The Company's primary administrative offices are located in Raleigh, North Carolina and Dallas, Texas. The Company owns and occupies a home office facility comprising approximately 165,000 rentable square feet, in Raleigh, North Carolina. The Company subleases a portion of its prior Raleigh home office facility which has a lease term expiring in 1999 and requires annual lease payments of approximately $1.1 million.
The Company, through its operating subsidiaries, is a low cost provider of accumulation, life, and fixed benefit accident and sickness insurance products throughout the United States and Canada. The Company's products are sold through several distribution channels, including exclusive agents, general agents, financial institutions, and payroll deduction programs, and are targeted primarily to lower and middle-income individuals in rural and suburban areas. These products are primarily small premium accident and sickness insurance policies with defined fixed benefit amounts, traditional whole life and universal life insurance with low face amounts and accumulation products such as single premium deferred annuities.
As a result, the Company began to realign its existing operating companies and incurred restructuring and period costs aggregating $21.4 million for the year ended December 31, 1997, directly associated with the initial divisional restructuring which will have no future economic benefit ("restructuring costs"), including the costs of employee termination benefits and relocation, early service contract termination, and facility abandonment.
In addition, on August 30, 1997 the merger agreement between Washington National Corporation ("Washington National") and the Company terminated. The Company incurred legal, accounting and financial advisory fees associated with the merger. In addition, the Company had begun to provide certain resources to Washington National including personnel to perform policy administration and claims processing function on Washington National's behalf. The aggregate advisory and administration costs incurred by the Company during 1997 were approximately $7.6 million.
Acquisitions. The Company's historical growth strategy has emphasized the acquisition of complementary insurance operations and the utilization of the Company's several distribution channels to further penetrate its target markets. In making acquisitions, the Company has sought to broaden its distribution channels, increase its product offerings and expand its geographic presence. The Company also seeks benefits from expense reduction through the consolidation of facilities and staff and the conversion to common administrative systems.
Through its initial direct investment of $120,000 in SW Financial (the "Southwestern Life Investment"), the Company beneficially owns 74.8% of SW Financial's outstanding common stock, including 100% of SW Financial's non-voting common stock, 14.3% of SW Financial's voting common stock, and 100% of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in Knightsbridge. As a result, the Company has an economic interest in SW Financial aggregating 78.0 percent (for additional information regarding SW Financial see Notes 6 and 19 of "Notes to Consolidated Financial Statements").
The comparability of the Company's financial position, results of operations and cash flows for each of the periods presented has been affected by these acquisitions. The pro forma effects of the acquisition of United Life is described in Note 3 of Notes to Consolidated Financial Statements included elsewhere herein.
Financings. In March 1997, the Company entered into a $450.0 million revolving credit agreement with a syndicate of banks ("the bank credit agreement") which replaced the Company's previously outstanding $175.0 million credit agreement which had been entered into in May 1996. Borrowings under the bank credit agreement during 1997 were used to: (i) retire previously outstanding bank indebtedness aggregating $92.0 million, (ii) make capital contributions to its
On August 2, 1996, the Company issued 2,875,000 shares of $3.50 Series II Convertible Preferred Stock ("Series II Convertible Preferred Stock") for net proceeds of $139.2 million. The cash raised through this offering, along with borrowings under the Company's bank credit facility, were utilized: (i) to fund the cash portion of the purchase price for United Life, aggregating $100.4 million, (ii) to fund a capital contribution of $57.3 million to United Life, and (iii) to pay related expenses of the acquisition of United Life of $9.7 million. The Company accrued or paid dividends of $10.1 million and $4.0 million during 1997 and 1996, respectively, related to the Series II Convertible Preferred Stock.
On February 28, 1996, PennCorp completed the sale of 5,131,300 shares of Common Stock, netting proceeds of $155.5 million ("February 1996 Common Stock Offering"). Proceeds from this offering were utilized to repay $80.0 million of corporate and $57.0 million of subsidiary indebtedness, and to pay $10.0 million to SW Financial's former owner in lieu of PennCorp's obligation to issue an equivalent number of shares of Common Stock.
On July 14, 1995, PennCorp issued 2,300,000 shares of $3.375 Convertible Preferred Stock ("Convertible Preferred Stock") for net proceeds of $110.5 million. On March 16, 1995, PennCorp issued 3,750,000 shares of Common Stock, for net proceeds of approximately $51.2 million. The proceeds from these two offerings were used to: (i) consummate the acquisition of Integon Life, which utilized funds totaling $33.4 million (including a capital contribution of $15.0 million), (ii) repay $28.5 million outstanding under, and subsequently cancel, a revolving credit facility, (iii) repurchase, for $34.6 million, all of the Company's Series A Preferred Stock, (iv) repay $11.2 million due to Integon Life's former parent company under a subordinated debenture, (v) pay the $15.4 million cash portion of the purchase price of Occidental Life Insurance Company of North Carolina ("OLIC") (which PennCorp purchased from Pennsylvania Life Insurance Company and its wholly-owned subsidiary, Penncorp Life Insurance Company (collectively referred to herein as "Penn Life") and subsequently contributed to Integon Life), (vi) prepay $20.0 million principal amount of subsidiary indebtedness, and (vii) make payments for general corporate purposes, including interest payments and the cancellation of certain interest rate swap agreements. The Company paid or accrued dividends on the Convertible Preferred Stock amounting to $7.8 million, $7.8 million and $3.6 million during 1997, 1996 and 1995, respectively.
For the years ended December 31, 1997, 1996 and 1995, the Company received net payments from the Surplus Note Companies of $44.1 million, $31.9 million and $19.1 million, respectively. The Surplus Note Companies received $32.1 million, $25.8 million and $21.6 million in dividends and tax sharing payments from their respective insurance subsidiaries.
The primary cash requirements of the Company are interest payments, preferred stock dividends and common stock dividends which aggregated $47.4 million, $33.9 million and $ 24.5 million for the years ended December 31, 1997, 1996 and 1995, respectively. For the years ended December 31, 1997, 1996 and 1995, cash requirements of the Company exceeded cash made available to the Company through payments under the surplus debentures by $3.3 million, $2.0 million and $ 5.4 million, respectively. During each of these periods, the Company utilized a balance of dividends and surplus note payments from the insurance subsidiaries and borrowings under the Company's credit facilities to fund PennCorp's cash requirements. This balance resulted in what management believes to be, along with other factors, an appropriate retention of statutory capital and surplus to improve the insurance subsidiaries' A.M. Best ratings without placing an undue debt burden upon the Company.
During 1998, the maximum dividends and tax sharing payments and corresponding surplus debenture payments, without prior regulatory approval, are anticipated to be approximately $79.0 million and the Company's cash requirements are anticipated to be approximately $59.0 million. As a result of the Company's historical policy of retaining capital and surplus at the insurance subsidiary level, and as a result of the Company's simplification of its corporate structure, including the statutory merger of a number of insurance companies, combined with realignment of the insurance subsidiaries into operating divisions, the Company believes that as of December 31, 1997, its insurance subsidiaries have excess capital and surplus. The Company's own established targets for estimated risk-based capital requirements indicate that the insurance divisions could make available approximately $40.0 million to PennCorp, subject to applicable regulatory approvals.
investment strategy fits the nature of its insurance products which have little or no inflation risk and limited build-up of cash accumulation values in earlier years.
The Company continuously evaluates its investment portfolio and the conditions under which it might sell securities, including changes in interest rates, changes in prepayment risk, liquidity needs, asset liability matching, tax planning strategies and other economic factors. Those securities that the Company believes would be subject to sale prior to the specified maturity date are included in "securities available for sale," which amounted to $2,719.0 million and $2,993.9 million at December 31, 1997 and 1996, respectively. Of those securities available for sale, 92.5% and 92.1% were rated Baa or above by Moody's Investors Services, Inc. at December 31, 1997 and 1996, respectively.
During 1995, the Company established a portfolio of "trading securities" to provide the Company with the opportunity to undertake interest rate hedging strategies, to participate in short-term relative value trades and to invest in special situations with the goal of generating short-term trading profits. As a result of trading activities, the Company recognized $1.1 million, $1.3 million and $5.7 million of profits during 1997, 1996 and 1995, respectively. As of December 31, 1997, the Company held no investments in its trading portfolio.
Mortgage loans on real estate amounted to 7.3% and 7.2% of total invested assets as of December 31, 1997 and 1996, respectively. United Life is the Company's only subsidiary which actively originates new mortgage loans. United Life invests in first mortgage loans and provides a mortgage loan warehousing facility for its former parent as a means of obtaining higher invested asset yields necessary to support competitively priced annuity products. The Company has established a reserve for loan loss which aggregated $6.0 million as of December 31, 1997. As of December 31, 1997 and 1996, the Company had non-performing loans amounting to $698,000 and $1.4 million, respectively. The Company is in various stages of foreclosure or sales of such loans. The Company believes its current loan loss provision is adequate to cover any future losses related to currently performing and non-performing loans.
Cash and short-term investments totaled $109.0 million and $102.6 million as of December 31, 1997 and 1996, respectively. At December 31, 1997 and 1996, respectively, the Company held approximately $135,000 and $12.2 million in short-term investments needed in the settlement of investment trades early in the following year.
acquisition contingencies or allocations: (i) the Company increased deferred tax assets and reduced associated costs in excess of net assets acquired associated with the Integon Life acquisition by $19.6 million as a result of the Company resolving certain acquisition date tax contingencies, (ii) the Company reduced both deferred tax liabilities and associated costs in excess of net assets acquired associated with the Marketing One acquisition by $1.1 million as a result of the Company resolving certain acquisition date tax contingencies, and (iii) the Company reduced costs in excess of net assets acquired and increased certain mortgage loan values by $1.1 million, associated with the acquisition of United Life, as a result of final appraisals becoming available.
For the year ended December 31, 1995, the Company determined a reduction in the valuation of the Series A Preferred Stock issued in conjunction with the AA Life acquisition of $3.9 million was necessary based upon final settlement, which resulted in a corresponding reduction in costs in excess of net assets acquired.
Disintermediation Risk. With the acquisition of United Life and Integon Life, the Company significantly expanded its interest sensitive portfolio of products including universal life and accumulation products. The Company actively manages the difference in interest yields on assets backing interest sensitive liabilities and amounts credited to policyholder account balances so as to provide a margin or "spread." For the years ended December 31, 1997 and 1996, the Company had total interest sensitive liabilities aggregating $2,563.9 million and $2,685.7 million and obtained a spread on such liabilities of 2.5% and 2.1%, respectively. As part of the ongoing management of interest sensitive business, the Company annually undertakes "cash flow testing" sensitivities in which Management evaluates a range of interest rate scenarios under which credited interest rates and asset/liability durational matching may become mismatched. The Company believes that it has sufficient liquidity to withstand all reasonable scenarios established by Management.
Inflation. The Company sells fixed benefit, life, and accumulation products. Approximately 48.9% of the Company's total policy revenues for the year ended December 31, 1997, were derived from fixed benefit products. These products typically provide a predetermined fixed payment that will be paid under specified conditions. Fixed benefit products are not designed to provide reimbursement for medical and related costs incurred as a result of accidents and sickness. Accordingly, payment amounts are not affected by the insured's actual cost of health care services. Because of the characteristics of its fixed benefit products, the Company believes that inflation does not have a material effect on its operations.
Subsequent Events. On December 31, 1997, at the Company's Annual Shareholders' Meeting, the shareholders approved the acquisition of the Controlling Interest in SW Financial and the acquisition of the Stone and Fickes Knightsbridge Interests. On January 2, 1998 and January 5, 1998 the Company consummated the acquisitions of the Controlling Interest in SW Financial and the Stone and Fickes Knightsbridge Interests, respectively. The acquisition of the Controlling Interest in SW Financial will expand the Company's Financial Services and Career Sales operations with similar products, distribution channels and asset mixes (see Notes 15, 16 and 19 of Notes to Consolidated Financial Statements).
On February 18, 1998, the Company announced that it had engaged investment banking firms to review strategic alternatives for maximizing shareholder value, including the sale of the Company's Career Sales Division. As a result, in the future the Company intends to account for the Career Sales Division as "businesses held for sale" (see Note 19 of "Notes to Consolidated Financial Statements").
The following unaudited pro forma selected financial data represents the Company's consolidated results of operations, as if the acquisition of the Controlling Interest in SW Financial occurred on January 1, 1997, and the pro forma consolidated financial position, as if such transaction occurred as of December 31, 1997. In addition, the following pro forma selected consolidated financial data presents the Company's consolidated results of operations for the Company's "retained businesses" (those businesses remaining after giving effect to the disposition of the Career Sales Division) as if the disposition of the Career Sales Division and the consummation of the acquisition of the Controlling Interest in SW Financial occurred January 1, 1997 and the pro forma consolidated statement of financial position as if the Career Sales Division was held for sale as of December 31, 1997. The unaudited pro forma selected financial data has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had the transactions been consummated as of January 1, 1997, or December 31, 1997, respectively, or the results of operations or financial position which may occur in the future. The retained business pro forma financial information reflects the historical results of the retained businesses and does not consider the use of proceeds likely to be derived from the disposition of the businesses held for sale. The significant subsidiaries included in businesses held for sale are PLIC and Union Bankers, a subsidiary of SW Financial.
New Accounting Pronouncements. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 is effective for annual and interim periods beginning after December 15, 1997. This statement establishes standards for reporting and displaying comprehensive income and its components and requires all items to be recognized under accounting standards as comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Examples of items to be included in the Company's presentation of comprehensive income, in addition to net income applicable to common stock, are unrealized foreign currency translation gains and losses as well as unrealized gains and losses on securities available for sale. The Company will adopt the provisions of SFAS No. 130 in 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was also issued in June 1997 by the FASB. This Statement requires that companies disclose segment data on the basis that is used internally
by management for evaluating segment performance and allocating resources to segments. This Statement requires that a company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It also requires various reconciliations of total segment information to amounts in the consolidated financial statements. The Company's current definition of its business segments will not materially change from the current presentation. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
In December 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-3. SOP 97-3 provides: (1) guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, (2) guidance on how to measure the liability, (3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and (4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. Early adoption is encouraged. Previously issued annual financial statements are not restated. The Company will report the effect of initially adopting this SOP in a manner similar to the reporting of a cumulative effect of a change in accounting principle. The Company is currently evaluating the financial impact, which is expected to be immaterial, as well as the changes to its related disclosures.
The ratio of total policy benefits to revenues increased during 1997 to 51.7% from 48.4% and 38.9% in 1996 and 1995, respectively. The increase in the ratio of total policy benefits to revenues during 1997 was primarily attributable to the continued increase in life and accumulation products, relative to fixed benefit products, since benefits for life insurance products are typically greater, as a percentage of revenues, than benefits for fixed benefit products. Additionally,
accumulation products, such as deferred annuities, are priced to allow for the vast majority of interest earned on assets backing policy reserves to be credited to the policyholder account balance resulting in a faster growth in policy benefits than policy benefits for fixed benefit products. During 1997, Penn Life continued to experience an increase of its benefit ratios, resulting in an increase in the Company's overall benefits ratio of approximately 1.8 percent. The increase was primarily a result of Penn Life's strengthening of certain claims reserves and the impact of the 1996 conversion to a new valuation system (see below). During 1996, the Company also experienced higher than expected mortality and morbidity costs for Penn Life and OLIC, which collectively resulted in an approximately 2.0% increase in the claims incurred ratio for the Company as a whole. During 1996, the Company refined the calculation of certain policy benefit reserves which collectively aggregated approximately $443.0 million. Such refinement resulted in an increase in future policy benefits of approximately $1.3 million for 1996. The refinement will result in slightly larger increases in the change in future policy benefits in near- term reporting periods.
During 1997, the Company's interest cost ratio increased modestly to 3.7% from 3.3% during 1996 after a decline from the interest cost ratio of 4.7% during 1995. The increase during 1997 was primarily a result of increased borrowings under the Company's revolving credit facility to repurchase common stock, contribute capital to the Company's insurance subsidiaries, acquire certain invested assets by non-insurance subsidiaries and fund certain of the Company's restructuring costs. The Company's overall weighted cost of indebtedness declined to 8.2% during 1997 from 8.8% during 1996. The reduction in the weighted average cost of indebtedness was due to general market conditions as the Company borrowings are primarily floating rate bank debt. The Company anticipates that the ratio of interest costs to total revenues will increase during 1998 as a result of the Company's acquisition of the Controlling Interest in SW Financial on January 2, 1998, on a leveraged basis. During 1996, the Company's interest cost ratio declined to 3.3% from 4.7% during 1995. The decline was primarily the result of the Company utilizing common and preferred stock offerings to finance acquisition activities rather than debt. The weighted average interest cost for outstanding indebtedness dropped to 8.8% for the year ended December 31, 1996, from 9.0% for the year ended December 31, 1995. The reduction in such interest costs was the result of the Company replacing subsidiary indebtedness with borrowings by the Company which carry substantially lower interest rates.
Fixed benefit policy revenues decreased by 0.2%, 3.1% and 1.2% to $169.0 million, $169.3 million and $174.7 million during 1997, 1996 and 1995, respectively. During 1997, 1996 and 1995, the Company's operating focus was
Other income. For purposes of presentation of the summary of the Selected Consolidated Financial Data, "other income" includes equity in earnings of unconsolidated affiliates, income as a result of trading portfolio activity and the income generated by the third party marketing activities of Marketing One. During 1997, 1996 and 1995, income from unconsolidated affiliates aggregated $19.0 million, $21.0 million and $4.7 million, respectively, including $19.0 million, $21.0 million and $910,000 as a result of the Company's economic interest in SW Financial during 1997, 1996 and 1995, respectively. (For additional information on the operating results of SW Financial see Note 6 of Notes to Consolidated Financial Statements). During 1995, the Company included its portion of the operating results of its 49% interest in the limited partnership which owned Integon Life aggregating $3.8 million prior to the Company's consummation of the acquisition of the remaining 51% of Integon Life in July 1995.
During 1997, the Company recognized a gain from the disposition of its Panamanian operation aggregating $4.1 million.
Net Gains/Losses From Sale of Investments. The Company maintains an investment portfolio that focuses on maximizing investment income, without exposure to unwarranted interest rate and credit risk. The Company actively manages asset duration and liquidity risks. As a result of this strategy, the Company routinely sells positions in securities no longer meeting its criteria. Sales of securities during 1997, 1996 and 1995, resulted in the Company realizing gains of $17.5 million, $1.3 million and $3.8 million during 1997, 1996 and 1995, respectively. During 1997, the Company liquidated the vast majority of its equity holdings and private placement bond holdings. In addition, the Company liquidated other securities available for sale in order to meet cash flow demands associated with policyholder surrenders that in the aggregate exceeded policyholder deposits by $275.7 million. During 1995, the Company liquidated its holdings in Conning & Co. which resulted in a realized gain of $3.2 million (see Note 15 of Notes to Consolidated Financial Statements contained elsewhere herein).
Claims Incurred. Claims incurred increased 7.5%, 33.0% and 25.9% during 1997, 1996 and 1995, to $202.8 million, $188.7 million and $141.9 million, respectively. The increase in claims during 1997 resulted from strengthening
of certain claims reserves for PennLife of approximately $6.9 million, additional claims of $4.2 million as the result of the inclusion of the results of United Life for the entire year and modestly higher claims payments for AA Life and Professional as a result of growth in the underlying business, which in the aggregate increased $3.2 million. The increase in claims during 1996 was due to the addition of United Life, $3.3 million, the inclusion of Integon Life for the full year, $35.1 million, and adverse mortality experience at OLIC and Penn Life of $4.2 million and $2.6 million, respectively, when compared to the previously reported period. The Company is continuing to closely monitor the claims activity in each insurance subsidiary. During 1995, the increase in claims incurred attributable to Integon Life and AA Life, was $22.8 million and $10.3 million, respectively.
Other Operating Expenses. Other operating expenses (including general operating, overhead and policy maintenance expenses) increased during 1997 to $128.1 million compared to $90.1 million during 1996 and $80.7 million during 1995. During 1997 the $38.0 million increase in operating expenses was due to: (i) restructuring and period costs associated with the Company's restructuring aggregating $21.4 million, (ii) transaction costs associated with the terminated Washington National merger totaling $7.6 million, (iii) additional expenses aggregating $4.6 million as a result of the inclusion of United Life for the full year period, (iv) certain other non-recurring operating charges aggregating $5.1 million and (vi) increased operating expenses primarily associated with outside contracting costs for the Company's year 2000 compliance initiative which were approximately $1.9 million. The increase in operating expenses during 1996 was primarily a result of the inclusion of Marketing One for the full year period ended December 31, 1996 which increased operating expenses by $10.1 million.
Also included in other operating expense is the amortization of costs in excess of net assets acquired which aggregated $9.5 million, $8.6 million and $6.5 million for 1997, 1996 and 1995, respectively.
Each of the operating divisions is primarily responsible for its remediation efforts with corporate oversight provided as necessary. The Company believes that the Career Division has substantially completed its year 2000 assessment and remediation efforts, which will be subject to ongoing tests for the remainder of 1998. The Payroll Division has completed the remediation of its largest administrative platforms, except for AA Life, and anticipates successful remediation and testing of the remaining sub-system and system interfaces during 1998. AA Life is in the process of upgrading its policy administration system to a year 2000 compliant version. AA Life will rely on contracted vendor resources in working to
complete its upgrade process. The Company's Financial Services Division has only recently begun its year 2000 remediation efforts. Those efforts are dependent on the utilization of outside resources. The Company believes that the Financial Services Division has contracted with sufficient resources to be able to remediate its essential business systems. In addition, the Financial Services Division has committed to a strategy of utilizing third party administrative experts, who have indicated year 2000 compliance, to handle the processing of its health insurance business, thus eliminating the need for the upgrade or modification of certain existing health administration systems.
Although the Company believes that its operating divisions, outside vendors and most critical business partners will be sufficiently compliant that the year 2000 issue should not cause a material disruption in the Company's business, there can be no assurance that there will not be material disruptions to the Company's business or an increase in the cost of the Company doing business. Although the Company believes that the year 2000 issues should not cause a material disruption in the Company's business, the Company is currently evaluating various contingency plans associated with remediation tasks which the Company believes are at a higher risk for potential failure.
Income Taxes. The effective tax rates for the years ended December 31, 1997, 1996 and 1995, were 39.5%, 37.0% and 35.0%, respectively. The 1997 and 1996 effective rates are higher than the statutory rate of 35% primarily due to non- deductible amortization of costs in excess of net assets acquired and foreign taxes in excess of foreign tax credits utilized. The lower effective tax rate for 1995 as compared to 1997 and 1996 is due to previously non-deductible operating losses becoming available to reduce tax on operating earnings.
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
PennCorp Financial Group, Inc. ("PennCorp", or the "Company") is an insurance holding company. Through its wholly-owned life insurance subsidiaries, Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary, Penncorp Life Insurance Company (collectively referred to as "Penn Life"), Peninsular Life Insurance Company ("Peninsular"), Professional Insurance Corporation ("Professional"), Pioneer Security Life Insurance Company ("Pioneer Security") and its wholly-owned subsidiaries American-Amicable Life Insurance Company of Texas and Pioneer American Insurance Company (Pioneer Security and its subsidiaries collectively referred to as "AA Life"), Integon Life Insurance Corporation ("Integon Life"), Occidental Life Insurance Company of North Carolina ("OLIC"), United Life & Annuity Insurance Company ("United Life"), Marketing One, Inc. ("Marketing One"), a third party marketing organization, and Pacific Life and Accident Insurance Company ("PLAIC"), the Company offers a broad range of accident and sickness, life, and accumulation insurance products to individuals through a sales force that is contractually exclusive to certain of the Company's subsidiaries and through general agents.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as revenues and expenses. Accounts that the Company deems to be acutely sensitive to changes in estimates include deferred policy acquisition costs, policy liabilities and accruals, present value of insurance in force and deferred taxes. In addition, the Company must determine the requirements for disclosure of contingent assets and liabilities as of the date of the financial statements based upon estimates. As additional information becomes available, or actual amounts are determinable, the recorded estimates may be revised and reflected in operating results. Although some variability is inherent in these estimates, management believes the amounts provided are adequate. In all instances, actual results could differ from estimates.
As a result of the Company's decision to exit the private placement bond sector, the Company transferred all of its remaining assets in the fixed maturities held for investment portfolio aggregating $49,384 to its fixed maturities available for sale portfolio as of April 1, 1997. In accordance with Statement of Financial Accounting Standards No. 115, the
Costs in excess of the fair value of net assets acquired are amortized on a straight-line basis primarily over 20 years. Accumulated amortization was $44,606 and $35,061 as of December 31, 1997 and 1996, respectively.
decreased real estate and mortgage loan loss valuations of Integon Life by $6.8 million, which resulted in a decrease in costs in excess of net assets acquired of $4.4 million and deferred tax assets of $2.4 million, and (iii) the Company increased certain policy reserves of Integon Life aggregating $10.0 million, which resulted in a corresponding increase to costs in excess of net assets acquired of $10.0 million.
Shares purchased are recorded at cost as a reduction of shareholders' equity.
presentation and disclosure requirements for earnings per share outlined under Accounting Principles Board Opinion ("APB") No. 15, "Earnings Per Share." SFAS No. 128 is effective for both interim and annual financial statements issued after December 15, 1997. The Company adopted SFAS No. 128 to compute earnings per share for all periods presented.
The following is a reconciliation of net income applicable to common stock as well as common stock used to compute basic and diluted earnings per share for the years ended December 31:
The Company adopted the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," in 1996. 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 of the Notes to Consolidated Financial Statements contains a summary of the pro forma effects to reported net income applicable to common stock and earnings per share for 1997 and 1996, 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, 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 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.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was also issued in June 1997 by the FASB. This Statement requires that companies disclose segment data on the basis that is used internally by management for evaluating segment performance and allocating resources to segments. This Statement requires that a company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It also requires various reconciliations of total segment information to amounts in the consolidated financial statements. The Company's current definition of its business segments will not materially change from the current presentation. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
to the reporting of a cumulative effect of a change in accounting principle. The Company is currently evaluating the financial impact, which is expected to be immaterial, as well as the changes to its related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 is effective for fiscal years beginning after December 31, 1997. Earlier application is encouraged. Restatement of disclosures for earlier periods provided for comparative purposes is required. SFAS No. 132 standardizes employers' disclosures about pension and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets to facilitate financial analysis, and eliminates certain irrelevant disclosures. The Company is currently evaluating the necessary changes to its related disclosures.
On July 22, 1996, the Company consummated the acquisition of United Life for a total purchase price of $110,056 including expenses incurred of $9,706 and earnings through the date of consummation of the acquisition of $3,608. The fair value of net assets acquired amounted to $82,580 (as adjusted) resulting in $27,476 (as adjusted) of costs in excess of net assets acquired which will be amortized over 20 years.
The United Life acquisition has been accounted for as a purchase transaction in accordance with generally accepted accounting principles, and accordingly, all assets and liabilities acquired were recorded at fair value as of the acquisition date which became the new accounting basis.
The Integon Life acquisition has been accounted for as a purchase transaction in accordance with generally accepted accounting principles, and accordingly, assets and liabilities acquired have been recorded as a step purchase with fair values determined as of January 20, 1995 and July 25, 1995, which became the new cost basis.
The amortized cost and fair value of investments in fixed maturities held for investment were as follows as of December 31:
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Included in fixed maturities held for investment as of December 31, 1996, are below investment-grade securities with an amortized cost, which approximates fair value, of $34,624.
Included in fixed maturities available for sale as of December 31, 1997 and 1996, are below investment-grade securities with an amortized cost of $165,511 and $91,590 and a fair value of $167,518 and $92,494, respectively. Included in fixed maturities available for sale as of December 31, 1997, are unrated securities with an amortized cost of $26,563 and a fair value of $36,175.
As of December 31, 1997, net unrealized appreciation in equity securities available for sale of $173 consisted of gross unrealized gains of $242, less gross unrealized losses of $69. As of December 31, 1996, net unrealized appreciation in equity securities available for sale of $3,356 consisted of gross unrealized gains of $4,047, less gross unrealized losses of $691.
Fair values for fixed maturity securities were provided by independent pricing services using market quotations, prices provided by market makers, or estimates of fair values obtained from yield data relating to investment securities with similar characteristics. The fair values for equity securities were determined using market quotations from principal public exchange markets.
The Company's commercial and residential mortgage portfolios had carrying values $240,879 and $264,732, respectively, and, fair values of approximately $248,052 and $269,142, respectively, as of December 31, 1997 and 1996. The fair values for mortgage loans on real estate are estimated using the quoted market prices for securities collateralized
Investments with a carrying value of $68,219 and $62,767 were on deposit with certain regulatory authorities as of December 31, 1997 and 1996, respectively.
("Knightsbridge"). PennCorp received fees aggregating $1,100 from Acordia for its underwriting and participation in the subordinated notes and preferred stock offering. Knightsbridge Management, L.L.C. ("KM") received sponsor fees and other fees aggregating $1,714 from Acordia for its role in consummating the Acordia acquisition.
On December 14, 1995, Southwestern Financial Corporation ("SW Financial"), a newly organized corporation formed by the Company and Knightsbridge (see Notes 15 and 16) purchased Southwestern Life Insurance Company, Union Bankers Insurance Company and certain other related assets from I.C.H. Corporation for $260,000.
Through its initial direct investment of $120,000 in SW Financial (the "Southwestern Life Investment"), the Company beneficially owns 74.8% of SW Financial's outstanding common stock, including 100% of SW Financial's non-voting common stock, 14.3% of SW Financial's voting common stock, and 100% of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in Knightsbridge. As a result, the Company has an economic interest in SW Financial aggregating 78.0 percent. Retained earnings of the Company include undistributed earnings of SW Financial aggregating $40,919, $21,947 and $910 as of December 31, 1997, 1996 and 1995, respectively.
On August 5, 1997, the Company purchased $40,000 of SW Financial Subordinated Notes (the "SW Financial Notes") from the liquidating trust for the creditors of ICH Corporation, SW Financial's former parent. SW Financial had issued the SW Financial Notes as part of the acquisition consideration paid to the liquidating trust. The SW Financial Notes were purchased by the Company at par and are included in other investments. Interest due under the SW Financial Notes is currently set at 7.0%, per annum.
On January 2, 1998, the Company acquired the SW Financial Controlling Interest (see Note 19).
The liability for future policy benefits consists of reserves for fixed benefit, life and accumulation 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.
The aggregate maturities of notes payable during each of the five years after December 31, 1997, are as follows: 1998, $617; 1999, $668; 2000, $724; 2001, $951; 2002, $242,149.
All of the Company's debt obligations contain financial and operating covenants. The Company and its subsidiaries were in compliance with or had received waivers from all applicable covenants as of December 31, 1997.
For the year ended December 31, 1996, the Company realized an after-tax extraordinary charge of $2,372. The charge represents (i) the write-off of $816 of deferred financing costs related to the retirement of certain indebtedness of the Company and its subsidiaries, and (ii) the write-off of $1,556 of deferred financing, swap cancellation and other costs related to the repurchase of approximately $35,354 in principal amount of the Senior Subordinated Notes.
The Company and a number of its non-insurance subsidiaries file a consolidated federal income tax return with a July 31 year end, which differs from its financial year end. Marketing One and its subsidiaries file a consolidated federal income tax return with a December 31 year end. The life insurance subsidiaries file federal income tax returns on a calendar year basis with either PLAIC or Pioneer Security as the parent of the particular consolidated life insurance company tax group.
Total income taxes were allocated as follows for the years ended December 31:
The provisions for income tax expense (benefit) attributable to income before income taxes, equity in earnings of unconsolidated affiliates and extraordinary charge are as follows for the years ended December 31:
As of December 31, 1997, the Company has life consolidated net operating loss carryforwards of approximately $99,823 for tax return purposes. In addition, OLIC and Peninsular have available, on a separate return basis, acquired net operating loss carryforwards of approximately $10,417. The utilization of acquired net operating loss carryforwards is limited in any one year to the lesser of (i) the life insurance group's consolidated taxable income or (ii) the subsidiary's taxable income computed on a separate return basis.
In conjunction with the acquisition of AA Life in August 1994, the Company issued 450,000 shares of nonvoting Series A Preferred Stock, $0.01 per share par value and $100 per share redemption value. The Series A Preferred Stock was redeemed on August 25, 1995, from the proceeds received from the issuance of the Convertible Preferred Stock. During 1995, the Company paid or accrued dividends on the Series A Preferred Stock amounting to $1,725.
The Company has established two management stock option plans, the 1992 Stock Option Plan which set aside up to 475,635 shares for grant and the 1996 Stock Option Plan which set aside up to 2,800,000 shares for grant. Options granted under the 1992 Stock Option Plan are deemed to be in four equal units which are earned over four years from the date of grant and are exercisable during a one-year period immediately following the fourth anniversary of the date of grant. The 1996 Stock Option Plan allows for awards of stock or options subject to such terms, conditions, and restrictions, and/or limitations, if any, as the Stock Option Committee of the Board of Directors deems appropriate.
The following table summarizes information concerning outstanding and exercisable options and warrants as of December 31, 1997:
Cash generated by the Company's insurance subsidiaries is made available to PennCorp principally through periodic payments of principal and interest on surplus debentures issued by PLAIC and Pioneer Security (collectively, the "Surplus Note Companies"). The amounts outstanding under the surplus debentures totaled $358,346 and $367,900 as of December 31, 1997 and 1996, respectively. These surplus debentures generally require (subject to availability of statutory capital and surplus and in some instances, regulatory approval) principal and interest payments to be made periodically in amounts sufficient to allow PennCorp to meet its cash requirements.
Statutory capital and surplus of the Company's life insurance subsidiaries as reported to regulatory authorities at December 31, 1997 and 1996, totaled $299,062 and $264,080, respectively. Shareholders' equity of the Company's life insurance subsidiaries included in the consolidated balance sheet totaled $755,365 and $580,334 at December 31, 1997 and 1996, respectively. Statutory net income (loss) of the Company's life insurance subsidiaries as reported to regulatory authorities totaled $18,776, ($28,600) and $13,579 for the years ended December 31, 1997, 1996, and 1995, respectively. Surplus note interest expense of $34,758, $51,254 and $24,170 for the years ended December 31, 1997, 1996, and 1995, respectively, is included in statutory net income (loss).
Postretirement benefits are accrued (but not funded) for eligible retirees only as all plans are closed to future retirees. The plans principally cover certain costs associated with medical insurance coverage.
For the year ended December 31, 1997, the postretirement benefit liability was calculated assuming an annual trend rate in health care inflation ranging from 7% to 8% in 1998 grading down to 5% in 2004 and after. If the health care cost trend rate assumption increased by 1%, the accumulated postretirement benefit obligation as of December 31, 1997, would increase $419 or 3 percent.
During 1995, two of the Company's officers and directors, Messrs. Stone and Fickes, formed a fund, Knightsbridge, for the purpose of making equity and equity linked investments in companies engaged primarily in the life insurance industry. Knightsbridge has received subscriptions for approximately $92,000 in limited partnership interests, including a $15,000 subscription from the Company. The general partner of Knightsbridge is Knightsbridge Capital L.L.C. ("Knightsbridge Capital"), the members of which are David J. Stone and Steven W. Fickes. Allan D. Greenberg, a member of the Company's Board of Directors, formerly owned a 5% interest in Knightsbridge Capital which was purchased by Messrs. Stone and Fickes. The general partner of Knightsbridge cannot be removed by the limited partners, unless a court has finally determined that the general partner has committed a willful and material breach of the limited partnership agreement.
In the second half of 1995, the Company and Knightsbridge determined that a joint venture strategy was in the best interest of both parties. As part of that joint venture, Knightsbridge provides PennCorp with a right of first refusal with respect to all insurance transactions considered by Knightsbridge. The joint venture entity formed for this purpose is KM. PennCorp participates in 45% of the net distributable income of KM.
On December 31, 1997, at the Company's annual shareholders meeting, shareholders approved a restructuring of the Knightsbridge relationship which included the following transactions (see Notes 16 and 19); (i) Messrs. Stone and Fickes entered into five-year employment agreements which include the contingent issuance of options to purchase 559,000 shares of Common Stock to both Messrs. Stone and Fickes, (ii) the acquisition of The Fickes and Stone Knightsbridge Interests, and (iii) the acquisition of The Fickes and Stone Interests in SW Financial, subject to certain contingencies.
As required by the joint venture agreement, all bonuses paid to officers of KM who are also officers of PennCorp must be approved by the Compensation Committee of the Board of Directors of PennCorp. During 1995, the Company paid or accrued for KM incentive bonuses to certain individuals who are officers of PennCorp and KM totaling $2,565. Such bonuses were expensed in the accompanying financial statements.
In August 1995, the Company sold its preferred and common stock position in a company which has historically provided investment management services to the PennCorp insurance subsidiaries and for which a senior executive officer of the investment management firm is a member of the PennCorp Board of Directors. Fees paid for such investment management services amounted to $1,083, $895 and $738 during 1997, 1996 and 1995, respectively.
During 1997, the Company's insurance subsidiaries paid management and commitment fees aggregating $444 to investment funds managed by a member of the Board of Directors.
Certain individuals, who are shareholders and directors of PennCorp, and affiliates of these individuals, provide services to the Company. During 1997, 1996 and 1995, payments aggregating $250, $250 and $210, respectively, were made to these individuals and their affiliates for services provided in connection with the Company's acquisition activity.
At December 31, 1997, an insurance subsidiary entered into a reinsurance agreement with Southwestern Life to coinsure certain annuities which had GAAP policy liabilities of $256,673. Cash of $50,000 and securities were transferred which had fair values equal to statutory policy liabilities of $255,195. No gain or loss was recognized on the transaction.
On December 1, 1997, the defendants and the plaintiffs' counsel agreed in principle to amend the Original Proposed Settlement (as so amended, the "Amended Proposed Settlement") following the PennCorp Board's conclusion that it would be appropriate to increase the amount paid to the Knightsbridge Fund for the SW Financial Controlling Interest to compensate the limited partners for, among other things, the unexpected and substantial delay in the consummation of the purchase of the SW Financial Controlling Interest. The terms of the Amended Proposed Settlement are identical to the terms of the Original Proposed Settlement, except that the Amended Proposed Settlement provides that the Company will acquire the SW Financial Controlling Interest for $73.8 million, and will provide a one-time "price protection" payment associated with a disposition of the SW Financial Controlling Interest by PennCorp during the 12-month period ending November 25, 1998. The Amended Proposed Settlement also requires Messrs. Stone and Fickes to grant PennCorp a price protection right in the event of a sale of their Portsmouth investment.
The Company is a party to various 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.
The Company has a contingent obligation for mortgage loans previously sold aggregating $10,719 as a result of the Company acting as a servicing conduit.
The Company cedes varying amounts of certain accident and sickness policies up to a maximum cession of $800, as well as varying portions of certain disability income policies on a facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Therefore, the Company is contingently liable for recoverable unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely event that assuming reinsurers are unable to meet their obligations. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The effect of reinsurance on policy revenues earned is as follows:
As a result of the Company's initiative to implement an operating division structure, the Company recorded a cumulative pre-tax restructuring charge of $19,071 during the three month period ended March 31, 1997. The restructuring charge recognizes: (a) severance and related benefits incurred due to staff reductions ($5,355), (b) estimated holding costs of vacated facilities ($6,166), (c) the write-off of certain fixed assets and other impaired assets ($1,526), (d) estimated contract termination costs ($24), and (e) the write-off of the Company's investment in certain foreign operations which will be closed ($6,000). As of December 31, 1997 the Company had charged against the accrual $2,411 of severance and related benefits, $1,916 of vacated facilities costs, $332 of fixed asset write-offs and $5,551 associated with the exit of the Company from certain foreign operations. During the three month period ended December 31, 1997, the Company re-evaluated such charge and reduced remaining accruals by $2,300 as a result of final determination of certain obligations.
The Company incurred $4,652 of pre-tax incremental costs associated with the restructuring during 1997. Such costs are included in the Company results of operations as underwriting and other general and administrative costs.
On January 2, 1998, the Company acquired the Controlling Interest in SW Financial for aggregate cash consideration ranging from $73,777 to $77,444 (excluding anticipated acquisition expenses) depending upon the outcome of certain contingencies (see Note 16). As a result of the Company's plans to consolidate certain of its operating locations and corporate functions, the Company expects to incur restructuring and certain other charges during 1998 not to exceed approximately $25.0 million.
On February 18, 1998, the Company announced that it had engaged investment banking firms to review strategic alternatives for maximizing shareholder value, including the sale of the Company's Career Sales Division.
The acquisitions of the SW Financial Controlling Interest and the Fickes and Stone Knightsbridge Interests will be accounted for using the purchase method of accounting. The total purchase price of the acquisitions will be allocated to the tangible and intangible assets and liabilities acquired based upon their respective values as of the respective consummation dates. The allocation of the aggregate purchase price reflected in the selected pro forma financial information is preliminary. The final allocation of the purchase price is upon determination of the fair values of the acquired assets and liabilities; however, that allocation is not expected to differ materially from the preliminary allocation. The Company's decision to dispose of the Career Sales Division in a period of time not likely to exceed one year will result in the assets and liabilities of the Career Sales Division to be considered "assets and liabilities held for sale," and as such will be segregated from those of the retained businesses for purposes of presentation of the Company's financial position. In addition, the Company will be required to provide certain information regarding the impact of the Career Sales Division on the Company's consolidated results. The following unaudited selected pro forma financial information is intended to summarize such transactions. The retained businesses pro forma information reflects the historical results of the retained businesses and does not consider the use of proceeds likely to be derived from the disposition of the businesses held for sale. The significant subsidiaries included in businesses held for sale are PLIC and Union Bankers, a subsidiary of SW Financial.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS as of December 31,1997 and 1996 (In thousands, except share information)
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for the Years Ended December 31, 1997 and 1996 (In thousands)
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 the provision for loan losses, if necessary. Policy loans are recorded at cost. Short-term investments purchased with maturities generally less than three months are recorded at cost, which approximates market. All short-term investments are considered to be cash equivalents.
Liabilities for future policy benefits for traditional life products generally have been computed on the net level premium method, based on estimated future investment yield, mortality, and withdrawals. For accident and health products, liabilities for future policy benefits are established equal to the excess of the present value of future benefits to or on behalf of policyholders over discounted net future premiums. Estimates used are based on the Company's experience adjusted to provide for possible adverse deviation. These estimates are periodically
Accounts and notes receivable consist primarily of agents' balances and premium receivable from agents and policyholders. Agents' balances are partially secured by commissions due to agents in the future and premiums receivable are secured by policy liabilities. An allowance for doubtful accounts is established, based upon specific identification and general provision, for amounts which the Company estimates will not ultimately be collected.
Deferred debt issuance costs, which are included in other assets, represent costs incurred in connection with obtaining long-term debt financing which have been capitalized and are being amortized on an interest yield method over the terms of the respective debt. Deferred costs totaled $2,530 and $3,309 which are net of accumulated amortization of $1,580 and $801 at December 31, 1997 and 1996, respectively.
Costs in excess of the fair value of net assets acquired are amortized on a straight-line basis over 30 years. Accumulated amortization totaled $8,260 and $4,130 at December 31, 1997 and 1996, respectively.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to (i) temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and (ii) operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The amortized cost and fair value of fixed maturities at December 31, 1997, by contractual maturity, are shown below:
Following is an analysis of net gains (losses) from sale of investments for the years ended December 31, 1997 and 1996:
Major categories of net investment income for the years ended December 31, 1997 and 1996 consist of the following:
At December 31, 1997 and 1996 the Company held mortgage loans principally involving commercial real estate with carrying values of $51,070 and $59,993, respectively, net of an allowance for losses of $680 and $1,000 at December 31, 1997 and 1996, respectively. Estimated fair values of mortgage loans totaled $51,816 and $59,993 at December 31, 1997 and 1996, respectively. The average outstanding loan balances were approximately $1,027 and $955 at December 31, 1997 and 1996, respectively. At December 31, 1997 mortgage loan investments were concentrated in the following states:
For traditional life products, the liability for future policy benefits has been computed by the net level premium method based on estimated future investment yield, mortality, and withdrawal experience. Reserve interest assumptions are graded and range from 6.25% to 7.375%. For accident and health products, liabilities for future policy benefits are established equal to the excess of the present value of future benefits to or on behalf of policyholders over future net premiums discounted at interest rates ranging primarily from 6.5% to 8.0%. The future policy benefits of traditional life products and accident and health products are determined using mortality, morbidity and withdrawal assumptions that reflect the experience of the Company modified as necessary to reflect anticipated trends and to include provisions for possible unfavorable deviations. The assumptions vary by plan, year of issue and duration.
While management believes the estimated amounts included in financial statements for policy liabilities and accruals are adequate, such estimates may be more or less than the amounts ultimately paid when the claims are settled. In addition, the Company is involved in certain litigation regarding policyholder benefits. The Company intends to vigorously defend its position relative to these claims; however, if unsuccessful, the level of reserves currently provided could be adversely effected.
The following table presents information on changes in the liability for policy and contract claims for the years ended December 31, 1997 and 1996:
Interest costs under the revolving bank debt totaled $7,860 and $8,128 for the years ended December 31, 1997 and 1996, respectively. The interest rate of the debt is based on, at the Company's option, either a floating rate (based on the base rate of the First National Bank of Chicago) plus a margin of 1.75% or a Eurodollar rate (based on the London Interbank Offered Rate or LIBOR) plus a margin of 2.75%. At December 31, 1997, the effective rate of the revolving loan was approximately 9.13%. The revolving bank debt was repaid on January 2, 1998.
Information related to the present value of insurance in force for the years ended December 31, 1997 and 1996 is as follows:
a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, will likely change to some extent prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements.
Statutory capital and surplus of the Company's life insurance subsidiaries as reported to regulatory authorities at December 31, 1997 and 1996 totaled approximately $174,715 and $177,510, respectively. Statutory net income (loss) of the Company's life insurance subsidiaries as reported to regulatory authorities totaled ($2,521) and $24,919 for the years ended December 31, 1997 and 1996.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Therefore, the Company is contingently liable for recoverable unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely event that assuming reinsurers are unable to meet their obligations. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The effect of reinsurance on policy revenues earned and the related benefits incurred by such reinsurers for the years ended December 31, 1997 and 1996 is as follows:
Southwestern Life previously ceded a block of annuities under a reinsurance agreement with Employees Reassurance Corporation (ERC). Such reinsurance, accounted for as a financing arrangement, is not reflected in the accompanying financial statements except for the risk fees paid to ERC. The reinsurance agreement was terminated as of November 30,
1997.Statutory surplus provided by this treaty totaled $8,714 at December 31, 1996. Risk fees paid to the reinsurer were 2% of the net amount of surplus provided, but not less than a minimum fee of $40 per quarter, and totaled $110 and $222 for the years ended December 31, 1997 and 1996, respectively. Amounts due from reinsurers included amounts due from ERC of $121,016 at December 31, 1996. The underlying assets held by ERC had carrying values of $121,016 and fair values of $122,639 at December 31, 1996.
At December 31, 1997, Southwestern Life entered into a reinsurance agreement with Integon Life Insurance Corporation (Integon), an indirect wholly-owned subsidiary of PennCorp, to coinsure certain annuities which had GAAP policy liabilities of $256,673. Cash of $50,000 and securities were transferred at a cost basis of $198,793 which had fair values equal to statutory policy liabilities of $255,195. The present value of insurance in force which Integon had recorded on these policies was estimated to be $2,291. Because Southwestern Life and Integon are affiliates, the historical GAAP book value of the securities and the present value of insurance in force at Integon was retained by Southwestern Life. Rather than record a loss of $3,634, which is net of taxes of $1,956, on a GAAP basis, Southwestern Life recorded a "deemed dividend" of this amount as a direct charge to its paid in capital. In addition, the change in unrealized investment gain (loss) associated with the transferred securities is recorded as an adjustment to prior unrealized gains.
The Company has a defined contribution retirement plan (Defined Contribution Plan) for all employees who have attained age 21 and completed a year of service. Contributions to the Plan are made pursuant to salary deferral elections by participants in an amount equal to 1% to 15% of their annual compensation. In addition, the Company makes matching contributions in an amount equal to 50% of each participant's salary deferral to a maximum of 3% of annual compensation. The Defined Contribution Plan also provides for a discretionary employer profit sharing contribution, which is determined annually by the Board of Directors for the succeeding plan year. Profit sharing contributions are credited to participant's accounts on the basis of their respective compensation. Salary deferral contribution accounts are at all times fully vested, while matching contribution and profit sharing contribution accounts vest ratably from one to five years of service. All participant accounts are fully vested at death, disability or attainment of age 65. Payment of vested benefits under the Defined Contribution Plan may be elected by a participant in a variety of forms of payment. Expenses related to this plan for the years ended December 31, 1997 and 1996 amounted to $936 and $696, respectively.
The Company provides certain health care and life insurance benefits for retired employees. Employees meeting certain age and length of service requirements become eligible for these benefits. The Company's obligation for accrued postretirement
For measurement purposes, an 5.5% annual rate increase in the health care cost trend rate was assumed for 1998; the rate was assumed to decrease gradually to 4.0% by the year 2015 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement health care benefit obligation as of December 31, 1997 by $767 and the aggregate of the service and interest components of net periodic postretirement health care benefit cost for 1997 by $127. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0%.
Certain lawsuits have been brought against the Company's life insurance subsidiaries in the normal course of the insurance business involving the settlement of various matters and seeking compensatory and in some cases punitive damages. Management believes that the ultimate settlement of all such litigation will not have a materially adverse effect on the Company's consolidated financial position or results of operation.
Mortgage and Collateral Loans: The fair values for mortgage and collateral loans are estimated using discounted cash flow analyses, based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations.