The Company's primary administrative offices are located in Dallas, Texas. Southwestern Financial Services Corporation ("SFSC") leases approximately 75,000 square feet in Dallas, Texas at an annual cost of $1.2 million (excluding the assigned office space as discussed below). The Company believes that its current office space is adequate for its operations. During the year ended December 31, 2000, the Company agreed to assign its lease on certain vacated office space to a third party and was released from obligations related to the vacated office space beginning January 1, 2001.
This "Management's Discussion and Analysis of Financial Condition and Results of Operations" reviews the consolidated financial condition of the Company as of December 31, 2000 and 1999, the consolidated results of operations for the three years ended December 31, 2000, and where appropriate, factors that may affect future financial performance.
On February 7, 2000, PennCorp filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court. From the petition date, PennCorp continued to operate and manage its assets and business as a debtor-in-possession as authorized by provisions of the Bankruptcy Code. None of PennCorp's insurance subsidiaries were involved in the bankruptcy filing.
On February 28, 2000 the Bankruptcy Court issued an order scheduling a hearing to consider approval of the sale agreement with Reassure America, subject to higher or better offers, and establishing procedures for the submission of competing offers.
On March 15, 2000, PennCorp received a competing bid in the form of a recapitalization plan submitted by Inverness and Vicuna on behalf of the unofficial ad hoc committee of preferred stockholders, and Rapoport and Sharpe. On March 23, 2000, PennCorp's Board of Directors selected the Recapitalization Plan as the final accepted offer pursuant to the bidding procedures approved as part of the sales procedure order. On March 24, 2000, the Bankruptcy Court approved the Board of Director's selection of the Recapitalization Plan. On April 14, 2000, the Texas Department of Insurance issued its order approving the Form A acquisition statement submitted by Rapoport and Inverness.
On June 13, 2000, the Company consummated the Recapitalization Plan and emerged from the Chapter 11 proceedings as SWL Holdings. Pursuant to the Recapitalization Plan, the Company issued 5,175,000 shares of common stock in exchange for all of the outstanding preferred stock of PennCorp. The Company also issued 1, 960,000 shares of common stock pursuant to a rights offering underwritten by Inverness and Vicuna and 1,840,000 shares to Rapoport and Sharpe in connection with their investments. These shares were issued at a price of $12.50 per share and the Company received $46.0 million in cash (net of related expenses of $1.5 million). Additionally, the Company awarded 60,000 shares to two executive officers and 24,000 shares to a former officer and director of PennCorp in consideration of his consulting services rendered in connection with the recapitalization transaction. All shares of PennCorp's common stock were canceled for no value. In addition, the Company consummated a new $95.0 million credit facility and borrowed $81.0 million under it at closing. According to the Recapitalization Plan, the Company received $49.1 million from PLAIC as principal and interest payments on an existing surplus debenture and $5.9 million as dividends. The $55.0 million was made available to PLAIC from Southwestern Life and Security Life as an extraordinary dividend. The Company used these proceeds to repay the principal balances of PennCorp's senior and subordinated debt aggregating $179.6 million and to pay a break fee of $6.0 million to Reassure America upon termination of its contract to purchase Southwestern Life and Security Life. Any and all other claims and liabilities of PennCorp were paid or accrued in accordance with their terms.
The Company issued non-qualified options to purchase 890,000 shares of its common stock at prices ranging from $12.50 to $15.00 per share. Included in these options were options to acquire 55,000 shares that were awarded to certain consultants at a price of $12.50 per share for which the Company recognized expense of $426,000. With the resignation of one of the executive officers effective August 1, 2000, the Company recognized expense of $75,000 with respect to previously granted stock options to acquire 150,000 shares. These options subsequently expired without being exercised.
Dispositions. On November 30, 2000 the Company sold Marketing One for nominal proceeds and recorded a loss of $14,000 from the sale.
Effective May 1, 2000, Southwestern Life and Security Life each consummated with RGA Reinsurance Company ("RGA") a 100% indemnity coinsurance agreement relating to all of their respective deferred annuity business. Southwestern Life and Security Life transferred to RGA cash of $433.0 million, which is equal to the amount of the reinsured statutory policy liabilities net of ceding allowance of $15.1 million. The Company recorded a deferred gain of $10.2 million, representing the difference between ceded policy liabilities calculated on a GAAP basis, net of deferred policy acquisition costs and present value of insurance in force associated with these policies, and the cash transferred net of the ceding allowance. The deferred gain is being recognized in other income over the life of the reinsured block of business. During the period from closing to December 31, 2000, the Company recognized $810,000 of such deferred gains. Southwestern Life and Security Life retained the administration for the ceded block of business and are reimbursed by RGA for administrative costs at the rate of $5.00 per annuity contract in force per month and will receive a monthly trail commission equal to one-twelfth of 0.32% of outstanding statutory reserves. (As a result of the merger of Security Life into Southwestern Life effective June 30, 2000, Southwestern Life succeeded to all of Security Life's rights and obligations under its agreement with RGA.) The Company recognized $5.3 million in pre-tax capital losses from liquidating invested assets to provide the cash required to consummate the reinsurance transaction. The Company has established an additional tax valuation allowance for capital loss carryforwards associated with the sale of invested assets which may not be recoverable prior to their expiration dates.
On February 4, 2000, PennCorp consummated the sale of the Payroll Sales Division for cash proceeds of $103.3 million. PennCorp used $100.0 million of the proceeds to repay its then-existing bank credit facility.
On July 30, 1999, PennCorp consummated the sale of the Career Sales Division to Universal American. The net cash proceeds after transaction costs and fulfillment of contract obligations were $82.0 million. On December 29, 1999, as a result of certain settlement and consideration adjustment provisions included in the purchase and sale agreement PennCorp reduced the consideration received by $2.6 million. PennCorp realized a foreign currency translation loss of $25.0 million, which represented previously unrealized translation losses on PennCorp's Canadian insurance operations, partially offset by a gain of $3.5 million resulting in a net loss of $21.5 million. In addition, as a result of the sale, unrealized gains on securities available for sale and unrealized foreign currency translation losses decreased by $2.3 million and $25.0 million, respectively.
On April 30, 1999, PennCorp consummated the sale of the United Life Assets to ING. The purchase consideration totaled $154.1 million including a dividend of $2.1 million that was paid by United Life at closing. The cash consideration ultimately was reduced as a result of PennCorp's obligation to purchase certain mortgages and other assets from United Life as well as for transaction related costs at closing. PennCorp received net cash proceeds of $136.5 million. PennCorp realized a loss from the sale totaling $3.9 million. As a result of the sale, unrealized gains on securities held for sale decreased by $1.7 million. As of December 31, 1999, PennCorp sold substantially all of the mortgages retained by the Company as a part of the sale of the United Life Assets for aggregate consideration of $8.0 million. The Company may be obligated to repurchase certain of the mortgages sold. At December 31, 2000, the Company had established a $1.2 million liability related to these contingencies. In addition, the Company settled with ING a dispute over certain federal income tax calculations under the provisions of the United Life Assets purchase and sale agreement relating to the differential in tax amounts between closing and the final return. The Company paid $721,000 with respect to the settlement.
Acquisitions. On January 2, 1998, PennCorp acquired the remaining equity interests in SW Financial, which became a wholly-owned subsidiary. The remaining interest was acquired from KB Fund and Messrs. Steven W. Fickes and David J. Stone, former executive officers and directors of PennCorp for an aggregate purchase price of $73.7 million (not including acquisition expenses).
Restructuring and Other Costs. PennCorp developed restructuring plans to realign or consolidate certain operations resulting in restructuring costs incurred during 2000, 1999, the fourth quarter of 1998 and the first quarter of 1998.
In connection with the merger of Security Life into Southwestern Life and the consummation of the Recapitalization Plan, the Company adopted a restructuring plan during the quarter ended June 30, 2000. Pursuant to the 2000 Plan, the Company reduced its workforce in most areas of the Company (including finance, policyholder services, marketing, information technology and human resources) by a total of 52 employees. The 2000 Plan was substantially completed as of December 31, 2000 and is expected to result in operating expense reductions and cash
savings of approximately $2.4 million annually. The Company incurred restructuring costs aggregating approximately $1.0 million for the year ended December 31, 2000 associated with such restructuring.
In connection with the sale of the United Life Assets along with other non-core operations during 1999, PennCorp announced a restructuring plan in June 1999 to significantly reduce its Dallas-based staff and vacate certain office space. PennCorp incurred restructuring costs aggregating $5.3 million for the year ended December 31, 1999 associated with such restructuring.
The following reflects the impact of activity for the years ended December 31, 1999 and 2000 on the restructuring accrual balances under the 1999 Plan (in thousands):
The following reflects the impact of activity for the years ended December 31, 1998, 1999 and 2000 on the restructuring accrual balances under the fourth quarter 1998 Plan (in thousands):
In January 1998, PennCorp acquired the SW Financial Controlling Interest and the Fickes and Stone Knightsbridge Interest. The acquisition allowed PennCorp to complete its divisional restructuring which began in 1997. PennCorp incurred restructuring costs aggregating approximately $11.8 million for the year ended December 31, 1998 associated with the divisional restructuring.
The following reflects the impact of activity for the years ended December 31, 1998, 1999 and 2000 on the restructuring accrual balances under the first quarter 1998 Plan (in thousands):
The first quarter 1998 Plan provided for vacating certain Dallas office space. In connection with the plan, PennCorp recorded estimated holding costs of vacated facilities of $2.2 million which represented the net present value of the rent on the office space to be vacated net of the estimated sublease rent to be received. During 1999 and 2000, PennCorp charged $350,000 and $1.6 million, respectively, of rent expense on vacated office space against the accrual.
The first quarter 1998 Plan also recognized impairment of certain furniture, fixtures and data processing equipment totaling $1.1 million which had been utilized in the office space to be vacated. PennCorp charged $831,000 of such assets against the accrual during 1998.
PennCorp incurred approximately $6.3 million of pre-tax period costs ("period costs") associated with the corporate restructuring for the year ended December 31, 1998. Such costs are included in the Company's Consolidated Statements of Operations and Comprehensive Income (Loss) as underwriting and other administrative expenses.
Since December 31, 1999 the Company has not experienced any significant disruption in the Company's business, or an increase in the cost of the Company doing business related to the year 2000 issue.
The Company provided certain representations and warranties to each respective purchaser of the businesses sold with respect to each entity's ability to process date-sensitive information for the year 2000 and beyond. Although the Company believes that it is in compliance with, and is not aware of any breach of the year 2000 representations and
warranties provided to the respective purchasers, there can be no assurances that the Company is in compliance with all such representations and warranties. A breach by the Company of such representations and warranties could result in indemnification obligations owed by the Company to the purchasers.
General. SWL Holdings ("parent company"), formerly known as PennCorp, is a legal entity, separate and distinct from its subsidiaries and has no material business operations. The parent company needs cash for: (i) principal and interest on debt; (ii) holding company administrative expenses; (iii) income taxes and (iv) investments in subsidiaries. The primary sources of cash to meet parent company obligations include statutorily permitted payments from life insurance subsidiaries, including: (i) surplus debenture interest and principal payments; and (ii) dividend payments. The parent company may also obtain cash through the sale of subsidiaries or other assets.
The following table shows the cash sources and uses of the parent company on a projected basis for 2001 and on an actual basis for the periods June 13, 2000 to December 31, 2000, February 8, 2000 to June 12, 2000 (as debtor-in - -possession), January 1, 2000 to February 7, 2000 (prior to the bankruptcy filing) and years ended December 31, 1999 and 1998:
consummation of the sale of the Career Sales Division and the surplus notes issued by Pioneer Security were repaid in full in connection with the consummation of the sale of the Payroll Sales Division. As part of a subsidiary realignment in conjunction with the Career Sales Division divestiture, PLAIC issued a new surplus debenture to SW Financial in the amount of $150.0 million to acquire the common stock of Southwestern Life. As part of a subsidiary realignment in conjunction with the Payroll Sales Division divestiture, PLAIC issued a new surplus debenture to SW Financial in the amount of $35.0 million to acquire the common stock of Security Life. With respect to Constitution, Pioneer Security and PLAIC (as to its surplus debenture issued as of July 30, 1999), the surplus debenture payments were made to non- insurance intermediate holding companies and subsequently paid to the Company in the form of dividends. The amount outstanding under the surplus debentures as of December 31, 1999 was $258.3 million. At December 31, 2000, there is only one remaining surplus debenture with an outstanding principal balance of $94.9 million. This debenture was issued by PLAIC and is held by SWFC. The PLAIC surplus debenture requires principal and interest payments to be made periodically in amounts sufficient to allow SWL Holdings to meet its cash requirements. These payments are subject to PLAIC's maintenance of capital and surplus of at least $1.2 million in excess of its investment in Southwestern Life. Any deviation from scheduled payments requires regulatory approval.
Currently PLAIC relies upon dividends and tax sharing payments from Southwestern Life, which is in turn subject to regulatory restrictions under the Texas insurance laws and regulations with respect to the maximum amount of dividends that can be paid to PLAIC within a twelve month period without prior regulatory approval. Such dividend restrictions are generally the greater of 10% of statutory surplus or prior year's statutory earnings. See Item 1. Business--Regulatory Matters and Note 13 of Notes to Consolidated Financial Statements for additional discussions of dividend restrictions.
Projected cash sources for 2001 include $24.1 million of interest and principal payments on PLAIC's surplus debenture. SWL Holdings also anticipates receiving approximately $10.0 million of cash dividends from ROP and SW Hotel. Such dividends are dependent on the ability of ROP and SW Hotel to liquidate certain assets. There can be no assurances that the PLAIC surplus debenture payments can be made, or that the ROP and SW Hotel assets can be liquidated in the periods expected or, if completed, that the Company will receive net proceeds projected. Projected cash uses include scheduled payments of principal of $8.6 million, discretionary payments of principal (including payments on the revolving credit facility) of $17.0 million and interest of $8.0 million on the new credit facility and payments for operating expenses of $1.3 million. Projected cash uses also include the release of an escrow account of $1.0 million that was established in connection with the sale of the Career Sales Division.
Management believes the Company will likely have sufficient financial flexibility and projected liquidity sources to meet all cash requirements. At December 31, 2000, the amount available to be drawn under the new credit facility was $11.0 million.
Cash Sources and Uses for the Period June 13, 2000 to December 31, 2000
Cash Sources and Uses for the Period February 8, 2000 to June 12, 2000
During the period from February 8, 2000 to June 12, 2000, PennCorp (as a debtor-in-possession) received $4.1 million of dividends and surplus debenture principal and interest from subsidiaries and $245,000 of short-term investment income, $57,000 of proceeds from sale of mortgage loans and collection of receivables and $32,000 from tax refunds. PennCorp paid $2.3 million in interest on its senior debt and incurred $1.0 million of operating expenses. PennCorp made a $5.0 million principal payment on its credit facility and payments of $855,000 to a non-insurance subsidiary representing a return of the subsidiary's funds previously swept to the cash collateral account.
Cash Sources and Uses for the Period January 1, 2000 to February 7, 2000
For the period from January 1, 2000 to February 7, 2000, PennCorp paid $10.0 million in employment contract obligations and $280,000 in transaction bonuses ($8.3 million had been accrued and expensed prior to December 31, 1999) under executive employment agreements with certain senior executives of PennCorp and its subsidiaries (see Notes 15 and 23 of Notes to Consolidated Financial Statements.) In addition, PennCorp paid $2.0 million for insurance coverage, principally to cover possible indemnification claims arising from a breach of the representations and warranties contained in each of the subsidiary and asset sale agreements, $1.9 million in retainers to professional services firms and $3.5 million for other professional and legal services. Interest totaling $3.1 million was paid during the period in order to bring PennCorp's bank credit facility current.
Cash Sources and Uses for the Years Ended December 31, 1999 and 1998
Cash from Subsidiaries. For each of the years ended December 31, 1999 and 1998, PennCorp received surplus debenture interest and principal payments from PLAIC of $223.5 million and $26.2 million, respectively, and received dividends and tax sharing payments of $126.4 million and $47.3 million, respectively, from non-insurance intermediate holding companies. Substantially all of the surplus debenture dividends and tax sharing payments made by PLAIC were the direct result of proceeds received by PLAIC from the disposition of Businesses Sold.
Other Investment Income. During 2000, 1999 and 1998, the Company received investment income from short- term invested assets of $353,000, $754,000 and $2.9 million, respectively.
Sales of Equity Securities. During 1998, PennCorp liquidated its common and preferred stock holdings in ACO Brokerage Holding Corp. ("ACO"), the parent company of Acordia Inc. Total proceeds received from the sale of the preferred and common stock aggregated $30.5 million. PennCorp had acquired the preferred stock interests in ACO for $20.0 million during 1997 and the common stock interests in January 1998 for $5.0 million as part of PennCorp's and the KB Fund's investment in ACO. See Note 17 of Notes to Consolidated Financial Statements for additional information regarding PennCorp's investment in ACO.
Sales of/Collection on Assets Held. During the year ended December 31, 1999, PennCorp received mortgage loan principal payments and distributions from a limited partnership totaling $1.4 million. In addition, PennCorp sold certain mortgage loans and the limited partnership interest held directly by PennCorp for proceeds aggregating $10.2 million.
Additional Borrowings. During 1998, PennCorp borrowed under then existing bank credit facilities primarily to fund acquisitions or repay existing indebtedness. See "Acquisition of Businesses" and "Reduction of Notes Payable" below for the use of proceeds from the additional borrowings.
Acquisition of Businesses. During 1998, PennCorp acquired the Controlling Interest in SW Financial for $73.7 million in cash and the Fickes and Stone Knightsbridge Interests for $10.6 million of which $200,000 of the consideration was paid in cash. To fund such acquisitions PennCorp utilized borrowings under its then existing credit facility. For additional information on the acquisition of the Controlling Interest in SW Financial and the Fickes and Stone Knightsbridge Interests, see Note 3 of Notes to Consolidated Financial Statements.
Reduction of Notes Payable. During the year ended December 31, 1999, the Company made repayments under its bank credit facility aggregating $267.0 million upon the consummation of sales of Professional, the United Life Assets, KIVEX and the Career Sales Division. An additional $2.0 million was repaid as a result of liquidity at the PennCorp level above amounts prescribed in the bank credit facility.
Capital Contributions to Subsidiaries. For the years ended December 31, 1999 and 1998, PennCorp made capital contributions to subsidiaries totaling $27.7 million and $7.9 million, respectively. During 1999, $3.3 million was contributed to PLAIC to make a subsequent capital contribution to PLIC and $3.1 million was contributed to a non-life insurance subsidiary. In addition, $21.3 million was contributed to subsidiaries to meet certain target capital and surplus requirements as required by the purchase and sale agreement for the Career Sales Division. PennCorp utilized funds from proceeds from the Businesses Sold to fund these contributions. During 1998, contributions were primarily made to certain non-life insurance subsidiaries, principally KIVEX, to fund expansion and for other corporate purposes.
Dividends of Preferred and Common Stock. During 1998, PennCorp paid common and preferred stock dividends aggregating $16.2 million. PennCorp halted common and preferred stock dividend payments during 1998 as a result of impending liquidity concerns.
Cash Flow from Operating Activities. Cash flow from operating activities, excluding the parent company, was $14.0 million, $54.9 million and $34.2 million, respectively, for the years ended December 31, 2000, 1999 and 1998. The decrease in cash flow from operating activities during the year ended December 31, 2000 principally resulted from the sale of certain subsidiaries which collectively provided cash flow of only $3.8 million during 2000 compared to $48.0 million and $123.7 million for the years ended December 31, 1999 and 1998, respectively. This was partially offset by increases in cash flow of retained companies. The increase principally resulted from decreasing costs associated with year 2000 remediation and reduced costs as a result of strategic business evaluation and associated restructuring of the Company. The increase in cash flow from operating activities for the year ended December 31, 1999 compared to 1998 is also attributable to the sale of KIVEX, which used cash from operating activities due to its rapid growth.
Cash Flow from Investing Activities. During the years ended December 31, 2000, 1999 and 1998, the Company's subsidiaries sold $559.4 million, $603.5 million and $1,019.9 million of fixed maturity and equity securities, and purchased $161.4 million, $814.2 million and $1,054.7 million of fixed maturity and equity securities, respectively. Sales exceeded purchases during 2000 primarily in order to meet cash flow demands associated with the reinsurance of deferred annuities with RGA.
For the years ended December 31, 2000, 1999 and 1998, the Company has prepared the following unaudited selected financial information for the Company's Insurance Operations (PLAIC and Southwestern Life, including Security Life which was merged into Southwestern Life effective June 30, 2000), Businesses Sold (Payroll Sales Division, Career Sales Division, Professional, the United Life Assets, KIVEX and Marketing One) and corporate activities. On November 30, 2000, Marketing One was sold and the results of operations of Marketing One have been included in "Businesses Sold" for all periods presented. "Operating Income (Loss)," as used below, excludes the impact of: (i) restructuring costs, (ii) gains or losses on the sale of investments and (iii) the impact of the Company's decision to dispose of the Businesses Held for Sale. The Company considers operating income (loss) to reflect "core earnings (loss)" and to be the most relevant and useful information to evaluate trends impacting the Company's operations. This information is used by the Company's principal decision makers to evaluate its performance as it eliminates the impact of transactions that the Company considers to be unrelated to core operating results. Other companies that operate primarily in the life insurance industry may or may not use similar measures.
The Company has prepared such information as it believes that the disposition of the Businesses Held for Sale and the restructuring costs are material enough to make historical comparative results not meaningful. In addition, the Company believes that the following selected financial information and subsequent discussion will assist the reader in understanding how management views and evaluates the operations of the Company.
Policy Revenues. Policy revenues include: (i) premiums received on traditional life products (ii) mortality charges and administrative fees earned on universal life insurance and annuities and (iii) surrender charges on terminated universal life and annuity products. In accordance with GAAP, premiums on universal life and annuity products are accounted for as deposits to insurance liabilities.
Premiums, net of reinsurance, by major product line and policy revenues for the years ended December 31, 2000, 1999 and 1998 are as follows:
premiums of $3.2 million and $387,000 during 2000 and 1999, respectively. Single premiums can vary significantly from period to period.
Annuity premiums have declined 64.7% to $3.1 million in 2000 compared to 1999 after declining $7.5 million or 46.4% in 1998. The decrease in annuity premiums in 2000 principally reflects the consummation of the RGA reinsurance transaction whereby Southwestern Life and Security Life reinsured substantially all of their existing deferred annuity blocks of business effective May 1, 2000 (see Note 3 of Notes to Consolidated Financial Statements). The decline in annuity sales is also attributable to a shift in the overall annuity market to sales of variable products (which Southwestern Life does not offer) from fixed products due to historically low interest rates and consumer interest in equities. Annuity sales are likely to continue to decline unless market conditions for fixed annuities become more favorable and ratings of Southwestern Life improve.
contracts which have reached the annuitization period. Consideration from supplemental contracts recognized as other income is offset by policyholder benefits, resulting in no effect on the Company's results of operations.
Policyholder benefits decreased 9.6% to $192.8 million in 2000 compared with 1999. Death benefits decreased $4.4 million or 5.5% in 2000 compared with 1999. Death benefits may vary significantly from period to period. Other policy benefits and change in future policy benefits decreased $16.1 million or 12.2% during 2000 and increased $4.7 million or 3.6% in 1999. The decrease in 2000 is attributable to a decline in interest credited on deferred annuities which were reinsured effective May 1, 2000. The decrease is also attributable to a decline in interest credited to universal life policies at Security Life as a result of fewer policies in force following the exchange program, surrender activity and the absence of new business production. The decreases were partially offset by increases to certain deficiency reserves and unearned revenue reserves during 2000 of $5.2 million as a result of unlocking assumptions, including future lapsation, on certain interest-sensitive blocks of business of Security Life. Also partially offsetting the decreases was an increase to policy liabilities of $4.7 million during 2000 pursuant to settlement of a class action lawsuit (see Item 3. Legal Proceedings). The recorded liability reflects costs the Company considers likely to be incurred based only on known or reasonably estimable factors. Therefore, the ultimate cost to the Company may be greater than estimated and may have a material adverse effect on the Company's financial condition, results of operations and cash flows. During the fourth quarter of 2000, the Company undertook an analysis of its reserving and other actuarial practices. As part of this review, the Company discovered that the method utilized to calculate deferred policy acquisition costs and policy liabilities on certain term policies was not correctly reflecting reinsurance ceded. As a result of correcting this methodology, policy liabilities increased approximately $1.0 million.
Insurance related expenses decreased $945,000 or 3.2% to $28.7 million during 1999 compared with 1998. The small decrease in 1999 reflects reduced insurance related expenses at Security Life as a result of declining production of new business for several years and a diminished block of in force business as a result of policy surrenders.
Other Operating Expenses. Other operating expenses (including general operating, overhead and policy maintenance) decreased $195,000 to $38.7 million in 2000 compared with 1999 and decreased $9.5 million to $38.9 million in 1999 compared with 1998. The liabilities held at Southwestern Life and Security Life for expected assessments to life and health guaranty associations of states in which the companies were licensed to do business were reduced by $3.4 million during 1999 as a result of completing these companies' evaluation of third party guaranty fund assessment data on a corporate-wide basis, including the impact of the disposition of the Businesses Sold. Expenses in 2000 also included $1.3 million of fees paid to plaintiffs' counsel in connection with the settlement of a lawsuit (see Item 3. Legal Proceedings). Without this 1999 reduction in guaranty fund liabilities and the fees paid in 2000 to settle litigation, operating expenses would have decreased $4.5 million in 2000 compared to 1999 reflecting the Company's efforts to reduce expenses. The decrease in 1999 compared to 1998 is attributable to ongoing reductions in costs associated with the restructuring of the Dallas operations, a reduction in expenses associated with year 2000 remediation efforts and systems conversions for Security Life. The decrease in 1999 compared to 1998 is also impacted by a charge of $2.3 million during 1998 for uncollectible agents' debit balances at Security Life as well as by the $3.4 million reduction in guarantee fund liabilities in 1999.
sponsored payroll deduction programs. United Life principally marketed fixed and variable annuities through financial institutions and independent general agents, primarily in the southern and western United States.
Interest and Amortization of Deferred Debt Issuance Costs. Interest and amortization of deferred debt issuance costs decreased $24.0 million in 2000 compared to 1999 and decreased $2.7 million in 1999 compared to 1998. The decrease is principally a result of principal repayments under PennCorp's bank credit facility. As a result of the sales of the Payroll Sales Division in 2000 and the Career Sales Division, KIVEX, the United Life Assets and Professional in 1999, PennCorp reduced its then outstanding bank credit facility by $367.0 million. PennCorp also repaid an additional $2.0 million of indebtedness as a result of liquidity at the parent company above the amount prescribed in the bank credit facility. In addition, at emergence from the Chapter 11 proceedings, the Company repaid the remaining amounts outstanding under PennCorp's bank credit facility and its senior subordinated notes aggregating $179.6 million with existing cash, borrowings of $81.0 million from the $95.0 million new bank credit facility (the "New Credit Facility") (see Note 8 of Notes to Consolidated Financial Statements), the $46.0 million capital contribution (net of related expenses) in connection with the recapitalization transaction and $55.0 million extraordinary dividends from Southwestern Life and Security Life. Since the consummation of the Recapitalization Plan, the Company has borrowed an additional $3.0 million, net of repayments, under the new credit facility. The decrease in 1999 was partially offset by the higher borrowing costs, additional costs associated with credit facility fees and costs incurred to amend the credit agreement as a direct result of PennCorp's deteriorating financial position. In addition, during 1999, PennCorp accelerated amortization of certain deferred loan costs in the amount of $2.1 million in accordance with Emerging Issue Task Force ("EITF") Issue No. 98-14, "Debtor's Accounting for Changes in Line-of-Credit or Revolving-Debt- Arrangement," as a result of the amendment to the bank credit facility. EITF Issue No. 98-14 requires the unamortized deferred loan costs to be amortized in proportion to the impact of period changes in a credit facility as compared with its original terms.
On September 8, 2000, the Company entered into an interest rate cap agreement with a bank to hedge a notional amount of $40.0 million of its outstanding floating rate notes for a term of 21 months effective December 12, 2000. Pursuant to the agreement, the Company will receive interest differential from the counter-party if the London Inter Bank Offering Rate ("LIBOR") exceeds 8.5%. At December 31, 2000, LIBOR was 6.6%.
Net investment income and other income. Net investment income and other income were $1.6 million, $2.7 million and $4.7 million for the years ended December 31, 2000, 1999 and 1998, respectively. The decreasing trend is principally the result of reduced balances of cash and cash equivalents.
Corporate Expenses. Corporate expenses and other costs were $29.0 million, $39.0 million and $41.0 million for the years ended December 31, 2000, 1999 and 1998, respectively. The decrease in 2000 compared to 1999 reflects the effect of management's efforts subsequent to the recapitalization to substantially reduce corporate overhead. The decrease was partially offset by a break fee of $6.0 million that was paid to Reassure America upon the termination of its contract to purchase Southwestern Life and Security Life and costs associated with the recapitalization of $5.4 million. Included in the 1999 results are non-recurring costs including additional amortization of costs in excess of net assets acquired associated with KB Management reflecting the decision to terminate KB Management and KB Investment as administrator and general partner respectively, of KB Fund, a previous affiliate, additional costs associated with efforts to develop recapitalization and restructuring alternatives, consulting and legal fees associated with the disposal of the Businesses Sold as well as other corporate matters.
The decrease in 1999 compared to 1998 principally reflects the cost savings realized by the decision to close PennCorp's New York and Bethesda offices and eliminate personnel located in those offices. This is partially offset by additional amortization of costs in excess of net assets acquired of approximately $7.6 million in 1999 associated with KB Management. The accelerated amortization reflected PennCorp's Board of Directors' decision to terminate KB Fund, for which KB Management and KB Investment acted as administrator and general partner, respectively. PennCorp also incurred (i) additional costs associated with efforts to develop recapitalization and restructuring alternatives aggregating $2.2 million; (ii) additional consulting and legal fees of $1.8 million associated with negotiation and implementation of, and compliance with, the amended bank credit facility, pending class action securityholder litigation and the SEC investigation; (iii) additional deferred compensation of $3.2 million associated with the two year employment agreements of PennCorp's senior executives which were entered into in May 1998; and (iv) provisions of $2.3 million to settle shareholder and other litigation.
The Company's independent auditors are engaged to express an opinion on the financial statements, review the financial records and related data and test the internal control system over financial reporting.
The Audit Committee of the Board of Directors, which is composed primarily of outside directors, serves in an oversight role to assure the integrity and objectivity of the Company's financial reporting process. The committee meets periodically with representatives of management, as well as the independent auditors, to review matters of a material nature related to financial reporting and the planning, results and recommendations of audits. The independent auditors have free access to the Audit Committee, without management present, to discuss any matter they believe should be brought to the attention of the committee. The committee is also responsible for making recommendations to the Board of Directors concerning the selection of the independent auditors.
Bernard Rapoport David A. Commons Chief Executive Officer Senior Vice President and Chief Financial Officer
The Shareholders and Board of Directors of Southwestern Life Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Southwestern Life Holdings, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations and comprehensive loss, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southwestern Life Holdings, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 7, the Company changed its method of recording claim reserves associated with disability income products of the Career Sales Division during the year ended December 31, 1998. The effect of the change in methodology is inseparable from the effect of the change in accounting estimates and is accordingly reflected in operations as a change in accounting estimate for the year ended December 31, 1998.
SOUTHWESTERN LIFE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
SOUTHWESTERN LIFE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands)
SOUTHWESTERN LIFE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Southwestern Life Holdings, Inc. ("SWL Holdings" or the "Company"), formerly known as PennCorp Financial Group, Inc. ("PennCorp"), is an insurance holding company. The name of the Company was changed effective June 13, 2000, the date the recapitalization transactions (see Note 3) were consummated.
As further discussed in Note 3, on February 7, 2000, PennCorp filed a voluntary petition for relief under Chapter 11 ("Chapter 11") of title 11 of the United States Bankruptcy Code ("Bankruptcy Code"). On June 13, 2000, PennCorp consummated a Recapitalization Plan and emerged from the Chapter 11 proceedings as SWL Holdings. The Company owns 100% of SWFC Nevada, Inc. ("SWFC") formerly known as Southwestern Financial Corporation ("SW Financial"). Through SWFC's wholly-owned life insurance subsidiary, Pacific Life and Accident Insurance Company ("PLAIC"), and its wholly-owned life insurance subsidiary, Southwestern Life Insurance Company ("Southwestern Life"), the Company offers a broad range of life, annuity and accident and health insurance products through both independent and exclusive agents. Additionally, the Company owns KB Management, LLC ("KB Management") which provides management and advisory services to the Company and its insurance subsidiaries and Southwestern Financial Services Corporation ("SFSC") which has a services agreement with the life insurance affiliates to provide personnel, data processing and other operational services at cost. As part of a subsidiary realignment, Security Life and Trust Insurance Company ("Security Life"), formerly a wholly-owned life insurance company, was merged into Southwestern Life effective June 30, 2000.
Operating results of all subsidiaries sold have been reported herein as "Businesses Held for Sale" or "Businesses Sold." United Life, UC, Cyberlink and certain assets of Marketing One collectively are referred to herein as "United Life Assets." Penn Life, Peninsular, Constitution, Union Bankers and Marquette collectively are referred to herein as "Career Sales Division." AA Life and Occidental collectively are referred to herein as "Payroll Sales Division."
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Although some variability is inherent in these estimates, management believes the amounts provided are adequate. In all instances, actual results could differ from estimates.
Fixed maturities and equity securities classified as available for sale are recorded at fair value, as they may be sold in response to changes in interest rates, prepayment risk, liquidity needs, the need or desire to increase income, capital or other economic factors. Fair values are determined based on quoted market prices, where available. For fixed maturities and equity securities not actively traded, fair values are estimated using values obtained from independent pricing services or are estimated based on expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. Changes in unrealized gains and losses related to securities available for sale are recorded as accumulated other comprehensive income, a separate component of shareholders' equity, net of applicable income taxes and amount attributable to deferred policy acquisition costs and present value of insurance in force related to universal life and annuity products. Mortgage-backed fixed maturity securities held for investment or available for sale are amortized using the interest method including anticipated prepayments at the date of purchase. Significant changes in estimated cash flows from original assumptions are reflected in the period of such change. Mortgage loans on real estate are recorded at cost, adjusted for amortization of premium or discount and provision for loan loss, if necessary. Policy loans and short-term investments are recorded at cost. Other invested assets include investments in limited partnerships stated at cost and adjusted for contributions, distributions and undistributed income and other miscellaneous investments carried at cost.
Realized investment gains and losses and declines in value which are other than temporary, determined on the basis of specific identification, are included in net income.
During 1999 and 1998, the Company recognized an aggregate $58.5 million and $343.0 million, respectively, of non-cash charges related to the fair value of consideration to be received upon disposition of certain operating companies which are aggregated for purposes of presentation of the Company's financial information as "assets and liabilities of Businesses Held for Sale."
In accordance with SFAS No. 121, the Company recorded the impairment provision in order to reflect the difference in the Company's accounting basis in the Businesses Held for Sale and the fair value of the consideration that the Company would likely receive for such businesses. The fair value of the consideration likely to be received was primarily based upon the terms of definitive sales agreements.
Estimated costs of acquiring new business which vary with, and are primarily related to, the production of new business, have been deferred to the extent that such costs are deemed recoverable from future revenues. Such estimated costs include commissions, certain costs of policy issuance, underwriting, certain variable agency and marketing expenses and other costs directly associated with these functions to the extent such costs are determined to vary with and are primarily related to the production of new business. Costs deferred associated with accident and health and traditional life policies are amortized, with interest, over the anticipated premium-paying period of the related policies in proportion to the ratio of annual premium revenue to expected total premium revenue to be received over the life of the policies. Expected premium revenue is estimated by using the same mortality, morbidity and withdrawal assumptions used in computing liabilities for future policy benefits. For interest-sensitive products and limited pay life products, policy acquisition costs are amortized in relation to the emergence of anticipated gross profits over the life of the policies.
For the year ended December 31, 1998, the Company made a valuation determination with respect to certain preacquisition contingencies. The Company reduced tax liabilities and associated costs in excess of net assets acquired associated with the SW Financial and United Life acquisitions by $6.4 million and $647,000, respectively, as a result of the Company resolving certain acquisition date contingencies.
Future policy benefits for traditional life insurance products generally have been computed on the net level premium method, based on estimated future investment yield, mortality, morbidity and withdrawals. Estimates used are based on experience adjusted to provide for possible adverse deviation. These estimates are periodically reviewed and compared with actual experience. Future policy benefits for interest-sensitive products include the balance that accrues to the benefit of the policyholders and amounts that have been assessed to compensate the life insurance subsidiaries for services to be provided in the future.
In assessing the realization of deferred taxes, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
Shares purchased are recorded at cost as a reduction of shareholders' equity. Shares abandoned by the associated shareholders are recorded at no cost. The cost basis of shares reissued from treasury are determined on the basis of specific identification. During 2000, all treasury shares were cancelled as a result of the consummation of the recapitalization transaction (see Note 3).
Accident and health insurance premiums are recognized as revenue ratably over the time period to which premiums relate. Revenues from traditional life insurance policies represent premiums which are recognized as earned when due. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the lives of the policies. This association is accomplished by means of the provision for liabilities for future policy benefits and the deferral and amortization of policy acquisition costs.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires increased disclosure of stock options and other stock based compensation. This statement provides a choice for the accounting of employee stock compensation plans. A company may elect to use a new fair-value methodology, under which compensation cost is measured and recognized in results of operations, or continue to account for these plans under APB No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Note 12 contains a summary of the pro forma effects to reported net loss and net loss per share for 2000, 1999 and 1998, as if the Company had elected to account for employee stock compensation plans utilizing the fair value methodology prescribed by SFAS No. 123.
The financial statement accounts of the Company's Canadian operations (sold July 30, 1999), which are denominated in Canadian dollars, are translated into U.S. dollars as follows: (i) Canadian currency assets and liabilities are translated at the rates of exchange as of the balance sheet dates and the related unrealized translation adjustments are included as accumulated other comprehensive income, a separate component of shareholders' equity, and (ii) revenues, expenses and cash flows, expressed in Canadian dollars, are translated using a weighted average of exchange rates for each of the periods presented.
In September 2000, the Emerging Issues Task Force ("EITF") issued EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets". EITF 99-20 requires that holders of certain securitized financial assets evaluate whether current projected cash flows are different from the projected cash flows when the security was acquired. If the present value of the original projected cash flows exceeds the present value of the current estimated cash flows, the security would be considered impaired to the extent amortized cost exceeded its fair market value. The difference would be recorded as a realized investment loss. EITF 99- 20 is effective for fiscal quarters beginning after March 15, 2001. The Company is currently evaluating the impact of EITF 99-20 on the consolidated financial statements.
On March 15, 2000, PennCorp received a competing bid in the form of a recapitalization plan submitted by Inverness/Phoenix Capital LLC ("Inverness") and Vicuna Advisors, LLC ("Vicuna") on behalf of the unofficial ad hoc committee of preferred stockholders, and Mr. Bernard Rapoport ("Rapoport") and Mr. John Sharpe ("Sharpe") (the "Recapitalization Plan"). On March 23, 2000, PennCorp's Board of Directors selected the Recapitalization Plan as the final accepted offer pursuant to the bidding procedures approved as part of the Sales Procedure Order. On March 24, 2000, the Bankruptcy Court approved the Board of Directors' selection of the Recapitalization Plan. On April 14, 2000, the Texas Department of Insurance issued its order approving the Form A acquisition statement submitted by Rapoport and Inverness pursuant to the Recapitalization Plan. On June 5, 2000, the Bankruptcy Court confirmed the Recapitalization Plan.
On June 13, 2000, the Company consummated the Recapitalization Plan and emerged from the Chapter 11 proceedings as SWL Holdings. Pursuant to the Recapitalization Plan, the Company issued 5,175,000 shares of common stock in exchange for all of the outstanding preferred stock of PennCorp. The Company also issued 1,960,000 shares of common stock pursuant to a rights offering underwritten by Inverness and Vicuna and 1,840,000 shares to Rapoport and Sharpe in connection with their investments. These shares were issued at a price of $12.50 per share and the Company received $46.0 million in cash (net of related expenses of $1.5 million). Additionally, the Company awarded 60,000 shares to two executive officers and 24,000 shares to a former officer and director of PennCorp in consideration of consulting services rendered in connection with the recapitalization transaction. All shares of PennCorp's former common stock were canceled for no value. Shares of SWL Holdings are listed on the Nasdaq National Market under the symbol "SWLH" and started trading on September 28, 2000. In addition, the Company consummated a new $95.0 million credit facility and borrowed $81.0 million under it at closing. According to the Recapitalization Plan, the Company received $49.1 million from PLAIC as principal and interest payments on an existing surplus debenture and $5.9 million as dividends. The $55.0 million was made available to PLAIC from Southwestern Life and Security Life as an extraordinary dividend. The Company used these proceeds to repay the principal balances of PennCorp's senior and subordinated debt aggregating $179.6 million (see Note 8) and to pay a break fee $6.0 million to Reassure America upon the termination of its contract to purchase Southwestern Life and Security Life. Any and all other claims and liabilities of PennCorp were paid or accrued in accordance with their terms. The Company has established an additional tax valuation allowance on certain net operating loss carryforwards, which may not be recoverable as a result of the recapitalization and other factors.
On March 31, 1999, PennCorp consummated the sale of Professional to GE Financial Assurance Holdings, Inc. ("GE Financial"). The operating results of Professional are included in the consolidated operating results through March 31, 1999. On September 15, 1999, as a result of certain settlement and consideration adjustment provisions included in the purchase and sale agreement PennCorp reduced the consideration received by $1.2 million. PennCorp realized a gain from the sale totaling $1.1 million. As a result of the sale, unrealized gains on securities available for sale decreased by $488,000.
On April 30, 1999, PennCorp consummated the sale of United Life Assets to ING America Insurance Holdings, Inc. ("ING"). The operating results of United Life Assets are included in the consolidated operating results through April 30, 1999. PennCorp realized a loss from the sale totaling $3.9 million. As a result of the sale, unrealized gains on securities held for sale decreased by $1.7 million. The purchase and sale agreement includes certain settlement and consideration adjustment provisions relating to certain mortgages retained by PennCorp and federal income tax calculations (see Note 19). In addition, the Company settled with ING a dispute over certain federal income tax calculations under the provisions of the United Life Assets purchase and sale agreement relating to the differential in tax amounts between closing and the final return. The Company paid $721,000 with respect to the settlement.
On July 30, 1999, PennCorp consummated the sale of the Career Sales Division to Universal American Financial Corp. ("Universal American"). During 1999 and prior to the consummation of the sale, PennCorp incurred an additional impairment provision of $58.5 million related to the Career Sales Division. This resulted from the decrease in the nominal purchase consideration of $38.0 million partially offset by an estimated discount to the stated value of the note to be received. In addition, impairment provision included the impact of the true-up of statutory capital and surplus of the Career Sales Division companies to levels specified in the sale agreement which aggregated approximately $24.2 million. Other factors modestly impacting the impairment provision included additional transaction costs, changes in unrealized gains and losses of securities, foreign currency translation and net income not considered in the determination of sale consideration. The operating results of the Career Sales Division are included in the consolidated operating results through July 30, 1999. On December 29, 1999, as a result of certain settlement and consideration adjustment provisions, included in the purchase and sale agreement PennCorp reduced the consideration received by $2.6 million. PennCorp realized a foreign currency transaction loss on the sale of the Career Sales Division totaling $25.0 million, which represented previously unrealized translation losses on PennCorp's Canadian insurance operations,
partially offset by a gain of $3.5 million on the disposition resulting in a net loss of $21.5 million. In addition, as a result of the sale, unrealized gains on securities available for sale and unrealized foreign currency translation losses decreased by $2.3 million and $25.0 million, respectively.
On February 4, 2000, PennCorp consummated the sale of the Payroll Sales Division receiving total cash proceeds of $103.3 million. As a result of the sale, unrealized losses on securities available for sale decreased by $9.9 million. PennCorp recognized a loss of $8.4 million from the sale. PennCorp used $100.0 million of the proceeds to repay a then-existing bank credit facility.
Effective May 1, 2000, Southwestern Life and Security Life each consummated with RGA Reinsurance Company ("RGA") a 100% indemnity coinsurance agreement relating to all of their respective deferred annuity business. Southwestern Life and Security Life transferred to RGA cash of $433.0 million, which is equal to the amount of the reinsured statutory policy liabilities net of a ceding allowance of $15.1 million. The Company recorded a deferred gain of $10.2 million, representing the difference between ceded policy liabilities calculated on a GAAP basis, net of deferred policy acquisition costs and present value of insurance in force associated with these policies, and the cash transferred net of the ceding allowance. The deferred gain is being recognized in other income over the life of the reinsured block of business. During the period from closing to December 31, 2000, the Company recognized $810,000 of the deferred gains. Southwestern Life and Security Life retained the administration for the ceded block of business and are reimbursed by RGA for administrative costs at the rate of $5.00 per annuity contract in force per month. (As a result of the merger of Security Life into Southwestern Life effective June 30, 2000, Southwestern Life succeeded to all of Security Life's rights and obligations under its agreement with RGA). The Company recognized $5.3 million in pre-tax capital losses from liquidating invested assets to provide the cash required to consummate the reinsurance transaction. In addition, the Company receives a monthly trail commission equal to one-twelfth of 0.32% of outstanding statutory reserves. The Company also established an additional tax valuation allowance for capital loss carryforwards associated with the sale of invested assets, which may not recoverable prior to their expiration dates.
On November 30, 2000, the Company completed the sale of Marketing One and recognized a loss of $14,000. The operating results of Marketing One are included in the consolidated operating results through November 30, 2000.
On January 2, 1998, PennCorp acquired the remaining equity interests in SW Financial, which became a wholly-owned subsidiary. This was accomplished with the acquisition of the SW Financial Controlling Interest (the holdings of common stock and/or common stock warrants of SW Financial) from KB Investment Fund I, LP ("KB Fund") and Messrs. Steven W. Fickes and David J. Stone, former executive officers and directors of PennCorp for an aggregate purchase price of $73.7 million (not including acquisition expenses). The fair value of net assets acquired amounted to $45.5 million resulting in $28.1 million of costs in excess of net assets acquired which is amortized over 30 years. As part of the acquisition of the SW Financial Controlling Interest on January 2, 1998, SW Financial Subordinated Notes in the amount of $40.0 million previously purchased by PennCorp were reclassified to purchase consideration for SW Financial. The acquisition of the SW Financial Controlling Interest has been accounted for as a step purchase transaction in accordance with generally accepted accounting principles, and accordingly, fair values of assets and liabilities acquired have been determined as of January 2, 1998.
On January 5, 1998, PennCorp consummated the acquisition of the interests of Messrs. Fickes and Stone in KB Management, KB Fund and KB Consultants LLC (formerly known as Knightsbridge Consultants LLC) (collectively, the "Fickes and Stone Knightsbridge Interests") for total consideration of $10.6 million (not including acquisition expenses). Under the transaction terms, Mr. Fickes was to receive consideration in the form of estimated annual interest payments, ranging from $301,000 to $330,000, on April 15 each year through 2001 and was to be issued 173,160 shares of the PennCorp's common stock on April 15, 2001. Prior to the recapitalization, PennCorp's Board of Directors approved a settlement with Mr. Fickes pursuant to which PennCorp paid him approximately
"Operating Income (Loss)," as used below, excludes the impact of (i) federal income tax expense (benefit) (ii) restructuring costs, (iii) gains or losses on the sale of investments and (iv) the impact of the disposition of Businesses Sold. The Company considers operating income (loss) to reflect "Core earnings (loss)" and to be the most relevant and useful information to evaluate trends impacting the Company's operations. This information is used by the Company's principal decision makers to evaluate its performance as it eliminates the impact of transactions that the Company considers to be unrelated to core operating results. Other companies that operate primarily in the life insurance industry may or may not use similar measures.
The amortized cost and fair value of fixed maturities available for sale as of December 31, 2000, by contractual maturity, are shown below:
Included in fixed maturities available for sale as of December 31, 2000 and 1999, are below investment-grade securities with an amortized cost of $126.4 million and $161.8 million and a fair value of $99.5 million and $139.5 million, respectively. Included in fixed maturities available for sale as of December 31, 2000, are unrated securities with an amortized cost of $21.9 million and a fair value of $17.5 million. Included in fixed maturities available for sale as of December 31, 1999 are unrated securities with an amortized cost of $33.0 million and a fair value of $21.1 million. Investments in a single entity, other than obligations of the U.S. government or agencies thereof, totaling in excess of
Included in fixed maturities are retained interests in securitized transactions known as Fund America 93-C Class B (Fund America) and Secured Investors Trust 93-1 Residual (SIST). At December 31, 2000 and 1999, these investments had a combined amortized cost of $15.5 million and $14.9 million, respectively and a fair value and carrying value of $16.0 million and $13.3 million respectively. The fair values were estimated by an independent investment advisor and are based on the future cash flows of the underlying collateral. A 100 basis point basis point rise in interest rates would decrease the estimated fair value by $3.4 million, while a 100 basis point decrease in interest rates would increase the estimated fair value by $4.5 million.
As of December 31, 2000, net unrealized appreciation in equity securities available for sale consisted of gross unrealized gains of $157,000 and gross unrealized losses of $358,000. As of December 31, 1999, there was no unrealized appreciation or loss in equity securities available for sale.
The Company's commercial mortgage portfolio had a net carrying value of $10.0 million and $20.0 million, respectively, and fair values of $10.0 million and $20.3 million, respectively, as of December 31, 2000 and 1999.
As of December 31, 1999, Southwestern Life owned 66,555 shares of redeemable preferred stock of Portsmouth Financial Group, Inc. ("Portsmouth"), an affiliate. During the first quarter of 2000, Portsmouth was reorganized and merged into ROP Financial Group ("ROP"), and became a wholly-owned subsidiary of the Company. ROP has been included in the consolidated financial statements since March 31, 2000.
During the fourth quarter of 2000, the Company undertook an analysis of its reserving and other actuarial practices. As part of this review, the Company discovered that the method utilized to calculate deferred policy acquisition costs and policy liabilities on certain term policies was not correctly reflecting reinsurance ceded. As a result of correcting this methodology, deferred policy acquisition costs decreased approximately $6.5 million.
The liability for future policy benefits consists of reserves for life, annuity and accident and health products. For interest-sensitive life and annuity products, the liability for future policy benefits is equal to the accumulated fund value. Fund values are equal to the premium received and interest credited to the fund value less deductions for mortality costs and expense charges. Current declared interest rates credited range from 4.0 to 6.75 percent. Mortality costs and expense charges are established by the Company based upon its experience and cost structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is based primarily upon Commissioners' Standard Ordinary Tables with interest rates ranging from 2.5 to 6.0 percent. Accident and health products establish a liability for future policy benefits equal to the excess of the present value of future benefits to or on behalf of the policyholder over the future net premium discounted at interest rates ranging primarily from 4.5 to 8.0 percent. Traditional life products and accident and health products future policy benefits may also be determined using Company
experience as to mortality, morbidity and lapses with a provision for adverse deviation. The Company may vary assumptions by year of policy issue.
The Company is continually evaluating actuarial assumptions associated with interest-sensitive life insurance contracts in which the determination of policy reserves is highly sensitive to assumptions such as lapse rates, investment earnings rates, mortality rates, and premium persistency. Policy reserves and account values associated with such contracts aggregated approximately $555.0 million and $527.1 million as of December 31, 2000 and 1999, respectively. Should lapse rates experienced on these policies be less than expected, the Company would be required to record additional reserves or reduce intangible assets, which could have a material impact on the Company's financial position and results of operations. For example, a decrease of 1% in the assumed lapse rate would increase policy reserves associated with such contracts by $13.9 million. Management continues to assess the potential impact of future actions that might mitigate the financial impact of these trends. Examples include, but are not limited to, the redetermination of non-guaranteed charges and/or benefits under the contracts, asset segmentation, and reinsurance. There are risks associated with management action, including potential sales disruption and the threat of litigation. During 1999, the Company modified certain assumptions associated with the blocks of business including lowering the aggregate expected lapse rate. In addition, the Company implemented a plan to continue charging certain non-guaranteed expense loads associated with certain interest-sensitive life insurance contracts. As a result of the actions, the Company increased the amount of reserves associated with these policies by approximately $6.2 million during the fourth quarter of 1999.
During the fourth quarter of 2000, the Company undertook an analysis of its reserving and other actuarial practices. As part of this review, the Company discovered that the method utilized to calculate deferred policy acquisition costs and policy liabilities on certain term policies was not correctly reflecting reinsurance ceded. As a result of correcting this methodology, policy liabilities increased approximately $1.0 million.
Total future policy benefits consist of the following as of December 31, 2000 and 1999:
As a result of changes in estimates of insured events in prior years and changes in methodology (described below), the liability for health policy and contract claims decreased net of reinsurance by $30,000 in 2000, and increased by $1.2 million in 1999 and $31.5 million in 1998.
Life increased by $25.7 million during 1998. The effect of the change in methodology is inseparable from the effect of the change in accounting estimate and is accordingly reflected in operations for the year ended December 31, 1998.
The maturities of the term loan during each of the five year after December 31, 2000 are as follows: 2001, $8.6 million; 2002, $12.1 million; 2003, $12.3 million; 2004, $12.4 million and 2005, $12.5 million.
The New Credit Facility imposes certain covenants on the Company, including covenants restricting the amount of additional indebtedness the Company may incur, limiting the Company's ability to engage in future acquisitions and certain other business transactions, and limiting the amount of dividends the Company may declare and pay, and requiring the Company to maintain specified financial ratios and meet specified financial tests. At December 31, 2000, the Company was in compliance with all applicable covenants.
As a holding company, SWL Holdings is largely dependent upon dividends and surplus debenture payments from its insurance subsidiaries to make principal and interest payments under its New Credit Facility (see Note 13). At December 31, 2000, the amount available to be drawn under the New Credit Facility was $11.0 million. Management believes the Company will likely have sufficient financial flexibility and projected liquidity sources to meet its cash requirements.
The Company's recording of impairment provisions associated with the sale of the Payroll Sales Division results in a reduction in deferred tax liabilities of $41.1 million during 1999 related to such assets.
As of December 31, 2000, the Company has life consolidated net operating loss carryforwards of approximately $33.2 million for tax return purposes which, if not utilized, will begin to expire in 2008. The Company has life consolidated capital loss carryforwards of approximately $17.4 million which, if not utilized, will begin to expire in 2002. These losses are subject to an annual IRC Section 382 limitation.
Pursuant to the Recapitalization Plan, SWL Holdings issued 5,175,000 shares of common stock in exchange for all of the outstanding shares of preferred stock of PennCorp. The Company also issued 1,960,000 shares of common stock pursuant to a right offering underwritten by Inverness and Vicuna and 1,840,000 shares to Rapoport and Sharpe in connection with their investments. These shares were issued at $12.50 per share and the Company received $46.0 million in cash (net of related expenses of $1.5 million). All shares of PennCorp's common stock were canceled for no value.
In addition, the Company awarded 60,000 shares to two executive officers and 24,000 shares to a former officer and director of PennCorp in consideration of his consulting services rendered in connection with the recapitalization transaction.
At December 31, 1999 PennCorp had 100,000,000 shares of $.01 par value common stock authorized and 30,143,416 shares issued and outstanding. The common stock had no preemptive or other subscription rights and there were no conversion rights, redemption or sinking fund provisions with respect to such shares.
Associated with the restructuring and the consolidation of all corporate functions into the Company's Dallas location, certain employees were severed. For the year ended December 31, 1998, notes receivable secured by 7,500 shares of common stock were discharged and 9,051 and 88,280 shares of common stock were abandoned as a result of the severance during 1999 and 1998, respectively. The result was to increase treasury stock, and decrease notes receivable secured by common stock, $261,000. During 1999, PennCorp reversed accrued interest on notes receivable secured by common stock totaling $146,000. During 2000, the remaining notes receivable were cancelled as a result of the consummation of the Recapitalization Plan.
PennCorp issued 2,875,000 shares of $50 redemption value (liquidation preference, $50 plus accrued and unpaid dividends) $3.50 Series II Convertible Preferred Stock (the "Series II Convertible Preferred Stock"). The Series II Convertible Preferred Stock was convertible at the option of the holder, unless previously redeemed, into 1.4327 shares of common stock for each share, subject to adjustment in certain events. These shares were exchanged for shares of common stock of SWL Holdings on a one for one basis as part of the Recapitalization Plan.
PennCorp issued 2,300,000 shares of $50 redemption value (liquidation preference, $50 plus accrued and unpaid dividends) $3.375 Convertible Preferred Stock (the "Convertible Preferred Stock"). The Convertible Preferred Stock was convertible at the option of the holder, unless previously redeemed, into 2.2124 shares of common stock for each share, subject to adjustment in certain events. These shares were exchanged for shares of common stock of SWL Holdings on a one for one basis as part of the Recapitalization Plan.
PennCorp suspended the payment of cash dividends during the third quarter of 1998 on its outstanding $3.375 Convertible Preferred Stock, $3.50 Series II Convertible Preferred Stock and Common Stock.
On July 25, 1995, PennCorp issued 178,500 shares of 9% Series C Preferred Stock to fund a portion of the Security Life purchase price. The Series C Preferred Stock was mandatorily redeemable on or before June 30, 1998. Effective March 31, 1998, PennCorp redeemed all of the outstanding Series C Preferred Stock into 691,528 shares of PennCorp's common stock under provisions of the Series C Preferred Stock certificate of designation. The result of such redemption was to increase common stock and additional paid in capital by $7,000 and $22.2 million, respectively, as well as reduce retained earnings by $1.9 million reflecting the difference between the reported and redemption amounts of the Series C Preferred Stock.
At the consummation of the Recapitalization Plan, SWL Holdings issued non-qualified options to purchase 890,000 shares of the Company's stock at prices ranging from $12.50 to $15.00 per share. Options granted to certain directors and executive officers vested immediately. Options granted to other officers vest during a four-year period. All options are exercisable during the period commencing from the date they vest until expiration ten years after grant. Included in these options were 55,000 shares that were awarded to certain consultants at a price of $12.50 per share for which the Company recognized expense of $426,000. With the resignation of one of the executive officers effective August 1, 2000, the Company recognized expense of $75,000 with respect to previously granted stock options to acquire 150,000 shares. These options subsequently expired without being exercised.
The following table summarizes information concerning outstanding and exercisable options as of December 31, 2000:
The following table summarizes data relating to PennCorp's stock options and warrants activity and associated weighted average option exercise price information for the years ended December 31:
As allowed under the provisions of SFAS No. 123, the Company utilizes APB Opinion No. 25 and related Interpretations in accounting for its stock option and warrant plans and, accordingly, does not recognize compensation cost based on fair value as a component of net income applicable to common stock. If the Company had elected to recognize compensation cost based on the fair value of the options and warrants as of the grant date, estimated utilizing the Black-Scholes multiple options approach prescribed by SFAS No. 123, the Company's net loss applicable to common stock as well as loss per share would have been reduced by the pro forma amounts indicated in the following table.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options having no vesting restrictions and which are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. As employee stock options and warrants have characteristics significantly different from those of traded options, and because changes in subjective assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of employee stock options and warrants. As SFAS No. 123 is effective only for awards granted after January 1, 1995, the pro forma disclosures provided above may not be representative of the effects on reported net income for future years.
Cash generated by the Company's insurance subsidiaries is made available to SWL Holdings principally through periodic payments of principal and interest on surplus debentures issued by PLAIC, Constitution (sold July 30, 1999) and Pioneer Security (sold February 4, 2000) (collectively, the "Surplus Note Companies"). The surplus debentures issued by PLAIC and Constitution were repaid in full in connection with the consummation of the sale of the Career Sales Division and the surplus notes issued by Pioneer Security were repaid in full in connection with the consummation of the sale of the Payroll Sales Division. As part of a subsidiary realignment in conjunction with the Career Sales Division divestiture, PLAIC issued a new surplus debenture to SW Financial in the amount of $150.0 million. As part of a subsidiary realignment in conjunction with the Payroll Sales Division divestiture, PLAIC issued a new surplus debenture to SW Financial in the amount of $35.0 million. With respect to Constitution, Pioneer Security and PLAIC (as a result of its surplus debentures issued as of July 30, 1999 and January 31, 2000), the surplus debenture payments have been made to non-insurance intermediate holding companies and subsequently paid to the Company in the form of dividends. The amount outstanding under the surplus debentures as of December 31, 1999 was $258.3 million. At December 31, 2000, there is only one remaining surplus debenture with an outstanding balance of $94.9
Statutory capital and surplus of the Company's life insurance subsidiaries as reported to regulatory authorities at December 31, 2000 and 1999, totaled $116.1 million and $253.4 million, respectively. Statutory net income (loss) of the Company's life insurance subsidiaries as reported to regulatory authorities totaled $11.3 million, $116.1 million and $(44.6 million) for the years ended December 31, 2000, 1999 and 1998, respectively. The 1999 statutory net income included gains on sales of subsidiaries totaling $127.4 million. Surplus note interest expense of $14.4 million, $34.6 million and $40.5 million for the years ended December 31, 2000, 1999 and 1998, respectively, is included in statutory net income (loss).
Texas, the state of domicile for the Company's insurance subsidiaries owned at December 31, 2000, has through regulation adopted an RBC regime which references, but is not identical to, that of the NAIC. The Texas RBC regulation provides that RBC is to be computed in a manner similar to that provided by the NAIC, but instead of establishing multiple levels of regulatory action, the Texas regulation provides that the commissioner of insurance is authorized to take enumerated actions, including, but not limited to, supervision, conservation or impairment or hazardous financial condition determinations, as to any insurer that failed to maintain, at a minimum, total adjusted capital equal to 70% of the authorized control level RBC.
Calculations using the NAIC formula and the life insurance subsidiaries' statutory financial statements as of December 31, 2000, indicate that each of the insurance subsidiaries' capital exceeded Company Action Level RBC requirements. In addition, calculations using the Texas regulations indicating that of the insurance subsidiaries' capital exceeded 70% of authorized control level RBC.
In May 1998, the three senior executives of PennCorp entered into two year employment agreements with PennCorp which have various annual bonus, deferred payment and termination provisions. As of December 31, 1999, PennCorp had accrued liabilities aggregating $1.8 million for the annual 1999 bonus and $8.3 million for deferred compensation provisions, respectively associated with these employment agreements. The deferred compensation provisions were payable upon the earliest of: expiration of the employment agreement; termination of the executive by PennCorp without cause; or termination by the executive for "good reason" as defined in the employment agreements. As a result of the agreements to sell the Payroll Sales Division, Southwestern Life and Security Life, the three senior executives of the Company became entitled to terminate their existing employment agreements for "Good Reason" (as defined therein). In order to ensure the continued services of the executives, on January 28, 2000, the Company entered into an agreement with each executive, pursuant to which the Company and each executive terminated their existing employment agreements and entered into new executive employment agreements. As a result, the Company paid a total of $10.0 million in employment contract obligations to the three senior executives of the Company.
The liability for accrued benefit obligation includes the following at December 31, 2000 and 1999:
Components of net periodic benefit cost include the following for the year ended December 31, 2000 and 1999:
For measurement purposes, an annual rate increase ranging from 5.5% to 6.5% in the health care cost trend rate was assumed for 2000; the rate was assumed to decrease gradually to 5.5% by year 2015 and remain at that level thereafter. The weighted average discount rates used in determining the accumulated postretirement benefit obligation ranged from 7.5% to 7.75%. The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
The fair value of the consideration likely to be received was based primarily upon the terms of definitive sales agreements. The impairment provisions of $58.5 million recorded in 1999 for the Career Sales Division resulted from a renegotiation of the purchase and sale agreement which included a decrease in the nominal purchase consideration of $38.0 million which was partially offset by an estimated discount to the stated value of the note to be received. In addition, impairment provision included the impact of the true-up of statutory capital and surplus of the Career Sales Division companies to levels specified in the sale agreement which aggregated approximately $24.2 million. Other factors modestly impacting the impairment provision included additional transaction costs, changes in unrealized gains and losses of securities, foreign currency translation and net income not considered in the determination of sale consideration. PennCorp realized a foreign currency transaction loss on the sale of the Career Sales Division totaling $25.0 million, which represented previously unrealized translation losses on PennCorp's Canadian insurance operations, partially offset by a gain of $3.1 million on the disposition resulting in a net loss of $21.9 million.
The following unaudited selected pro forma financial information has been prepared to illustrate the pro forma effects of the sales of Marketing One (sold November 30, 2000), Payroll Sales Division (sold February 4, 2000) (see Note 3), Career Sales Division (sold July 30, 1999), KIVEX (sold June 30, 1999), the United Life Assets (sold April 30, 1999) and Professional (sold March 31, 1999) . The pro forma statements of operations for the years ended December 31, 2000 and 1999 give effect to such sales as if they had occurred on January 1, 1999. The unaudited selected pro forma financial information has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had such sales been made as of January 1, 1999, or results which may occur in the future.
The Company and its subsidiaries are obligated under operating leases, primarily for office space. Rent expense, net of sublease income, was $1.1 million, $2.8 million and $5.3 million in 2000, 1999 and 1998, respectively.
2001.............................................................. $ 1,994 2002.............................................................. 1,942 2003.............................................................. 1,693 2004.............................................................. 1,705 2005.............................................................. 1,235 2006 and thereafter............................................... 2,677 -------- Total minimum payments required................................ $ 11,246 ========
During 2000, as a part of the Company's restructuring plan, the Company assigned its lease on certain vacated office space to a third party and was released from obligations related to the vacated office space beginning January 1, 2001. As a part of the lease assignment, the new lessee has the use of furniture located in the vacated space but the Company retains the future furniture lease obligation which totals approximately $184,000 per year through 2004.
The parties entered into a Stipulation of Settlement dated May 24, 2000 providing for payment of $9.0 million of cash, plus interest accruing through the date of consummation of the settlement, in full and final settlement of all claims. Of that sum, $1.5 million was paid by PennCorp during the fourth quarter of 1999 into an interest-bearing escrow account established by plaintiffs' counsel and $7.5 million plus interest is to be paid by PennCorp's third party director and officer liability insurance carrier upon finalization of the settlement.
The settlement received preliminary approval from the court in June 2000 and was submitted to the court for final approval at a hearing set for that purpose in November 2000. No objections regarding the terms of the settlement were presented to the court at such final hearing and the court indicated that it would issue a ruling after further review. At present the court has not issued its final ruling in this matter. The Company expects the settlement to receive final approval during 2001.
products and requested to be informed if Security Life were to change that practice. Security Life responded to the NCDOI's inquiry by verifying that no decision had been made to date to change such practice and that such practice had not changed; and confirmed that the NCDOI would be notified in the event that such practice were to be changed.
During 1999 Security Life initiated a voluntary exchange program which enabled policyholders of such life insurance products to terminate their policies and, in exchange for the termination of the original policy and a release, obtain either (i) the refund of all premiums paid and other consideration or (ii) another Security Life life insurance product.
On September 8, 2000, the court granted preliminary approval of the settlement and ordered that notice be sent to all class members. The court granted final approval of the settlement at a hearing held on November 17, 2000, and the period for appeal of that ruling expired prior to the end of 2000. Thus, the settlement is now final and is being implemented.
Schnoebelen was an independent insurance broker whose marketing contract with United Life provided that he would be entitled to an annual commission based on the total accumulated value of annuity contracts in force for 13 months or more with United Life which were sold by Schnoebelen and his designees. Schnoebelen generally ceased writing new business with United Life in 1993, and his marketing contract was terminated in 1997.
A petition was filed on September 7, 2000 in state District Court located in Jasper, Texas asserting claims against Southwestern Life and its agent co-defendant on behalf of a purported class of persons who had an ownership interest in universal life insurance policies or interest-sensitive non-participating whole life insurance policies issued by Southwestern Life during the period from January 1, 1981 to the present and who were residents of the United States on the date(s) of issuance of such policy(ies). The petition alleges that Southwestern Life and/or its agent co-defendant committed, among other things, breach of contract, breach of fiduciary duty, breach of duty of good faith and fair dealing, negligent misrepresentation, unfair or deceptive acts, and fraud in connection with the sale of such policies, and seeks class certification, equitable relief and recovery of actual, statutory and punitive damages in unspecified amounts as well as costs and attorneys' fees.
On or about February 19, 2001, Southwestern Life received a demand letter from attorneys representing Fred Rosen, Marian Rosen and Norman Bock. This demand letter asserts, on behalf of the named claimants individually and on behalf of all other persons who purchased a universal life insurance policy from Georgia International Life Insurance Company ("Georgia International"), that Georgia International and its successors in interest, including Southwestern Life, misrepresented the cost of such policies and concealed the fact that premiums on such policies would substantially increase over the life of same. Further, the demand letter alleges that Southwestern Life has assumed responsibility for these policies and demands that Southwestern Life place all members of the purported class of claimants in the same position they would have been in had the policies in question performed as originally represented. Litigation is threatened for, among other things, violation of the Texas Deceptive Trade Practices Act should Southwestern Life not provide the relief demanded.
Southwestern Life is investigating the allegations contained in the demand letter and has not yet responded. It believes, however, that the allegations made in the demand letter are without basis and intends to defend vigorously
Stephen R. Plaster, Trustee of the Robert W. Plaster Irrevocable Trust, as holder of three universal life insurance policies issued by Southwestern Life on the life of Robert W. Plaster having a combined death benefit of approximately $20.9 million, brought suit against Southwestern Life in state Circuit Court located in Camden County, Missouri on May 20, 1999, claiming, in essence, that Southwestern Life committed fraud by misrepresenting the terms, characteristics and performance of its universal life insurance policies at the time of purchase. The plaintiff specifically alleges that the policies were represented to be "single premium" policies not requiring payment of any additional premiums, but that instead Southwestern Life has demanded payment of additional premiums in order to keep the policies in force. Plaintiff seeks recovery of all premiums paid to Southwestern Life to date (alleged to be approximately $2.9 million), all additional premiums demanded by Southwestern Life to date (alleged to be approximately $3.7 million), interest, punitive damages, legal fees and expenses, and reformation and specific performance of the policies.
Southwestern Life's attempt to remove this case to federal court was unsuccessful and the case is now in the discovery stage. Southwestern Life denies plaintiff's claims and intends to defend this case vigorously. There can be no assurance that Southwestern Life will be able to defend or resolve the issues presented in this action successfully or at all or that any verdict or other resolution would not have a material adverse effect on the Company's financial condition, results of operations or cash flows.
The life insurance subsidiaries of the Company are parties to various other pending or threatened legal actions arising in the ordinary course of business, some of which include allegations of insufficient policy illustrations and agent misrepresentations. Although the outcome of such actions is not presently determinable, management does not believe that such matters, individually or in the aggregate, would have a material adverse effect on the Company's financial position or results of operations if resolved against the Company's subsidiaries.
The life insurance subsidiaries of the Company are required to be members of various state insurance guaranty associations in order to conduct business in those states. These associations have the authority to assess member companies in the event that an insurance company conducting business in that state is unable to meet its policyholder obligations. Assessments from guaranty associations, which have not been material, are recorded in accordance with Statement of Position 97-3 issued by the AICPA, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments."
The Company provided certain representations and warranties to each respective purchaser of the businesses sold with respect to each entity's ability to process date-sensitive information for the year 2000 and beyond. Although the Company believes that it is in compliance with, and is not aware of any breach of, the year 2000 representations and warranties provided to the respective purchasers, there can be no assurances that the Company is in compliance with all such representations and warranties. A breach by the Company of such representations and warranties could result in indemnification obligations owed by the Company to the purchasers.
At December 31, 2000, the Company had a contingent obligation for mortgage loans previously sold aggregating $3.2 million as a result of the Company acting as a servicing conduit.
Effective May 1, 2000, Southwestern Life and Security Life each consummated with RGA a 100% indemnity coinsurance agreement of all of their respective deferred annuity business (see Note 3).
Fees incurred for financial reinsurance were approximately $372,000 and $675,000 during 1999 and 1998, respectively. The Company had no financial reinsurance during 2000.
In connection with the merger of Security Life into Southwestern Life and the consummation of the Recapitalization Plan, the Company adopted a restructuring plan during the quarter ended June 30, 2000. Pursuant to the 2000 Plan, the Company reduced its workforce in most areas of the Company (including finance, policyholder
The following reflects the impact of activity for the year ended December 31, 2000 on the restructuring provision and accrual balance under the 2000 Plan:
The following reflects the impact of activity for the years ended December 31, 1999 and 2000 on the restructuring accrual balances under the 1999 Plan:
The 1999 Plan provided for the termination of 50 employees consisting of divisional management and staff in Dallas over a nine-month period. The staff reduction was completed in 2000. The 1999 Plan also provided for vacating certain floors of the Company's Dallas leased offices. The restructuring provision of $2.1 million represented the estimated net present value of the rent on the office space to be vacated net of the estimated sublease rental income to be received by the Company. During the quarter ended June 30, 2000, the Company agreed to assign its lease on certain vacated office space to a third party and was released from obligations related to the vacated office space beginning January 1, 2001. As a part of this agreement, the new lessee has the use of furniture located in the vacated space but the Company retains the furniture lease obligation which totals approximately $184,000 per year through 2004. The Company adjusted the remaining accruals pursuant to these agreements.
The following reflects the impact of activity for the years ended December 31, 1998, 1999 and 2000 on the restructuring accrual balances under the fourth quarter 1998 Plan:
The following reflects the impact of activity for the years ended December 31, 1998, 1999 and 2000 on the restructuring accrual balances under the first quarter 1998 Plan:
The first quarter 1998 Plan provided for vacating certain Dallas office space. In connection with the plan, the Company recorded estimated holding costs of vacated facilities of $2.2 million which represented the net present value of the rent on the office space to be vacated net of the estimated sublease rent to be received. During 1999 and 2000, the Company charged $350,000 and $1.6 million, respectively, of rent expense on vacated office space against the accrual.
The first quarter 1998 Plan also recognized impairment of certain furniture, fixtures and data processing equipment totaling $1.1 million which had been utilized in the office space to be vacated. The Company charged $831,000 of such assets against the accrual during 1998.
The following is a summary of the carrying value and fair value of the Company's financial instruments at December 31, 2000 and 1999:
Cash and Cash Equivalents, Accounts and Notes Receivable: The carrying value approximates their fair value due to the short-term maturity of these instruments.
Other Investments: Other investments consist primarily of limited partnerships. Carrying value represents the underlying equity of the limited partnerships at cost which approximates fair value.
The following is a summary of the quarterly results of operations for the years ended December 31, 2000 and 1999 (in thousands, except per share amounts):
The Company's fourth quarter 1999 reported loss primarily resulted from an impairment of intangibles totaling $95.5 million. The Company evaluated the intangible assets of the Payroll Sales Division based upon the proceeds received from the sale of the Payroll Sales Division on February 4, 2000 (see Note 3). The Company increased the valuation allowances associated with tax assets by $17.9 million as the result of the increased likelihood that certain operating losses and capital loss carryforwards would not be utilized and the impact or potential impact of a "change in control" as defined by the Internal Revenue Code Section 382.