Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and contingent assets and contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The estimates most susceptible to material changes due to significant judgment (the “critical accounting policies”) are those used in determining investment impairments, the reserves for future policy benefits and claims, deferred acquisition costs and VOBA, and the provision for income taxes. The results of these estimates are critical because computed results affect our profitability and may affect key indicators used to measure the Company’s performance. These estimates have a material effect on our results of operations and financial condition.
The following table sets forth selected financial data for the Employee Benefits-Insurance segment for the years ended December 31:
The Individual Insurance segment sells disability insurance and fixed-rate annuities to individuals. Our disability income insurance products are sold nationally through master general agents and brokers, primarily to physicians, lawyers, other professionals, executives, and small business owners. 87% of these policies are non-cancelable, guaranteeing the customer a fixed premium rate for the life of the contract.
Disability and annuity sales in 2002 and 2001 were substantially affected by the changes in distribution as a result of the two transactions for this segment. The changes included the addition of a national marketing agreement with Minnesota Life for individual disability products. In addition, sales of individual disability and annuity products increased as a result of expansion of distribution channels since 2000. Approximately one-third of individual disability insurance sales in 2002 were through Minnesota Life general agencies. Increased sales of our fixed-rate annuities also reflect increased consumer interest in fixed-rate annuity products compared to equity based variable annuity products. Annuity sales growth will vary depending on movement in interest rates, the equity markets and the level of economic uncertainties.
StanCorp’s ability to pay dividends to its shareholders, repurchase its shares, and meet its obligations substantially depends upon the receipt of dividends from its subsidiaries, including Standard. Standard’s ability to pay dividends to StanCorp is affected by factors deemed relevant by Standard’s board of directors, including the ability to maintain adequate capital (see “-Risk-Based Capital”) and Oregon law. Under Oregon law, Standard may pay dividends only from the earned surplus arising from its business. It also must receive the prior approval of the Director of the Oregon Department of Consumer and Business Services (the “Oregon Department”) to pay a dividend if such dividend exceeds certain statutory limitations. The current statutory limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31st of the preceding year or (b) the net gain from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses for the twelve-month period ended on the December 31st last preceding. In each case the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Department broad discretion to disapprove requests for dividends in excess of these limits.
The Company manages interest rate risk, in part, through asset/liability duration analyses. As part of this strategy, detailed actuarial models of the cash flows associated with each type of insurance liability and the financial assets related to the liability are generated under various interest rate scenarios. Both interest rate risk and investment strategies are examined. The actuarial models include those used to support the statutory Statement of Actuarial Opinion required annually by insurance regulators. According to presently accepted actuarial standards of practice, statutory reserves of Standard and related items at December 31, 2002 made adequate provision for the anticipated cash flows required to meet contractual obligations and related expenses, in light of the assets actually held.
Use of estimates. Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and contingent assets and contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The estimates most susceptible to material changes due to significant judgment are those used in determining investment impairments, deferred acquisition costs, the reserves for future policy benefits and claims and the provision for income taxes. The results of these estimates are critical because computed results affect our profitability and may affect key indicators used to measure our performance.
Non-affiliated tenants leased approximately 44.1%, 44.5%, and 45.6% of the home office properties at December 31, 2002, 2001, and 2000, respectively. Income from the leases is included in net investment income.
Other comprehensive income. Other comprehensive income consists of the current increase or decrease in unrealized capital gains and losses on investment securities available-for-sale, net of the related tax effects. Unrealized gains and losses and adjustments for realized gains and losses, were as follows for the years ended December 31:
for Stock Issued to Employees,” and related interpretations in accounting for its stock-based compensation plans. Other than restricted stock, no stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.
Investments. The fair values of investment securities were based on quoted market prices, where available, or on values obtained from independent pricing services. The fair values of commercial mortgage loans were estimated using option adjusted valuation discount rates. The carrying values of policy loans approximate fair values. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.
In 2002, we adopted the 2002 Stock Incentive Plan. This plan authorizes the board of directors to grant eligible employees and certain related parties incentive or non-statutory stock options and restricted stock. The maximum number of shares of common stock that may be issued under this plan is 1.45 million. As of December 31, 2002, no stock options or stock awards had been granted pursuant to this plan.
Standard is involved in a reinsurance and third-party administration arrangement with The Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) to market Northwestern Mutual’s group long term and short term disability products using their agency distribution system. Generally, Standard provides reinsurance to Northwestern Mutual for 60% of the risk, and receives 60% of the premiums for the policies issued. In addition to assuming reinsurance risk, Standard provides product design, pricing, state regulatory filings, underwriting, legal support, claims management and other administrative services under the arrangement. Premiums assumed by Standard for the Northwestern Mutual business accounted for 3.6%, 3.9% and 4.0% of the Company’s total premiums in 2002, 2001, and 2000, respectively. If Standard were to become unable to meet its obligations, Northwestern Mutual would retain the reinsured liabilities. Therefore, in accordance with an agreement with Northwestern Mutual,
During the first quarter of 2002, Standard formed a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”) that offers Standard’s policyholders new and more flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists. As part of this alliance, Standard and Ameritas entered into a reinsurance agreement, effective June 1, 2002, that provides for approximately 15% of the net dental premiums written by Standard to be ceded to Ameritas.
At December 31, 2002, the Company had outstanding commitments to fund or acquire various assets, generally commercial mortgage loans with fixed interest rates ranging from 6.00% to 8.25%, totaling $118.2 million. The commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s credit worthiness individually and may terminate a commitment based on the financial condition of the borrower. Additionally, a small percentage of borrowers allow their commitments to expire without being drawn upon.