Domestic Operations. In May 2001 we completed the construction of a new domestic home office of 58,000 square feet at 10689 North Pennsylvania Street, Indianapolis, Indiana. In December 2001, we signed a promissory note and mortgage due December 31, 2011 in the principal amount of $6.9 million to finance the new home office building. Approximately 46,000 square feet of the building is leased to Standard Life pursuant to a lease entered into on January 1, 2002.
International Operations. Standard Management International entered into a lease on November 17, 1997 for approximately 4,500 square feet in an office building located at 13A, rue de Bitbourg, L-1273 Luxembourg-Hamm, Grand Duchy of Luxembourg which expires on November 16, 2003.
The following historical financial data was derived from our audited consolidated financial statements. This historical financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our Consolidated Financial Statements and related Notes.
Year Ended December 31 2001	 2000	 1999 1998 1997 STATEMENT OF OPERATIONS DATA:
Earnings to fixed charges 1.1X 1.2X 1.2X 1.3X 1.2X Earnings to fixed charges, excluding policyholder interest 		 1.5X 2.5X 2.8X 3.0X 2.4X
BALANCE SHEET DATA (at year end): Invested assets $961,229 $754,839 $ 648,503 $592,123 $398,782 Assets held in separate accounts 401,097 520,439 319,973 190,246 148,064 Total assets	 1,607,653 1,470,457 1,150,977 956,150 668,992 Mortgage payable 6,900 -- -- -- -- Notes payable 	 19,100 31,500 34,500 35,000 26,141 Total liabilities 1,516,764 1,401,028 1,091,087 883,578 625,679 Trust preferred securities 20,700 -- -- -- -- Preferred stock	 -- 6,530 6,530 6,530 -- Shareholders' equity 70,189 62,899 53,360 66,042 43,313
Notes to Selected Historical Financial Data (Dollars in Thousands, Except Per Share Amounts)
(c)	Operating income is commonly used as a meaningful measure of reporting results as a supplemental disclosure to net income. Operating income is not a GAAP measure of performance and may not be comparable to similarly titled measures used by other companies. Operating income represents net income before 1) extraordinary gains (losses), and 2) net realized investment gains (losses) (less related income taxes (benefits) and amortization). Operating income should be reviewed in conjunction with net income and cash flow information included elsewhere in this report.
The following discussion highlights the principal factors affecting the results of our operations and the significant changes in our balance sheet items on a consolidated basis for the periods listed, as well as liquidity and capital resources. This discussion should be read in conjunction with the accompanying Consolidated Financial Statements, related Notes and selected historical financial data.
* Regulatory changes or actions, including those relating to regulation of financial services affecting bank sales and underwriting of insurance products, regulation of the sale, underwriting and pricing of insurance products.
International Product Profitability. Margins on our international unit-linked products are driven by the relationship between fees we collect on the products and our costs to sell and administer those products. Fee amounts are largely related to separate account asset values. In a declining equity environment, as we experienced in 2001, separate account fee income declines along with the asset values, resulting in lower margins. Conversely, as global equity values increase, separate account fees and margins increase as well.
Present Value of Future Profits. In accordance with industry practice, when we purchase a block of existing insurance business, we assign a portion of the purchase price, called the present value of future profits ("PVP"), as the pre-tax value of the business acquired. The asset is the discounted value of future cash flows arising from the existing block of business. The discount rate used is based upon many elements, such as yields generated on similar business, our cost of capital and the interest rate environment as of the purchase date. Discount rates used in determining our PVP assets range from 12.45% to 18.00%.
Variances Between Actual and Expected Profits. Actual experience on purchased and produced insurance may vary from projections due to differences in renewal premiums collected, investment spreads, mortality costs, persistency, administrative costs and other factors. Variances from original projections, whether positive or negative, are included in net income as they occur. To the extent that these variances indicate that future experience will differ from the estimated profits reflected in the capitalization and amortization of the PVP and DAC assets, current and future amortization rates may be adjusted.
Accounting for Deferred Annuities and Universal and Interest- Sensitive Life Products. We primarily account for our annuity, universal and interest-sensitive life policy deposits in accordance with Statement of Financial Accounting Standards No. 97 ("SFAS No. 97"), "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses on the Sale of Investments." Under SFAS No. 97, a benefit reserve is established at the time of policy issuance in an amount equal to the deposits received. Thereafter, the benefit reserve is adjusted for any additional deposits, interest credited and partial or complete withdrawals. Revenues for annuities and universal and interest-sensitive life policies, other than certain non-interest sensitive annuities, consist of policy charges for surrenders and partial withdrawals, mortality and administration, and investment income earned. These revenues do not include the annuity, universal and interest-sensitive life policy deposits. Expenses related to these products include interest credited to policyowner account balances, operating costs for policy administration, amortization of DAC and mortality costs in excess of account balances.
Costs relating to the acquisition of new business, primarily commissions paid to agents, which vary with and are directly related to the production of new business, are deferred to the extent that such costs are recoverable from future profit margins. At the time of issuance, the acquisition expenses, approximately 11% of our initial annuity premium deposits and 119% of our premiums from universal and interest-sensitive life products, are capitalized as DAC. In accordance with SFAS No. 97, DAC with interest is amortized over the lives of the policies in a constant relationship to the present value of estimated future gross profits.
Accounting for Traditional Life Products. Traditional life insurance products are accounted as long-duration insurance contracts in accordance with Statement of Financial Accounting Standards No. 60 ("SFAS No. 60"), "Accounting and Reporting by Insurance Enterprises". Under SFAS No. 60, benefit reserves are actuarially calculated using the net level reserve method. Revenues consist of policy premiums and investment income on assets supporting policy liabilities. Expenses consist of policy benefits incurred, increases in policy liabilities, and operating costs for policy administration, and amortization of DAC.
Accounting for Unit-linked Assurance Products. Separate account income statements and balance sheets are maintained for international unit-linked assurance products. Separate account investment income and investment gains and losses accrue directly to unit-linked policyholder accounts. Revenue and expense recognition for unit-linked products follows a SFAS No. 97 model, with fee income recorded as revenue, and administrative expenses recorded as expense. Policy acquisition costs and revenue from initial sales charges are deferred and amortized as DAC and deferred revenue respectively.
Results of operations by segment for the three years ended December 31, 2001:
The following tables and narratives summarize the results of our operations by business segment:
Domestic operations	 		 $ 6,955 $ 5,440 $ 6,054 International operations	 2,164 3,128 1,266
Consolidated operating income before income taxes 	 9,119 8,568 7,320 Applicable income taxes related to operating income	 1,790 1,235 2,099
Consolidated realized investment gains (losses) before income taxes (benefits)	 (7,329) (2,164) 78 Applicable income taxes (benefits) related to realized investment gains (losses)	 (1,780) (457) 27
Consolidated realized investment gains (losses) after taxes (benefits)	 (5,549) (1,707) 51
Subtotal - interest-sensitive and other financial products 	 322,473 196,489 165,676 Total premiums and deposits collected	 $ 331,892 $ 205,921 $175,957
Statement of Operations: Premium income 	 $ 9,419 $ 9,432 $ 10,281 Policy income	 7,721 8,204 6,826
Net investment income	 58,539 50,279 43,167 Call option gains (losses)	 (5,906) (7,603) 1,209 Fee and other income	 7,347 5,980 4,207
Supplemental Information: Number of annuity contracts in force	28,482 24,216 24,322 Interest-sensitive annuity and other financial products reserves, net of reinsurance ceded	 $926,539 $ 695,475 $595,388 Number of life policies in force	 47,575 55,533 61,573 Life insurance in force, net of reinsurance ceded $744,569 $1,042,566 $1,367,533
General: Our domestic operations segment consists of revenues earned and expenses incurred from our United States operations. Our primary products include deferred annuities, equity-indexed annuities and single premium immediate annuities. The profitability of this segment is primarily a function of net investment spread (the difference between the investment income earned on our investments less the interest we credit to our policyholders), persistency of the in force business, mortality experience and management of our operating expenses.
* Premium deposits for 2000 increased $30.8 million or 19% to $196.5 million. Single premium immediate annuities and other deposits increased $21.9 million to $27.8 million. Equity- indexed annuities increased $13.8 million or 23% to $73.1 million.
Policy income represents 1) mortality income and administrative fees earned on universal life products, and 2) surrender income earned as a result of terminated universal life and annuity policies.
* During 2001, policy income decreased $.5 million or 6%, to $7.7 million which includes a $.3 million decline in surrender income. Generally during a declining interest rate environment, policyholders are less likely to terminate existing annuity policies, therefore resulting in less surrender income.
* During 2001, net investment income increased $8.3 million or 16% to $58.5 million. Average cash and invested assets, at book value, increased by $158.0 million or 22% due to the growth in insurance liabilities from annuity sales in recent periods.
Call option losses relate to equity-indexed products which are hedged with call options to limit risk against unusually high crediting rates from favorable returns in the equity market.The market value of these call options fluctuate from period to period and are substantially offset by amounts credited to policyholder account balances.
* During 2001, call option losses decreased by $1.7 million or 22% to $5.9 million.
* During 2000, call option losses increased $8.8 million to ($7.6) million compared to call option gains of $1.2 million in 1999.
Call option losses for the 2001 and 2000 periods were due to the impact from changes in the market value of our call options as a result of changes in the S & P 500 Index and the purchase of additional options to support increased equity-indexed liabilities.
* During 2001, fee and other income increased by $1.4 million or 23% to $7.3 million. This increase includes commission income from Savers Marketing of $6.2 million, an increase of $1.5 million compared to the 2000 period.
* During 2000, fee and other income increased $1.8 million or 42%, to $6.0 million. This increase includes 1) commission income from Savers Marketing of $4.7 million, an increase of $1.5 million compared to the 1999 period and 2) $.3 million of other income related to a recovery under a keyman insurance policy.
Benefits and claims include 1) mortality experience, 2) benefits from other policies that incorporate significant mortality features and 3) changes in future policy reserves. Throughout our history, we have experienced both periods of higher and lower benefit claims. Such volatility is not uncommon in the life insurance industry and, over extended periods of time, periods of higher claim experience tend to offset periods of lower claim experience.
* Benefits and claims in 2001 decreased by $6.7 million or 49% to $7.1 million. This decrease includes the impact from single premium immediate annuity reserves of approximately $5.2 million, which are offset by a comparable increase in commission expense and premium tax. In addition, we experienced favorable mortality of $.9 million compared to the 2000 period.
See also "Commission expenses" and "Other operating expenses" for additional information regarding the impact of our single premium immediate annuities.
Interest credited to interest sensitive annuities and other financial products represents interest credited to insurance liabilities of the flexible premium deferred annuities, equity- indexed annuities, single premium immediate annuities and other financial products. This expense fluctuates with changes in 1) the average interest-sensitive insurance liabilities, 2) the average credited rate on those liabilities, 3) interest earned on invested assets supporting equity-indexed products, 4) the market value fluctuations of call options and 5) the impact of SFAS No. 133, which is substantially offset by amortization.
* In 2000, interest credited decreased $4.4 million or 17%, to $21.3 million. This decrease consists of a $7.6 million decline in the market value of call options supporting equity-indexed products. This decrease was offset by increased interest credited due to increased average interest sensitive liabilities of $98.9 million or 20% for the period, including a $61.4 million increase from equity-indexed products.
* Our weighted average credited rate was 5.00%, 4.90% and 4.89% for the years ended 2001, 2000 and 1999, respectively.
The increase in our weighted average crediting rate for 2001 is primarily due to the increased volume of new business which tends to have higher crediting rates than renewal business. Sales of interest sensitive products increased 64% compared to the 2000 period.
* Amortization in 2001 decreased by $.7 million or 8% to $8.9 million. This decline relates to 1) lower amortization of $.7 million from our purchased insurance business, 2) $.4 million from lower surrenders and 3) $.4 million as a result of adopting FASB 133. These decreases were offset by $.7 million of additional amortization related to annuity sales in recent periods.
* During 2001, commission expenses increased $7.3 million to $9.3 million primarily due to $4.5 million of non-deferrable commissions from increased single premium immediate annuity sales of approximately $48.6 million compared to the 2000 period, and $1.1 million of additional commissions paid by Savers Marketing due to increased sales.
* During 2000, commission expenses increased $1.2 million to $1.9 million primarily due to non-deferrable commissions from increased single premium immediate annuity sales of approximately $21.9 million, compared to the 1999 period.
Benefits and claims have been reduced by increased commission expenses related to single premium immediate annuity sales in the periods ending December 31, 2001 and 2000, respectively.
* In 2001, other operating expenses increased $.5 million or 5% to $11.2 million. This increase is primarily due to $.8 million of premium tax expense from increased sales of single premium immediate annuities, and litigation settlement costs.
Benefits and claims have been reduced by increased premium taxes related to single premium immediate annuity sales for the periods ending December 31, 2001 and 2000, respectively.
* In 2001, interest expense and financing costs increased by $.1 million to $3.5 million. Average borrowings for the period increased $1.6 million primarily due to the Trust Preferred Offering completed in August 2001.
* Net realized investment losses, net of amortization, for 2001 were $6.5 million, which is reduced by $3.8 million of deferred acquisition cost amortization. The majority of the loss was attributable to the sale of Enron bonds and write- downs on the value of collateralized debt obligations due to increased default rates. In addition, losses for the 2001 period included the write-off of an investment in an internet based business.
* Net realized investment losses, net of amortization, for 2000 were $2.2 million, which is reduced by $2.3 million of deferred acquisition cost amortization. Approximately 64% of the gross losses for 2000 are related to fixed maturity securities that have a decline in fair value that is considered other than temporary. These securities are considered to be in substantive default.
We maintain a high quality investment portfolio with 95% and 94% of our fixed maturity securities classified as investment grade securities in 2001 and 2000, respectively.
Premiums and deposits collected: Traditional life			 $ 57 $ 41 $ 100 Separate account deposits	 74,364 170,514 55,192
Separate account deposits consist of deposits from our unit- linked assurance products. For GAAP these separate account deposits are not shown as premium income in the income statement. A change in separate account deposits in a single period does not cause our operating income to change, although continued increases or decreases in separate account deposits may affect the growth rate of separate account assets on which fees are earned.
* During 2001, net deposits decreased $96.2 million to $74.4 million. The decrease in deposits is primarily due to the volatile global equity environment which has caused a shift in sales to fixed-income based investments.
* During 2000, net deposits increased $115.3 million or 209%, to $170.6 million for the period. The increase in deposits is primarily due to 1) strengthening of our distribution system by engaging more, highly productive agents, 2) concentrated marketing efforts in certain European countries, primarily Sweden and Belgium and 3) favorable demand, in general, for investment based products.
* Net investment income was $.5 million in 2001 and 2000, respectively. Corporate assets averaged $12.1 million for 2001 and $11.5 million for 2000, respectively.
* The net investment yields earned on average invested assets were 3.80%, 4.31% and 4.06% for the years ended 2001, 2000 and 1999, respectively.
* The impact of foreign exchange translation increased fees from separate accounts $.5 million in 2001 and $.7 million in 2000.
* Other operating expenses increased $.8 million or 38% in 2000, to $3.0 million primarily as a result of costs associated with international business growth. The number of separate account contracts administered increased 48% to 4,989 in 2000.
Net realized investment losses generally arise when securities are sold in response to changes in the investment environment.
Standard Management is a financial services holding company whose liquidity requirements are met through payments received from our subsidiaries. These payments include 1) surplus debenture interest, 2) dividends, 3) management fees, 4) equipment rental fees, 5) lease income and 6) allocation of taxes through a tax sharing agreement, all of which are subject to restrictions under applicable insurance laws and are used to pay our operating expenses and meet our debt service obligations. These internal sources of liquidity have been supplemented in the past by external sources such as revolving credit agreements and long-term debt and equity financing in the capital markets.
Surplus Debenture Interest. We loaned $27.0 million to Standard Life pursuant to unsecured surplus debenture agreements ("surplus debentures") which requires Standard Life to make quarterly interest payments at a variable corporate base rate plus 2% per annum, and annual principal payments of $1.0 million per year beginning in 2007 and concluding in 2033. The interest and principal payments are subject to quarterly approval by the Indiana Department of Insurance, depending upon satisfaction of certain financial tests relating to levels of Standard Life's capital and surplus and general approval of the Commissioner of the Indiana Department of Insurance. We currently anticipate these quarterly approvals will be granted. Assuming the approvals are granted and the December 31, 2001 interest rate of 6.75% continues, we are expected to receive interest income of $1.8 million from the surplus debenture in 2002.
Dividends paid from Standard Life are limited by laws applicable to insurance companies. As an Indiana domiciled insurance company, Standard Life may pay a dividend or distribution from its surplus profits, without the prior approval of the Commissioner of the Indiana Department of Insurance, if the dividend or distribution, together with all other dividends and distributions paid within the preceding twelve months, does not exceed the greater of 1) net gain from operations or 2) 10% of surplus, in each case as shown in its preceding annual statutory financial statements. In 2001, we received dividends of $1.6 million and $.5 million from Standard Life and Savers Marketing, respectively. In 2002, we could receive dividends of approximately $4.4 million from Standard Life.
Management Fees. Pursuant to a management services agreement, Standard Life paid $3.6 million during 2001 for certain management services related to the production of business, investment of assets and evaluation of acquisitions. In addition, Dixie Life paid Standard Life $1.1 million in 2001, respectively, for certain management services provided. Both of these agreements provide that they may be modified or terminated by the applicable Departments of Insurance in the event of financial hardship of Standard Life or Dixie Life. In 2002, we are expected to receive management fees of $3.6 million from Standard Life.
Lease Income. Effective January 1, 2002, we entered into a lease agreement with Standard Life whereby Standard Life will lease approximately 46,000 square feet of our office space located at 10689 North Pennsylvania Street. In 2002, we are expected to receive lease income of $.8 million from Standard Life.
* interest payments required in 2002 based on current balances will be $.5 million;
The following are characteristics of our amended credit agreement at December 31, 2001:
* principal payments: $.6 million due March 2002 and $2.5 million due annually thereafter through March 2005;
The following are characteristics of our subordinated debt agreement at December 31, 2001:
* interest rate is greater of 1) 10% per annum or 2) six month London Inter-Bank Offered Rate ("LIBOR") plus 1.5%;
* interest payments required in 2002 based on current balances will be $1.1 million.
Trust Preferred Securities: These securities represent an undivided beneficial interest in the assets of SMAN Capital Trust I, a Delaware business trust organized to purchase our junior subordinated debentures and issue preferred securities. The assets of the Trust consist solely of the debentures which were purchased by the Trust with the proceeds of the offering. On August 9, 2001, the Trust completed a public offering of $20.7 million of its 10.25% preferred securities. The Trust used the proceeds of this offering to purchase our 10.25% junior subordinated debentures. Net proceeds from the sale of the debentures of approximately $19.3 million were used to redeem our Series A preferred stock of $6.5 million and repay $7.3 million of our notes payable. The remaining proceeds were used for general corporate purposes.
The following are characteristics of our trust preferred securities at December 31, 2001:
* distributions required in 2002 based on current balances will be $2.1 million;
We are subject to a number of factors affecting our business, including intense competition in the industry and the ability to attract and retain agents and employees. If we are unable to respond appropriately to any of these factors, business and financial results could suffer.
Our management believes that the ability to compete is dependent upon, among other things, the ability to retain and attract independent general agents to market products and the ability to develop competitive products that also are profitable. Although management believes that good relationships with our independent general agents exist, competition for those agents among insurance companies is intense. Our independent general agents typically represent other insurance companies and may sell products that compete with our products. Sales of our annuity, life insurance and unit-linked assurance products and therefore, our business, results of operations and financial condition may be adversely affected if we are unsuccessful in attracting and retaining independent agents and marketing organizations. See "Business of Standard Management-Competition."
Insurers compete with other insurance companies, financial intermediaries and other institutions on the basis of a number of factors, including the ratings assigned by A.M. Best Company, Inc. A.M. Best Company assigns ratings labeled A++ through F ("Superior," "Excellent," "Very Good," "Fair," "Marginal," "Weak," "Poor," "Under Regulatory Supervision," and "In Liquidation"). Standard Life and Dixie Life have a rating of B++ (Very Good) and B (Fair), respectively, by A.M. Best Company. A.M. Best Company's ratings represent their opinion based on a comprehensive quantitative and qualitative review of our financial strength, operating performance and market profile. A rating of B++ is assigned by A.M. Best to companies that, in their opinion, have achieved very good overall performance when compared to the standards established by A.M. Best, and have a good ability to meet their obligations to policyholders over a long period of time. A rating of B is assigned by A.M. Best to companies that, in their opinion, have achieved good overall performance when compared to the standards established by A.M. Best. According to A.M. Best, these companies generally have an adequate ability to meet their obligations to policyholders, but their financial strength is vulnerable to unfavorable changes in underwriting or economic conditions. In evaluating a company's financial and operating performance, A.M. Best reviews the company's profitability, leverage and liquidity as well as the company's book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its reserves, and the experience and competence of its management. A.M. Best reviews its ratings of insurance companies from time to time. If the A.M. Best ratings were downgraded, sales of annuity products could be significantly impacted and the financial condition and results of operations could be materially adversely affected. See "Business of Standard Management-Competition."
Changes in governmental regulation and legislation could have a substantial impact on our profitability.
In addition, the federal government has become increasingly involved with insurance regulation in recent years, including the passage of the Gramm-Leach-Bliley Act, and more comprehensive federal legislation in this area is still being actively considered by Congress. Federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation and federal taxation, affect us specifically and the insurance business in general. New state or federal laws or regulations, as well as a more strict interpretation of existing laws or regulations, may adversely affect our current claims exposure, adversely affect the profitability of our current and future products, and materially affect our future operations by increasing the costs of regulatory compliance. We cannot predict the impact of future state or federal laws or regulations on our business. See "Business of Standard Management - Regulatory Factors."
As of December 31, 2001, approximately 88% or $735 million of annuity contracts in force (measured by statutory reserves) were surrenderable. Approximately 12% of those contracts or approximately $97 million of annuity contracts in force (measured by statutory reserves) are surrenderable without charge. Changes in prevailing interest rates, ratings or other factors which result in or lead to significant levels of surrenders of existing annuity contracts could have a material adverse effect on our financial condition and results of operations. Surrenders result in a reduction of invested assets that earn investment income and a reduction of policyholder account balances that credit interest.
Included in our financial statements are certain assets that are primarily valued, for financial statement purposes, on the basis of management's assumptions. These assets include items such as:
The assumptions are based upon, among others, interest rate spread and rates of mortality, surrender and lapse. If, for instance, future mortality rates were higher than expected, projected margins would be lower and deferred acquisition cost amortization would increase. The value of these assets reflected in our December 31, 2001 balance sheet totaled $150 million, or 9.3% of our assets. Although we have established procedures to periodically review the assumptions used to value these assets and determine the need to make adjustments, if our assumptions are incorrect and adjustments need to be made, our financial results could be materially adversely affected.