------- ----------- ---------- ---------- $ 724,454 $ 37,273 $ 16,928 $ 704,109 =========== =========== ========== ==========
Year Ended December 31, 1993: Life insurance in force*$11,823,127 $ 3,859,945 $ - $7,963,182 - =========== =========== ========== ========== ====
Premiums and Policy Charges:
Group Medical $ 362,888 $ 24,154 $ 19,050 $ 357,784 5.3% Senior Health 243,899 - - 243,899 - Life Insurance 55,433 16,438 288 39,283 .7 Medical Utilization Management - - - - ----------- ----------- ---------- ---------- $ 662,220 $ 40,592 $ 19,338 $ 640,966 =========== =========== ========== ==========
Year Ended December 31, 1992: Life insurance in force*$10,338,557 $ 3,929,621 $ - $6,408,936 - =========== =========== ========== ========== ====
Premiums and Policy Charges:
Group Medical $ 305,833 $ 14,328 $ 15,375 $ 306,880 5.0% Senior Health 253,014 - - 253,014 - Life Insurance 51,332 16,141 28 35,219 .1 Medical Utilization Management - - - - ----------- ----------- ---------- ---------- $ 610,179 $ 30,469 $ 15,403 $ 595,113 =========== =========== ========== ==========
*At end of year
SCHEDULE V
PIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Deductions- Doubtful Accounts Written Balance at Additions- off During Balance Beginning Charged to the Year at End Description of Year Expense /Disposals of Year ----------- --------- ---------- ---------- --------
Year Ended December 31, 1994: Allowance for doubtful accounts$ 1,271 $ 2,425 $ 2,801 $ 895 Accumulated depreciation on building and equipment 16,891 5,532 3,098 19,325
Year Ended December 31, 1993: Allowance for doubtful accounts 1,504 1,171 1,404 1,271 Accumulated depreciation on building and equipment 11,646 5,515 270 16,891
Year Ended December 31, 1992: Allowance for doubtful accounts 147 1,475 118 1,504 Accumulated depreciation on building and equipment 9,122 3,245 721 11,646
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.
PIONEER FINANCIAL SERVICES, INC.
BY: /S/ Peter W. Nauert _______________________________________ Peter W. Nauert, Chairman/Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: March 22, 1995
/S/ Peter W. Nauert /S/ Michael A. Cavataio __________________________________ ___________________________________ Peter W. Nauert, Chairman, Michael A. Cavataio Chief Executive Officer, and Director Director
/S/ William B. Van Vleet /S/ R. Richard Bastian, III __________________________________ ___________________________________ William B. Van Vleet, Executive R. Richard Bastian, III Vice President and Director Director
/S/ David I. Vickers /S/ Karl-Heinz Klaeser __________________________________ ___________________________________ David I. Vickers, Treasurer Karl-Heinz Klaeser and Chief Financial Officer Director
/S/ Robert F. Nauert /S/ Richard R. Haldeman __________________________________ ___________________________________ Robert F. Nauert Richard R. Haldeman Director Director
/S/ Charles R. Scheper /S/ Michael K. Keefe __________________________________ ___________________________________ Charles R. Scheper Michael K. Keefe President - Life Division Director and Director
/S/ Thomas J. Brophy /S/ Carl A. Hulbert __________________________________ ___________________________________ Thomas J. Brophy Carl A. Hulbert President - Health Division Director and Director