LSL leases its property located at Suite 101, Building 100, Southeast Executive Park, Brewster, New York under the terms of an agreement which provides for a term through April 30, 1998. The annual rental payment was $176,000 in 1996.
This Form 10-K contains forward looking statements that are qualified by the fact that actual results of the Company may differ materially from any such statement due to the following important factors, among other risks and uncertainties inherent in the Company's business:
On February 23, 1997, ReliaStar and Security-Connecticut signed a definitive agreement to combine the two companies through the statutory merger of Security-Connecticut with and into ReliaStar. The Board of Directors of Security-Connecticut has unanimously approved the merger. Completion of the merger is subject to normal closing conditions, including approval by the Company's shareholders and various regulatory approvals. Provided there has been no material breach by ReliaStar of the representations, warranties, covenants and agreements of ReliaStar under the merger agreement, Security-Connecticut has agreed to pay ReliaStar $8 million if the merger agreement is terminated either as a result of (a) the modification or withdrawal, in any way detrimental to ReliaStar, of the recommendation of the Security-Connecticut Board with respect to the merger, or (b) the execution by Security-Connecticut of a definitive agreement with a party other than ReliaStar with respect to a publicly announced offer or intent to make an offer to acquire all or substantially all Security-Connecticut or its subsidiaries.
Concurrent with this growth in demand for life insurance and annuity products, the life insurance business in the United States has undergone major product and structural changes in response to increased competition from other financial intermediaries. Until the late 1970s, life insurance products consisted primarily of fixed premium/guaranteed cost value and death benefit whole life products, which combined a death benefit with cash accumulation. These products were competitive under stable and low interest rate environments; however, the volatile and high interest rate environments of the late 1970s and early 1980s caused many insurance buyers to consider other higher yielding financial products. As a result of the increase in competition from savings products offered by mutual funds, savings and loan associations, banks and other financial institutions, many insurers responded by offering products such as low-cost term insurance and higher yielding annuity products, in addition to their traditional products. In addition, the life insurance industry responded to the demand for capital accumulation insurance products by introducing universal life, variable life and variable universal life products which combine the tax-deferred income accretion of traditional insurance products with flexible payment features and yields comparable to other investment vehicles. A consolidation trend emerged in the industry in the 1990s, spurred on by factors such as intensified competition, focus on profitable growth, increased rating agency scrutiny and deregulation in the financial services industry.
The following analysis of the consolidated results of operations and financial condition should be read in conjunction with "Selected Financial Data" and the consolidated financial statements and accompanying notes included elsewhere herein.
On a statutory-basis, the Company's first year annualized life premiums on new life insurance sales for individual life insurance increased $2.7 million, or 5.6% from $46.9 million in 1995 to $49.6 million in 1996. This was primarily the result of a 24.1% increase in term life sales offset by a 5.2% decrease in universal life insurance sales. Although first year annualized life premiums increased in comparison to the prior year, such premiums decreased during the second half of 1996 in comparison to both the first half of 1996 and the last six months of 1995. The Company expects this trend to continue through at least the first quarter of 1997 due to the highly competitive insurance environment and the recent downgrade of the Company's claims paying ability by A.M. Best. Annualized annuity sales decreased $44.9 million or 45.9% from $97.7 million in 1995 to $52.8 million in 1996 due primarily to the relatively flat yield curve interest rate environment that has made fixed annuity products less attractive than variable annuity products. In addition, the Company elected to maintain profit margins on annuity products rather than sacrifice profitability to increase sales.
Insurance and Other Expenses - Insurance and other expenses increased $6.6 million, or 7.8%, from $85.2 million in 1995 to $91.8 million in 1996. Commissions, net of DAC, increased $1.0 million, or 3.0%, from $32.0 million in 1995 to $33.0 million in 1996. This increase in net commission expense was due to a decrease in the deferral of commissions on new business as a result of an increase in reinsurance ceded in connection with the quota share reinsurance agreements. General administrative and other operating costs, net of DAC, increased $5.6 million, or 10.7%, from $53.2 million in 1995 to $58.8 million in 1996 primarily due to: (i) an increase in legal costs, including additions to reserves, of $3.7 million, (ii) an increase in staff related expenses of $4.6 million, and (iii) an increase in interest expense of $1.0 million, partially offset by a reduction in taxes, licenses and fees expense of $6.5 million, primarily due to the release of a portion of the liability for guaranty fund assessments.
Realized Gains (Losses) on Investments - Net realized losses on investments were $0.7 million in 1994 compared with net realized gains of $6.2 million in 1995. The 1995 gains were the result of net realized gains from the sale of investments of $15.1 million, partially offset by increases in the allowance for losses and permanent impairment writedowns of $4.3 million and DAC associated with realized gains of $4.6 million. One investment represented $3.0 million of the increase in allowance for losses. The 1994 losses were the result of net realized capital gains of $3.5 million from the sale of investments offset by increases in the allowance for losses and permanent impairment writedowns of $2.7 million and DAC associated with realized gains of $1.3 million.
Benefits and Reserve Increases - Benefits and reserve increases increased $30.5 million, or 17.2%, from $177.1 million in 1994 to $207.6 million in 1995. Life and annuity benefits increased $19.8 million, or 24.9%, from $79.9 million in 1994 to $99.7 million in 1995. The Company's life claim experience for 1995 was unfavorable compared to expected experience by $14.3 million, or 21.1%, and was approximately $17.1 million above 1994. Subsequent mortality studies indicated that the adverse mortality was not attributable to any single source of business, product or cause of death. Interest credited to policyholders increased $11.3 million, or 14.9% from $75.7 million in 1994 to $87.0 million in 1995 due primarily to the growth of account values of annuity, universal life and other interest sensitive products, offset somewhat by a slight decrease in crediting rates.
Insurance and Other Expenses - Insurance and other expenses increased $1.9 million, or 2.3%, from $83.3 million in 1994 to $85.2 million in 1995. Commissions, net of DAC, decreased $0.7 million, or 2.3%, from $32.7 million in 1994 to $32.0 million in 1995. This decrease in commission expense was due to the decrease in annuity sales in 1995. The 1994 net commission expense was negatively impacted by a refinement in the coinsurance commission DAC estimate of $1.8 million. General administrative and other operating costs, net of DAC, increased $2.6 million, or 5.2%, from $50.6 million in 1994 to $53.2 million in 1995 primarily due to (i) an increase in guaranty fund assessments of $3.1 million, and (ii) an increase in interest expense of $1.7 million.
As a holding company whose principal assets are the investments in AHL and SCL and its wholly owned insurance subsidiary, the Company's future ability to pay operating expenses, meet debt service payments and make dividend payments to shareholders depends upon receiving sufficient funds from SCL and AHL. Those funds may come either from dividend payments or payments for services, which may be provided by the Company to SCL.
The principal requirement for liquidity in connection with SCL's insurance operations is its contractual obligations to policyholders and annuitants, and its payment of dividends to the Company. SCL's contractual obligations include payments of surrender benefits, guaranteed interest, contract withdrawals, claims under outstanding insurance policies and annuities, and policy loans. The primary source of meeting these contractual requirements is investment income from its total investment portfolio, scheduled maturities from its fixed maturity security portfolio, and principal repayments from its mortgage portfolio, as well as a portion of premium income.
The NAIC has a system for assessing the adequacy of statutory capital and surplus for life and health insurers. The system, known as risk-based capital ("RBC"), augments the states' current fixed dollar minimum capital requirements and was effective beginning with annual statutory reports in 1993. The focus of the system is a risk-based formula that applies prescribed factors to various risk elements in an insurer's business to develop a minimum capital requirement that is proportional to the amount of risk assumed by the insurer. Based on computations made by the Company in accordance with the prescribed formula, RBC at December 31, 1996, for both SCL and LSL, significantly exceeded the minimum capital requirements as produced by the RBC formula.
The Company does not believe that inflation has had a material effect on its results of operations. The Company manages its investment portfolio, in part, to reduce its exposure to interest rate fluctuations. In general, the market value of the Company's fixed maturity portfolio increases or decreases in inverse relationship with fluctuations in interest rates, and the Company's net investment income increases or decreases in direct relationship with interest rate changes. For example, if interest rates decline (as was the case in 1995), the Company's fixed maturity investments generally will increase in market value, while net investment income may decrease as fixed maturity investments mature or are sold and proceeds are reinvested at the declining rates. If interest rates increase (as was the case in 1996), the Company's fixed maturity investments generally will decrease in market value, while net investment income may increase as fixed maturity investments mature or are sold and proceeds are reinvested at the increased rates.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Security-Connecticut Corporation at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Year ended December 31, --------------------------------- 1996 1995 1994 --------- --------- --------- REVENUES Premiums $ 58,261 $ 64,085 $ 66,503 Insurance fees 136,864 125,481 116,875 Net investment income 135,361 131,974 115,464 Realized gains (losses) on investments 7,251 6,166 (726) Other 610 1,451 255 --------- --------- --------- Total revenues 338,347 329,157 298,371
DIVIDENDS DECLARED PER COMMON SHARE $ 0.48 $ 0.48 $ 0.48 ========= ========= =========
The consolidated financial statements of the Company have been prepared in conformity with generally accepted accounting principles ("GAAP"), which vary from statutory accounting practices prescribed or permitted by insurance regulatory authorities (see Note 9). They include the accounts of the Company and its subsidiaries, SCL and its wholly owned subsidiary, LSL, and AHL. Significant intercompany transactions and balances have been eliminated.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the financial statements, and that affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
All fixed maturity securities (bonds) and equity securities (common and preferred stock) are classified as available-for-sale and, accordingly, are carried at fair value. The cost of fixed maturity securities is adjusted for amortization of premium or discount through charges or credits to net investment income. Changes in the fair values of available-for-sale securities are reported directly in shareholders' equity after adjustments for related amortization of deferred policy acquisition costs ("DAC") and changes in other policy-related liabilities, net of tax, which would have been required had these securities actually been sold.
For the securitized investment portion of the fixed maturity securities portfolio, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic lives of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. This adjustment is reflected in net investment income.
Mortgage loans and policy loans are carried at unpaid balances net of allowances for uncollectible amounts. The determination of declines in value deemed other than temporary and related adjustments are made on a quarterly basis by management in consultation with its investment advisor. The change in these allowances is reported as realized gains (losses) on investments.
Realized gains (losses) on sales of investments are recognized in net income using the specific identification method. Realized gains (losses) on investments supporting interest-sensitive policies include adjustments for DAC and other policy-related liabilities.
Interest on investments is recognized on the accrual basis as earned, and dividends on equity securities are recognized principally on the ex-dividend date. Interest on restructured loans is recognized on the cash basis.
Cash and invested cash include all highly liquid debt instruments purchased with a maturity of three months or less. Carrying value approximates fair value.
To the extent recoverable from future policy revenues and gross profits, commissions and other costs, net of commission and expense allowances for reinsurance ceded, incurred to acquire or renew universal life insurance and other interest-sensitive life insurance, traditional life insurance, and annuities that vary with and are primarily related to the production of new business, have been deferred. DAC for universal life insurance policies and deferred annuities is amortized over the lives of the policies in relation to the present value of estimated gross profits from surrender charges and investment, mortality and expense margins. Traditional life DAC is amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy reserves.
The value of acquired insurance in-force represents the present value of future profits of the business in force on October 31, 1979 (the date LNC acquired SCL), using a discount rate of 15%. Interest is accreted at 15% per annum, and the present value of future profits is amortized over the estimated premium-paying period in proportion to the ratio of annual anticipated premium revenues to total anticipated premium revenues. Generally, the same assumptions used in calculating the liability for future policy benefits (also referred to as policy reserves) were used in computing the anticipated annual profits. Accumulated amortization was $60.8 million and $60.1 million at December 31, 1996 and 1995, respectively. The carrying value of acquired insurance in-force is reviewed periodically for indicators of impairment in value.
Property and equipment owned for Company use is carried at cost less allowances for depreciation. Depreciation is computed principally on the straight-line method over the estimated useful lives of the assets.
Policy benefits are charged to expense in the period incurred. All insurance related benefits and expenses are reported net of reinsurance ceded; policy liabilities and accruals are reported gross of reinsurance ceded.
The liability for unpaid claims is based on estimates of ultimate payments to be made for the individual claims reported and unreported. In addition SCL and LSL pay interest to policy beneficiaries in the ordinary course of paying death claims. Cash paid for interest for 1996, 1995 and 1994, was $3.5 million, $4.4 million and $3.2 million, respectively.
Amounts recoverable from reinsurers for unpaid losses, and future life and health benefits, are recorded in a manner consistent with the related liabilities associated with the reinsured policies.
The Company accounts for income taxes in accordance with FAS Statement No. 109 "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis assets and liabilities, principally DAC, unrealized gains (losses) on available-for-sale securities, acquired insurance in-force and liabilities for future policy benefits and claims.
Primary earnings per common share is based on the weighted average number of common shares outstanding during the periods presented including, if applicable, dilutive common stock equivalents. Common stock equivalents consist of stock options for the period prior to their exercise or cancellation. Fully diluted earnings per common share are not presented as they are not materially different from primary earnings per common share.
Year ended December 31, --------------------------------- 1996 1995 1994 --------- --------- --------- (000s omitted) Fixed maturity securities $ 116,877 $ 112,726 $ 95,323 Equity securities 10 36 98 Mortgage loans 13,634 15,092 17,380 Policy loans 5,104 5,344 4,855 Other invested assets 3,385 1,888 1,671 --------- --------- --------- Total investment income 139,010 135,086 119,327 Investment expenses 3,649 3,112 3,863 --------- --------- --------- Net investment income $ 135,361 $ 131,974 $ 115,464 ========= ========= =========
Year ended December 31, -------------------------------- 1996 1995 1994 --------- --------- --------- (000s omitted) Fixed maturity securities available-for-sale: Gross gains $ 6,306 $ 9,494 $ 7,493 Gross losses (3,091) (1,353) (7,621) Equity securities: Gross gains 4,520 5,684 2,154 Gross losses (1,069) (260) (235) Mortgage loans: Gross gains 1,335 887 595 Gross losses (678) Real estate (37) Policy loans* (18) (11) (4) Other invested assets* (695) (7,597) (3,108) --------- --------- --------- Realized gains (losses) on investments 7,251 6,166 (726) Tax benefit (expense) (2,533) (2,158) 254 --------- --------- --------- Net realized gains (losses) on investments $ 4,718 $ 4,008 $ (472) ========= ========= =========
* 1995 and 1994 amounts consist principally of provisions for losses, net of recoveries. The realized losses on other invested assets also reflect the amortization of DAC recognized upon the realization of gains above.
The cost information for mortgage loans, policy loans and other invested assets is net of allowances for losses. The cost and allowances for such items are as follows: December 31, --------------------------------------------- 1996 1995 ---------------------- --------------------- Cost Allowances Cost Allowances ---------- ---------- ---------- ---------- (000s omitted) Mortgage loans $ 128,870 $ 340 $ 146,316 $ 1,236 Policy loans 74,719 326 74,220 304 Other invested assets 6,914 10,822 4,601
The change in unrealized gains (losses) on investments consisted of the following:
Year ended December 31, --------------------------------- 1996 1995 1994 ---------- ---------- ---------- (000s omitted)
Fixed maturity securities $ 63,181) $ 153,111 $ (144,232) Equity securities (2,879) 3,509 (1,041) ---------- ---------- ---------- Total unrealized gains (losses) $ (66,060) $ 156,620 $ (145,273) ========== ========== ==========
At December 31, 1996, fixed maturity securities with a fair value of approximately $3.4 million were on deposit with state insurance departments to satisfy regulatory requirements.
The increase in net unrealized gains (losses) and the adjustments to DAC and other policy liabilities reflect the effects the unrealized gains and losses have on DAC and other policy liabilities as if realized. The above adjustments to DAC and other policy liabilities are netted against the DAC and the future policy benefits and claims accounts in the accompanying balance sheets.
The following data for fixed maturity securities is based on contractual maturities, except for securitized investments which are not due at a single maturity date. Actual maturities will differ in some cases because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 1996 ---------------------- Amortized Fair Cost Value ---------- ---------- (000s omitted) Due in one year or less $ 50,367 $ 51,300 Due after one year through five years 307,875 318,385 Due after five years through ten years 415,337 425,321 Due after ten years 342,964 345,209 Securitized investments 439,341 447,094 ---------- ---------- Total $1,555,884 $1,587,309 ========== ==========
December 31, --------------------------------- 1996 1995 1994 --------- --------- --------- (000s omitted)
Balance at beginning of period $ 1,236 $ 2,088 $ 4,674 Provisions for losses 616 1,012 Releases, principally due to sales (896) (1,468) (3,598) --------- --------- --------- Balance at end of period $ 340 $ 1,236 $ 2,088 ========= ========= =========
December 31, ------------------------------------------------ 1996 1995 ----------------------- ---------------------- Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ---------- ---------- --------- ---------- (000s omitted) Assets Mortgage loans (1) $ 128,530 $ 134,280 $ 145,080 $ 153,858 Policy loans (2) 74,393 77,244 73,916 78,840
Liabilities Deposit contracts (2)(3) $ 21,383 $ 20,884 $ 24,451 $ 24,106 Long-term debt (4) 75,000 74,255 65,000 65,000
(1) Estimated fair values for mortgage loans were established using a discounted cash flow method based on credit rating, maturity and future income when compared to the expected yield for mortgages having similar characteristics. The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt service coverage, loan to value, caliber of tenancy, borrower and payment record. Fair values of impaired mortgage loans are measured based either on the present value of expected future cash flows discounted at the loan's effective interest rate, at the loan's market price or the fair value of the collateral if the loan is collateral dependent. If the estimated fair value of the mortgage loan is less than the recorded investment in the loan, the difference is recorded in the allowance for loan losses account.
(2) Estimated fair values for policy loans and deposit contracts were calculated on a composite discounted cash flow basis using risk free interest rates consistent with the maturity durations assumed. These durations were based on historical experience.
(4) Estimated fair value of long-term debt was determined using a discounted cash flow method based on crediting rate, mortality and future income when compared to the expected yield for long-term debt having similar characterstics.
On June 8, 1995, the Company registered $100 million of debt securities on Form S-3 with the Securities and Exchange Commission. The Company sold $75 million of medium term debt securities ("Debt") on March 1, 1996 and used $65 million of the net proceeds to repay the Term Note to LNL. The remainder of the proceeds was used for general corporate purposes. The Debt has an effective rate of 7.39%, is due March 1, 2003 and may not be redeemed prior to maturity. Interest on the Debt is payable semiannually in arrears on March 1 and September 1 of each year. Interest payments began on September 1, 1996. In 1996, 1995 and 1994 the Company paid interest of $4.4 million, $4.5 million and $2.2 million, respectively, on both the LNL note payable and the Debt.
Federal income taxes paid in 1996, 1995 and 1994 were $22.1 million, $22.9 million and $14.3 million, respectively.
The effective tax rate on pre-tax income is different from the prevailing corporate federal income tax rate of 35%. A reconciliation of this difference follows: Year ended December 31, ------------------------------ 1996 1995 1994 -------- -------- -------- (000s omitted)
Current $ (510) $ (3,532) Deferred 21,419 41,710 --------- --------- Total $ 20,909 $ 38,178 ========= =========
Security-Connecticut has separate company net operating loss carryforwards of $11.7 million and capital loss carryforwards of $0.5 million which are available to offset future separate company taxable income of Security-Connecticut. The loss carryforwards will expire as follows: $0.5 million in 1999, $3.1 million in 2009, $4.7 million in 2010 and $3.9 million in 2011.
The Company is involved in both the cession and assumption of reinsurance with other companies. The maximum retention limits for SCL are as follows: (i) group, $250,000; (ii) individuals up to age 70, $500,000; (iii) individuals age 70 and over, $250,000; and (iv) second-to-die, $1,000,000; (v) joint end age 70 and over, $500,000. Facultative reinsurance relationships exist for cases where SCL deems it appropriate to lower its retention limits, desires more competitive rates, or needs greater capacity.
In the accompanying financial statements, premiums, benefits and reserve increases and insurance and other expenses are reported net of reinsurance ceded; policy liabilities and accruals are reported gross of reinsurance ceded.
The income statement caption, "Benefits and reserve increases," is net of reinsurance recoveries of $48.7 million, $49.7 million and $39.3 million for the years ended December 31, 1996, 1995 and 1994, respectively. Amounts recoverable from reinsurers for claims paid by the Company were $3.0 million and $0.3 million at December 31, 1996 and 1995, respectively. Amounts payable to reinsureds for claims were $2.8 million and $1.1 million at December 31, 1996 and 1995, respectively.
The Company remains liable to its policyholders without regard to whether its reinsurers are able to meet their contractual obligations under the applicable reinsurance agreements. To minimize its exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers. The Company seeks to enter into reinsurance treaties with highly rated reinsurers. For 1996, no one reinsurer assumed more than 18% of the Company's life insurance ceded. Life Reinsurance Corporation of America, Life Re International, LTD, Swiss Re Life Company America, RGA Reinsurance Company and Transamerica Occidental Life Insurance Company had 10% or more. All of these reinsurers are rated "A" or better by A.M. Best.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," ("FASB 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
As of February 2, 1994, 47,727 shares of restricted stock were granted under the SIP subject to restrictions on transfer, which lapsed upon repayment of the Term Note on March 1, 1996. The value of the restricted stock awards of $22.00 per share, was reported as deferred compensation in a separate component of shareholders' equity. Deferred compensation expense was recognized in equal amounts over the three year vesting period.
Pro-forma information regarding net income and earnings per share is required by FASB 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that FASB. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1996 and 1995, respectively: risk-free interest rates of 6.21% and 7.49%; dividend yields of 0.86% and 1.04%; volatility factors of the expected market price of the Company's common stock of 24.34%; and a weighted-average expected life of the options of 10 and 9.9 years.
Net income: As Reported $ 35,345 $ 24,110 Pro-Forma 34,767 23,772 Primary EPS: As Reported $ 4.10 $ 2.81 Pro-Forma 4.03 2.77
The weighted-average fair value of options granted during 1996 and 1995 was $12.02 and $11.58, respectively.
Options Outstanding Shares ------------------------ Available Weighted-Average for Grant Shares Exercise Price --------- -------- --------------
Balance at January 1, 1994 510,000 Granted (234,792) 234,792 $ 21.87 Forfeited 11,205 (11,205) 22.00 Restricted stock awards (47,727) --------- --------- --------- Balance at December 31, 1994 238,686 223,587 21.87 Granted (75,900) 75,900 24.13 Exercised (909) 22.00 Forfeited 1,818 (1,818) 22.00 --------- --------- --------- Balance at December 31, 1995 164,604 296,760 22.45 Granted (87,550) 87,550 26.43 Exercised (7,026) 22.26 Forfeited 7,160 (7,160) 23.70 --------- --------- --------- Balance at December 31, 1996 84,214 370,124 $ 23.34 ========= ========= =========
On February 20, 1997, 74,800 options were granted with an exercise price of $36.50. In connection with the merger of the Company and ReliaStar, each outstanding Security-Connecticut stock option will be assumed by ReliaStar and will be exercisable on the same terms and conditions as under the Security-Connecticut option plan under which such option was granted and related stock option agreement. However, each option will be exercisable for the number of shares of ReliaStar common stock as would have been received pursuant to the merger for the shares of Security-Connecticut common stock subject to the option had the option been exercisable and exercised immediately prior to the merger date. The exercise price of the options will be adjusted accordingly.
The Company has adopted the Security-Connecticut Corporation Management Incentive Plan ("MIP") for management positions whose level of responsibility is such as to impact significantly on Company results. The participants are measured on overall Company performance goals as measured against established targets. The participants' percentage of eligibility is determined by their level of responsibility. The level of cash and/or stock payment to the executive officers is determined based on the Company attaining set performance goals. Total awards earned in 1996, 1995 and 1994 were $1.2 million, $0.3 million and $1.0 million, respectively. In 1995, the Company reserved 100,000 shares of the Company's common stock for issuance under the MIP. As of December 31, 1996 and 1995, 8,964 and 8,267 shares, respectively, had been issued.
The Company is a party to employment contracts with certain key executives which provide for employment terms and benefits upon a change of control of the Company. These contracts generally provide that, upon a change in control of the Company, the executive will be guaranteed employment with the Company for a specified period of time following the change in control. In the event of a termination of employment or a diminution in the executive's compensation, benefits, responsibilities or working conditions, the executive is entitled to severance pay and a continuation of certain benefits. These contracts are not expected to have a material impact on the Company's financial statements.
December 31, ------------------- 1996 1995 -------- -------- (000s omitted) Actuarial present value of benefit obligation: Vested benefits $ (1,244) $ (1,207) -------- -------- Accumulated benefit obligation (1,244) (1,207) Effect of projected future compensation increases (933) (707) -------- -------- Projected benefit obligation (2,177) (1,914) Unrecognized transition obligation 111 124 Unrecognized net gain 327 271 -------- -------- Accrued pension costs included in other liabilities $ (1,739) $ (1,519) ======== ========
Net pension cost for the defined benefit pension plans consists of the following components:
Year ended December 31, ------------------------- 1996 1995 1994 ------- ------- ------- (000s omitted)
Service cost-benefits earned during the year $ 766 $ 633 $ 649 Interest cost on projected benefit obligation 767 636 570 Actual return on plan assets including realized gains and losses on investments (823) (1,616) (310) Net amortization (deferral) 146 1,044 (254) ------- ------- ------- Net pension cost $ 856 $ 697 $ 655 ======= ======= =======
Effective January 1, 1996, the following changes to the Plan occurred which reduced the net periodic postretirement benefit cost: (i) retirees must attain age 65 (previously 55), and (ii) benefits are now administered through a managed care organization which has reduced the Company's medical premiums to zero.
Generally, the net assets of the Company's insurance subsidiaries available for transfer to the parent company are limited to the amounts that the insurance subsidiaries' net assets, as determined in accordance with statutory accounting practices, exceed minimum statutory capital requirements; however, payments of such amounts as dividends are subject to approval by regulatory authorities. In 1997, the Company's insurance subsidiary, SCL, can transfer approximately $22.1 million in the form of dividends to the parent without prior approval of the regulatory authorities. AHL can transfer up to 15% of total statutory capital and surplus, or approximately $0.3 million as of December 31, 1996, without prior permission from the Bermuda Registrar of Companies.
Year ended December 31, 1996 1995 1994 --------- --------- --------- (000s omitted)
Consolidated GAAP shareholders' equity $ 355,232 $ 348,362 $ 245,309 Eliminate parent company deficit 71,101 61,313 58,846 Eliminate AHL surplus (2,221) ---------- --------- --------- SCL consolidated GAAP shareholders' equity 424,112 409,675 304,155 Add (subtract) GAAP adjustments DAC (405,231) (383,347) (355,132) Change in future policy benefits 153,475 136,921 114,863 Unrealized (gains) losses on fixed maturity securities available-for-sale (31,425) (94,606) 58,505 DAC (FAS 115) 16,563 47,526 (21,002) Future policy benefit costs (FAS 115) (1,832) (5,012) 2,280 Asset valuation reserve (17,770) (17,840) (13,377) Deferred income tax liabilities 25,683 44,988 38,279 Acquired insurance in-force and goodwill (28,937) (30,523) (32,153) Policyholders' share of surplus on participating business 8,023 7,667 7,332 Other 5,684 10,511 16,661 --------- --------- --------- SCL consolidated statutory-basis capital and surplus $ 148,345 $ 125,960 $ 120,411 ========= ========= =========
During 1984, SCL entered into a sale/leaseback agreement for its home office property. The agreement provides for a 25-year lease period with options to renew for six additional terms of five years each. The agreement also provides SCL with right of first refusal to purchase the property during the term of the lease, including renewal periods, at a price as defined in the agreement. In addition, SCL has the right to purchase the leased property at fair market value as defined in the agreement on the last day of the initial 25-year lease period or the last day of any of the renewal periods.
In addition, SCL leases an office suite in Lee's Summit, Missouri and LSL leases property in Brewster, New York. Both of these lease agreements expire in 1998. The Missouri lease can be extended for three additional periods of one year each.
Total rental expense on operating leases was $3.3 million in 1996, $2.9 million in 1995 and $2.8 million in 1994. Future minimum rental commitments are as follows (000s omitted) at December 31, 1996:
1997 $ 2,515 1998 2,391 1999 3,075 2000 3,190 2001 2,927 Thereafter 19,870 --------- Total $ 33,968 =========
The following table presents an analysis of the value of acquired insurance in-force:
Balance at beginning of year $ 8,966 $ 9,691 $ 10,528 Interest accretion at 15% 1,344 1,454 1,579 Amortization (2,026) (2,179) (2,416) -------- -------- -------- Balance at end of year $ 8,284 $ 8,966 $ 9,691 ======== ======== ========
In addition, the Company is involved in three class action lawsuits as follows:
Zipf vs. Security-Connecticut Life Insurance Company, et al., Court of Common Pleas of Allegheny County, Pennsylvania.
Jacobson, et al. vs. Security-Connecticut Life Insurance Company, et al., Superior Court, Judicial District of Hartford/New Britain at Hartford, Connecticut.
The proposed amended complaint alleges breach of contract, fraud, fraud in the sale of insurance contracts, and violation of Connecticut's Unfair Trade Practices Act. It does not allege, as before, that SCL charged additional premiums to pay for tax on DAC. SCL has filed an objection to the plaintiffs' request to amend the Complaint. The plaintiffs also have moved to withdraw their claims against LNL, stating that the claims in the proposed amended complaint do not directly implicate LNL.
The plaintiff filed a class action complaint in February 1997 against SCL and twenty-nine other insurance companies, alleging that those companies have improperly collected "unearned premiums" for a period of time when they do not actually provide insurance coverage. The plaintiff, who purchased a life insurance policy from First Colony Life Insurance Company, claims that all the defendant companies provide in their contracts that no insurance shall take effect until the policy is delivered and the first premium paid during the continued good health of the proposed insured. The companies bill premiums, however, from either an issue date or policy date, which allegedly might precede the effective date of coverage. The plaintiff claims that this industry practice violates certain provisions of California's Business and Professions Code.
Separately and not additionally, if the merger agreement is terminated by ReliaStar on the basis that the Security-Connecticut shareholders did not approve the merger, then Security-Connecticut would be required to pay ReliaStar $2.5 million to reimburse ReliaStar's expenses incurred in connection with the merger agreement. In addition to the foregoing $2.5 million payment, if an acquisition proposal is outstanding on the date of such termination, or at any time within 90 days thereafter, and an acquisition proposal is consummated within twelve months of the termination of the merger agreement, the Company has agreed to pay ReliaStar an additional $5.5 million. The foregoing discussion is qualified in its entirety by reference to the merger agreement filed as an exhibit to this report.